Elena Khripounova is the Director of Transfer Pricing and Valuation Services in the Washington, D.C. office of Mayer Brown, with almost 20 years of transfer pricing, valuation, and general quantitative analysis experience, including over 19 years with Mayer Brown. Ms. Khripounova has performed transfer pricing and valuation analyses for purposes of advance pricing agreements (APAs), tax planning, contemporaneous documentation, audit defense, and litigation for clients that range from some of the largest multinational enterprises in the world to privately-held companies in a wide range of industries. Ms. Khripounova has been engaged in numerous projects that involve transfer pricing of intangible property, including the development of royalty rates for licensed intangibles, valuation of intellectual property for purposes of corporate restructuring, and economic modeling of returns on investment for purposes of cost-sharing arrangements.
Scott Stewart is a Tax Partner in the Chicago office of Mayer Brown, who focuses on tax disputes, including transfer pricing and intercompany debt issues. He represents taxpayers at all levels of U.S. federal tax controversy, including audits, administrative appeals before the IRS, mediation involving the Appeals division of the IRS, and litigation before the U.S. Tax Court. Mr. Stewart is experienced in all aspects of international transfer pricing, including cross-border movements of tangible and intangible property, APAs, cost sharing agreements (CSAs), Section 6662 documentation, and issues related to the OECD BEPS project.
Jason Osborn is a Tax Partner in the Washington, D.C. office of Mayer Brown, who provides sophisticated transfer pricing and international tax advice to multinational clients in a wide range of industries. Mr. Osborn rejoined Mayer Brown in 2013 after holding transfer pricing-related positions with the IRS from 2008-2012, initially as a team leader in the Advance Pricing Agreement Program, and subsequently as a manager in the transfer pricing branch of the Office of Associate Chief Counsel (International). Mr. Osborn is a frequent speaker and author on topics related to transfer pricing, APAs, competent authority, and the OECD BEPS project.
Astrid Pieron is a Tax Partner in the Brussels office of Mayer Brown, heading the Mayer Brown European Transfer Pricing Centre. She counsels on the transactional aspects of transfer pricing, tax optimization of mergers and acquisitions, structuring of investment funds, and provides general assistance for private equity deals. Ms. Pieron currently serves as a member of the EU Platform for Good Tax Governance, advising the EU commission on BEPS implementation.
The foregoing practitioners answered the following questions for BEPS Global Currents on January 3, 2019, regarding compliance with certain BEPS project developments:
Q: How are your clients generally complying with country-by-country (CbC) reporting requirements?
A: Overall, for many of our clients, compliance with CbC reporting is going relatively smoothly. Early in the process, because of the differences in the timing of CbC report filing requirements across jurisdictions, many companies had to figure out which countries required CbC reports, which countries allowed surrogate parent filing, specific local rules for surrogate parent filing, and jurisdiction-specific notification requirements.
The surrogate CbC report filing issues were particularly relevant for U.S.-parented groups, because of the timing of the U.S. filing requirement and the IRS delay in completing competent authority agreements (CAAs) for the bilateral exchange of CbC reports. The OECD BEPS Action 13 final report requires each legal entity to provide a notification to its own tax authority as to how it intends to comply with the CbC reporting requirement (i.e., through either local entity filing, ultimate parent filing, or surrogate parent filing) by December 31st of each tax year (or other date as may be adopted by local law). In effect, this requires taxpayers to commit to how they are going to file their CbC report, up to a year in advance of the CbC report due date. This in turn forced U.S.-parented groups to make predictions a year in advance about whether the IRS would meet its goal of completing all CAAs on time.
In several instances, the local entities notified their tax authorities that they would comply through the U.S. parent’s filing, but the requisite CAAs between the IRS and the local taxing authorities were not concluded in time. The local entities then needed to figure out whether a surrogate filing would still be permissible in their local jurisdiction, or if it was too late to elect this option. Transitional relief was also available in some jurisdictions.
Now, with the first year of CbC report filing behind us, the process has become more familiar. This is not to say, however, that it has been painless. Depending on the size and complexity of operations of the multinational groups, many clients face challenges with collecting the underlying data, and presenting it in a format that is consistent for all jurisdictions. Some clients still have questions as to the level of data aggregation and whether additional disclosure is required in Table 3 of their CbC report. Most often, Table 3 is used to explain the constituent entity’s main business activity, if it does not fit within one of the defined categories in Table 2 of the CbC report.
CbC reporting is also bringing changes to how multinationals approach transfer pricing documentation. Before the BEPS Action 8-10 and 13 recommendations were finalized in 2015, many clients approached documentation at the local level. Now, because of the increase in time spent on compliance, companies look for efficiencies, and adopt a more centralized approach, where the process of preparing the three-tiered documentation (i.e., master file, local file, and CbC report) is managed by the parent entity. The centralization of the process is driven by the goal of presenting consistent information in all three tiers of the documentation. For this purpose, companies also engage their business departments in drafting the master and local files, where previously this task was delegated to the CFO and the tax department. Clients with particularly complex global footprints are focusing on data compilation and retention, which was spurred – to some extent – by the revision of Chapters II and VI of the OECD Transfer Pricing Guidelines.
Q: Is there a way for taxpayers to use CbC reports to their advantage?
A: The OECD has designed the CbC report as a risk assessment tool for tax authorities to use for high-level transfer pricing and other BEPS risks, as well as for statistical analyses. For taxpayers, it can be a BEPS diagnostic tool, as it allows taxpayers to assess the current tax positions of the group across the jurisdictions where the taxpayer operates. Information on the global value chain of the group will also most likely become more transparent from the information filled in Tables 1 and 2 of the CbC report. Preparing a draft CbC report as early as possible in the year allows taxpayers to verify key ratios and other indicators for purposes of risk assessment and comparison against benchmarks. This can enable taxpayers to self-adjust the overall business model, and develop a risk management strategy.
Ensuring consistency between the three layers of transfer pricing documentation, as well as with the legal framework, is a best practice. Specifically, the information gathered in the CbC report should reflect the functions and risks identified and described in the master and local files. This consistency should provide a straight picture of the taxpayer’s business, and potentially reduce follow-up questions and data requests from tax authorities.
Another risk management tip would be to reconcile, to the extent possible, the financial data provided in the CbC report (under the format foreseen by the filing jurisdiction) and the audited financial statements, in order to provide a solid foundation in case of future audits.
Q: In a “substance over form” post-BEPS context, what are the areas that require particular attention from taxpayers?
A: In the post-BEPS environment, thorough analysis of risk and functions, and careful consideration of realistic alternatives are paramount for a successful audit defense. The concepts of realistic alternatives and economic substance are not new and can be traced back to Treas. Reg. 1.482-1 and the 1995 OECD Transfer Pricing Guidelines.
Now, however, these concepts seem to carry the additional weight of the final BEPS Actions 8-10 guidance adopted in the 2017 OECD Transfer Pricing Guidelines. This new guidance encourages tax authorities to examine whether the taxpayer’s “transaction possesses the commercial rationality of arrangements that would be agreed between unrelated parties under comparable economic circumstances, not whether the same transaction can be observed between independent parties.” Tax authorities might take a different position from the one adopted by the taxpayer as a result of this definition. In fact, some of the ongoing litigation in Medtronic, Inc. & Consolidated Subsidiaries v. Commissioner, No. 17-1866 (8th Cir. 2018) and Amazon.com, Inc. v. Commissioner, 148 T.C. No. 8 (Mar. 23, 2017) embodies this dispute.
In this regard, one cannot emphasize enough the need for consistency between the legal framework and conduct of the parties. Even though the accurate delineation of the actual transaction starts with a review of the contractual terms, a mere contractual form of a taxpayer’s decision-making process is no longer sufficient to demonstrate the performance of decision-making functions. The “substance over form” consideration has acquired an extra dimension with the new six-step approach to risk analysis, where the parties’ conduct in relation to risk, their ability to control the risk, and the capacity to assume risk are required for a contractual risk assumption to be respected. Without control and financial capacity, tax authorities may assert that risks should be reallocated to the party that exercises control over the risk, and has the financial capacity to bear it, thereby aligning the risks with substance, which may not agree with “form.”
The above consideration directly relates to the BEPS Actions 8-10 concept of development, enhancement, maintenance, protection, and exploitation of intangibles (DEMPE) functions, which has also been adopted in the 2017 OECD Transfer Pricing Guidelines. Before the DEMPE concept was introduced by the BEPS Actions 8-10 guidance, the legal owner of an intangible was often entitled to essentially all the returns generated by that particular intangible. Post BEPS, tax authorities increasingly take the position that returns from intangibles accrue to the entities that carry out the DEMPE functions of the intangibles. Mere legal ownership or financing is no longer sufficient. The legal owner now “must perform all of the functions, contribute all assets used and assume all risks related to the development, enhancement, maintenance, protection and exploitation of the intangible” to be entitled to retain all of the returns from the exploitation of that intangible.
In the post-BEPS world, the term “substance,” arguably, has a deeper and broader meaning than it used to have. Now, taxing jurisdictions can take the position that the extent to which local personnel can make decisions to take on or lay off risk, which would have been sufficient in the past, is no longer adequate to retain all of the intangible returns. In the post-BEPS environment, in order to provide the legal owner with all of the intangible returns, taxpayers must ensure that legal ownership and DEMPE functions are aligned, which may require changes to the taxpayer’s value chains.
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