Transfer Pricing Documentation – Country by Country Reporting – An Overview

Synopsis1. Introduction2. Objectives of transfer pricing documentation requirements3. A three-tiered approach to transfer pricing documentation4. Country-by-Country Reporting Implementation Package5. Recent Developments in India6. Conclusion

1.       Introduction

1.1 International tax issues have never been as high on the political agenda as they are today. The integration of national economies and markets has increased substantially in recent years, putting a strain on the international tax rules, which were designed more than a century ago. Weaknesses in the current international taxation rules create opportunities for BEPS, requiring bold moves by policy makers to restore confidence in the system and ensure that profits are taxed where economic activities take place and value is created.

Following the release of the report Addressing Base Erosion and Profit Shifting in February 2013, OECD and G20 countries adopted a 15-point Action Plan to address BEPS in September 2013. The Action Plan identified 15 actions along three key pillars:

a) introducing coherence in the domestic rules that affect cross-border activities,

b) reinforcing substance requirements in the existing international standards, and

c) improving transparency as well as certainty.

1.2 So far, prior to the release of reports on Action 8-10 Aligning Transfer pricing Outcomes with Value Creation and Action 13 – TP Documentation and Country-by-Country, the OECD TP Guidelines for MNEs and Tax Administrations issued in July 2010, has been a major source of guidance on the TP issues to the MNEs and Tax Administrations.

1.3 Significant changes are proposed in OECD TP Guidelines, 2010, by Action 8-10 Aligning Transfer pricing Outcomes with Value Creation and Action 13 – TP Documentation and Country-by-Country Reporting, the summarised details of which are as follows:

It is expected that a new version of OECD TP Guidelines for MNEs and Tax Administrations would be issued by OED before the end of the year 2016, incorporating the changes suggested in the BEPS Reports on Action 8-10 Aligning Transfer pricing Outcomes with Value Creation and Action 13 – TP Documentation and Country-by-Country Reporting.

1.4   Implementation therefore becomes key at this stage. The BEPS package is designed to be implemented via changes in domestic law and practices, and via treaty provisions, with negotiations for a multilateral instrument are under way and expected to be finalised in 2016. OECD and G20 countries have also agreed to continue to work together to ensure a consistent and co-ordinated implementation of the BEPS recommendations. Globalisation requires that global solutions and a global dialogue be established which go beyond OECD and G20 countries. To further this objective, in 2016 OECD and G20 countries are preparing an inclusive framework for monitoring, with all interested countries participating on an equal footing.

A better understanding of how the BEPS recommendations are implemented in practice could reduce misunderstandings and disputes between governments. Greater focus on implementation and tax administration should therefore be mutually beneficial to governments and business. Proposed improvements to data and analysis will help support ongoing evaluation of the quantitative impact of BEPS, as well as evaluating the impact of the countermeasures developed under the BEPS Project.

BEPS Action 13 report contains revised standards for TP documentation and a template for Country-by-Country [CbC] Reporting of income, taxes paid and certain measures of economic activity.

1.5 Action 13 of the Action Plan on Base Erosion and Profit Shifting requires the development of “rules regarding TP documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business. The rules to be developed will include a requirement that MNEs provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template”. In response to this requirement, a three-tiered standardised approach to TP documentation has been developed.

First, the guidance on TP documentation requires MNEs to provide tax administrations with high-level information regarding their global business operations and TP policies in a “master file” that is to be available to all relevant tax administrations.

Second, it requires that detailed transactional TP documentation be provided in a “local file” specific to each country, identifying material related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions.

Third, large MNEs are required to file a CbC Report that will provide annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax and income tax paid and accrued. It also requires MNEs to report their number of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction. Finally, it requires MNEs to identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in.

Taken together, these three documents (master file, local file and CbC Report) will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess TP risks, make determinations about where audit resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries.

1.6  This information should make it easier for tax administrations to identify whether companies have engaged in transfer pricing and other practices that have the effect of artificially shifting substantial amounts of income into tax-advantaged environments. The countries participating in the BEPS project agree that these new reporting provisions, and the transparency they will encourage, will contribute to the objective of understanding, controlling, and tackling BEPS behaviours.

The specific content of the various documents reflects an effort to balance tax administration information needs, concerns about inappropriate use of the information, and the compliance costs and burdens imposed on business. Some countries would strike that balance in a different way by requiring reporting in the CbC Report of additional transactional data (beyond that available in the master file and local file for transactions of entities operating in their jurisdictions) regarding related party interest payments, royalty payments and especially related party service fees. Countries expressing this view are primarily those from emerging markets (Argentina, Brazil, People’s Republic of China, Colombia, India, Mexico, South Africa, and Turkey) who state they need such information to perform risk assessment and who find it challenging to obtain information on the global operations of an MNE group headquartered elsewhere. Other countries expressed support for the way in which the balance has been struck in BEPS Action 13 report. Taking all these views into account, it is mandated that countries participating in the BEPS project will carefully review the implementation of these new standards and will reassess no later than the end of 2020 whether modifications to the content of these reports should be made to require reporting of additional or different data.

1.7   Consistent and effective implementation of the TP documentation standards and in particular of the CbC Report is essential. Therefore, countries participating in the OECD/G20 BEPS Project agreed on the core elements of the implementation of TP documentation and CbC Reporting. This agreement calls for the master file and the local file to be delivered by MNEs directly to local tax administrations. CbC Reports should be filed in the jurisdiction of tax residence of the ultimate parent entity and shared between jurisdictions through automatic exchange of information, pursuant to government-to-government mechanisms such as the multilateral Convention on Mutual Administrative Assistance in Tax Matters, bilateral tax treaties or tax information exchange agreements (TIEAs). In limited circumstances, secondary mechanisms, including local filing can be used as a backup.

These new CbC Reporting requirements are to be implemented for fiscal years beginning on or after 1 January 2016 and apply, subject to the 2020 review, to MNEs with annual consolidated group revenue equal to or exceeding EUR 750 million. It is acknowledged that some jurisdictions may need time to follow their particular domestic legislative process in order to make necessary adjustments to their local law.

1.8 In order to facilitate the implementation of the new reporting standards, an implementation package has been developed consisting of model legislation which could be used by countries to require MNE groups to file the CbC Report and competent authority agreements that are to be used to facilitate implementation of the exchange of those reports among tax administrations. As a next step, it is intended that an XML Schema and a related User Guide will be developed with a view to accommodating the electronic exchange of CbC Reports.

It is recognised that the need for more effective dispute resolution may increase as a result of the enhanced risk assessment capability following the adoption and implementation of a CbC Reporting requirement. This need has been addressed when designing government-to-government mechanisms to be used to facilitate the automatic exchange of CbC Reports.

Jurisdictions endeavour to introduce, as necessary, domestic legislation in a timely manner. They are also encouraged to expand the coverage of their international agreements for exchange of information. Mechanisms will be developed to monitor jurisdictions’ compliance with their commitments and to monitor the effectiveness of the filing and dissemination mechanisms. The outcomes of this monitoring will be taken into consideration in the 2020 review.

2.       Objectives of transfer pricing documentation requirements

3.       A three-tiered approach to transfer pricing documentation

3.1   This approach to TP documentation will provide tax administrations with relevant and reliable information to perform an efficient and robust TP risk assessment analysis. It will also provide a platform on which the information necessary for an audit can be developed and provide taxpayers with a means and an incentive to meaningfully consider and describe their compliance with the arm’s length principle in material transactions.

     (i)            Master file

The master file should provide an overview of the MNE group business, including the nature of its global business operations, its overall TP policies, and its global allocation of income and economic activity in order to assist tax administrations in evaluating the presence of significant TP risk. In general, the master file is intended to provide a high-level overview in order to place the MNE group’s TP practices in their global economic, legal, financial and tax context. It is not intended to require exhaustive listings of minutiae (e.g. a listing of every patent owned by members of the MNE group) as this would be both unnecessarily burdensome and inconsistent with the objectives of the master file. In producing the master file, including lists of important agreements, intangibles and transactions, taxpayers should use prudent business judgment in determining the appropriate level of detail for the information supplied, keeping in mind the objective of the master file to provide tax administrations a high-level overview of the MNE’s global operations and policies. When the requirements of the master file can be fully satisfied by specific cross-references to other existing documents, such cross references, together with copies of the relevant documents, should be deemed to satisfy the relevant requirement. For purposes of producing the master file, information is considered important if its omission would affect the reliability of the TP outcomes.

The information required in the master file provides a “blueprint” of the MNE group and contains relevant information that can be grouped in five categories:

            a)   The MNE group’s organisational structure;

            b)  A description of the MNE’s business or businesses;

            c)  The MNE’s intangibles;

            d)  The MNE’s intercompany financial activities; and

            e)  The MNE’s financial and tax positions.

Taxpayers should present the information in the master file for the MNE as a whole. However, organisation of the information presented by line of business is permitted where well justified by the facts, e.g. where the structure of the MNE group is such that some significant business lines operate largely independently or are recently acquired. Where line of business presentation is used, care should be taken to assure that centralised group functions and transactions between business lines are properly described in the master file. Even where line of business presentation is selected, the entire master file consisting of all business lines should be available to each country in order to assure that an appropriate overview of the MNE group’s global business is provided.

   (ii)            Local file

In contrast to the master file, which provides a high-level overview, the local file provides more detailed information relating to specific intercompany transactions. The information required in the local file supplements the master file and helps to meet the objective of assuring that the taxpayer has complied with the arm’s length principle in its material TP positions affecting a specific jurisdiction. The local file focuses on information relevant to the TP analysis related to transactions taking place between a local country affiliate and associated enterprises in different countries and which are material in the context of the local country’s tax system. Such information would include relevant financial information regarding those specific transactions, a comparability analysis, and the selection and application of the most appropriate TP method. Where a requirement of the local file can be fully satisfied by a specific cross-reference to information contained in the master file, such a cross-reference should suffice.

 (iii)            Country-by-Country Report

The CbC Report requires aggregate tax jurisdiction-wide information relating to the global allocation of the income, the taxes paid, and certain indicators of the location of economic activity among tax jurisdictions in which the MNE group operates. The report also requires a listing of all the Constituent Entities for which financial information is reported, including the tax jurisdiction of incorporation, where different from the tax jurisdiction of residence, as well as the nature of the main business activities carried out by that Constituent Entity.

3.2   The CbC Report will be helpful for high-level TP risk assessment purposes. It may also be used by tax administrations in evaluating other BEPS related risks and where appropriate for economic and statistical analysis. However, the information in the CbC Report should not be used as a substitute for a detailed TP analysis of individual transactions and prices based on a full functional analysis and a full comparability analysis. The information in the Country-by- Country Report on its own does not constitute conclusive evidence that transfer prices are or are not appropriate. It should not be used by tax administrations to propose TP adjustments based on a global formulary apportionment of income.

4.       Country-by-Country Reporting Implementation Package

4.1   Countries participating in the OECD/G20 BEPS Project have therefore developed an implementation package for government-to-government exchange of CbC Reports.

More specifically:

Model legislation requiring the ultimate parent entity of an MNE group to file the CbC Report in its jurisdiction of residence has been developed. Jurisdictions will be able to adapt this model legislation to their own legal systems, where changes to current legislation are required. Key elements of secondary mechanisms have also been developed.

Implementing arrangements for the automatic exchange of the CbC Reports under international agreements have been developed, incorporating the suggested conditions. Such implementing arrangements include competent authority agreements (“CAAs”) based on existing international agreements (the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, bilateral tax treaties and TIEAs) and inspired by the existing models developed by the OECD working with G20 countries for the automatic exchange of financial account information.

4.2   Participating jurisdictions endeavour to introduce as necessary domestic legislation in a timely manner. They are also encouraged to expand the coverage of their international agreements for exchange of information. The implementation of the package will be monitored on an ongoing basis. The outcomes of this monitoring will be taken into consideration in the 2020 review.

5.       Recent Developments in India – Amendments by the Finance Act, 2016

5.1   The Finance Act, 2016 has inserted section 286 relating to furnishing of report in respect of international group by every parent entity or the alternate reporting entity resident in India, on or before the due date specified u/s 139(1) of the income-tax act, 1961, in the Form and manner, yet to be prescribed. This section is effective from 1-4-17 i.e. assessment year 2017-18 and subsequent years.

Further, new section 271GB has been inserted wef 1-4-17 i.e. assessment year 2017-18 and subsequent years relating to penalty for failure to furnish report or for furnishing inaccurate report u/s 286.

In addition, section 271AA of the Act relating to penalty for failure to keep and maintain information and document etc. has been amended to provide that if any person being constituent entity of an international group referred to in section 286 fails to furnish the information and document in accordance with provisions of section 92D, then, the prescribed authority may direct that such person shall be liable to pay a penalty of Rs. 5,00,000/-.

5.2   Background as explained in Explanatory memorandum explaining provisions of the Finance Bill, 2016, is as follows:

“BEPS action plan – Country-By-Country Report and Master file

Sections 92 to 92F of the Act contain provisions relating to transfer pricing regime. Under provision of section 92D, there is requirement for maintenance of prescribed information and document relating to the international transaction and specified domestic transaction.

The OECD report on Action 13 of BEPS Action plan provides for revised standards for transfer pricing documentation and a template for country-by-country reporting of income, earnings, taxes paid and certain measure of economic activity. India has been one of the active members of BEPS initiative and part of international consensus. It is recommended in the BEPS report that the countries should adopt a standardised approach to transfer pricing documentation. A three-tiered structure has been mandated consisting of:-

(i)     a master file containing standardised information relevant for all multinational enterprises (MNE) group members;

(ii)    a local file referring specifically to material transactions of the local taxpayer; and

(iii)   a country-by-country report containing certain information relating to the global allocation of the MNE’s income and taxes paid together with certain indicators of the location of economic activity within the MNE group.

The report mentions that taken together, these three documents (country-by-country report, master file and local file) will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess transfer pricing risks. It will facilitate tax administrations to make determinations about where their resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries.

The country-by-country report requires multinational enterprises (MNEs) to report annually and for each tax jurisdiction in which they do business; the amount of revenue, profit before income tax and income tax paid and accrued. It also requires MNEs to report their total employment, capital, accumulated earnings and tangible assets in each tax jurisdiction. Finally, it requires MNEs to identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in. The Country-by-Country (CbC) report has to be submitted by parent entity of an international group to the prescribed authority in its country of residence. This report is to be based on consolidated financial statement of the group.

The master file is intended to provide an overview of the MNE groups business, including the nature of its global business operations, its overall transfer pricing policies, and its global allocation of income and economic activity in order to assist tax administrations in evaluating the presence of significant transfer pricing risk. In general, the master file is intended to provide a high-level overview in order to place the MNE group’s transfer pricing practices in their global economic, legal, financial and tax context. The master file shall contain information which may not be restricted to transaction undertaken by a particular entity situated in particular country. In that aspect, information in master file would be more comprehensive than the existing regular transfer pricing documentation. The master file shall be furnished by each entity to the tax authority of the country in which it operates.

In order to implement the international consensus, it is proposed to provide a specific reporting regime in respect of CbC reporting and also the master file. It is proposed to include essential elements in the Act while remaining aspects can be detailed in rules. The elements relating to CbC reporting requirement and matters related to it proposed to be included through amendment of the Act are:

          (i) the reporting provision shall apply in respect of an international group havingconsolidated revenue above a threshold to be prescribed.

            (ii) the parent entity of an international group, if it is resident in India shall berequired to furnish the report in respect of the group to the prescribed authority on or before the due date of furnishing of return of income for the Assessment Year relevant to the Financial Year (previous year) for which the report is being furnished;

               (iii)  the parent entity shall be an entity which is required to prepare consolidated financial statement under the applicable laws or would have been required to prepare such a statement, had equity share of any entity of the group been listed on a recognized stock exchange in India;

               (iv)  every constituent entity in India, of an international group having parent entity that is not resident in India, shall provide information regarding the country or territory of residence of the parent of the international group to which it belongs. This information shall be furnished to the prescribed authority on or before the prescribed date;

                (v) the report shall be furnished in prescribed manner and in the prescribed form and would contain aggregate information in respect of revenue, profit & loss before Income-tax, amount of Income-tax paid and accrued, details of capital, accumulated earnings, number of employees, tangible assets other than cash or cash equivalent in respect of each country or territory along with details of each constituent’s residential status, nature and detail of main business activity and any other information as may be prescribed. This shall be based on the template provided in the OECD BEPS report on Action Plan 13;

              (vi)  an entity in India belonging to an international group shall be required to furnish CbC report to the prescribed authority if the parent entity of the group is resident;-

(a)   in a country with which India does not have an arrangement for exchange of the CbC report; or

(b)   such country is not exchanging information with India even though there is an agreement; and

(c)    this fact has been intimated to the entity by the prescribed authority;

             (vii)  If there are more than one entities of the same group in India, then the group can nominate (under intimation in writing to the prescribed authority) the entity that shall furnish the report on behalf of the group. This entity would then furnish the report;

           (viii) If an international group, having parent entity which is not resident in India, had designated an alternate entity for filing its report with the tax jurisdiction in which the alternate entity is resident, then the entities of such group operating in India would not be obliged to furnish report if the report can be obtained under the agreement of exchange of such reports by Indian tax authorities;

              (ix)  The prescribed authority may call for such document and information from the entity furnishing the report for the purpose of verifying the accuracy as it may specify in notice. The entity shall be required to make submission within thirty days of receipt of notice or further period if extended by the prescribed authority, but extension shall not be beyond 30 days;

                (x)  For non-furnishing of the report by an entity which is obligated to furnish it, a graded penalty structure would apply:-

(a)   if default is not more than a month, penalty of Rs. 5000/- per day applies;

(b)   if default is beyond one month, penalty of Rs. 15000/- per day for the period exceeding one month applies;

(c)    for any default that continues even after service of order levying penalty either under (a) or under (b), then the penalty for any continuing default beyond the date of service of order shall be @ Rs. 50,000/- per day;

              (xi) In case of timely non-submission of information before prescribed authority when called for, a penalty of Rs. 5,000/- per day applies. Similar to the above, if default continues even after service of penalty order, then penalty of Rs. 50,000/- per day applies for default beyond date of service of penalty order;

              (xii) If the entity has provided any inaccurate information in the report and,-

(a)   the entity knows of the inaccuracy at the time of furnishing the report but does not inform the prescribed authority; or

(b)   the entity discovers the inaccuracy after the report is furnished and fails to inform the prescribed authority and furnish correct report within a period of fifteen days of such discovery; or

(c)    the entity furnishes inaccurate information or document in response to notice of the prescribed authority, then penalty of Rs. 500,000/- applies;

         (xiii)The entity can offer reasonable cause defence for non-levy of penalties mentioned above.

The proposed amendment in the Act in respect of maintenance of master file and furnishing it are: –

(i)    the entities being constituent of an international group shall, in addition to the information related to the international transactions, also maintain such information and document as is prescribed in the rules. The rules shall thereafter prescribe the information and document as mandated for master file under OECD BEPS Action 13 report;

(ii)   the information and document shall also be furnished to the prescribed authority within such period as may be prescribed and the manner of furnishing may also be provided for in the rules;

(iii)  for non-furnishing of the information and document to the prescribed authority, a penalty of Rs. 5 lakh shall be leviable. However, reasonable cause defence against levy of penalty shall be available to the entity.

As indicated above, the CbC reporting requirement for a reporting year does not apply unless the consolidated revenues of the preceding year of the group, based on consolidated financial statement, exceeds a threshold to be prescribed. The current international consensus is for a threshold of € 750 million equivalent in local currency. This threshold in Indian currency would be equivalent to Rs. 5395 crores (at current rates). Therefore, CbC reporting for an international group having Indian parent, for the previous year 2016-17, shall apply only if the consolidated revenue of the international group in previous year 2015-16 exceeds Rs. 5395 crore (the equivalent would be determinable based on exchange rate as on the last day of previous year 2015-16). …..”

5.3   Section 286 of the Act relating to furnishing of report in respect of international group provides for furnishing of a report in respect of an international group, if the parent entity of the group is resident in India.

Sub-section (1) provides that constituent entity in India of an international group, not having a parent entity resident in India shall notify the prescribed authority regarding the parent entity of the group to which it belongs or an alternate reporting entity which shall furnish the report on behalf of the group in the prescribed manner.

Sub-section (2) provides that the parent entity of an international group, which is resident in India, shall furnish a report in respect of the international group on or before due date specified under sub-section (1) of section 139 for furnishing of return of income of the relevant accounting year.

Sub-section (3) provides for the details to be contained in the report to be furnished. It, inter alia, provides that the report shall contain aggregate information in respect of amount of revenues, profit and loss, taxes accrued and paid, number of employees, details of constituent entities and the country or territory in which such entities are resident or located.

Sub-section (4) provides for furnishing report by entities resident in India and belonging to an international group not headed by Indian resident entity.

Sub-section (5) provides for circumstances under which the constituent entities referred to in sub-section (4) shall not be required to furnish the report.

Sub-section (6) provides that the prescribed authority may, by issuance of notice for the purpose of verifying the accuracy of the report furnished by any entity, require submission of information and document as specified in the notice.

Sub-section (7) provides that the reporting requirement under this section shall not apply to an accounting year, if the total consolidated group revenue for the accounting year preceding it, does not exceed the prescribed threshold.

Sub-section (8) provides for application of the section in accordance with such guidelines and subject to such conditions as may be prescribed.

Sub-section (9) of the proposed new section, inter alia, defines various terms for the purposes of the new section.

5.4   The new section at 5 places makes reference to ‘as may be prescribed’ in respect of form, manner and date of notification, form and manner of report to be submitted, other information to be included in the report, threshold limit of total consolidated group revenue for application of section and other guidelines and conditions for application of section. However, so far no rules have been prescribed in respect of section 286.

5.5   However, as mentioned in the Explanatory Memorandum, CbC reporting for an international group having Indian parent, for the previous year 2016-17, shall apply only if the consolidated revenue of the international group in previous year 2015-16 exceeds Rs. 5,395 crore (the equivalent would be determinable based on exchange rate as on the last day of previous year 2015-16).

6.       Conclusion

6.1   So far 44 countries have signed the Multilateral Competent Authority Agreement (MCAA) on CbC reporting including India.

In addition, on 16 August 2016 OECD has issued further Guidance on the Implementation of Country-by-Country reporting. This guidance covers the following issues:

               (i)  Transitional filing options for MNEs (“parent surrogate filing”).

              (ii) The application of CbC reporting to investment funds.

              (iii)The application of CbC reporting to partnerships.

              (iv) The impact of currency fluctuations on the agreed EUR 750 million filing threshold.

6.2   Countries have agreed that implementing CbC reporting is a key priority in addressing BEPS risks, and the Action 13 Report recommended that reporting take place with respect to fiscal periods commencing from 1 January 2016. Swift progress is being made in order to meet this timeline, including the introduction of domestic legal frameworks and the entry into competent authority agreements for the international exchange of CbC reports. MNE Groups are likewise making preparations for CbC reporting, and dialogue between governments and business is a critical aspect of ensuring that CbC reporting is implemented consistently across the globe. Consistent implementation will not only ensure a level playing field, but also provide certainty for taxpayers and improve the ability of tax administrations to use CbC reports in their risk assessment work.

[We have extensively relied upon final report on ‘Action 13 – Transfer Pricing Documentation and Country-by-Country Reporting’ and ‘Guidance on the Implementation of Country-by-Country Reporting’ issued by OECD in August, 2016, and the Memorandum Explaining the Finance Bill, 2016, in preparing the above article giving an overview of the subject.]

***