Category: Transfer Pricing

OECD Aligning Transfer Pricing

In December of 2015, the US issued proposed regulations related to the implementation of OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, Action 8-10 – Aligning Transfer Pricing Outcomes with Value Creation. (Have we lost you yet?) These proposed regulations would require US Multi-National Enterprises (MNEs) with annual revenues of $850 million (Now have you checked out?) to report, on a country by country (CbC) basis, detailed information on its business activities, revenues, profits, taxes, capital, assets, and employees.

Reporting will be required in the year following the year the regulations are finalized. Meaning, not this fiscal year, but next, at the earliest. (By now, surely you have stopped reading.) Finally, the US tax authorities have indicated that they will not require companies to comply with BEPS Master File and Local File reporting as they believe existing tax forms (Form 1120 Schedule UTP, Form 5471 Schedule M, and Form 5472) already collect the same information. (Done, Checked out, Why are you bothering me?)

But wait. Are small and mid-size US MNEs in the clear? The answer, unfortunately is no. While it is true that US MNEs will not be subject to CbC reporting even after the regulations are finalized due to the $850 million trhreshold, and it is true that the US tax authorities have no plans to require Master File and Local File reporting, small and mid-size US MNE may still have a significant compliance burden beginning in the 2016 tax year.

The Master File

The Master File is a document that provides a blueprint of the entire MNE with specific detailed information on the following 5 categories:

1. Organizational structure
2. Business description including profit drivers, supply chains, intercompany services agreements, and a functional analysis of all value creation activities
3. Intangible assets owned including the MNE overall strategy for R&D and a general description of the transfer pricing policies related to those intangibles and R&D activities
4. Intercompany financing activity
5. Financial and tax positions including a list of any advance pricing agreements (APA)

The Master File is to be prepared by the parent of the MNE and filed with the parent’s home country tax authority. OECD and non OECD countries alike are currently implanting Master File and Local File reporting requirements, most with a consolidated revenue threshold of euro 50 million.

OK, so the first bit of good news is that most US MNEs will not have a Master File filing responsibility.

Now for the bad news. The Local File is a document that provides detailed information to the taxing authority in the local entity’s tax jurisdiction. This information includes:

1. A detailed description of the business and business strategy of the local entity
2. Transfer Pricing documentation of all material controlled transactions including a description of the controlled transactions, copies of all intercompany agreements, best (or most appropriate) method selection, selection of comparable transactions, and a list of any APAs

Local Files

Local Files can be required by the local taxing jurisdiction regardless of whether a Master File is required of or prepared by the parent of MNE. The same threshold of MNE consolidated revenue of euro 50 million applies to the Local File. To date, a number of countries have adopted Master File and Local file requirements for the 2016 tax year. One such country is the Netherlands. Dutch penalties for failure to file the Local File include a fine of euro 8,100 (unintentional) and euro 20,250 (intentional). However, Dutch penalties also include criminal penalties of up to 6 months in prison (unintentional) and up to 4 years (intentional). Other countries that have adopted CbC, Master File and Local File reporting requirements include France, Italy, Japan, and Mexico among others.

US MNEs should immediately determine if they have a requirement to file a Local File for one or more of their foreign operations. If a filing requirement is identified, the US MNE should ensure that its transfer pricing documentation is sufficient to comply with those filing requirements.

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CbC Not For Me? Think Again. OECD Aligning Transfer Pricing

In December of 2015, the US issued proposed regulations related to the implementation of OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, Action 8-10 – Aligning Transfer Pricing Outcomes with Value Creation. (Have we lost you yet?) These proposed regulations would require US Multi-National Enterprises (MNEs) with annual revenues of $850 million (Now have you checked out?) to report, on a country by country (CbC) basis, detailed information on its business activities, revenues, profits, taxes, capital, assets, and employees. Reporting will be required in the year following the year the regulations are finalized.

Meaning, not this fiscal year, but next, at the earliest. (By now, surely you have stopped reading.) Finally, the US tax authorities have indicated that they will not require companies to comply with BEPS Master File and Local File reporting as they believe existing tax forms (Form 1120 Schedule UTP, Form 5471 Schedule M, and Form 5472) already collect the same information. (Done, Checked out, Why are you bothering me?)

But Wait!

But wait. Are small and mid-size US MNEs in the clear? The answer, unfortunately is no. While it is true that US MNEs will not be subject to CbC reporting even after the regulations are finalized due to the $850 million trhreshold, and it is true that the US tax authorities have no plans to require Master File and Local File reporting, small and mid-size US MNE may still have a significant compliance burden beginning in the 2016 tax year.

The Master File is a document that provides a blueprint of the entire MNE with specific detailed information on the following 5 categories:

1. Organizational structure
2. Business description including profit drivers, supply chains, intercompany services agreements, and a functional analysis of all value creation activities
3. Intangible assets owned including the MNE overall strategy for R&D and a general description of the transfer pricing policies related to those intangibles and R&D activities
4. Intercompany financing activity
5. Financial and tax positions including a list of any advance pricing agreements (APA)

Master File

The Master File is to be prepared by the parent of the MNE and filed with the parent’s home country tax authority. OECD and non OECD countries alike are currently implanting Master File and Local File reporting requirements, most with a consolidated revenue threshold of euro 50 million.

OK, so the first bit of good news is that most US MNEs will not have a Master File filing responsibility.

Now for the bad news. The Local File is a document that provides detailed information to the taxing authority in the local entity’s tax jurisdiction. This information includes:

1. A detailed description of the business and business strategy of the local entity
2. Transfer Pricing documentation of all material controlled transactions including a description of the controlled transactions, copies of all intercompany agreements, best (or most appropriate) method selection, selection of comparable transactions, and a list of any APAs

Local File

Local Files can be required by the local taxing jurisdiction regardless of whether a Master File is required of or prepared by the parent of MNE. The same threshold of MNE consolidated revenue of euro 50 million applies to the Local File. To date, a number of countries have adopted Master File and Local file requirements for the 2016 tax year. One such country is the Netherlands. Dutch penalties for failure to file the Local File include a fine of euro 8,100 (unintentional) and euro 20,250 (intentional). However, Dutch penalties also include criminal penalties of up to 6 months in prison (unintentional) and up to 4 years (intentional). Other countries that have adopted CbC, Master File and Local File reporting requirements include France, Italy, Japan, and Mexico among others.

US MNEs should immediately determine if they have a requirement to file a Local File for one or more of their foreign operations. If a filing requirement is identified, the US MNE should ensure that its transfer pricing documentation is sufficient to comply with those filing requirements.

 

US multi-nationals have long enjoyed the simplicity and tax certainty afforded by Cost Sharing Arrangements (CSA). In a CSA, participants share in the development of valuable intangibles in exchange for the right to exploit the resulting intangible. The cost of the development activity is allocated to the participants based on each participant’s expected benefit. (To the extent that a participant contributes a resource, capability or right that was developed outside of the CSA, that resource, capability or right must be valued at arm’s length. Each participant is then allocated their share of that arm’s length value.)

October 2015 saw the release of the Final Report OECD/G20 Base Erosion and Profit Shifting Project. There were few surprises in the Final Report. Much of the content had been previously released in discussion drafts and had been commented on by interested parties. However, certain comments within the report on Actions 8-10 Aligning Transfer Pricing Outcomes with Value Creation may surprise taxpayers and service providers.

In Action 8, the OECD Transfer Pricing guidelines were modified to include the following language regarding Cost Contribution Arrangements (CCA, the OECD equivalent of the CSA):

“For development CCAs, the measurement of current contributions at cost will generally not provide a reliable basis for the application of the arm’s length principle.”

Rather, the value of the current contributions must be determined under the arm’s length principles. This change from cost to value represents a significant shift and should cause all multi-nationals currently in or contemplating CCAs or CSAs to reevaluate the costs and benefits.

US Tax Law versus OECD Guidelines

To the extent that the US multi-national has entered into a CSA with an entity with a tax home in a country that has adopted the OECD Transfer Pricing guidelines, a conflict will arise with respect to the allocation of development costs. The OECD country tax authority will potentially look to value the contributions of each participant at some amount greater than cost.

Impact on Simplicity

Capturing the costs of development activities incurred within a CCA or CSA is generally a straightforward exercise. To the extent that each contribution now must be evaluated under the arm’s length principle, multi-nationals will now need to perform an economic analysis of each contribution, thus eliminating one of the major advantages of the CCA or CSA.

Tax Certainty

When allocating the CCA or CSA development cost and the method for calculating contributions made to development activities is based on cost, the only variable that exists is the anticipated benefits of each participant.   However, if each contribution must be valued, a plethora of new variables (and hence, uncertainty) are created. At the extreme, the value placed upon the contribution of one participant could be so great that it renders the CSA or CCA worthless. That is to say, the allocation of development cost would equate to the arm’s length royalty that would be charged in the event of a successful development effort.

Conclusion

All multi-nationals should evaluate the consequences of valuing contributions to CSAs and CCAs at an amount in excess of cost.

 

 

Apple Eurozone Tax 348 million

If there was any doubt regarding the changing international tax landscape, Apple became among the first of what is sure to be many multi-national enterprises to enter into a multi-million dollar tax settlement related to its European operations.  Italy’s La Republicca announced last week that Apple has agreed to pay the Italian tax authority 318 million euro (US $348 million) to settle a tax controversy related to its 2008-2013 tax years.  The settlement relates to payments made from Apple’s “high tax” Italian subsidiary to its “low tax” Irish subsidiary.  Click here for the original story in La Republicca and here for the English report in Reuters.  As part of the settlement, it was reported that Apple will enter into an advance agreement with the Italian tax authorities for future years.

The Details

While details of the underlying issues were not disclosed, transfer pricing likely played an important role in negotiations.  It was reported that Apple recorded more than 1 billion euro in revenue in Italy, but only paid 30 million euro in Italian tax.  Payments made from the Italian operating subsidiary to Apple’s Irish headquarters company shifted the majority of the profit from high-taxed Italy to low-taxed Ireland.  Apparently Italy was successful in challenging whether those payments were at “arm’s length.”

The Beginning

And this is just the beginning.  Countries have barely begun implementing new rules consistent with the October Base Erosion and Profit Shifting  (“BEPS”) Project released by the OECD.  The rules will increase the transparency of related company profit shifting payments.  Once fully implemented, tax authorities in the paying and receiving countries will receive a clear, simply road map to these transactions.  This road map will allow them to quickly and easily analyze related company profit shifting payments and determine if a further investigation, audit or assessment is warranted.

Multi-national enterprises must act now to get in front of these fresh challenges.

ValueScope is uniquely positioned to assist companies with everything from an initial risk assessment to the development and documentation of new/adjusted transfer prices.