Transfer pricing used to be so easy. For years, multinational enterprises (MNEs) could create a single generic report to explain transfer pricing transactions to tax authorities in every country in which they did business. Not anymore. In recent years, the landscape has significantly changed. Countries have created their own transfer pricing regulations, and MNEs must adhere to each one’s unique documentation requirements. Now a generic report will serve only to put MNEs at risk for audits.
How have country-specific requirements changed the transfer pricing landscape? And how can an MNE comply with global documentation requirements? CrossBorder Solutions’ co-founder and chief operating officer David Bukovac and former vice president, customer success Nicole Sciuto sat down in a podcast discussion to explain why a one-size-fits-all report is no longer the answer to transfer pricing compliance.
In real estate, it’s all about location, location, location. In transfer pricing documentation, the mantra is local, local, local. “Different countries have different preferences for what they want to see in the reports, and they’re more aggressive about transfer pricing in general,” says Sciuto. “Ever since the BEPS initiative, they’ve laid out what they’re looking for. Local documentation is super important, as are local comparables.”
But even with local comparables, a benchmarking study alone isn’t enough to satisfy tax authorities. “A client often will get a study done by one of the big consulting or professional services firms for compliance and planning purposes,” says Sciuto, “but for planning purposes, a benchmark memo does not rise to the level of jurisdictional requirements for documentation. Often, there are required elements missing.”
In Italy, for example, the local file and master file aren’t required but are strongly recommended for penalty protection. If an MNE submits the master and local files, they must be in a specific, mandatory format (chapters, paragraphs, and sub-paragraphs). And, mio Dio, the local file must be submitted in Italian.
“Local documentation is more work,” says Bukovac. “There’s no question. But there are upsides to doing the documentation. It’s the best place to explain your business. I’ve worked with clients that have undertaken transfer pricing projects not only for the documentation, but because they wanted to have a good functional definition of their business and provide a place for the entire organization to learn about it.”
It’s also the best place to build a case that you’re practicing business fairly, he says. “If you prepare the paperwork inadequately, you’re missing a huge opportunity to defend your transactions. And if you have insufficient documentation, like generic reports, it’s a huge red flag for tax authorities.”
One of the best ways for MNEs to get the job done right is enlisting technology. CrossBorder Solutions’ Fiona AI-driven software allows MNEs to produce efficient, customized, hyper-localized transfer reports that comply with each country’s individual regulations—in a fraction of the time and at fraction of the cost of the traditional way, relying on consultants.
Beware of Common Mistakes
When we perform gap analyses—examining an MNE’s current documentation and comparing it to local regulations—we often discover common documentation mistakes. Generic reports are missing local comparables. They miscalculate benchmarks and omit detailed functional analyses. Often, they fail to include information about an MNE’s corporate group. Any one of these shortcomings can stamp a report as insufficient documentation.
Understand OECD Guidelines Are Guidelines—Not Laws
OECD guidelines recommend how individual countries’ tax authorities can determine arm’s-length transfer prices, but the OECD’s recommendations aren’t official until they’re adopted by a country. Complicating things: Tax authorities sometimes adopt the OECD guidelines as law or adopt certain parts of the guidelines. “Some that come to mind,” says Bokuvac, “are Austria, France, Luxembourg, South Africa. Others add their own local stipulations to the guidelines, tweaking them a bit. Then there are other countries that tossed them completely and created their own mandates. Those are a little tougher.”
Brazil, the United States, and China are among a least 43 very active transfer pricing countries that have either added local stipulations to the OECD guidelines or ignored them and created their own unique laws, he explains. India and Germany are outliers, both embracing the master and local file and the country-by-country (CbC) reports—and also, adding documentation requirements of their own.
India requires the OECD’s recommended three-tiered approach but has also added its own requirements:
- The master file is required for MNEs with consolidated revenues of more than 5 billion Indian rupees (US$67 million); the OECD’s threshold is $800 million.
- A separate form with the master file—3CEAA for a single constituent entity and form 3 CEAB for multiples—also is required.
- The country’s tax authorities also mandate that specific functional, asset, and risk (FAR) details be noted in documentation, requiring a huge investment of time and in paperwork. Taxpayers also must file contemporaneously.
Germany follows the OECD guidelines of a master file, a local file, and a CbC report, and has added these tweaks:
- German tax authorities require that a report includes an executive summary of the entire company contracts, essential intangibles owned and used by the taxpayer, and the names of company employees with decision-making power over business relationships.
- They also require a description of the value chain and the taxpayer’s contributions to it.
Base erosion and profit sharing (BEPS) Action 13, released by the OECD in November 2015, was created to streamline transfer pricing regulations, but instead has created chaos. Action 13, OECD’s transfer pricing documentation recommendation, suggests a three-tiered approach: the master file, the local file, and the country-by-country report for tax years beginning after Jan. 1, 2016. Action 13, explains Sciuto, renders generic reports completely useless. “They weren’t all that acceptable before, but now with so many countries differentiating their regulations, you really can’t use those sorts of generic reports at all. You must have reports that cover the rules and regulations that are espoused by the local countries themselves.”
Transfer pricing documentation requirements can vary in terms of formatting, methodology, thresholds, and benchmarking. “Each country is very specific and if you’re not complying with those requirements, you’re leaving yourself far more open to adjustments than you were before,” Sciuto says.
Know Who You’re Dealing With
Today’s tax authorities are more sophisticated, and applying greater transfer pricing scrutiny, than ever. Here are examples of how they’ve stepped up their games:
- In 2017, the United Kingdom collected $1.6 billion in adjustments and added 150 auditors.
- Canada collected $7 billion in adjustments and added 100 additional auditors.
- Poland issued 500 transfer pricing audits in 2017—an increase from 134 in 2016.
- With a new task force comprised of 390 professionals in 2017, Australia was expected to generate $3.7 billion in adjustments for 2018.
For MNEs of all stripes and sizes, transfer pricing compliance comes down to documentation. Adhering to local requirements, as varied and challenging as they may be, is the only way to go.
Want to hear CrossBorder Solutions’ podcast discussion on generic reports? Listen to Episode 8 of The Fiona Show: The Truth About Generic Reports.