Transfer Pricing Documentation in a Post-BEPS World

“It is not the strongest or the most intelligent who will survive but those who can best manage change”-Charles Darwin

The Organization for Economic Co-operation and Development (OECD) released its final recommendations on the Base Erosion and Profit Shifting (BEPS) Project on October 5, 2015. The BEPS project consist of fifteen (15) Action Points geared towards fixing the gaps and mismatches in the current international tax framework. One of the Action Points, Action 13, covers Transfer Pricing Documentation and Country-by-Country Reporting (CbCR). The final report of Action 13 creates a new paradigm on how transfer pricing documentation should be prepared going forward. This article outlines some of the key features of the new transfer pricing documentation requirements and its impact on Multinational Enterprises (MNEs) as they embrace the realities of a post-BEPS world.

Before BEPS…

Prior to the inception of the BEPS project, MNEs have always relied on local transfer pricing rules and the guidance provided by the OECD Transfer Pricing Guidelines. Usually, companies are required by the relevant enabling legislation to prepare transfer pricing documentation that covers the controlled transactions carried on by the companies. A typical transfer pricing documentation will contain sections that provides brief description of the MNE, detailed description of the reporting group entity, an analysis of the industry the reporting entity is a part of, functional analysis and economic analysis.

For MNEs that are headquartered in the European Union (EU), transfer pricing documentation is slightly different. The EU in 2005 prescribed a two layered approach to transfer pricing documentation which consists of the master file and the country specific file. According to the guidance provided by the EU Joint Transfer Pricing Forum (EJTPF), an MNE should prepare one set of documentation containing common standardized information relevant for all entities within the group. In addition, the MNE is required to prepare the second set of documentation that is specific to the country of the reporting entity.

The EJTPF recommended that the master file should contain details such as the general description of the business and its strategy; general description of the MNE’s organizational, legal and operational structure; general identification of the associated enterprises engaged in controlled transactions; general description of the functions performed and the risk assumed; ownership of intangibles; the MNE’s transfer pricing policy; list of cost contribution agreements, advance pricing agreements and transfer pricing rulings.

On the other hand, the country specific documentations is expected to provide detailed description of the business and its strategy; information on country-specific controlled transactions; comparability analysis economic circumstances; explanation on the selection and application of transfer pricing methods’ relevant information on internal and /or external comparables.

New Reporting Requirements

Quite different from what MNEs are used to before the release of the final BEPS reports, BEPS Action 13 recommends a three- tiered standardized approach to transfer pricing documentation –(i) master file (ii) local file (iii) Country-by- Country Report. Similar to the EU master file requirements, master file under Action 13 provides a “blueprint” of the MNE group and should contain relevant information that can be placed into five categories: (a) the MNE group’s organizational structure (b) a description of the MNE’s business or businesses (c) the MNE’s intangibles (d) the MNE’s intercompany financial activities; and (e) the MNE’s financial and tax positions.

Same as the EU Joint Transfer Pricing Forum?

A cursory review of the recommended content of the master file may suggest that the new reporting requirement is same as that of the EJTPF as highlighted above. However, when reviewed in detail, one will realize that the new reporting requirements require the disclosures of additional and more detailed information. Under the new reporting requirements, MNEs are expected to provide the description of the supply chain for the group’s five largest products and /or service offerings by turnover plus any other products and/or services amounting to more than 5 % of the group turnover. Also, MNEs are required to provide description of the main geographic markets for the MNE group’s products and services. Where there has been an important business restructuring, acquisition and divestitures during the fiscal year, the details of these activities are to be documented in the master file.

Further, there is a requirement to document intangibles within the MNE as well as a general description of any important transfers of interests within the group and the basis of compensations of such transfers. Another disclosure that is important to note is that of the MNE group’s intercompany financial activities. Action 13 requires MNE groups to document how the group is financed, identify group entities that provide central financial function as well as state the country under whose laws the central financial entities are organized and the place of effective management of such entities.

A review of the documentation requirement for local file under Action 13 reveals that to a large extent there are no significant new disclosure requirement save those listed below:

A description of the management structure of the local entity, a local organization chart, and a description of the individuals to whom local management reports and the country(ies) in which such individuals maintain their principal offices.

• A detailed description of the business and strategy pursued by the local entity including an indication whether the local entity has been involved in or affected by business restructurings or intangibles transfers in the present or immediately past year and an explanation of those aspects of such transactions affecting the local entity.
• A copy of existing unilateral and bilateral/multilateral APAs and other tax rulings to which the local tax jurisdiction is not a party and which are related to controlled transactions described above.
• Information and allocation schedules showing how the financial data used in applying the transfer pricing method may be tied to the annual financial statements.

The third tier of transfer pricing documentation which is entirely new is the CbCR. Action 13 recommends that the CbCR should contain summary data by jurisdiction including revenue, income, taxes, number of employees etc. In implementing the CbCR, the OECD has recommended that the CbCR be required from MNE groups with annual consolidated group revenue of more than EUR750million. Also, the commencement date for the implementation has been fixed for the fiscal year beginning on or after 1 January 2016. The CbCR is expected to be filed in the ultimate parent company of the multinational group’s jurisdiction (or that of the surrogate parent entity). It is expected that the tax administration in the country where the CbCR is filed will subsequently share the report with tax administration of the countries where members of the MNE group operates under the relevant exchange of information protocols.

Post BEPS realities

From the commencement of the BEPS Project in 2013 to the publication of the final reports this year, the G20, OECD and scores of other countries have negotiated, deliberated and reached consensus on the 15 Action Points. Considering the above, one can conclude that transfer pricing documentation cannot be business as usual in a post- BEPS environment. The tax topography will be radically transformed! A very interesting development can be observed in countries like Australia, Canada and Spain. Even before the release of the final BEPS package, these countries had set machinery in motion to ensure the adoption of Action 13 especially the CbCR. Another indicator of post- BEPS realities is seen in Nigeria. The tax authorities in Nigeria has requested CbCR from a taxpayer via the TP audit process. The Post BEPS realities of Action 13 are discussed below.

Firstly, the tax authority will have access to more quantum of information on the MNE group as a whole and the reporting entity more specifically. Where the requisite information are not provided with the expected level of details or not provided at all, the reporting entity may be exposed to significant transfer pricing audit risk. Also, MNEs transfer pricing audit risk may increase significantly where information submitted to the tax authorities are contradictory.

Secondly, financial arrangement is now one of the areas of focus of disclosure. While financing activities /arrangements do relate specifically to loan transactions, it may include short-term credit facilities, revolving loans, inventory financing, capital issuance, purchase order financing etc. With this, financial arrangements that are not regarded as important or significant prior to the BEPS era may now attract the attention of the tax authorities. Therefore, it is important that MNE groups put in place a robust process that will enable it capture and document the various financing arrangements existing within the MNE group. Failure to do this may put the MNE group at the risk of omission of key disclosure items.

Thirdly, MNE groups may need to reevaluate the allocation of manpower to its tax and transfer pricing compliance units as there may be expanded scope when it comes to tax and transfer pricing compliance as well as audits going forward.

Finally, MNE groups need to have a transfer pricing documentation strategy to coordinate the collation of financial data and preparation of the TP documentation to ensure that the three reports consistently explain the MNE group’s business model and outcomes.