In 2018 most MNEs have to file the CbC report for fiscal year 2017, as well as the CbCR notifications for fiscal year 2018. This article intends to share some of the insights gained by Quantera Global during the CbCR for fiscal year 2016.
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As of fiscal year 2016 MNEs have been faced with a significant increase of transfer pricing compliance, including Country-by-Country Reporting (“CbCR”) for MNEs with a turnover exceeding EUR 750 million in the previous year. CbCR requires MNEs to provide tax authorities with an annual report that breaks down the key elements of their financial statement for each jurisdiction. The CbC report should enable tax authorities to make a first assessment on MNE’s transfer pricing risks.
The exchange of CbC reports among tax authorities has started yet and it will be interesting to see how the CbC report will be analysed and used by tax authorities for planning and handling of transfer pricing audits.
Finding 1: The MNE ultimate parent entity is located in a jurisdiction that has no automatic exchange agreement in place for CbCR.
As it is typically the ultimate parent entity of the MNE that is required to file a CbC report, a difficulty may arise when the ultimate parent entity is located in a jurisdiction that has no activated bilateral CbCR exchange relationships with the other jurisdictions involved or only with a limited number of jurisdictions. For instance, China has currently only limited exchange relationships with Germany, France and the UK for fiscal year 2017. This means that Chinese MNEs with entities in other jurisdictions would be required to file a CbC report in each individual jurisdiction that has implemented CbCR.
A practical solution to reduce the compliance burden within the EU can be found in so-called “EU filing”. In case of EU filing, an EU group entity is designated to file the CbC report in the member state of which it is considered to be tax resident. This EU group entity has to notify the tax authorities that it intends to make use of EU filing. The tax authorities of the relevant member state will then automatically exchange the CbC report with all EU member states of which the group entities are considered to be a tax resident. Although this practical solution seems to be simple, it is important to manage it carefully.
Finding 2: CbCR template – how to deal with it?
As a basis for the CbC report, most jurisdictions have adopted the OECD standardized electronic XML format which consists of three tables.
- Table 1 contains ten fields of numeric information on the MNE’s economic activities, aggregated by jurisdiction.
The data to be included in table 1 may be based on MNE’s consolidated financial statements, entity statutory financial statements, regulatory financial statements, or internal management accounts. It is important that the data included in the CbC report are in line with data included in other sources such as the Master File, Local Files and financial reports in order to maintain consistency. Significant differences, for instance reporting negative unrelated party revenues,
will probably immediately raise questions with the tax authorities.
- Table 2 contains information on each constituent entity in the MNE group
The data to be included in table 2 provide tax authorities with an overview of the main business activity(ies) of each constituent entity within a certain jurisdiction. Table 2 divides the main business activities into several categories. When choosing a certain category, MNEs should always be aware of any misinterpretations that may arise. It is evident here that alignment between the indication of an entity’s main business activity(ies) in the CbC report and the transfer pricing system in place and realized results are of key importance.
In addition, we note that the term “constituent entity” also includes permanent establishments. It is required to include information on permanent establishments of the MNE group in table 2 of the CbC report. As the definition of permanent establishment varies among jurisdictions, confusion may arise when determining whether there is a permanent establishment in a jurisdiction for the purpose of the CbC report.
- Table 3 allows MNEs to provide additional information to clarify the content of the CbC report.
In table 3 MNEs may include any further information or explanation they consider necessary or that would facilitate the understanding of the mandatory information to be provided in the CbC report. As such, including additional information in table 3 of the CbC report is not mandatory.
It may vary per MNE whether it is recommendable to include additional information in table 3. On the one hand, table 3 provides MNEs with the opportunity to include upfront additional information which may clarify the content of the CbC report, and, as such, may be helpful to explain apparent anomalies and potential risk indicators. On the other hand, MNEs may consider not including any additional information as that information may lead to extra attention and questions by local tax authorities. However, MNEs should always be able to explain all information included in the CbC report when questions are raised by the tax authorities.
Finding 3: the interpretation of information included in the CbCR by tax authorities
The CbC report provides tax authorities an overview of the MNE group as a whole that may not be available from existing data sources, especially not the analysis by jurisdiction and entity. The information included in the CbC report will be used by tax authorities to identity potential tax risks and to allocate tax audit resources. It is interesting how tax authorities will handle all new information, how they will analyse and translate it into transfer pricing audits and how they will come to transfer pricing adjustments.
Although there is no practical experience yet in how tax authorities will interpret CbC reports as tax authorities are currently analysing CbCR information for FY2016, attention points can be derived from the OECD Handbook on Effective Tax Risk Assessment.
Some obvious potential tax risk indicators which are meant are for instance:
- the footprint of a group in a jurisdiction;
- jurisdictions with significant profits but low levels of tax accrued; and
- jurisdictions with significant activities but low levels of profit (or losses).
In order to get upfront insight in potential tax risk indicators in MNE’s CbC report, we recommend performing a transfer pricing risk analysis of the data included in the CbC report and calculating relevant ratios. In the CbCR-ring it is of utmost importance that MNEs closely monitor the way information in the CbC report is presented and analyse how this information would probably be interpreted by tax authorities. Consistency among all relevant sources such as financial reports, the CbC report, the Master File and Local files is key. This is important to limit risks and the time necessary to answer questions raised by tax authorities, which may even be more time consuming than the preparation of the CbC report itself.
Considering the challenges of CbCR, it goes without saying that it is crucial to start on time with the gathering of all relevant data and the preparation of the CbC report.
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Transfer Pricing Analyst