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.
In a good sign for U.S.-based MNEs concerned about the potential disclosure issues that surround the filing of country by country reports (CbCR), the IRS confirmed on April 28th that it has concluded two competent authority agreements for CbCR, one with the Netherlands and the other with a country that Douglas O’Donnell, the U.S. Competent Authority who confirmed the signings to Bloomberg BNA, did not name.
The Netherlands agreement was posted on the IRS.gov web page on May 17, and it appears that it is nearly identical to the Model Agreement. The only difference between the Model and the Netherlands agreement is the definition of “constituent entity.” The Model included a multi-part definition that sought to separately describe separate business units that are included in consolidated financial statements, separate business units that are excluded from consolidated financial statements and permanent establishments. The agreement simply defines “constituent entity” as it is defined in the respective domestic laws of the Netherlands and the United States. Given the complexity of the original definition it is likely that the approach taken in the Netherlands agreement will be taken in all the other agreements. It is still an open question which other country has signed an agreement with the United States or whether the other country is also in Europe or in some other region of the world. Nevertheless, it is good news that the IRS is getting some agreements in place in advance of the first exchange of CbCRs, which under the CbC MCAA signed by 57 countries (and counting) are anticipated to be exchanged in early 2018.