With the G20 Leaders’ endorsement of the Organisation for Economic Co-operation and Development’s (OECD) 13 final reports under its Action Plan on Base Erosion and Profit Shifting in November 2015, it’s now up to individual countries to update their tax treaties and translate the proposals into their domestic law. Some jurisdictions, like the United Kingdom and the European Union, have jumped ahead and already introduced BEPS proposals, while the timing and degree of take-up of the proposals by other countries remains to be seen.
With the world’s international tax regimes in flux and tax authorities under pressure to increase collections, the potential for tax disputes is rising and expected to swell into an avalanche of controversy in the years to come. Transfer prices are at the core of many OECD BEPS Action Plan items, and so it seems a spike in the number of disputes in this area is inevitable.
To examine the latest BEPS developments related to transfer pricing and how companies can manage their implications, Sharon Katz-Pearlman hosted a recent webcast with Steven Wrappe and François Vincent, Principals with KPMG’s Global Transfer Pricing Services leaders in the United States, Angela Wood, Asia Pacific Leader of KPMG’s Global Tax Dispute Resolution and Controversy Services (GDTRC), and Peter Steeds, Associate Partner and Special Adviser on Transfer Pricing Policy with the GDTRC group of KPMG in the UK.
As a package, the OECD’s 15 Action Plan items aim to modernize international tax regimes and curb BEPS through coordinated rules based on coherence, transparency and substance. While only a third of the Action Plan items address transfer prices directly, many other items overlap, with implications for the taxation of intercompany cross-border transactions as well.
Improved transparency is central to the re-examination of transfer pricing documentation under Action 13. The OECD’s related proposals are designed to give tax authorities the information they need to perform proper risk assessments and conduct audits while encouraging companies to take a comprehensive approach to the global transfer pricing policies. To these ends, the OECD’s proposals under Action 13 would require companies to prepare three levels of detailed transfer pricing documentation:
1. Master file, which provides an overview of the company’s global operations and its various functions
2. Local file, which is similar to current OECD-endorsed contemporaneous documentation and sets out the considerations and rationale for transfer prices set by group companies within a particular country
3. Country-by-country (CbyC) report, which provides a global view of the company’s activities and profits in each country in which the company operates
CbyC reporting is expected to fuel potential disputes, as tax authorities gain a much broader view of companies’ global tax positions so they can ensure equivalent parts of the organization (e.g., procurement) are attributed equivalent profits in each jurisdiction. Tax inspectors will have access to detailed data by country on revenues, tax payments, capital, earnings and – more controversially – number of employees and tangible assets other than cash and cash equivalents. CbyC reports will highlight special function entities that may earn substantial profits without a substantial number of employees. These final two factors could become significant sources of controversy if tax authorities decide to give them added weight when determining where profits should be allocated for tax purposes.
Multinational companies would be required to file CbyC reports if their consolidated group revenue in the preceding fiscal year was 750 million Euros or more. The first set of reports is required for fiscal years starting on or after 1 January 2016, and they are due within one year of the fiscal year-end. As a result, companies with calendar year-ends only have until the end of 2015 to adjust structures and operations that might draw attention when the CbyC reports are examined.
The ultimate parent company is required to file the report. If the CbyC report is not required by parent’s country of residence, the company can appoint a surrogate parent entity. Six months after the first filing deadline – or mid-2018 for the first set of calendar-year filers – tax authorities will automatically share the reports with other tax authorities. (In later years, this sharing will occur within 3 months of the filing deadline, i.e., 15 months after the company’s year-end.) Given this timeframe, we can expect to see audit activity arising from CbyC reports commencing in the last half of 2018.
Companies can prepare to manage the implications of CbyC reporting by conducting a readiness check and risk assessment for each of the three levels of disclosure and by determining your company’s documentation strategy and approach for CbyC reporting. Next steps will involve designing and implementing processes to produce the required documentation.
In addition to addressing transfer pricing documentation under Action 13, Actions 8, 9 and 10 of the OECD’s BEPS plan deal explicitly with transfer pricing. These items aim to ensure transfer pricing outcomes align with value creation as it relates to transactions involving intangibles, the contractual allocation of risks, and other high-risk transactions such as management fees. As noted, other Action Plan items also have an impact on transfer pricing. These include:
On Actions 8, 9 and 10, the OECD has proposed substantive changes to its existing transfer pricing guidelines. One area of change involves the delineation of actual transactions. Analysis of functions, risks and assets as set out in written contracts remain the starting point for this exercise, but now the OECD says actual conduct should be weighed to support or contradict the contract. Additionally, the OECD now specifies that synergistic benefits should be allocated on a pro-rata basis. Cash-box entities area entitled to no more than a risk-free return if the only function they provide is financing.
The analysis of risk is given more importance under the new guidelines. The contractual allocation of risk will be more in focus. Weight will be given to the entity’s ability to take on risk, its ability to make and act on decisions in response to risk, and its ability to take steps to mitigate risk.
Other substantive changes to the OECD’s transfer pricing guidelines are made in these areas:
Among the OECD-endorsed transfer pricing methods, use of the comparable uncontrolled price (CUP) and profit split methods likely would be optimal for pricing intangibles. However, the difficulty of identifying the comparables needed to apply CUP will create pressure to move to one of the alternatives. The OECD plans to launch a new discussion draft and consultation on transactional profit split methods in May 2016.
Finally, ‘options realistically available’ (ORA) will play an even bigger role in transfer pricing analyses than before. Under this concept, independent enterprises would consider all ORAs and be presumed to choose to enter a particular transaction if no other option is more attractive. Because ORAs are treated separately from recharacterization, this change will make it more difficult to resolve a number of transfer pricing issues.
Some areas where the BEPS changes are expected to open more occasion for dispute involve:
Ways for avoiding and mitigating disputes in these areas are set out in the following sections.
The sweeping international tax changes proposed by the OECD are occurring in an environment that is already rife with tax dispute potential. Since 2008, governments and their tax authorities have been acting under rising media and public pressure to ensure corporations pay an appropriate amount of tax in all their jurisdictions of operation. Politicians are conducting public inquiries into the tax affairs on global companies. Some governments have moved rapidly to adopt BEPS proposals in advance of – and out of synch with – the OECD’s final proposals. Revenue authorities are increasing their cooperation, and cross-border information-sharing will expand even more as CbyC reporting and automatic tax information exchange take hold.
The OECD’s Action Plan acknowledges the need for effective ways to resolve international tax disputes as part of the BEPS package. The goal of Action 14 is to improve the effectiveness of mutual agreement procedures (MAP) in the timely resolution of treaty-based disputes between countries.
The OECD proposes to achieve this goal by setting minimum standards for MAP processes and procedures, by making it easier for taxpayers to enter MAP, and by ensuring adequacy of resources and clear, consistent approaches through periodic peer reviews by members of the OECD’s Forum of Tax Administrations (FTA). The FTA will facilitate and lead tax administrations in a collective approach to bilateral dispute resolution that highlights transparency, acting in good faith, and information sharing.
A number of best practices are endorsed, including advance pricing agreement programs and suspension of the collection of disputed taxes. Procedures for publishing MAP agreements could give taxpayers valuable guidance on how they can avoid potential disputes in the future, although the requirement to publish these results will vary by country.
Taxpayers also stand to benefit from a change that will see both countries involved in a dispute from the initial application stage, rather than just the taxpayer’s country of residence. This will ensure both countries’ viewpoints are considered when weighing a MAP application’s merits.
The OECD BEPS proposals call for mandatory binding arbitration in cases where MAP disputes come to a stalemate. Binding arbitration can bring quicker resolutions, but many countries are unwilling to give up sovereignty over taxing matters by putting ultimate authority for breaking MAP disputes in an arbiter’s hands. Further, it could be difficult to identify arbiters who are perceived as having sufficient expertise and independence –qualities that are critical for an arbitration’s success. Taxpayers may be excluded from the arbitration process entirely, eliminating their ability to influence outcomes.
While the OECD plan acknowledges and aims to mitigate disputes, inconsistent adoption and subjective interpretation could thwart the objectives of the Action 14 recommendations. It also remains to be seen how the MAP changes will interact with domestic dispute resolution processes and whether taxpayers may be subject to parallel but inconsistent regimes.
The high potential for tax disputes makes it critical to have documentation on hand that appropriately and comprehensively documents the substance of transactions in terms of what the parties involved agreed and how the agreement is implemented in practice. Facts and evidence to support your position can include not only legal and corporate documents but also documentation of price negotiations, channel profits, staff recollections, correspondence and advice. This evidence should be contemporaneous, and it should be objectively assessed to determine what inferences could be drawn and whether it needs to be supplemented with expert opinion. Finally, the evidence should be evaluated against any domestic transfer pricing laws that may be relevant.
In summary, the top 5 ways of avoiding transfer pricing disputes and influencing the outcomes of any disputes that arise are:
1. Objectively assess dealings at time they are entered into and evaluate any perceived tax risks that may arise
2. Track information available in each jurisdiction – know what might be shared between revenue authorities
3. Assess relationships with revenue authorities – proactively engage and identify points of influence
4. Review internal resourcing with an eye to ensure adequate resources to manage global tax controversy in-house
5. Adopt technological solutions to track and monitor tax disputes globally.
As the former Head of Transfer Pricing for HM Revenue & Customs (HMRC), Peter Steeds has been deeply involved in the OECD’s BEPS work since the project began. Among other things, Peter served as the UK’s delegate on Working Party 6 of the OECD’s Committee on Fiscal Affairs, and, as the UK competent authority, he was one of the first members of the FTA MAP forum.
Peter says that, for the OECD, developing a coordinated set of international tax rules to address BEPS is only part of the task. Given the extensive changes being made to the world’s tax regimes and high potential for cross-border disputes, businesses were promised first-class dispute resolution mechanisms so they were not saddled with heightened controversy or double taxation, which could hamper business and impede economic growth.
Now the deliverable on dispute resolution under Action 14 is complete, Working Party 6 has handed the task of overseeing its implementation to the FTA. The FTA brings together the tax officials responsible for administering MAP programs. The FTA’s Strategic Plan, released in 2014, sets out its multilateral strategy for continuous MAP improvement. This group has been charged with delivering globally coordinated MAP processes by the end of 2016.
For the enhanced MAP processes to succeed, the FTA’s peer review program will be the key to ensuring countries live up to their obligations. Currently, a number of countries are failing to commit sufficient resources and falling short of meeting these obligations. Countries also need to move quickly to change their domestic rules and practices to enable universal access to MAP. Businesses can play an important role by keeping pressure on their governments to devote resources and act quickly to effect change.
Tax authorities’ mindsets will also have to change in order to foster a more collaborative approach to resolving disputes through MAP. While this will take time, there are already signs of improving relationships among tax authorities. For example, since India’s new government was elected in 2014, its tax authority has displayed a more cooperative spirit, introducing measures such as interquartile ranges and APA rollbacks that ease the potential for cross-border tax disputes. As a result, relationships between India’s tax authority and their counterparts in the US and European countries have noticeably improved.
Meanwhile, developments affecting tax dispute resolution are moving quickly in Europe and the UK:
High-profile developments like these are causing European companies to move quickly to develop a strategic approach to their transfer pricing compliance management. In the US, however, companies have been insulated from these developments and are more concerned about readying their systems and processes for the extensive new transfer pricing disclosures.
With the first set of new transfer pricing reports covering 2016 fiscal years, you won’t want to wait to take action in this regard. Preparing a company-wide standardized response to anticipated inquiries is highly recommended. This response can help demonstrate preparedness to support and debate any issue that tax authorities are likely to look into.
Companies can also benefit from developing a benchmark APA for systemic issues. This involves preparing a bilateral APA between two ‘leading countries’ to address transactions representative of other transactions within the related group. The taxpayer then attempts to use information developed and outcome reached to discourage unreasonable positions taken by other countries on similar transactions.
For example, taxpayer could negotiate a bilateral US-Japan APA on distribution return. Despite geographic differences, that APA may have relevance with regard to related party distributor returns in other countries regarding sales of the same product.
At minimum, steps to consider taking now include:
Two years from now, most local legislation will have been amended, and taxpayers will be in the midst of dealing with many new rules and requirements. As a result, we anticipate a dramatic increase in the number of tax disputes in which double tax is in issue, and the Mutual Agreement Process will likely be overburdened by the weight of double tax cases in jurisdictions where mandatory MAP arbitration is not in place.
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