Editor: Alex J. Brosseau, CPA
Country-by-country (CbC) reporting provisions have now been in force in some jurisdictions for as long as four years. In many of these jurisdictions, CbC legislation has increased the amount of information available to tax authorities, which in theory has enabled them to perform better high-level assessments of transfer-pricing risk. At the same time, CbC reporting requirements have imposed new compliance burdens on large multinationals (MNEs) that are subject to the provisions (entities with cross-border transactions and annual revenues in excess of €750 million ($850 million for U.S. multinationals)).
After four years, the question arises: has CbC reporting become a relatively routine compliance matter, or do MNEs still face substantial challenges and pitfalls in this area? As the Organisation for Economic Co-operation and Development (OECD) member states plan to perform a comprehensive review of the CbC framework in 2020, this discussion highlights several common issues large U.S. MNEs may face.
Issue 1: Deviation from BEPS Action Item 13 framework
One goal of OECD base erosion and profit shifting (BEPS) Action Item 13 was to standardize the information provided to tax authorities in order to limit the incremental costs and burdens imposed by the new regime. To that end, the OECD also published model CbC legislation intended to maximize uniformity of CbC provisions, to the extent consistent with the laws of individual countries.
The CbC reporting implementation process did not turn out entirely as expected. There are deviations in the specific items of information that tax authorities require in the CbC notification forms (these are forms that tell the local tax authority which entity will file the MNE's CbC report), but the larger issue for U.S. multinationals is deviation from the model legislation when it comes to local filing rules.
Under the OECD's model legislation, local filing requirements come into play if the United States and the other jurisdiction do not have a competent authority agreement (CAA) in place and if there is an international agreement that forms the legal basis for automatic exchange of information between the two jurisdictions (that is, a bilateral income tax treaty or a tax information exchange agreement (TIEA) providing for automatic exchange of tax information). However, some jurisdictions have enacted legislation that requires local filing of CbC reports, even though the country does not have an international agreement with the United States. Imposing filing requirements under these circumstances is inconsistent with the consensus reached during BEPS Action Item 13 negotiations.
U.S. MNEs may face a difficult choice in those jurisdictions. One option is simply to decline to file in the local country, although that approach may result in monetary penalties or other consequences. While a filing according to local rules may avoid noncompliance penalties, the information provided is not subject to the protections of a competent authority agreement, nor has the IRS vetted the jurisdiction for CbC information confidentiality, data safeguards, and appropriate use. Privately owned MNEs, which do not publicly disclose financial data, may have particular concerns regarding disclosure of information under these conditions.
Another alternative is to use a surrogate parent entity (SPE). SPE filing is made in a third-country jurisdiction that does have an active CbC exchange relationship with the local country and is willing to act as an SPE for a U.S. MNE. SPE filings pose several potential issues, however. For example, the SPE filing must comply with the procedural rules in the surrogate jurisdiction, and those rules may differ from the rules in the United States. Also, the SPE filing in effect results in a second round of CbC data exchange, in addition to the exchange originating from the United States (the jurisdiction of the actual ultimate parent entity). As a result, when SPE filing is done, the local jurisdictions may receive two separate sets of CbC data for the same entity. These sets of data may be in different formats and may follow different reporting rules. Overall, this could create confusion on the part of tax administrations. SPE filing thus has the potential to draw attention to a taxpayer, when in fact the taxpayer took extra steps to meet its CbC reporting obligations.
Issue 2: Dealing with the December rush
In the past several years, some tax authorities have been slow to release guidance clarifying the scope of the local filing obligation or to finalize agreements (for example, a CAA) that, if in place, would negate any such filing requirement. A few examples of late-issued guidance are provided below:
- The United States signed a spontaneous exchange agreement (as opposed to an automatic exchange agreement) with Germany and France on Dec. 13, 2017 (local filing would otherwise have been due on Dec. 31, 2017);
- India's local filing deadline was extended on Dec. 26, 2018 (filing would otherwise have been due on Dec. 31, 2018);
- The Bulgarian tax authority notified taxpayers in late December 2018 that they might not need to submit a local CbC report for 2017 because the CAA was expected to be signed in early 2019; and
- Argentina clarified in mid-November 2018 that 2017 local filing was not required for a U.S. MNE's subsidiaries (filing would otherwise have been due on Dec. 31, 2018).
The net result is that it may be unclear whether a U.S. MNE must file in a particular local country until a few weeks or even days before the filing deadline. By that time, however, most MNEs will have prepared the CbC report, so resources are in effect wasted if the filing obligation is withdrawn at the 11th hour. To minimize such inefficiencies, it is hoped that tax authorities will redouble efforts to further clarify local filing obligations in advance of the calendar year-end filing deadlines.
Issue 3: When do errors in CbC reporting require amendments?
Given that CbC reporting is relatively new, U.S. MNEs have little guidance concerning the types of errors and/or omissions that constitute failure to furnish information, necessitating an amended return. Errors or omissions range in materiality from incorrectly reporting the residence of an entity with significant sales and profits to omitting a dormant entity (that is, an entity with zero sales, profits, or assets) in a Schedule A. BEPS Action Item 13 was intended to permit tax authorities to gather information from large MNEs for use in high-level transfer-pricing and BEPS risk assessments. Here, the term "high level" may be instructive.
With this language in mind, some taxpayers have chosen to amend a previously filed CbC report only if they conclude that the error(s) or omission(s) would materially impair the usefulness of the data for purposes of high-level transfer-pricing and BEPS risk assessments. Note that this is not the same standard that would apply under the U.S. regulations to evaluate whether a U.S. information return (such as IRS Form 8975, Country-by-Country Report) contains erroneous or incomplete data.
Issue 4: US regulatory guidance unclear or absent
Situations have arisen where the U.S. CbC regulations do not clearly address a specific point or conflict with other more general guidance provided by the OECD. The final regulations in Regs. Sec. 1.6038-4 and the instructions for CbC reporting (Form 8975) address some of the most common issues, such as how to calculate the annual revenue threshold and how to compile and report detailed information for constituent entities in specific jurisdictions. It would be unrealistic to expect the regulations to cover every issue that U.S. MNEs will face across a wide range of industries and specific fact patterns. Common areas of uncertainty, however, include the impact of acquisitions and dispositions; treatment of "short" years for financial and tax reporting purposes; name changes; and curtailment of business operations. As a practical matter, U.S. MNEs must look for guidance in Regs. Sec. 1.6038-4 and the preamble to those regulations, the instructions to Form 8975, and other resources, including OECD guidance.
The OECD has continued to expand its own CbC guidance by addressing common errors and recurring fact patterns. As of December 2019, that guidance imposes some requirements that do not have parallels in Regs. Sec. 1.6038-4. The OECD guidance, although useful, does not have the force of law and does not protect the taxpayer from penalties that may apply to erroneous or incomplete filing under Regs. Sec. 1.6038-4. U.S. MNEs and their advisers are looking forward to when, this year, the United States and other OECD members will perform a comprehensive review of the CbC regime. Hopefully, that review may lead to additional guidance concerning areas of recurring uncertainty or controversy regarding CbC reporting obligations.
Issue 5: How reliable is the data?
Ultimately, the key question is whether CbC reporting provides tax authorities information they need to perform high-level identification of transfer-pricing risks. If the goal is to identify legal structures or transactional patterns that give rise to potential transfer-pricing abuse, it is not apparent that the data currently being collected is suited to the task in all cases. A few examples of false positives (and false negatives) under the current CbC rules include the following:
- Operating partnerships are classified by default as "stateless" entities that pay zero tax, even if their owners face large tax bills in one or more high-tax jurisdictions on the profits distributed by the partnership.
- Profit before tax (PBT), rather than operating profit, is used as a measure of profit. While this can be useful in identifying base erosion by means of intercompany interest charges, it also takes into account legitimate (arm's-length) interest payments to uncontrolled parties, as well as large one-time costs or income items that generally are irrelevant to transfer pricing.
- Transfer-pricing adjustments made to tax accounts but not book accounts are not reflected, assuming that the MNE uses headquarters-country generally accepted accounting principles as opposed to local country statutory accounts. Because taxpayers have the freedom to select which source of data to use (statutory or tax accounts), this increases the likelihood that the amount of PBT in the CbC report may be very different from the amount seen by the local tax authority in the entity's tax return.
Further, some tax authorities indicate that they plan to automate the first phase of audit-risk analysis by using algorithms to identify taxpayers with high potential risks in their CbC data. Having too many false positives defeats the purpose of using automation and also results in inefficient application of audit resources. False negatives make it difficult to identify the subset of MNEs that may be engaged in BEPS activities. Ideally, tax authorities will find ways to integrate analysis of CbC data with other tax return data sources (e.g., IRSForm 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, in the United States) to improve the reliability of algorithm-based risk assessments.
Transforming the transfer-pricing compliance model
This discussion identifies several concerns with respect to uniformity, certainty, and clarity, and the overall reliability of the data provided in CbC reports. Some of these issues may be considered and resolved during the upcoming OECD review to be performed this year. Looking beyond 2020, however, CbC reporting seems likely to transform the way tax authorities conduct transfer-pricing audits, as they build out new analytical capabilities that will allow them to select taxpayers for audit and to identify specific issues for examination. It appears that in the coming years CbC reporting will continue to be an important aspect of international tax compliance for large U.S. MNEs with cross-border operations.
Alex J. Brosseau, CPA, is a senior manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax office.
For additional information about these items, contact Mr. Brosseau at 202-661-4532 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.
This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.