Overview of the Three Tiered BEPS Action Plan Requirements
As enterprises continue to expand operations across borders, Base Erosion and Profit Shifting (BEPS) has become a prioritized issue in international taxation. BEPS refers to the tax planning strategies of multinational entities designed to exploit differences in tax rules among mixed tax jurisdictions.
Because of insufficient reporting requirements and lack of information sharing among international tax administrations, large organizations often artificially shift profits to either low or tax-free areas where there is little economic activity and as a result, avoid taxation in high-tax jurisdictions that harbor value-added economic activity.
Overview of the BEPS 13 Three-Tiered Standardized Approach
In an effort to enhance transparency of transfer pricing documentation for various tax administrations throughout the globe, the Organisation for Economic Co-operation and Development (OECD) issued the Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan) in 2013.
The guidance in BEPS Action 13 encourages countries to develop a three-tiered standardized approach to transfer pricing documentation for multinational enterprise (MNE) which include a master file, local file and a country-by-country report.
This new approach to transfer pricing documentation endeavors to ensure taxpayers remit appropriate consideration per international transfer pricing regulations and to provide tax administrations with a useful base of information that would permit an effective audit of transfer pricing practices.
The master file contains high level information pertinent to all members of the MNE group and should be made available to all relevant tax administrations. The taxpayer should exercise judgement in determining the sufficiency of detail to be reported and need not include trivial elements. Usually, the master file will include an overview of the MNE’s global operations, overall transfer pricing policies, supply chain details, main profit drivers, and primary geographic markets. Each country determines who is required to file this.
The local file should include documentation supporting material intercompany transactions of the local group member of the MNE. The local file is specific to each country and should disclose detailed transfer pricing policies, amounts involved in material related party transactions and the company’s analysis of the transfer pricing documentation relating to each transaction. Materiality will vary per country, as the taxpayer should consider size and nature of local business activity relative to the local economy.
Additionally, the local file will include information about the entity such as management structure and business strategy. Each country determines who is required to file this.
The third and last element of standardized transfer pricing documentation is the country-by-country report (CbCR) which provides information relating to global allocation of the MNE group’s income and taxes paid on a per-country basis. It also requires MNEs to report number of employees, stated capital, accumulated earnings and tangible assets in each tax jurisdiction.
Additionally, it should identify each entity within a group doing business in each jurisdiction and its respective business purpose.
Generally, the CbCR on its own does not constitute concrete evidence that appropriate transfer pricing policies have been employed and the OECD strongly recommends that tax administrations do not exclusively require this form of documentation.
Any company who has over €750M in revenues (or $850M) is required to complete the CbCR. The threshold for reporting has been set by the OECD at €750M in revenues. However, some countries have provided a translated amount in the local currency. For example, the U.S. filing threshold is $850M USD.
Variations from Country to Country
Since the release of BEPS Action 13, many countries have implemented their own versions of the BEPS Standardized Approach. Consequently, the requirements for both the master and local file vary based on the specific country the entity is operating in.
For an overview of reporting requirements of countries in North America and selected other countries, please download our complimentary Guide (no form required)
While some now require each the master, local and country-by-country report, others have merely employed the use of one or two, and some have not yet at all. Each tax jurisdiction has a minimum revenue threshold for transfer pricing reporting and it is imperative that companies be wary of these thresholds as many jurisdictions have adopted penalties to increase compliance.
Connect with a Freed Maxick International Tax Expert on Transfer Pricing Issues
We strongly recommend that you review your business operations in all jurisdictions to determine if any of these reporting requirements affect your business.
If you have any questions or concerns about how these reporting requirements may impact you, please reach out to the International Tax Team at Freed Maxick for a complementary Tax Situation Review.
Call us at 716-847-2651 to discuss your tax situation, or start the process of setting an appointment by clicking here and submitting your contact information.View full article
In recent years the IRS has focused more heavily on the transfer pricing of intangible property. Section 482 of the regulations provide guidelines so that these controlled transactions are conducted at an arm’s length when intangible property is owned by one company but used by another related company in another jurisdiction.
In this post, we'll summarize the different types of methods that are available to compare intercompany transactions of intangible property to uncontrolled transactions.
Intangible Property Can Come in Many Forms
Some of the most common intangible property that may be shared between related parties in separate jurisdictions are patents, know-how, trademarks and trade names. The available transfer pricing methods for pricing transfers of intangible property are as follows:
Comparable uncontrolled transaction transfer pricing method: Under this method you would be comparing the controlled transaction (intercompany/related party) to an uncontrolled transaction (unrelated/third-party). The intangible property must be used with similar products/processes in the same industry or market and have a similar profit potential.
An example of this would be if a company had a manufacturing process that it allowed its related company to use as well as an unrelated company in the same country with the same profit potential. For tax purposes, the company will need to prove that they are pricing the uncontrolled and controlled transactions the same. If there are different factors that need to be considered such as risk and an adjustment can be readily calculated, those need to be considered as well.
Comparable profits transfer pricing method: This method is based on profit level indicators. The goal of profit level indicators is to identify the amount of profit which would have been earned in an uncontrolled transaction of a similar taxpayer. Profit level indicators can be based on assets (operating profit / operating assets), sales (operating profit / sales), or expenses (gross profit / operating expenses). The reliability of these indicators can vary depending on size, industry, or relevant product lines, so it is important to understand the nature of the business and the uncontrolled taxpayer(s) with which you are comparing.
Profit split transfer pricing method: There are two ways the profit split method which can be used—the comparable profit split and the residual profit split. In practice, the comparable profit split method is rarely found as it’s based on profit from an uncontrolled transaction involved in similar transactions and activities. As this information is rarely available, the more commonly used is the residual profit split method.
Under the residual profit method, the first step is to allocate a portion of the income to each of the “routine” activities of the taxpayers. Next, the remaining residual profit is divided among the controlled taxpayers based on the value of the non-routine business activities in the process. Routine business activities are considered to be those directly related to the operating profit of the business. Non-routine activities would include the value of intangible property.
Unspecified methods: Used if a method other than those listed above is considered the best for the specific situation.
Avoid Penalties with Contemporaneous Transfer Pricing Documentation
While the implementation of the transfer pricing adjustments into your taxable income is very important, another critical aspect of transfer pricing is the documentation. Transfer pricing documentation on all intercompany transactions, including those on intangible property, must be contemporaneous. This means that it must be in place as of the time the tax return is filed. Without documentation there could be severe penalties of 20-40% of the underpaid tax due on the transfer pricing adjustments that the district director deems reasonable for the intercompany transactions.View full article
Does your company have intercompany transactions? Do the transactions cross over multiple foreign local jurisdictions?
If you answered yes to either of these questions, you may be at risk for a transfer pricing adjustment from the IRS, foreign jurisdiction, or even a state jurisdiction. In addition, with the current OECD base erosion and profit shifting (BEPS) action items coming into the spotlight, transfer pricing should be at the forefront of all companies. Each entity should be analyzing their intercompany transactions to ensure they can be supported as arm's length transactions. This analysis can provide support that the taxpayer is not intentionally shifting profits into a lower tax jurisdiction at a rate that is unreasonable, and also provide excellent tax planning opportunities.
Intercompany transactions cover many different types of transactions. Some examples are as follows:
- Tangible transactions from a manufacturer to a related-party distributor
- Intangible transactions of know-how from one related-party to another
- Fees for services of one related-party to another
- Management fees for centralized corporate offices for services such as admin, HR, and finance
The key phrase to all transfer pricing is “arm's length.” Arm's length means that the transaction should be executed as if it were being done with a third-party. There should be no advantage to the transaction due to the intercompany nature. According to the U.S. and many foreign jurisdictions regulations, each intercompany transaction must support that their transactions are at arm’s length and the company is not trying to erroneously shift profits to lower tax jurisdictions.
Do you have support that shows the intercompany transactions are at arm’s length? Do you have intercompany agreements in place that are followed for these intercompany transactions?
If you answered no to either of these questions, you may not have the adequate support that the IRS deems necessary according to the transfer pricing regulations in Section 482. These documents are meant to be contemporaneous in nature, which means that they should exist as the intercompany transactions exist. As part of the increasing scrutiny on transfer pricing, a company that faces an IRS audit will most likely be asked for their contemporaneous transfer pricing documentation.
The documentation required by the IRS is known as the following 10 principal documents:
1. Overview of your company’s business
2. Description of your company’s organizational structure
3. Any document explicitly required by the §482 regulations
4. Description of the method selected and the reason why the method was selected
5. Description of the alternative methods considered and rejected
6. Description of the controlled transactions and internal data used to analyze them
7. Description of the comparables used, how comparability was evaluated, and what adjustments were made
8. Explanation of the economic analysis and projections relied on
9. Summary of any relevant data that your company obtains after the end of the tax year and before filing a tax return
10. General index of the principal and background documents, and a description of your record-keeping system
While these are the documents the IRS requests, companies should continue to be cognizant of the level of risk in their intercompany transactions and whether or not an entire transfer pricing study is deemed necessary according to the company’s appropriate level of risk. A more practical approach may be available if the company decides that the risk level of their transactions is minor.
What Should Companies Do?
With transfer pricing being a hot topic in the tax world, companies should have documentation on the intercompany transactions that cross over multiple jurisdictions. Taxpayers should be able to support that their intercompany transactions are being transacted at an arm's length standard to the IRS if an audit were to occur. This documentation is important as protection for the company should an audit occur and could be used as a tax planning tool to be able to reasonably, within an arm's length standard, shift profits to a lower tax jurisdiction. For expert guidance in compiling and reviewing your documentation, please contact us.View full article
If your company has a U.S. subsidiary, you will most likely have some transfer pricing considerations that need to be addressed. Transfer pricing can be one of the more complex tax issues affecting multi-national businesses. The goal for this post is to educate you about some of the transfer pricing related issues and terms and some of the documentation you’ll want to have on hand.
What is Transfer Pricing?
Transfer pricing principles apply to related company transactions that cross borders. These principles try to align the value and the income from operations within a jurisdiction where the relevant functions are performed and risks taken. Perhaps one of the clearest examples is to compare two companies that assemble, finish and sell wooden furniture.
Company 1 is located entirely in the U.S. and buys the wood that it will assemble and finish from unrelated companies. Company 2 is the U.S. subsidiary of a Canadian parent and it buys all of the wood that it assembles and finishes at its U.S. location from the parent company. Assuming that Canadian tax rates are lower than U.S. tax rates, Company 2 would seek to minimize its income in the U.S. to reduce its global tax burden.
This could be accomplished by having the Canadian parent supply the wood to them at a high cost, resulting in a high cost of goods sold in the U.S. that would reduce taxable income there.
Transfer pricing rules are designed to ensure that the price the Canadian parent charges its U.S. subsidiary is comparable to the price that its U.S. subsidiary would pay had it purchased wood from an unrelated party in an “arm’s-length” transaction.
Transfer pricing principles stipulate that the U.S. subsidiary would be required to have on hand contemporaneous documentation that the price it paid for the wood from its foreign parent was comparable to an arm’s-length price.
While this very basic example focused entirely on cost of goods sold, these same rules apply to all related party transactions such as charges for administrative support, royalties, interest and similar types of charges between a foreign parent and its U.S. subsidiary. Additionally, these rules work in alternate situations where the transactions are between a U.S. parent and a foreign related entity.
Transfer Pricing: Theory and Practice
In theory, transfer pricing is about making sure that income and value are recorded in the country and localities where the corresponding operations of the business are performed.
In practice, the U.S. and foreign governments audit transfer pricing with an eye toward making sure that multi-national businesses have apportioned profits related to operations in a manner that ensures these businesses pay the full amount required in their respective countries. Businesses, on the other hand, focus on managing international operations to minimize the amount of profits generated in higher tax countries.
The critical point for businesses is not that you should try to contort your numbers in order to minimize your U.S. tax burden when you file a return. More than anything else, you need to consider the possibility of cross-border commerce from the start of your business. Plan growth in a manner that provides optimal support for operations in other countries while minimizing income that could be apportioned to high tax jurisdictions. If transfer pricing is not considered until your tax preparer is working on your U.S. tax return, you won’t be able to do much to manage the impact in the current year.
The U.S. rules require that the rationale for your related party transaction pricing be documented thoroughly at the time the return is filed. That documentation is not sent with the return, but it must be made available to the IRS in the event of an audit.
What’s at Stake If a Transfer Price Is Revised?
In addition to owing additional income tax related to the adjustment from the transfer price, U.S. law also provides for penalties in this area. Penalties for inaccurate transfer pricing can range from 20% to 40% of the tax related to the understatement of the income that resulted from the transfer prices used by the taxpayer. In addition, depending on tax treaties or the tax policy in the parent company’s home country, the changes could result in double taxation of certain income. If the U.S. determines that more income should be subject to tax in America, the parent company’s home country may not accept a corresponding decrease in taxable income calculated there.
The analysis, calculations and documentation required to accurately set and support transfer pricing policies within a company should always be performed or supervised by a professional with considerable experience in the field. Given the significant penalties that can be assessed if transfer prices are determined to be inaccurate, few businesses can afford to run the risk of miscalculating these numbers.
Documenting a Transfer Price
U.S. tax regulations provide a specific list of the documentation needed to support a transfer price calculation. The rules do not require that all of this information be filed along with the tax return, but they do require that the calculation of the transfer price and the creation of the related documents occur during the process of preparing the tax return. If your return is selected for audit, the IRS will ask for these documents and the rules require that you provide them within 30 days of the request.
Proper documentation for a transfer price calculation on a U.S. tax return includes:
- An overview of the taxpayer’s business.
- A description of the taxpayer’s organizational structure covering all related parties engaged in transactions that may include transfer pricing.
- Any documents specifically required by regulations.
- A description of the transfer pricing method selected and an explanation of why it was selected.
- A description of alternative transfer pricing methods that were considered and an explanation of why they were not selected.
- A description of the transactions between the parent and controlled parties.
- A description of how the transfer price was compared to relevant alternatives.
- An explanation of the economic analysis and projections used to develop the transfer pricing method.
- A description or summary of any relevant data obtained by the taxpayer after the end of the tax year and before the filing of the return that would help determine if the taxpayer selected and applied the transfer pricing method in a reasonable manner. And,
- A general index of the principal and background documents and a description of the recordkeeping system used for cataloging and accessing those documents.