This content is from: Transfer Pricing

New trends in transfer pricing documentation

Oliver Wehnert and Ivo Tankov discuss the OECD White Paper on transfer pricing documentation

Globalisation has led to a significant increase in international intra-group trade and consequently to a heightened awareness, as well as scrutiny, of multinational (MNE) transfer pricing policies.

In July this year the OECD published its Action Plan on Base Erosion and Profit Shifting (BEPS), which contained specific provisions on developing rules, which would enhance overall tax transparency through the further improvement of transfer pricing documentation rules.

Action number 13 specifically requires that MNEs provide all relevant governments with complete information of their global allocation of income and consequently the taxes paid on a country by country basis.

As a follow-up to the BEPS Action Plan, the OECD published its White Paper on Transfer Pricing Documentation on July 30, 2013. The White Paper is essentially a document aimed at analysing the transfer pricing documentation approach, focusing on the purposes and objectives of such documentation and finally making suggestions as to how transfer pricing documentation rules may be improved to offer increased transparency for the tax authorities while also allowing for lower compliance costs on the taxpayer side.

Documentation policies and differences in approach

It is important to note that because most transfer pricing documentation regulations are grounded in local tax law it is often quite burdensome for MNEs to be fully compliant in all tax jurisdictions in which they operate. Furthermore, the tax authorities also find it increasingly difficult to obtain financial information that would give them the appropriate level of tax data for their tax enforcement needs.

A local overview

The OECD, through its Working Party 6 of the Committee of Fiscal Affairs (WP 6) has conducted an internal review of the local documentation requirements of several countries. This review of local country documentation regimes has allowed the OECD to better understand some of the tax reporting issues across the different tax jurisdictions.

There is an increasing number of countries worldwide who have transfer pricing documentation regulations. It is also quite often the case that the individual local country transfer pricing regulations focus on the intercompany transactions primarily from a domestic perspective while the MNEs have a more global approach to their transfer pricing policies. In addition to the above transfer pricing documentation regulations, countries differ significantly, shifting the compliance burden on to the taxpayer.

The one-sided analysis frequently applied across jurisdictions limits the respective countries’ view of the counterparty to the transaction thereby limiting their understanding of the global MNE business. In addition to this limited view, local tax authorities have partial or no insight into the overall legal and transfer pricing standing of the taxpayer – for instance many transfer pricing documentation regulations do not require the taxpayer to provide any information regarding their APA or MAP proceedings, which may have a significant impact on their overall transfer pricing policies and more importantly their general tax positions.

There are significant differences across countries in terms of what is required to fulfill local transfer pricing documentation requirements. In addition the rationale behind the requested information also differs – for example some countries will ask for general information, to obtain an overall view of the transfer pricing policies implemented. In other cases local tax authorities may ask for detailed information that could be used during a transfer pricing audit. Finally there are also significant differences in terms of the actual timing of submission of a transfer pricing documentation. In some jurisdictions the transfer pricing documentation is required with the submission of the annual corporate tax return and in other cases the transfer pricing documentation is only requested during a tax audit.

The international perspective on transfer pricing documentations

The OECD White Paper points out significant differences in transfer pricing documentation requirements when analysed from a local tax authority perspective. The documentation guidance provided by international bodies tends to be slightly more consistent as we discuss below.

Chapter 5 of the 1995 OECD guidelines, though without very detailed guidance, can be noted as the first attempt at formalising uniform transfer pricing documentation requirements. The guidelines allowed for the outlining of useful transfer pricing information both from the perspective of the taxpayers as well as from the perspective of the local tax authorities. Nevertheless the 1995 OECD guidelines did leave significant room for the local tax authorities to define useful financial and tax information as they see fit.

In 2006 the Council of the European Union came to an agreement with regard to the approach to transfer pricing documentations to be taken by member states. The methodology relied on two elements: a masterfile that would have general information about the transfer pricing policy and a specific country file which would focus on the individual countries in which the MNEs operate in. The introduction of these standardised transfer pricing documentation regulations was not entirely successful as evidenced by a 2009 OECD survey where a significant amount of the MNE taxpayers chose to implement only parts of of the European Union transfer pricing documentation methodology.

Similarly the 2003 Pacific Association of Tax Administrators Tax Package as well as the International Chamber of Commerce Proposal did not develop into a uniform transfer pricing documentation approach that would be voluntarily followed by a majority of the corporate taxpayers.

It is relatively apparent that the differences in local transfer pricing documentation regulations as well as the inability for the international business community to fully adapt and utilise some of the initiatives set forth from 1995 to 2006 reflects the notion that there is a need for the overall improvement of the transfer pricing documentation regulations.

Rationale behind transfer pricing documentations

The OECD White Paper focuses on the following three reasons for which governments require transfer pricing documentations:

1. Transfer pricing documentations are meant to provide the tax authorities with the information necessary to conduct an appropriate transfer pricing risk assessment.

2. Documentations are also necessary to ensure that the taxpayers themselves have given the necessary consideration to intercompany transactions and that they have reported the income derived from such transactions.

3. To provide the tax authorities with the necessary information for them to be able to conduct a thorough tax audit.

Risk assessment is one of the most important activities carried out by local tax authorities. In order for the respective local fiscal authorities to be able to effectively estimate tax risk, access to sufficient information is necessary. The means by which this information is obtained often differs from country to country. One way of obtaining the information is through a transfer pricing form, which is filed along with the annual corporate tax return. These forms usually contain information about the intercompany transactional volume, entities involved and method selected. Another means of extracting necessary tax information is through a transfer pricing questionnaire. These types of documents are usually submitted to the taxpayer upon an ad-hoc review of their annual tax return. Finally, local transfer pricing documentation regulations as well as a cooperative approach with the tax authorities further allows the government to enhance its evaluation of the potential tax risk.

Transfer pricing documentations also force the taxpayers themselves to give significant consideration to their transfer pricing policies on an ex-ante basis. By doing so the taxpayer is put in a position where he or she needs to consider their transfer pricing policies before executing them. Furthermore, the documentations introduce a compliance culture that further allows the taxpayer to engage with the tax authorities in a pre-emptive conversation versus an ex-post battle. It is also important to note however, that the current transfer pricing regulations utilise penalties to enforce timely preparation of the respective transfer pricing documentations. The OECD White Paper argues that for this reason the current transfer pricing documentations are often presented in a template format with only certain parts being altered to fit the particular case at hand. The OECD further argues that this approach can be detrimental to the overall understanding of the MNE transfer pricing policies whereby significant details are omitted primarily for the purpose of meeting compliance deadlines without delay.

A third reason as to why transfer pricing documentations are important, especially with respect to their content, is tax audits. It is also important to note that having a documentation prepared in a preemptive manner gives the taxpayer a certain advantage in the discussions with the respective tax authorities. In addition the documentation requirement allows the taxpayer to organise all the information necessary should the authorities decide to pose questions or extend the audit proceedings. Furthermore as MNEs operate across several jurisdictions the documentation itself preemptively forces them to collect all the necessary information before the local authorities request it. Consequently, the local tax authorities have a legal means for requesting full taxpayer information without the need for additional discussions between governments. Finally a significant point in the context of the tax audit proceedings is the burden of proof. Transfer pricing documentation requirements may be impacted depending on which party to the audit, the government or the taxpayer, ultimately carries the burden of proof.

It is important to note that governments need access to information for the respective tax authorities to be able to conduct the necessary risk assessment. Furthermore it is also very important for the taxpayer to take care of their transfer pricing policies preemptively to avoid any unnecessary retroactive disputes with the authorities. Despite the notion that the compliance process should not be burdensome on the taxpayer the OECD argues that ultimately the transfer pricing documentation approach should not inhibit the government’s access to information.

A step-by-step coordinated approach to transfer pricing documentation

At this stage we have analysed the local and international perceptions on transfer pricing documentations as well as the rationale behind the need for this reporting system from the perspective of the OECD White Paper. In this section of our examination we would like to focus on the recommended future approach to transfer pricing documentations as presented by the OECD White Paper but would also like to introduce some potential comments to the proposed methodology.

Recommended OECD transfer pricing documentation approach

The OECD White Paper approaches the topic of the future transfer pricing documentations through the following three points:

· What information would be required for a transfer pricing risk assessment?

· What would the structure of a global documentation package be?

· How should the transfer pricing documentation be prepared?

The OECD White Paper introduces nine specific features indicating the presence of significant tax risk:

· Significant transactions with, and income allocated to, related parties in low tax jurisdictions;

· Transfers of intangibles to related parties;

· Business restructurings;

· The existence of specific types of related party payments that have the potential to erode the tax base, including payments of interest, insurance premiums and royalties;

· Year on year loss making;

· Poor or non-existent documentation of related party transactions and their results;

· Excessive debt.

As a follow-up to the afore mentioned risk areas the OECD White Paper further suggests that the following types of information should be available in the respective transfer pricing documentations:

· Identification of material cross border transactions between associated enterprises, including material payments for goods, services, intangibles, and interest flows.

· Identification of recent business restructuring transactions and transfers of intangibles.

· Information regarding the levels of corporate debt and interest expense in relevant countries.

· Information regarding the MNE’s global transfer pricing policies and the financial results of applying those transfer pricing policies. It would particularly include a description of where in the group important intangibles are held. It would also include the identification of the MNE Group’s existing APA and ruling arrangements related to income allocation with various countries.

· The taxpayer’s explanation of how its material transfer pricing arrangements comply with the arm’s-length principle and local transfer pricing rules.

As we can infer, the OECD White Paper, focuses heavily on the ability of the tax authorities to have a broader perspective of the intercompany transactions taking place within MNEs. In the context of the BEPS discussions the only way that a tax authority would be able to trace whether an MNE is engaging in a profit shifting action would be to have a wider view of that MNE’s transfer pricing policies through the list of key transfer pricing documentation inputs shown above.

Furthermore the OECD suggests that MNEs are capable of delivering information regarding their local income allocation. Often times the income allocation, without a detailed functional and risk analysis, may be sufficient to uncover profit shifting policies applied by the taxpayer.

The OECD White Paper also focuses on the structure of the global documentation package in the context of tax compliance as well as the monitoring of any tax avoidance attempts by MNEs. With this respects the OECD seems to favour the 2006 EU approach to documenting intercompany transactions through the use of a masterfile and local country file transfer pricing documentations.

The approach described in the White Paper goes slightly further than what was proposed by the EU in 2006 and further requests that information regarding recent business restructurings and transfer of intangibles also be included in the masterfile. Furthermore individual transfer pricing analyses would not be included in the document as those would be shifted to the local documentations. The local files would contain more detailed analysis of the individual transactions taking place including but not limited to the transfer pricing method applied.

The actual mechanics applied to the preparation of the transfer pricing documentation are also described in the White Paper. The OECD focuses on how these mechanics may be streamlined to lower the compliance cost of MNEs:

· Certification of documentation by an outside auditor – the OECD states that a certification of the transfer pricing documentation by outside auditors or consultants may be excessive and lead to an unnecessary burden on the taxpayer.

· Mandatory use of consulting firms to prepare documentation – in this case the OECD suggests that personnel employed by the MNEs should also be able to prepare the transfer pricing documentations in jurisdictions where this is currently not allowed.

· Use of local or regional comparables – in this case the OECD strongly argues that the use of regional comparables, where local comparables are available, in order to minimise compliance costs should not take place. The quality and availability of the comparables should be prioritised over the cost of compliance.

· Translation of documents – translation of the global masterfiles should be requested in advance and in the beginning of a tax audit to minimise the taxpayer burden involved in translating large documents.

· Materiality standards – to have an effective approach towards the transfer pricing documentation compliance burden, materiality standards should be established based on the size of the economy in which the MNE operates in as well as the size of its entities operating in the local economy.

To improve the current transfer pricing documentation methodology the OECD suggest that there is a need for a coordinated approach. The preferred approach by the OECD follows a two-tier methodology using a masterfile and a local file.

The transfer pricing documentation should be in line with the following three principles: provide an efficient amount of information to perform a risk assessment analysis, provide a platform for which information for an audit may be gathered and it should provide the taxpayers with a means to consider their current transfer pricing policies.

The OECD specifically states that the masterfile should illustrate the following five information categories:

· Information on the MNE group;

· Description of the MNE’s business or businesses;

· Information on the MNE’s intangibles;

· Information on the MNE’s intercompany financial activities;

· Information on the MNE’s financial and tax positions.

In line with the masterfile, the local file, would supplement the information stated above with a comparability analysis, financial information regarding the specific transactions as well as an evaluation of the most appropriate transfer pricing method.

The OECD White Paper concludes with the following open points:

· Timing of transfer pricing documentation submission;

· Decision regarding application of materiality standards;

· Incentives for transfer pricing documentation compliance;

· Means by which to introduce greater transfer pricing documentation uniformity across the different jurisdictions.


Brief comments to OECD transfer pricing documentation approach

After having discussed the contents of the OECD White Paper we would like to now focus on several key aspects as well as offer some comments on the overall documentation approach.

We begin by focusing on the masterfile approach as discussed in the OECD White Paper. The overall intention of the masterfile should be to ensure that there is a single format for each respective MNE to ensure consistent information which can later be used for documentation purposes across all of the legal entities. Secondly the masterfile approach will allow for providing the necessary high level information requested by the tax authorities for an initial tax risk assessment. Ultimately it is imperative that the balance between the necessary reporting information and the compliance burden is achieved.

Paragraph 72 of the OECD White Paper also discusses the notion of a country by country reporting system which is in line with action point number 13 of the BEPS Action Plan. It is expected that the OECD will develop a reporting template however it is not entirely clear at this stage if the reporting template will be part of the masterfile. It is also very important that this reporting template does not break any confidentiality policies in place. For this reason it would seem reasonable that the OECD consults the business community on how much information is typically available on a local entity level and what types of information may be considered confidential for business competition purposes.

The disclosure of APAs and tax rulings in Paragraph 70 may be seen as slightly too invasive. Providing this type of information to local tax authorities may hinder the desire for MNEs to conclude APAs in the first place if for instance this information would be used by foreign tax authorities to force unfavourable tax positions upon the MNE in other countries. In addition it is also important to note that the additional financial data that may be requested for the country by country reporting template should not be used to alter the overall means by which the transfer pricing method selection and analyses is conducted.

With regard to the local file comments presented in the OECD White Paper it is imperative that the principles of balanced information and taxpayer transfer pricing sustenance are followed. Furthermore it is reasonable, for taxpayers who have prepared a transfer pricing documentation, not to be subject to additional penalties in case transfer pricing adjustments are made by the authorities.

In terms of the burden of proof it may be recommended that this burden be shifted to the tax authorities especially in cases where the taxpayer has prepared the necessary transfer pricing documentation. Furthermore materiality thresholds as well as the corresponding transfer pricing risk should be the documented by the taxpayer – for instance in the case of low value transactions the taxpayers should be in the position to perform their own risk assessment. For this assessment to be possible however corresponding guidance from the OECD should be made available.

In terms of the comparability analyses it is reasonable for the OECD to request local comparables where these are available, nevertheless, the use of non-local comparables should remain an option from a pure compliance perspective without local authorities automatically demanding local comparables.

On the issue of timing of the preparation of transfer pricing documentations it would be reasonable to follow the taxpayers approach and not alter or seek out new information after the transfer pricing documentation has been prepared on an ex-ante basis. Similarly it may also seem reasonable that documentations are always provided upon request without the need for such a documentation to be provided on annual basis along with the corporate tax return. Consequently if the taxpayer has indicated that no material changes have taken place from one financial year to the next he or she should not be obligated to re-run comparability analyses.

At this stage it may be assumed that additional guidance from the OECD on the transfer pricing documentation approach will be necessary to ensure a higher degree of uniformity across different jurisdictions. It may also be highly beneficial to invite non OECD member countries for an in depth discussion of their transfer pricing documentation approach in order to ensure that the final documentation guidelines include various positions thereby making it easier to implement them worldwide.

Unnecessary burden

In the context of an increasingly globalised world where intra-group transactions are on the rise the topic of a uniform transfer pricing documentation becomes quite important.

In light of the ongoing country by country reporting and transfer pricing documentation discussion led by WP 6 it may be expected that the OECD will issue additional, more detailed, guidance on its overall transfer pricing reporting stance. Nevertheless it is important to keep in mind that all of the policies illustrated in the OECD White Paper may not necessarily come to fruition if they apply an unnecessary burden on the taxpayer or put the taxpayer in an unfavorable position across its operational jurisdictions. In order for us to avoid a selective compliance approach by the MNEs it is of utmost importance that the feedback from the international business community is taken under serious consideration by the OECD so that progress with respect to the transfer pricing documentation approach may indeed be made.

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