Inside this edition: U.S. Multinationals Grappling with Misaligned CbC Reporting Deadlines
U.S. Multinationals Grappling with Misaligned CbC Deadlines
The IRS regulations to implement Country-by-Country (“CbC”) reporting are expected to be finalized by June 30, 2016, making the regulations effective for all tax years beginning after that date. As a result, there will be a gap period between the U.S.’ effective date on CbC reporting (June 30, 2016) and the Organization for Economic Cooperation and Development’s (“OECD”) proposed effective date (January 1, 2016). Given that many foreign jurisdictions have already implemented CbC reporting using the OECD’s recommended effective date, U.S.-based multinationals face the reality that foreign jurisdictions may request their CbC report during the gap period, despite there being no formal requirement to file the U.S.
Under the OECD CbC framework, taxpayers are only required to file their CbC report in the jurisdiction where the Ultimate Parent Entity resides. The CbC report is then subject to automatic sharing (i.e., the exchange of the report among jurisdictions, under various international mechanisms such as the Multilateral Competent Authority Agreement (“MCAA”)). During the 2016 gap period, US-based multinationals may be cautious to hand over their CbC reports directly to foreign jurisdictions, if requested, as this would circumvent the U.S. mechanisms for automatic exchange which requires the careful vetting of foreign tax counterparties.
To deal with this gap period, some taxpayers and practitioners have proposed that U.S.-based multinationals might consider filing their CbC reports early with the IRS. However, IRS and Treasury officials have publicly stated that there are no plans to accommodate early voluntary filings. Another option provided for under the OECD rules is to file the CbC report with a surrogate country that is not the parent company’s home jurisdiction and have that country share the report with other affiliate countries for the first year and then file with the U.S. going forward. Many U.S.-based multinationals are considering filing in jurisdictions such as the UK temporarily until the U.S. is set up to accept CbC reports.
Meanwhile, the European Union (“EU”) released a statement on March 8, 2016 to announce the creation of an automatic exchange of information agreement between EU Member States. The press release states that (emphasis added) “The parent company will provide this information [the CbC report] to the tax authorities of its country of establishment in Europe, where applicable; otherwise, EU-based subsidiaries will be obliged to request that information from their parent company.”
It is difficult to predict how this issue will play out between U.S.-based multinationals and foreign taxing authorities, such as those in the EU. If anything, this gap period illustrates the complexity of implementing international tax reform across multiple jurisdictions.
OECD Publishes Standardized Electronic CbC Template
On March 22, 2016, the OECD published a standardized electronic template for the automatic exchange of CbC reports called the CbC XML Schema (“CbC Schema”). The CbC Schema presents Competent Authorities and tax administrations with an electronic format for coding and standardizing information in the CbC report. To that end, the CbC Schema closely follows the format of previous publications from the OECD on CbC implementation. Those following the CbC developments may note that the CbC XML Schema does require the filing of tax identification numbers for all group entities when available, and strongly recommends filing addresses for all group entities, thus adding to companies’ compliance burden.
It also should be noted that the CbC Schema is designed for the automatic exchange of reports between Competent Authorities. Thus, it is expected that tax authorities will be required to translate CbC reports into the electronic CbC Schema. However, the OECD does mention that “the CbC Schema can also be relied upon by Reporting Entities for transmitting the CbC Report to their tax authorities, provided the use of the CbC XML Schema is mandated domestically.”
To access the press release: click here.
To access the CbC Schema files and user guide: click here.
IRS Releases Several Transfer Pricing Related Practice Units
Throughout the month of March, the IRS released several Practice Units that address various areas of transfer pricing. While they are not official announcements of laws or directives, Practice Units are developed internally by the IRS and are meant to act as both job aids and training materials on international tax issues. They also serve as a resource for the IRS’s field teams when conducting audits. For transfer pricing practitioners and taxpayers, Practice Units can shed valuable light on how the IRS views certain transfer pricing issues. The following sections summarize the Practice Units released during March.
Review of Transfer Pricing Documentation by Outbound Taxpayers
Released on March 4, 2016, this Practice Unit gives guidance on how to best review taxpayer transfer pricing documentation (“TPD”) associated with outbound transactions (i.e. tangible goods, intangibles, or services leaving the US). The Practice Unit provides a useful review of the US transfer pricing documentation requirements as outlined by IRC 6662(e). While TPD is not a requirement in the US, TPD done in good-faith can shield taxpayers from penalties imposed on transfer pricing adjustments. The Practice Unit describes ‘good-faith TPD requirements’ as “(T)he taxpayer must maintain and provide the IRS with documentation sufficient to establish that the taxpayer reasonably concluded that the chosen pricing method was the best method and its application provided the most reliable measure of an arm's-length result, given the available data.”
The Practice Unit also provides practical advice to IRS staff that should not be ignored by taxpayers and practitioners. Specifically, the Practice Unit advises that the first step upon receipt of the TPD is to “map Forms 5471, 8858, and 8865 to the TPD.” In practice, the economic analyses presented in a taxpayer’s TPD may often reflect the transfer pricing policies in place rather than the actual year end transfer pricing results. For example, while the TPD may illustrate the case for why a taxpayer’s foreign distributor should earn a fixed level of profit, based on an economic analysis of comparable distributors, the taxing authorities will need to be able to map the economic analysis results from the TPD directly to information reported in tax filings (e.g., Forms 5471, 8858, and 8865). In order to avoid any misunderstandings at the onset of a transfer pricing audit, taxpayers would be well served to perform a reconciliation exercise annually to ensure the economic analysis from their TPD can be directly linked to information on their tax returns. If necessary, taxpayers should consider adding an explanatory addendum to bridge any potential discrepancies.
Outbound Services by US Companies to CFCs
Released on March 4, 2016, this Practice Unit covers one of the most common intercompany transactions for US-based multinationals: the provision of services by US companies to their Controlled Foreign Corporations (“CFCs”). The Practice Unit provides a helpful summary of the Service Regulations under Treas. Reg. 1.482-9, including how the regulations should be applied in practice. This Practice Unit presents an analogous framework to the Practice Unit released last month which covered the analysis of intercompany loans under the Situs Rule. Specifically, the Practice Unit on intercompany loans describes how for any analysis to be done on the arm’s length nature of an intercompany interest rate, it must first be established that the loan itself is classified as bona fide debt. In following a similar framework, the Practice Unit on outbound services states that before any analysis of the arm’s length charge can be analyzed, it must first be established that i) an intercompany service was provided and ii) the recipient received a benefit. This Practice Unit on outbound services serves as a reminder that an analysis of the underlying substance of a services transaction is the first and most important step in any services analysis.
Residual Profit Split Method - Outbound
Released March 7, 2016, this Practice Unit covers the use of the residual profit split method (“RPSM”) for outbound transactions. The Practice Unit makes clear that the RPSM is only applicable when both controlled taxpayers make significant non-routine contributions to the intercompany transaction and if the identification of a market return for those non-routine contributions is not possible. Application of the RPSM consists of two primary steps: 1) compensating any routine contributions made; and 2) allocating the residual profits amongst the participants. In practice, the latter step is the most difficult and contentious.
There are two ways for residual profits to be split under the RPSM: 1) market observations can be used to determine how parties operating at arm’s length and engaged in a comparable division of non-routine functions split their operating profit; or 2) internal data from the taxpayer can be used to estimate the non-routine contributions made by each respective participant (e.g., development costs incurred). The Practice Unit points out what transfer pricing practitioners have long since recognized; in practice, the RPSM generally relies on internal data to allocate residual profit amongst the participants because observations between two arm’s length parties to support a market-based approach are generally unavailable. However, the Practice Unit does make mention, without naming specifics, that in some industries market-based observations of profit splits can be more easily observed. In summary, taxpayers that apply the RPSM should be able to prove that each party makes significant non-routine contributions and that pricing those contributions is not possible with the data available under any other method.
Further information on the IRS’s International Practice Units can be found on their website here.
Canada Releases 2016 Budget
On March 22, 2016 Canada’s Liberal government released the 2016 budget. Noteworthy items for corporate taxpayers and transfer pricing practitioners include the following proposals:
Legislation to implement CbC reporting;
Legislation to implement the automatic exchange of CbC reports under the Common Reporting Standard developed by the OECD;
Legislation to narrow interpretation of the cross-border anti-surplus-stripping rule in order to reduce tax-free cross-border distributions of capital;
A $444.4 million five year investment for the Canada Revenue Agency (“CRA”) to hire additional staff to combat tax evasion and tax avoidance; and
A $351.6 million five year investment to enhance CRA’s ability to collect outstanding tax debts.
Budget Day in the UK
March 16, 2016 marked the UK’s Budget Day where the Chancellor of the Exchequer detailed to Parliament, among other things, measures on this year’s Finance Bill. Included in the measures were major changes to the UK’s business tax system. Key areas affecting transfer pricing in the UK include:
Wholesale adoption of BEPS Action Items, including those on hybrids, interest deductibility, harmful tax practices, and treaty abuse;
Restrictions on carried forward loss utilizations;
Adoption of the OECD’s revised, post-BEPS Transfer Pricing Guidelines into UK legislation; and
Gradual reduction of the corporation tax rate to 17% by April 1, 2020 (currently 20%).
A full summary is available from Duff & Phelps' Compliance and Regulatory Consulting Practice here.