By Geri Westphal
Transfer pricing and BEPS: fraught with uncertainty and complexity with far-reaching impact.
“Fraught with uncertainty and complexity with far-reaching impact.” Sounds like a great way to start a new year, doesn’t it? Unfortunately that’s what the OECD’s BEPS Plan is expected to deliver to tax and treasury departments and tax strategies in general in 2016.
Historically, establishing one of those strategies, transfer-pricing, was reasonably straightforward with corporate tax taking the lead role on identifying structures and treasury providing arm’s length rates to be used in the calculation of interest when funds are transferred between subsidiaries.
Spring peer group surveys from The NeuGroup suggest treasurers think BEPS will have only a moderate impact on their transfer pricing programs. But based on the latest report released to the G-20 in October, it looks like the impact will be far greater than expected as scrutiny will increase.
Life is about to change
The newly announced BEPS guidance will now require multinationals to prepare a significant amount of additional analysis and documentation. This has been labeled by BEPS supporters as a game changer that will alter the transfer pricing outcomes in many situations.
BEPS arose from the financial crisis, which for many governments quickly became a fiscal crisis prompting them to seek ways to increase tax revenue. The goal was to eliminate the zero-tax rates achieved by MNCs, mostly from the US, and force corporates to report very detailed key country-by-country financial metrics. The very simplistic notion taken by taxing authorities follows this logic: “If 20 percent of your operations and employees are in our jurisdiction, why aren’t 20 percent of the taxable profits?”
The new guidelines place increased scrutiny on most aspects of the transfer pricing program including detailed analysis to determine the economic substance of each transaction. Transfer pricing plans must now break out the financing risk from the operational risk and provide significant detail on each.
Financial risk must be distinguished from operational risk with precise guidelines to determine who (1) provides financial capital, (2) performs operations, and (3) manages and controls these activities. When more than one entity controls the risks that drive the returns, each entity may be entitled to a share of the income, depending on their respective contributions to the creation of value.
The new guidance provides tax authorities with a powerful tool to disregard the contractually agreed upon risk-return allocation between parties. You can bet that entities that cross tax jurisdictions will end up in a tug-of-war over who gets what amount of tax revenue. Corporate tax departments could end up in the middle of these fights.
Are there too many cooks in the kitchen? Yes.
One major deliverable that is due beginning in 2017 (for the fiscal period on or after January 1, 2016) is the newly mandated Country by Country (CbC) Report. This report is expected to take significant resources both in time and employee headcount to prepare as the expected level of detail. This is most likely where the treasury department will get sucked into the BEPS vortex. It is reasonable to assume that the corporate tax department will look to finance and treasury to help provide the financial details necessary for this new report. The CbC report should contain aggregate information (without adjustments or eliminations) for all entities and for each tax jurisdiction for things like revenue by related and unrelated parties including royalties, service fees, interest income; profits before tax; income tax paid including withholding taxes; income tax accrued among other things.
Another area of high scrutiny is expected to be that of cost allocation between entities engaging in common services either through the use of a shared service center or treasury center. For efficiency reasons, many organizations use these structures to provide affiliates with a variety of inter-company support activities including HR, finance, treasury, IT, legal and marketing. Typically, these support services are reallocated to the participants based on a cost or cost plus method. Tax authorities have expressed skepticism of these allocated costs, citing the potential erosion of the tax base through excessive management fees and head office allocations. This area will receive a lot more review and scrutiny as tax jurisdictions begin to debate cost allocation methods and fight for their share of perceived revenue.
As the mandatory reporting period draws closer, US MNCs will have a better idea of how the OECD taxing jurisdictions will review and approve transfer pricing structures, but it is fair to say that this area of global activity will take center stage over the next several years. It’s just one more compliance issue for US MNCs to absorb. Good luck.