The Organization for Economic Cooperation and Development (OECD) recently released 15 action-plans to address the issue of “Base Erosion & Profit Shifting” or BEPS, which has led to misalignment between where taxes are paid and where value is actually created.
In this column, we will discuss Action Plan 13, which has introduced new transfer-pricing documentation requirements with a view to create more transparency on value drivers and where is value being created.
Under the new requirements, multinational enterprises (MNEs) will need to maintain three-layered transfer-pricing documentation—a master file, a local file, and a country by country reporting (CbCR) template.
The master file will give an overview of the group, including the key transfer-pricing policies employed. The local file will provide more granular information about arm’s length pricing of intra-group transactions carried out by each legal entity. MNEs will have to align their existing transfer-pricing documentation with the master file—which will be available to tax authorities in all jurisdictions where the group is present; and the local file—which will be available to respective tax authorities in jurisdiction where each entity is present.
The CbCR template will contain key financial information about each group entity, including its revenues, profits, taxes paid, information on capital and assets, etc. Importantly, it will also provide crucial non-financial information such as nature of activity performed by each group entity, number of employees, country of tax residence, etc. The headquarter entity of the group will be required to file CbCR with the authorities in its country of tax residence.
These authorities will then share it through information sharing mechanisms with those in the other countries, where the group and its entities operate, and will assist them in undertaking audit risk assessments. The OECD is currently working on the technology required to ensure seamless sharing of this information across countries.
The OECD has recommended that the CbCR be mandated only for MNEs having consolidated annual turnover of more than 750 million euros (approximately, $825 million or R5,300 crore), and most countries are expected to align with this mandate.
The new requirements are expected to raise transparency and consistency at MNEs at the global level. Key financial and non-financial indicators required to assess MNEs will be available to tax authorities worldwide in a standard format. Existence of group entities engaged in businesses, which do not require significant people functions, and which earn very high profits, could trigger strict scrutiny by the tax authorities. Examples include group finance companies and IP holding companies.
Globally, these new requirements are to be adopted starting tax year 2016. In fact, some countries (including the UK, China, Mexico, Denmark and the Netherlands) have already announced proposals to adopt these requirements.
In India, these requirements may be adopted in the Budget FY17 and applicable soon afterwards. Key finance ministry officials have announced their intent to implement these as soon as practicable.
India-based MNEs that have made outbound investments will need to file information about all subsidiaries across the world with the Indian tax authorities, as a part of the return of income or through separate transfer-pricing filings. Subsidiaries of foreign MNEs will need to provide the requisite information to their global headquarters in a prompt manner, consistent with their group reporting systems. Corporations will need to deploy multi-functional and multi-country teams to address these requirements. While it is primarily a finance/tax exercise, other functions will need to provide critical non-financial information. For instance, the legal function will need to provide information relating to key agreements entered into by group entities. Similarly, the HR function will need to provide information about the number of employees in each jurisdiction.
All entities within the group will need to report consistent transfer-pricing policies to their respective tax authorities.
Therefore, it will be crucial to have a top-level review of all group entities’ reporting. The groups’ financial reporting systems will need to efficiently compile the requisite data in a timely, consistent and accurate manner, since group entities operate in different geographies, employ different accounting software, and may be subject to different accounting and reporting standards.
Indian MNEs should start preparing for the new requirements even before formal rules are announced. This should help them test the level of understanding and awareness across different functions located in different countries, test the effectiveness of their reporting systems, confirm that the results accurately reflect the facts applicable to the group, and highlight any red flags identified as a part of the exercise. Having compliances done on a test basis should help MNEs comply with the requirements confidently once those are formalised.
Mehta is partner (transfer pricing) and Shah is associate director, Price Waterhouse & Co. LLP.
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