Since the mid-1990’s, when the United States revised the regulations under IRC section 482 governing intercompany transactions (and imposed specific transfer pricing documentation requirements on U.S. multinationals), and the Organization for Economic Cooperation and Development (OECD) also issued transfer pricing guidelines that acknowledged the value of transfer pricing documentation, many countries have followed the example of the United States and established country specific documentation requirements. As a result, large MNEs have grappled (and continue to grapple) with how to meet the increasingly diverse expectations of an increasing number of tax authorities. Until the BEPS project the OECD Guidelines themselves did not identify any specific documentation that would be considered appropriate, but with BEPS Action Item 13 the OECD finally set forth proscriptive rules that identify three specific types of documents that the OECD states will “help meet the objective of providing tax administrations with useful information to assess transfer pricing risks, make determinations about where audit resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries.” Putting the U.S. rules side-by-side with the Action 13 guidelines, particularly the master file, one can see that their differences are not just in form, but in the apparent purpose underlying the rules themselves, and therefore MNEs will need to approach the master file differently than they have approached U.S. documentation.
Historical Development of Documentation Regimes
The U.S. documentation rules (effective in February 1996) were imposed in conjunction with a complete overhaul of the substantive regulations issued under section 482 to govern the pricing of intercompany transactions. After identifying “the arm’s length standard” as the proper measure of the clear reflection of income under section 482, the regulations for the first time included specific methods that taxpayers were to use to measure the arm’s length nature of their transactions. To “encourage” compliance with such methods, the IRS created (also for the first time) a specific requirement that taxpayers document the results of their intercompany transactions that fall within the scope of section 482 and show how the taxpayer applied the specified method (or a properly documented unspecified method) to the transaction to demonstrate an arm’s length result. While the documentation was not required to be submitted with the tax return, to avoid the onerous “gross valuation misstatement” penalty of section 6662 the documentation was required to be “in existence” on the date that the taxpayer filed its tax return.
The OECD Guidelines that were released in 1995, in contrast to the compliance, rules-based approach of the United States, presented a principles-based approach designed to provide guidance to countries seeking to resolve double tax cases in treaty-based mutual agreement proceedings between OECD member countries. The preface to the 1995 rules encourages OECD member countries to follow the principles set forth in the guidelines in their domestic transfer pricing practices, but the guidelines were not proscriptive, and in fact encouraged tax examiners to be “flexible” when examining a MNE’s transfer pricing, and take the taxpayer’s commercial judgment into account when analyzing its transfer pricing results.
In a post-BEPS environment, however, the level of transparency the OECD recommends that taxpayers provide regarding their transfer pricing policies is vastly expanded. U.S. rules require a taxpayer to provide information about its overall industry and to provide an organization chart, but the documentation need test only transactions that implicate section 482, and the org chart need show only those related parties that are “relevant under section 482.” This approach makes sense in the context of the compliance goals the IRS had at the time it created the regulatory framework, but it is in stark contrast with the OECD post-BEPS expectations that taxpayers provide three different reports (master file, local file and country by country report “CbCR”) and that in their master file describe, among other things:
- Most significant value drivers;
- Top 5 products and/or services
- Most important intercompany service arrangements, including R&D
- Main geographic markets
- Global functional analysis
- Significant acquisitions, divestitures or restructures occurring during the year
- Description of all intangibles “important for transfer pricing purposes”
- Any important intangibles transfers occurring during the year
- A description of the group’s financing activities and intercompany financing transactions
Clearly, the OECD (and those countries that take a similar approach) expect taxpayers to tell their entire global story in their master file documentation, and this story likely will inform how the tax authorities understand both the local file and the CbCR.
Challenges Facing U.S.-Based MNEs
For those U.S.-based MNEs that are subject to the OECD Guidelines as well as the U.S. rules (presumably most large U.S.-based MNEs) these somewhat-similar-but-not-quite-the-same documentation requirements create many challenges, the most basic of which is, how do you efficiently prepare all these various documents, both from a time and expense perspective?
Looking specifically at the master file, one question that comes up is can I leverage the U.S. docs? The answer, in my view, is NO. While the local file does focus on transactions and testing, and in format much more closely aligns with the structure of the U.S. documentation report such that there likely can be some sharing of information across documents, the master file is completely different, both in terms of the information included, and more importantly, in what taxpayers are asked to explain about their transfer pricing practices and policies.
For example, the first piece of substantive information that needs to be in the master file is a written description of the taxpayer’s business, including: “the important drivers of business profits.” Compare this with the U.S. rules, which require “An overview of the taxpayer’s business, including an analysis of the economic and legal factors that affect the pricing of its property or services.” The U.S., as noted above, is focused in the documentation exercise on ensuring that the taxpayer is pricing its transactions in an arm’s length manner, therefore the taxpayer needs to discuss the factors that can influence that pricing, including the macroeconomic factors that impact the business. On the other hand, the OECD begins by asking about drivers of business profit in general, and then asks taxpayers to provide a description of the supply chain for the group’s five largest products and/or service offerings by turnover, plus any other products or services that amount to more than 5 percent of group turnover. The U.S. regulations do not ask for any information about global profit or revenue, but limit the documentation to “all related parties engaged in transactions potentially relevant under section 482, including foreign affiliates whose transactions directly or indirectly affect the pricing of property or services in the United States.”
Given this difference in focus it is advisable for U.S. MNEs to prepare the master file with a clean piece of paper, so to speak. If the same group of people prepare both documents it is advisable to have an objective third party review both documents to confirm that each document meets its own objectives and is consistent with the other.
This is a post-BEPS Brave New World, and it is important for U.S. MNE’s to understand that and prepare their documentation accordingly.
1. OECD Guidelines Chapter IV Para. 4.9 (1995)
2. OECD Action Item 13 Final Report, Annex 1 to Chapter V of OECD Transfer Pricing Guidelines
3. Treas. Reg. 1.6662-6 (d)(2)(iii)(B)(1)
4. Id. at (B)(2).