Ready or not, new regulations on country-by-country (CbC) reporting are coming.
The Treasury Department projects that U.S. proposed regulations will be finalized on June 30, to apply for tax years beginning in 2017. The proposed regulations will require annual CbC reporting by U.S. business entities that are the ultimate parent entity (UPE) of a U.S. multinational entity (MNE), essentially copying the template form and many of the definitional rules set by the Organisation for Economic Co-operation and Development (OECD).
A forms-based reporting regime, temporarily described as “Form XXXX” in the proposed regulations, is one of the most significant aspects of the base erosion and profit shifting (BEPS) action taken by the OECD. Ideally, this approach ensures that tax administrations obtain a complete understanding of the way U.S. MNEs structure their global operations — enabling global transparency — yet tax professionals worry the method could result in an audit roadmap for tax examiners.
Due dates could present tricky timing issues. The U.S. report will be due with a timely filed federal income tax return, including extensions, which in a given year would be Sept. 15 for calendar-year U.S. taxpayers. However, the OECD guidelines require the report to be filed 12 months after the UPE’s year-end. This means certain information, such as statutory reports, may not be available by the earlier U.S. deadline. This also means foreign subsidiaries may be required to report 2016 information in local jurisdictions under secondary mechanisms during transition years, as the proposed regulations are currently not effective. See How US country-by-country reporting came to be
for gap-year comments by Robert Stack, Treasury’s deputy assistant secretary for international tax affairs. A discussion on preparing for the rules is available here
Defining an ultimate parent
The final regulations will require a UPE of a U.S. MNE group to file if the annual revenue of the U.S. MNE group for the immediately preceding annual accounting period is $850 million USD or more. Treasury estimates 1,600 to 1,800 U.S. taxpayers could be affected.
A U.S. business entity is the UPE of a U.S. MNE group if it:
Owns directly or indirectly a sufficient interest in one or more non-U.S. business entities such that it would be required to consolidate the accounts of the other business entities with its own accounts under U.S. GAAP
Is not owned directly or indirectly by another business entity that consolidates the accounts of the U.S. business entity with its own accounts
A business entity is broadly defined and includes partnerships, permanent establishments and disregarded entities (DREs). Form XXXX requires that information for constituent entities — separate business entities required to be consolidated with the UPE under U.S. GAAP — be aggregated by jurisdiction. A constituent entity does not include foreign corporations or foreign partnerships that are not controlled foreign corporations or controlled foreign partnerships of the UPE.
Confusion could reign
One of the bigger areas of confusion is determining how and if the rules apply. Here are two examples.
Two otherwise unrelated consolidated groups of corporations are held by a domestic partnership. In this structure, the partnership may be considered the UPE. Assuming one consolidated group of corporations has $750 million in revenue while the other has $250 million in revenue, these entities may have to combine and report under the new rules. Otherwise, the two groups of corporations may never have been subject to combined income tax reporting, and practically speaking, they may have separate and distinct international operations.
A purely domestic company has de minimis branch operations in Canada. The Canadian branch is not a legal entity but a permanent establishment. Now that the company is taxable in more than one jurisdiction, it has to start filing CbC reports (assuming it also satisfies the other requirements (e.g., the revenue threshold).
Defining a permanent establishment is itself an issue. Permanent establishment rules are subjective in nature, which leads to uncertainty. For example, the presence of one employee, who is not always in a particular location, nonetheless may create one or more permanent establishments in certain circumstances.
What goes into a CbC report?
An abundance of consolidated financial information goes into a CbC report and is required on a jurisdiction-by-jurisdiction basis: revenue from unrelated and related parties, profit before income tax, income tax paid (on a cash basis) and accrued, stated capital, accumulated earnings, the number of employees, and tangible assets other than cash and cash equivalents. A U.S. MNE also has to report its principal business activity for each constituent entity.
A tax professional has to determine if the CbC information will be aggregated based on a “bottoms up” approach, using local country statutory financial statements, or a “top down” approach, using U.S. GAAP information.
A tax professional should think through the reasoning behind the information reported. A tax examiner might see a tight link between the number of employees and the reported income or gross sales in an effort to align substance with profitability levels. Yet a “boots on the ground” approach is not always realistic in the real world of business, where tremendous value can be created by a limited number of people using technology.
This new world of tax transparency
under the rules could be viewed as a way to promote tax equality and give all countries their fair share. It also could be viewed as a way for tax examiners to more easily audit U.S.-based MNEs. Whatever the result, and whatever their final form, the rules are coming and taxpayers need to educate themselves and be prepared.
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