Transfer Pricing Developments in 2016
Apple and the Transfer Pricing Turmoil
The European Union’s (“EU”) antitrust regulator, the European Commission (“Commission”), has changed the way the world looks at transfer pricing and tax-favored regimes. Asserting that certain Member States of the European Union have gained an unfair competitive advantage because of government help, the Commission recently demanded large tax assessments against Apple, Fiat Chrysler, Starbucks, and AB InBev, among others. More assessments are pending against other U.S.-based multinational entities (“MNEs”) such as Amazon and McDonalds.
Putting a whole new twist on how taxes are determined, the Commission’s State Aid Investigation assessments do not examine whether tax laws have been complied with in the Member States. Traditional transfer pricing guidelines promoted by the Organization for Economic Cooperation and Development (“OECD”) and transfer pricing reporting condoned by Advanced Pricing Agreements (“APAs”) are not considered either. Rather, the assessments derive from the assertion that “any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favoring certain undertakings or the production of goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.” (Footnote 1)
In the Apple case, the Commission demanded that $14.5 billion of unpaid taxes in Ireland accumulated from 2004-2014 be paid to the Irish government. The Commission’s investigation determined that Ireland gave illegal tax benefits in 1991 and 2007 that allowed Apple to pay annual tax rates in Ireland of between 0.005% and 1% on its European profits, by designating a small portion of its profit as taxable in Ireland. Apple was thereby able to avoid taxation on almost all profits generated by sales of products in the EU. These illegal benefits were sanctioned by APAs with the Irish government with regard to what profits were reportable in Ireland. The Commission stated that the APAs granted to Apple were illegal under EU state aid rules because they allowed Apple to pay substantially less than other businesses.
The consequences of the Commission’s State Aid Investigation assessments are far-reaching, both for the U.S. government and U.S. companies. As noted in the U.S. Department of the Treasury White Paper on the topic:
- The Commission’s actions undermine OECD’s and the United States’ efforts to develop transfer pricing norms through the OECD/G20 Base Erosion and Profit Shifting (“BEPS”) project.
- Repayments to Member States ordered by the Commission will be considered foreign tax credits, thereby transferring deferred U.S. revenue to the EU from the U.S. government and its taxpayers.
- The Commission has suggested that it is still evaluating other tax rulings and may initiate more cases, which could lead to a chilling effect on U.S. – EU cross border investment.
- The new anticompetitive enforcement regime is adopted retroactively and sets an unwelcome precedent for tax authorities around the world to take similar retroactive actions.
Despite the recent developments resulting from the EU antitrust regulator, MNEs still must consider the existing OECD transfer pricing guidelines and U.S. Treasury regulations to support and document transfer pricing policies. Whether the accepted methodologies for determining and reporting the arm’s length standard will withstand the regulatory adjustments remains to be seen, as most of the Member State governments involved are appealing through the courts, and the companies maintain they have complied with the law.
Recent Efforts to Develop Transfer Pricing Norms
There has been an ongoing public debate based upon the perception that international tax planning by MNE’s allows firms to pay less than their fair share of taxes on global income. Pursuant to a directive from the G20, the OECD initiated the BEPS project in 2012. The OECD developed a list of 15 action items to deal with this perceived global tax base erosion and profit shifting. The project aimed to minimize tax revenue losses by closing existing “loopholes” and realigning taxation with “real economic activity.”
In October 2015, the OECD released and the G20 endorsed its final report on each of the 15 BEPS action items, including action item 13. Under action item 13, the OECD published revised standards for transfer pricing documentation, including countryby- country (“CbC”) reporting. Action item 13 sets forth a three-tier approach for transfer pricing documentation that includes a framework for a master file, a local file and CbC report which incorporates a template. The new documentation requirements are designed to increase global transparency in transfer pricing. The master file provides an overview of the MNE. The local file includes a detailed transfer pricing study and a group organization chart, as well as the taxpayer’s financial statements. The CbC report requires basic items of financial data in each country where an MNE is organized. Specifically, MNEs must provide information on revenues, profits and taxes accrued and paid, in addition to other activity indicators such as the number of employees in each jurisdiction. All of the information is filed in the MNE’s primary country of residence and will be automatically exchanged with countries meeting certain conditions, in particular confidentiality and proper use of the information.
The new reporting package is required of MNE’s with global revenues in excess of 750 million euro and will be required to be filed for years beginning January 1, 2016.
United States Treasury Developments
On June 29, 2016, the U.S. Treasury Department and Internal Revenue Service (“IRS”) released final regulations that align U.S. transfer pricing reporting requirements with those recommended by the OECD. Similar to the OECD’s BEPS action item 13, the U.S. regulations require documentation that includes the CbC reporting.
The finalized regulations apply to businesses that are ultimate parents of a U.S. MNE group with an annual revenue of at least $850 million. An ultimate parent entity of a U.S. MNE group is defined as a U.S. entity that controls a group of business entities, at least one of which is organized or is a tax resident outside of the United States; that are required to consolidate their accounts for financial reporting purposes under U.S. GAAP; or that would be required to consolidate their accounts if equity interests in the U.S. business entity were publicly traded on a U.S. securities exchange.
Based on the final regulations, new Form 8975 (yet to be released) will have three sections: (i) constituent entity information; (ii) financial and employee information by tax jurisdiction; and (iii) additional information.
Form 8975 will require the ultimate parent entity to report the following for each foreign entity:
- Complete legal name of the constituent entity.
- Tax jurisdiction in which the entity is organized or incorporated, if different from the tax jurisdiction of residence.
- Tax identification number, if any, used by the tax administration in the entity’s jurisdiction of tax residence.
- Main business activity or activities of the constituent entity.
These requirements are consistent with the OECD’s BEPS action item 13.
The following financial and employee information will be required to be reported on Form 8975:
- Revenues generated from transactions with other constituent entities.
- Revenues not generated from transactions with other constituent entities.
- Profit or loss before income tax.
- Total income tax paid on a cash basis to all tax jurisdictions, and any taxes withheld on payments received by the constituent entities.
- Total accrued tax expense recorded on taxable profits or losses, reflecting only operations in the relevant annual period and excluding deferred taxes or provisions for uncertain tax liabilities.
- Stated capital.
- Total accumulated earnings.
- Total number of employees on a full-time equivalent basis.
- Net book value of tangible assets. In addition to the above information, Form 8975 will have an “Additional Information” section.
Under the final regulations, the CbC reporting requirement applies to reporting periods of ultimate parent entities of U.S. MNE groups that begin on or after the first day of a tax year of the ultimate parent entity that begins on or after June 30, 2016. This differs from the OECD recommendation that CbC reporting apply to fiscal years beginning on or after January 1, 2016, and creates the potential for foreign entities of U.S. MNE groups with fiscal years beginning January 1, 2016, through June 30, 2016, to be subject to secondary CbC reporting requirements in foreign jurisdictions. To address this transition-year issue, the final regulations state that the U.S. Treasury and the IRS intend to allow voluntary filing, or “parent surrogate filing,” of the CbC report with the IRS and subsequent exchange with foreign jurisdictions based on a procedure to be defined in forthcoming guidance.
Countries that adopted the CbC reporting requirements for periods earlier than the U.S. would require a U.S.-based MNE’s subsidiary to file a CbC report on behalf of the MNE group if it’s a tax resident of that country. The OECD released guidance to address this issue on June 29, 2016.
Will CbC reporting alter the way MNEs conduct business?
The new CbC reporting requirements include much more detail on the overall operations of MNEs and on the locations where their profits are generated. This reflects the emphasis on the concept of value creation stemming from the BEPS project and the intent of monitoring whether operations are separated from the location where profits are accrued/reported. The IRS has indicated that it will use the CbC report as a tool to assess risk.
As such, MNEs should consider what information is required to fulfill the new requirements and the story their documentation will tell when read and analyzed together, once provided to or filed with various tax authorities. In addition, MNEs should consider questions that could be raised regarding their value chain and how this ties out with the CbC report details for those countries. A value chain analysis is now a more vital tool because it provides companies with a means of defending their transfer pricing. It may be especially useful under the new CbC reporting requirements.
How Marcum Can Help
Given the changes in the transfer pricing world, now is a good time to evaluate the need for transfer pricing advice and related services.
Marcum LLP provides transfer pricing services to clients in multiple industries and jurisdictions. Services provided are in accordance with existing laws and regulations including:
- Planning – Assistance in developing economically supportable transfer pricing policies and executing sustainable tax planning with effective tax rate benefits.
- Documentation and Compliance.
- Implementation – Providing advice on developing and implementing policies, procedures and systems for setting, monitoring and documenting intercompany transactions.
- Dispute resolution.
For international organizations engaged in transfer pricing, the best defense is to perform adequate research and build a strategy early to anticipate and manage new laws and regulations. Marcum LLP can provide insight to the changing requirements in multiple jurisdictions.