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.
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.
Tax authorities around the globe have begun the process of setting up internal systems for the acceptance and automatic exchange of the Country by Country Reports (“CbC Reports”) developed as part of Action Item 13 of the BEPS project. To facilitate the automatic exchange, most of the BEPS participants have signed on to a Multilateral Competent Authority Agreement (“CbC MCAA”) that was developed under the Convention on Mutual Administrative Assistance in Tax Matters (the “Convention”), which in turn was an agreement written jointly by the OECD and the Council of Europe in 1988 and amended by Protocol in 2010. By signing the CbC MCAA the country agrees to automatically exchange CbC Reports with any other signatory that complies with the terms of the CbC MCAA (e.g., exchanges information within the designated time frame, applies confidentiality standards to the exchanged information, uses the CbC Report for the stated purposes, etc.). In this way countries can avoid the tedious exercise of entering into separate bilateral agreements with all of their treaty partners (or all other signatories of the Convention).
The United States, however, has not signed the MCAA but rather has announced that it will, in fact, pursue separate bilateral agreements with all of its treaty and TIEA partners. Why this is the case is at the same time simple and complicated. The simple reason is that, although the United States signed the original Convention in 1989, ratified it in 1991, and it entered into force in 1995, the United States has signed but not ratified the 2010 Protocol. Therefore, the United States cannot be a party to the MCAA because it has not agreed to its current provisions. The reason why the Protocol has not been ratified is a more complicated issue, involving the inevitable politics of Washington, and the inability of the Senate to ratify any international agreement that requires its approval since Senator Rand Paul began placing holds on all such agreements in 2010, allegedly as a protest against the Foreign Account Tax Compliance Act (otherwise known as “FATCA”). The Senate Finance Committee voted the Protocol (and seven other treaties that have been held up) out of committee during one of Senator Paul’s absences in late 2015, but there has been no move to get a vote of the full Senate on any of the treaties since then.
In light of this, the IRS is forced to engage in the tedious exercise described above under the existing treaties and TIEAs, and enter into separate bilateral agreements for the automatic exchange of CbC Reports as a specific type of tax information allowed to be exchanged under these treaties/TIEAs. The IRS has released the language of the Model CbC CAA that it is presenting to treaty partners, and recently announced that it has reached a bilateral agreement with Netherlands and one other as-yet-unnamed country. The IRS has not indicated, however, exactly which treaty partners have been given the Model, which treaty partners are on the top of the list for automatic exchange, or even whether it would consider a case-by-case exchange of CbC Reports under the general Exchange of Information article of its existing treaties. Stay tuned.