OECD Unveils Plans to Overhaul Global Corporate Tax Reporting

Developed nations are taking aim at the long-standing practice by many multinational companies of parking profits overseas where they are subject to more favorable tax treatment.

Indeed, a complex web of new international tax laws and compliance obligations that the United States and countries in Europe and elsewhere are considering could make it harder for companies to pursue such a strategy.

The Organization for Economic Cooperation and Development issued its first series of recommendations this month as part of an ambitious global effort by G20 nations to improve consistency and transparency among tax authorities around the world in an effort to make it more difficult for multinational companies to shift profits to low-tax jurisdictions. The joint plan, called the Base Erosion and Profit Shifting action plan which the OECD developed last year at the request of the G20, has since garnered the support of all 34 OECD member countries.

The first set of seven—out of fifteen total—recommendations issued on Sept. 16 include plans to eliminate the use of so-called “hybrid mismatch arrangements,” which are complex financing structures that enable companies to double-deduct payments by taking advantage of different tax rules; establish arduous country-by-country reporting requirements; and prevent treaty abuse, which the OECD defines as inefficiencies in tax treaties that trigger double non-taxation in a number of inappropriate circumstances.

“Our recommendations constitute the building blocks for an internationally agreed-upon and coordinated response to corporate tax planning strategies that exploit the gaps and loopholes of the current system,” OECD Secretary General Angel Gurría said in a statement.

The OECD will present the remaining eight recommendations to the G-20 for final approval by the end of 2015. From there, each country that has signed on to the agreement will interpret the measures and enact them into local law.

Many accounting and legal experts agree that adoption by OECD member countries is likely. “In principle, one would expect them all to implement the recommendations,” Dan Neidle, a partner in the London office of law firm Clifford Chance, says.

That doesn’t mean it will happen quickly. Before the United States can adopt the BEPS action plan, for example, “you need IRS and Treasury to work together on regulations,” Robert Stack, deputy assistant secretary for international tax affairs at the Treasury Department, said during a recent Webcast, sponsored by KPMG. Some have speculated on a Jan. 1, 2016, deadline, Stack added, but that “sounds quick to me.”

“With the new master file standard, tax authorities would, for the first time, have visibility into a company’s total global supply chain structure across its entire operation, not just in one region.”
Brian Tully, Head of ONESOURCE Transfer Pricing, Thomson Reuters

Still, global support of the OECD’s initial guidance is what gives it serious teeth. “The [BEPS recommendations], if adopted by key OECD member countries and observers as expected, will have a significant impact on U.S. multinationals with overseas operations, whether or not the United States makes changes in regulations or practices as a result of the recommendations,” said Manal Corwin, national leader of international tax at KPMG and former deputy assistant secretary for tax policy for international tax affairs at the Treasury Department.

From a practical standpoint, companies will not only face new compliance obligations, but may also have to make changes to their current operating structures. “Companies clearly need to focus on the details of the report on the 2014 deliverables and carefully track how countries in which they operate are reacting and planning for change,” Corwin added.

The potential administrative and cost burdens are nothing to take lightly either. “Although the OECD does not technically have any governing authority, the widespread adoption of its proposals would usher in an era of unprecedented change in regional tax laws, as countries worldwide set about harmonizing to the new guidelines,” Brian Tully, head of Onesource transfer pricing at Thomson Reuters, says.

The new recommendations, once adopted, could also lead to more tax audits. “Once some of these changes start to take effect, governments around the world are going to be reviewing data that they’ve never had to review before,” Tully adds. “This will result in an increase in audit activity on a global scale.”

Reporting Obligations

The push behind the BEPS action plan started from the realization that tax authorities around the world don’t have enough information to perform audits. “The OECD believes that tax authorities need a lot of information about where profits are located geographically, what the supply chain looks like, and that this [information] is critical to do their own risk assessments and audits,” Clark Chandler, principal, economic and valuation services at KPMG, said.

MULTINATIONAL ENTERPRISES

According to OECD, the following information should be included in the master file:
Organizational structure: A chart illustrating the multinational enterprise (MNE)’s legal and ownership structure and geographical location of operating entities.
General written description of the MNE’s business(es) including:
Important drivers of business profit;
A description of the supply chain for the group’s five largest products and/or service offerings by turnover plus any other  products and/or services amounting to more than 5 percent of  group turnover. The required description could take the form of a chart or a diagram;
A list and brief description of important service  arrangements between members of the MNE group, other  than research and development (R&D) services, including a  description of the capabilities of the principal locations  providing important services and transfer pricing policies for  allocating services costs and determining prices to be paid  for intra-group services;
A description of the main geographic markets for the group’s products and services that are referred to in the second bullet point above;
A brief written functional analysis describing the principal  contributions to value creation by individual entities within  the group, i.e. key functions performed, important risk assumed, and important assets used;
A description of important business restructuring transactions, acquisitions and divestitures occurring during  the fiscal year.
MNE’s intangibles (as defined in Chapter VI of the guidelines)
A general description of the MNE’s overall strategy for the development, ownership and exploitation of intangibles, including location of principal R&D facilities and location of R&D management.
A list of intangibles or groups of intangibles of the MNE group that are important for transfer pricing purposes and which entities legally own them.
A list of important agreements among identified associated enterprises related to intangibles, including cost contribution  arrangements, principal research  service agreements and license agreements.
A general description of the group’s transfer pricing policies related to R&D and intangibles.
A general description of any important transfers of interests in intangibles among associated enterprises during the fiscal year concerned, including the entities, countries, and compensation involved.
MNE’s intercompany financial activities
A general description of how the group is financed, including important financing arrangements with unrelated lenders.
The identification of any members of the MNE group that provide a central financing function for the group, including the country under whose laws the entity is organized and the place of effective management of such entities.
A general description of the MNE's general transfer pricing policies related to financing arrangements between associated enterprises.
MNE’s financial and tax positions
The MNE’s annual consolidated financial statement for the fiscal year concerned if otherwise prepared for financial reporting, regulatory, internal management, tax or other purposes.
A list and brief description of the MNE group’s existing unilateral advance pricing agreements (APAs) and other tax rulings relating to the allocation of income among countries.
Source: OECD.

Of particular concern to tax authorities around the world are transfer-pricing arrangements, in which companies redistribute profits by charging for goods or services sold by one subsidiary to another, typically located in different countries. To address this concern, the BEPS action plan provides for a three-tiered approach to transfer-pricing documentation and reporting, which will effectively create several new compliance challenges for multinational companies.

This new three-tiered documentation approach will involve:

Country-by-country reports. The most controversial recommendation is the newly established country-by-country reporting requirements, which would call on multinational companies to collect and report annually essential financial data for each country in which it operates. Companies must report, for example, profit before income tax and income tax paid and accrued, total employment, capital, retained earnings, and tangible assets in each tax jurisdiction. Companies must also identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in.

If that all sounds cumbersome, that’s because it is; the biggest concern for many companies is the compliance costs associated with preparing the required information. Such a reporting requirement will introduce an “unprecedented amount of detailed data reporting to global tax authorities,” Tully says. “Companies have never had to collect, let alone report, this kind of data, and countries have never had to enforce it.”

Master file reports. Additionally, companies would be required to provide to all relevant tax authorities high-level information regarding their global business operations and transfer pricing policies in a standardized master file. “With the new master file standard, tax authorities would, for the first time, have visibility into a company’s total global supply chain structure across its entire operation, not just in one region,” Tully explains.  

Local file reports. Companies also would be required to provide transactional transfer pricing documentation in a “local file” in each country, which is intended to supplement the master file. The local file calls for more detailed information relevant to the transfer pricing analysis related to the transactions taking place between a local country affiliate and associated companies in different countries, and which are “material in the context of the local country’s tax system,” OECD stated.

This documentation must include, for example, relevant financial information regarding related-party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions, according to the OECD.

How the master file and country-by-country reports will be filed and shared with relevant tax authorities, however, remains to be addressed. A letter to the U.S. Treasury by the Business Roundtable, an association of chief executive officers with $7.4 trillion in annual revenues, recommended the use of treaty arrangements to maintain confidentiality of proprietary operating information to competitors, which remains one of the biggest concerns posed by the BEPS action plan.  

The Business Roundtable letter also called on the need for improvements in dispute resolution mechanisms. “Better dispute resolution mechanisms are not a panacea, however,” the letter stated. “The best dispute resolution is clear rules that prevent disputes from occurring.”

More to Come

The OECD’s action plan, while it sets out to address the unique tax challenges posed by the digital economy, stops short of adopting specific recommendations. “Because the digital economy is increasingly becoming the economy itself, it would not be feasible to ring-fence the digital economy from the rest of the economy for tax purposes,” the OECD stated, noting the need for further work in 2015.

Some of the more pressing unresolved issues are how the recommendations will be implemented, by what countries, when, and how consistent the various implementations will be. Never has there been any attempt to coordinate tax legislation across multiple jurisdictions in this way, “and the process is, therefore, inevitably going to be slow and subject to inconsistencies and quirks between different jurisdictions,” Neidle says.

“It’s certainly premature for companies to start putting measures in place now to deal with all these issues, particularly given the uncertainties around who will implement what, and how long it will take,” Neidle says. Still, companies should start looking at their existing arrangements that might be affected by the proposals, “so they are in a position to move as quickly as possible once the likely results of BEPS implementation become clearer,” he says. 

Many companies over the last couple of months already have started to change the way they think about their tax structures.  “A number of discussions have been within the lens of country-by-country reporting,” Brett Weaver, KPMG’s partner of international tax, said. They realize that they’re going to have to do a lot of work in a relatively short period of time, he said, if they’re going to be a position to address changes that are, at this point, pretty certain.