In 2015 the OECD released the final report on Action Item 13 – Transfer Pricing Documentation and Country-by-Country Reporting, which proposed a new documentation scheme that included the preparation of: 1) a master file; 2) local files; and 3) a document called a “country-by-country report,” (“CbCR”) the last of which was unlike any report or filing regarding transfer pricing that had ever previously been proposed. Perhaps not surprisingly, all heads turned to the CbCR, with its request for country-level data on revenue, headcount, functions, and most uncomfortably, taxes paid and accrued, from MNEs with at least €750 million in annual consolidated revenue.
Many hands were wrung and ink spilled while countries and commentators alike pondered to what nefarious use such reports could be put, since the recommendations included an exchange mechanism, intended to be automatic, to allow the sharing of a CBCR prepared in the MNE’s home country with tax authorities in all the other countries where the MNE does business. At the time, very little attention was paid to the first two items on the list, since they kinda sorta sounded like the documentation that MNEs were already preparing, and besides, HEADCOUNT!
As the country-level implementation of the recommendations began, it was clear that most of the OECD/G20 countries that participated in the BEPS project (and other interested country observers) fully supported both the CbCR and the exchange mechanism, and more than 50 countries signed on to a Multilateral Competent Authority Agreement for CbCR (“MCAA for CbCR”) that would allow the automatic exchange of reports with all other signatories.
The United States, (which could not sign the MCAA for CbCR for reasons discussed in an earlier blog post), has worked on a nearly identical bilateral agreement, which as of this writing has been signed by 17 U.S. treaty or TIEA partners, including a number of European treaty partners (Netherlands, Belgium, Denmark and Ireland), Brazil (through a TIEA) and Canada. The Treasury Department has stated that it expects to have agreements signed with a substantial number of the larger treaty partners before the automatic exchanges begin during the first half of 2018. So for better or for worse, it appears that the CbCR will become a part of the transfer pricing documentation package of all large MNEs.
Investment in a good master file can pay dividends
While all this hand-wringing was going on, it seems that much less attention was paid to the audit implications of the master file, but in my opinion the master file is the place where audit cases will begin (or not). The OECD could not have been clearer that the master file is intended to be a roadmap of transfer pricing risk, as described below:
The master file should provide an overview of the MNE group business, including the nature of its global business operations, its overall transfer pricing policies, and its global allocation of income and economic activity in order to assist tax administrations
in evaluating the presence of significant transfer pricing risk. In general, the master file is intended to provide a high-level overview in order to place the MNE group’s transfer pricing practices in their global economic, legal, financial and tax context. 1
The master file tells the taxpayer’s transfer pricing story, and if the master file is not coherent and consistent, both internally and when read in conjunction with local files and CbCRs, the document could increase the chances of a taxpayer being subject to a transfer pricing audit by one or more tax authorities. And unlike the CbCR, which asks for financial and business data with little explanation, the master file is intended to provide context to the data and to assist the tax authority in assessing the potential for further examination. And it should be remembered that audit risk is relative, in that resource-strapped tax authorities are looking for the biggest bang from their limited bucks when they open any audit, but especially a transfer pricing audit.
First, in talking with field auditors from the IRS they universally agree that transfer pricing audits are the most fact-intensive, complicated cases they handle, so it is critical to them that after identifying a case for examination they are able to make a solid, defensible transfer pricing adjustment, or determine very quickly that there is no issue to explore.
Second, in order to help auditors get to the “nothing to see here, move on down to the next taxpayer” place, a well-prepared master file could be the most important document provided to the tax authorities, including the IRS field auditors. Although there is no requirement under U.S. law to prepare a master file, it is likely that most U.S.-based MNEs will find themselves required to provide a master file in other countries, and it is likely that IRS field auditors will ask taxpayers who have prepared a master file for another jurisdiction to provide the document to them, as well.
Finally, if taxpayers give the appropriate attention to the master file, if the file tells a coherent, consistent story about the taxpayer’s business that leads to the conclusion that the taxpayer’s transfer pricing policies and strategies are consistent with the arm’s length standard, then taxpayers should consider providing the master file as the first response to an audit notice, even before a tax authority makes any document requests. A transfer pricing story well told in a master file might not save you from a transfer pricing dispute, but it can frame how the auditors view the case and pay dividends in the ultimate result.
1. - OECD (2010) OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (July 2010), OECD Publishing, Paris at Chapter V.C.1 Para 18.