Many tax professionals think the United States could have taken the lead in reforming the area of tax reporting by U.S. multinational entities (MNEs). Instead, the Treasury Department and the IRS chose to basically copy the Organisation for Economic Co-operation and Development’s country-by-country (CbC) rules as a way to make sure U.S. MNEs are not doing anything wrong. Transfer pricing has no one right answer. Nonetheless, with these regulations, tax professionals must put down an answer, or take a position, on a return. This comes without any advancement in substantive provisions and leaves fundamental issues unaddressed, such as the high U.S. corporate tax rate, a broad U.S. tax base, and dated transfer pricing rules for intercompany tangible, intangible and financial transactions, which have been in place for at least 20 years. There was no white paper or other comprehensive analysis or study before the proposed rules were announced.
Improvements to the U.S. transfer pricing rules should perhaps include updated rules for intercompany transfers of intangibles, intercompany financial transactions (e.g., loans, guarantees, etc.), updated rules for taxpayer-initiated transfer pricing self-corrections, a regime that is less penalty-driven, and a forms-based approach for all MNEs.
Strategic document and a big influence
CbC reports are, in substance, a strategic document, not merely a reporting form or a template. That is true regardless of the jurisdiction or format. In every case, the information that an MNE must put down is designed to identify key facts or situations that could potentially lead a tax authority to conclude that the taxpayer has not achieved arm’s length results for its transactions. This would, could and probably should influence corporate behavior, in which case the reports become more than simply reporting/disclosure forms, but strategic documents in corporate governance.
See Massaging the knots of country-by-country reporting
The proposed regulations seem to have been promulgated with little or no regard for the existing regime, under which taxpayers are not required to perform a study but many (or most) do, either for penalty protection or to use best efforts to determine the “correct price” (which is the penalty regulation language). One could reasonably question why a documentation study and separate penalty regime are necessary, given that a taxpayer required to file “Form XXXX” is under a different standard and regime (i.e., a forms-based reporting regime). Is there a need for a separate study? For those under the threshold, this creates a logic box situation, since the IRS, in an information document request process, could simply ask for the same information that otherwise would be required.
Robert Stack, Treasury’s deputy assistant secretary of international tax affairs, not long ago noted that Treasury intended the rules to provide flexibility and judgment. Taxpayers have argued that flexibility and judgment can also lead to confusion and possibly unintentional errors. Treasury also noted uncertainty within the rules in terms of reporting for private equity and pension funds, which was one reason the regulations were not issued in final or temporary form. Some tax professionals have speculated that as the rules are written, private equity groups with several foreign portfolio companies in a single fund may face significant implementation issues. Everyone seems to wish Treasury would address a key concern: If the United States does not require reporting information in 2016, but a non-U.S. tax authority does require it and posts it, the cat is out of the bag. Do we need treaty exchange provisions to be enacted if the information is already out there for all to see?
See Stack’s comments on gap-year issues in How US country-by-country reporting came to be
A brave new world
We are standing on the edge of a brave new world of transparency. How will this new era affect corporations’ interactions with tax authorities? If a corporation is under the reporting threshold, it may not stay there. If it is on the cusp, it may be excluded or included based on exchange rates or other ancillary factors — then what does it do? It may be required to file and not even know it.
With such uncertainty, U.S. MNEs need to know their business inside out. They should assess information requirements and determine constituent entities and respective jurisdictions where entities are subject to income tax.
They should know revenue, profit/loss before income taxes, stated capital, accumulated earnings, accrued income taxes paid, certain related party transactions (and what constitutes a related party), tangible assets and their main business activity, with substantiating documentation and the ability to reconcile such information to financial statements and/or income tax returns.
They should also know the number of employees and how that is calculated and pertains to value, permanent establishments, cash tax paid, tax residency information and the identification numbers of constituent entities.
U.S. MNEs should evaluate the capabilities of their data and software systems, and identify and close information gaps. They may also want to prepare a mock CbC report to find holes and make adjustments before they have to complete an actual report. Knowing as much as possible and being proactive are almost always better than reacting under a filing deadline.
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