On February 9, 2018, Jennifer Best, Director of Treaty and Transfer Pricing Operations, U.S. IRS Large Business and International (LB&I) Division, said during a panel event at a mid-year conference sponsored by the American Bar Association Tax Section in San Diego that the IRS intends to take a leading role in the OECD’s International Compliance Assurance Program (ICAP) pilot for country-by-country (CbC) report filings. Ms. Best said: “The hope with the pilot program is that participants will be able to identify certain flows that can be removed from the audit process, so it really is a dispute prevention effort from the start.”
The OECD established the ICAP to perform a multilateral risk assessment and assurance process for what the OECD considers non-high-risk multinational enterprise (MNE) groups. ICAP is a voluntary program, which uses CbC reports in its analysis. It focuses on issues such as transfer pricing and permanent establishments (PEs). ICAP’s purpose is to provide certainty to MNE groups and assurance to tax authorities. It allows MNEs to engage simultaneously with multiple tax administrations and should result in fewer MAP disputes.
On January 23, 2018, the OECD announced the launch of the ICAP pilot for tax administrations and MNEs.
The ICAP program will allow MNE groups the opportunity to explain the details in their CbC reports, and provide a better understanding of their cross-border activities. Tax administrations can use this information to reach an early decision about the level of transfer pricing risk, PE risk, and other potential specific international tax risks. Following its joint review of CbC reports supplied by an MNE group, tax administrations will coordinate regarding follow-up questions. The MNE group can work simultaneously with the tax administrations (generally, through the tax administration in its headquarter jurisdiction).
The ICAP pilot should ensure a more effective use of transfer pricing information (i.e., a group’s CbC report, master file, and local file). It should also provide a more efficient use of resources for the MNE group and tax administrations, leading to fewer mutual agreement procedure (MAP) cases. ICAP has been developed under the framework of the OECD Forum on Tax Administration (FTA) Large Business and International Program, sponsored by the Canada Revenue Agency (CRA).
A pilot for ICAP, which includes eight FTA member tax administrations (Australia, Canada, Italy, Japan, the Netherlands, Spain, the U.K., and the U.S.), launched on January 23rd at a participant orientation event, introduced by David Kautter, Acting Commissioner of the U.S. IRS, and Bob Hamilton, Commissioner of the CRA. A multilateral assessment of specific international tax risks posed by each MNE group will begin during the first half of 2018, and is expected to be completed within 12 months.
A handbook providing additional details on ICAP, as well as the procedure for the pilot, was provided during the January 23rd event.
CbCR Risk Assessment
Following its implementation of CbC reporting, a tax authority will need to begin using the transfer pricing information that it receives. The OECD’s Country-by-Country Reporting: Handbook on Effective Tax Risk Assessment takes into account the different approaches to tax risk assessment applied in different countries, the types of tax risk indicators that may be identified using information in CbC reports, and potential challenges. It shows how CbC reports can be an important tool for tax authorities in detecting and identifying transfer pricing and other BEPS-related risks.
Chapter 2 of the handbook says that many jurisdictions are in the process of implementing changes to their tax risk assessment processes, and provides a brief overview of the risk assessment approaches of seven jurisdictions (Australia, Brazil, Canada, Chile, India, the Netherlands, and Spain).
Chapter 4 of the handbook discusses several ways in which tax authorities may test for tax risks using CbC reporting data. Chapter 4 also lists 19 risk indicators:
- The footprint of a group in a particular jurisdiction.
- A group’s activities in a jurisdiction are limited to those that pose less risk.
- There is a high value or high proportion of related-party revenues in a particular jurisdiction.
- Results in a jurisdiction deviate from potential comparables.
- Results in a jurisdiction do not reflect market trends.
- There are jurisdictions with significant profits but little substantial activity.
- There are jurisdictions with significant profits but low levels of tax accrued.
- There are jurisdictions with significant activities but low levels of profit (or losses).
- A group has activities in jurisdictions posing a BEPS risk.
- A group has mobile activities located in jurisdictions where the group pays a lower rate or level of tax.
- There have been changes in a group’s structure, including the location of assets.
- Intellectual property (IP) is separated from related activities within a group.
- A group has marketing entities located in jurisdictions outside its key markets.
- A group has procurement entities located in jurisdictions outside its key manufacturing locations.
- Income tax paid is consistently lower than income tax accrued.
- A group includes dual-resident entities.
- A group includes entities with no tax residence.
- A group discloses stateless revenues in Table 1 of their CbC report (Table 1 includes a summary of the revenues, profits, assets and other attributes of constituent entities in an MNE group, listed by the jurisdiction in which an entity is tax resident).
- Information in a group’s CbC report does not correspond with information previously provided by a constituent entity.
Chapter 4 of the handbook also includes the following financial ratios to evaluate information in CbC reports for the above-mentioned risk indicators, among others:
- Profit margin = profit before tax/total revenues
- Effective tax rate = income tax accrued/profit before tax
- Revenue or profits per unit of economic activity = total revenues or profit before tax/(number of employees) or (tangible assets)
- Pre-tax return on equity = profit before tax/(stated capital + accumulated earnings)
- Post-tax return on equity = (profit before tax – income tax accrued)/(stated capital + accumulated earnings)
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