Spotlight on Transfer Pricing

The US Treasury Department (“Treasury”) and the Internal Revenue Service (“IRS”) released the much-anticipated US Country-by-Country (CbC) Reporting rules on December 21, 2015. These proposed rules, issued in the form of proposed regulation §1.6038-4, would require the ultimate US parent of a multi-national enterprise (MNE) group with annual revenues exceeding $850 million to file an annual report containing the following information on a CbC basis:

  • Revenues generated from transactions with members of the MNE group,
  • Revenues generated from transactions outside the MNE group,
  • Profit (or loss) before income tax,
  • Income tax paid (including withholding tax),
  • Accrued tax expense,
  • Capital,
  • Accumulated Earnings,
  • Employees (full time equivalents), and
  • Assets

The Treasury and the IRS have indicated that the rules are intended to be consistent with the OECD/G20 guidelines finalized this October, although they have requested comments related to taxes paid or accrued in the relevant accounting period and any other item that should be further refined or additional guidance is needed.

The effective date will be for tax years beginning on or after the date of publication of final regulations. That would mean no earlier than 2017 for calendar year taxpayers.

Proposed Rule

The Notice of Proposed Rule Making states that, “The Treasury Department and the IRS have determined that the information required under these proposed regulations will assist in better enforcement of the federal income tax laws by providing the IRS with greater transparency regarding the operations and tax positions taken by US MNE groups.” Specifically, the IRS believes that the CbC reports will assist them in performing high-level transfer pricing risk identification and assessment.

The Notice

The Notice states that the proposed regulations were issued pursuant to the Treasury’s existing authority granted under sections 6001, 6011, 6012, 6031, 6038, and 7805. Previously, the Treasury had implied that the issuance of these rules should help protect the confidentiality of the information provided by US MNE groups.  For example, if the US were to delay implementation of the CbC reporting rules, foreign subsidiaries of the US MNE group might still be required to provide CbC reports to local taxing jurisdictions. These CbC reports could be provided to taxing jurisdictions that do not have a treaty with the US that will provide for built-in protection of the confidentiality of taxpayer information.

Even though these rules are not yet effective, US MNE groups need to review immediately their own transfer pricing risk from both a US and a foreign tax perspective and make whatever structural changes are necessary to minimize those risks.

The Chart

The chart below provides an example of how the IRS would use this report to highlight transfer pricing risk. US Co owns 100% of three foreign subsidiaries. The graph below reflects the profit level by number of employees as well as the effective tax rate of the entity. The size of the circle indicates the number of employees. Based on the data provided in the CbC report, the IRS would likely suspect that the transfer pricing methods utilized by US Co inappropriately shift profits to a low-taxed foreign subsidiary and would begin a formal review.

Spotlight on Transfer Pricing

ValueScope is available to assist with everything required in this process, from the initial risk assessment to the development and documentation of new/adjusted transfer prices.

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