They’re one of the transfer pricing industry’s biggest scams: generic transfer pricing reports mean nothing but red flags to tax authorities. They’re just big, bright signals that imply your company has something to hide. So why are big consulting firms still using them? Together with podcast co-hosts Matthew DeMello and transfer pricing AI genius Fiona, CrossBorder Solutions’ own David Bokuvac, Nicole Sciutto, and Mimi Song discuss the undue risk involved in using generic reports.

Mimi Song: Let’s start with defining the document. What does it mean when you say generic report?

Nicole Sciutto: So generic reports are the reports that were historically produced, and these reports would be sort of a one-size-fits-all report that is meant to be given to all of the different tax authorities. But it’s meant to cover transfer pricing where it’s not localized to any specific country’s requirements.

It’s sort of a report that would have certain standard components that were generally accepted by all regions. But as regulations changed, you sort of generally accepted features are no longer allowed within different regions.

Mimi Song: So I mean, that’s a great point you bring up: Clearly the compliance environment has changed. Things have evolved. What our tax authorities looking for?

Nicole Sciutto: Tax authorities are really interested in localization of the reports. Different countries have different preferences as to what they want to see in the reports and they’re more aggressive about transfer pricing in general. Ever since the BEPS initiative, they have kind of laid out for the companies in the industry what it is that they’re going to be looking for. And because of that, they’re actually looking at the reports more than they had in the past. So local documentation is super important, local comparables are important. And there’s all sorts of additional features that these reports need to have that are specific to certain jurisdictions. That is the hardest thing to come by and reports when we see localization.

Mimi Song: So, so given the current new guidelines, regulations, can a generic report actually protect a company from being audited?

Nicole Sciutto: Bottom line? No, it cannot.

So that’s, that’s the big problem here is that multinationals think, “Oh, let me produce a standard approach to my transfer pricing and I’m going to make all my reports look the same!” And they think of that as consistency. Consistency is really maybe using one provider to provide the reports but making sure that those reports sort of speak the different languages of the jurisdictions, while having the common theme and common message with regard to the transaction. Generic reports are a huge red flag for audits and, frankly, in today’s environment they’re pretty much useless.

Mimi Song: When you work with new clients and you review their existing documentation, what are the kinds of things that you actually notice?

Nicole Sciutto: Well, the first thing that we notice is if this documentation is usually prepared by one of the big reputable tax firms if not law firms. But we review it to see where the client might be vulnerable to penalties or adjustments based on what’s in the report in its current state. And there are certain things that we’ll see time and time again.

We often see reports prepared in accordance with the OECD guidelines, but not local mandates. We’ll see reports prepared for planning purposes that don’t meet the compliance requirements of any jurisdiction or let alone the specific jurisdiction that the report was intended for. We’ll see some reports that are just not contemporaneous. They may use one report to cover several years. We see incomplete organizational charts and all sorts of missing information really.

Mimi Song: We, we also want to welcome David Bukovac to the conversation here. David is not only a founder of CrossBorder Solutions, but he was probably the first economist with CrossBorder Solutions, the first time around. So how did you get into transfer pricing to begin with, David? Just a little bit about it for your background.

David Bokuvac: Oh my goodness, do what you want the long version? Well, this is only a 45 minute podcast. I think I’ll give you the long version.

I grew up in rural Pennsylvania where there’s nothing to do, right? And I always wanted to travel the world. So I did some traveling and I got bitten by the “international bug” and so when I went to school, I wanted to do as much as I could internationally. So I went to a graduate program at Brandeis for International Economics and Finance. And lo and behold, transfer pricing kind of picked me, right? Because transfer pricing is all about multinational companies who trade internationally and it’s all about economics and finance. And so that’s how I sort of fell into transfer pricing.

Mimi Song: There’s a lot of people, I feel like, that fell transfer pricing. Not a lot of people grow up thinking that they want to be a transfer pricing honest. But given that we were talking about the current transfer pricing landscape and you know how generic reports don’t work anymore.

And in fact, you know, David, when you work with a new client and you go over their existing documentation, what are the kinds of things that you notice or what are the potential gaps in the reports that you see?

David Bokuvac: The biggest gaps in the reports that I see are that they’re incomplete. My experience is that transfer pricing that’s done by a Big Four firm or any consultant that tends to be expensive because accounting firms throw bodies at this to do it. And so the more time it takes, the more expensive the reports are, and so they have to find ways to cut corners. They end up cutting things out of the reports that really should be there.

But a lot of firms figure, “Well, you know, what’s really important is the number at the end of the day, so we’ll get the calculation correct, but you know, everything else will suffer a little bit.”

We get where they’re coming from there, but the problem with that is if you hand that to a tax authority. When they open the cover, they’re looking for those specific things that show that you’ve paid attention to things that are happening in that country and the laws that apply there. When those things are missing, you get a huge red flag. Even if the numbers are perfectly correct, the tax authority could say, “Hey, you know what? I don’t like your report and take issue with it.”

Mimi Song: Nicole, What are some of those specific requirements that countries are looking for now?

Nicole Sciutto: So countries are looking for local benchmarks. They’re looking for a local documentation that answers specific questions that certain jurisdictions are looking for. They like to calculate those benchmarks differently based on a different jurisdiction. And there’s many components. One example we see time and time again is that a client will get a study done by one of these big firms for compliance purposes and planning purposes. But for planning purposes, a benchmark memo does not rise to the level of jurisdictional requirements for documentation. So just because you have a benchmark and it was prepared by one of these firms, there are many elements missing to that report that’s a required.

Matthew DeMello: Just a quick question a little bit more for the folks outside of the discipline of transfer pricing that I’m thinking of. But given the approach that these big accounting firms are taking with what you’re describing and the ever-intensifying global regulatory environment, Nicole, why are we still seeing such inaccurate reporting?

Nicole Scuitto: Well, the answer is really simple. It’s because it costs a fortune to do it the right way. Especially using traditional firms, it costs a fortune. You’re working with an hourly billing model, and the fact of the matter is after BEPS, having a generic report is only cost-effective way to get it done. But the truth is it really doesn’t cover you. There is no protection. It’s not really insuring you any audit safety. As far as coverage goes, a tax authority has zero interest in a generic report. And so although you’ve gone through all these hoops to create a report, the tax authority is going to just throw out that report and look at it the way that they want to look at it.

Matthew DeMello: But even generic reports aren’t cheap and you might agree with that. Given your background in putting together these reports for multinationals and even cutting corners. The whole thing still takes a very long time.

So let’s talk about the OECD and the BEPS action 13 package of measures that they released in November 2015. BEPS stands for base erosion and profit shifting, but maybe we can get a more effective definition explainer from Fiona of what the plan is in its impact on the transfer pricing industry. Fiona, can you tell us about the BEPS action plan?

Fiona: I’d be delighted. BEPS section 13 is the OECD is transfer pricing documentation recommendation. It suggests a three-tiered approach: the master file, the local file, and the CBC report for tax years beginning after January 1st, 2016.

Matthew DeMello:  And that all wasn’t that long ago. Nicole, how do you think the BEPS action plan impacts generic reports?

Nicole Sciutto: It kills them. It renders them completely useless. They weren’t all that acceptable before, but now with so many countries differentiating their regulations, you really can’t use those sort of generic reports at all. You must have reports that cover the rules and regulations that are espoused by the local countries themselves.

Every single country has something different that they like about the report, whether it’s the formatting of the report, the methodology of the report, the benchmarks of the report, a value chain analysis that needs to be put into place… I mean, the list really goes on. 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. Now, if you have hyperlocalized documentation tailored to the rules or regulations of that jurisdiction, you are far less likely to incur an adjustment than the other 25 reports that are sitting on the examiners desk that have regional or generic OECD documentation.

Mimi Song: Wow, that’s just crazy. You know, given the, it just increases the risk of audit tenfold.

So, David, you probably hear this all the time too: Companies saying, “But this country, uh, accepts OECD guidelines.” Is that the case that in certain countries the OCD guidelines are acceptable or mandated into law?

David Bokuvac: Well, sometimes individual countries adopt the OECD guidelines and accept them, make them law, or make the same kind of analysis applicable in their country. Some that come to mind, there are a few: Austria, France, Luxembourg, South Africa… There are other countries that take the guidelines and add their own local stipulations. So they’ll base it on the OECD and then just tweak them a little bit. Then there are other countries that tossed them completely and created their own mandates. Those are a little tougher.

Mimi Song: Like Brazil?

David Bokuvac: Like Brazil, the U.S.,  China… At least 43 very active transfer pricing countries have either added local stipulations or tossed them and created their own unique laws.

Mimi Song: So let’s ask Fiona, because you know, clearly she’s our artificial intelligence engine here. Yoda, can you give us some examples of countries whose regulations differ from the OECD guidelines?

Fiona: Of course I can. Let’s start with India. The country requires the three-tiered approach recommended by the OECD. However, the Indian tax authorities have added their own requirements as well. First off, the master file is required for MNEs with consolidated revenues of more than 5 billion Indian rupee. That $77 million us dollars. The Indian threshold is $800 million.

So you can see a staggering difference and that’s just one threshold difference. India has others. India also requires a separate form with the master file, 3CF or a single constituent entity and form 3C for multiples. The tax authorities also mandate specific functional, asset, and risk – or FAR – details noted in documentation.

This requirement learned means a huge investment of time and paperwork and if that weren’t enough taxpayers must file contemporaneously.

Mimi Song: Wow. Fiona, you really are amazing.

Fiona: That’s what I keep telling everyone.

Mimi Song: India has also increased the number of transfer pricing audits by 300% in the past three years. And if you fail to submit the correct information to the Indian tax authorities, uh, you’re practically begging for an audit.

So Fiona, can you tell us about another country with its own requirements?

Fiona: Certainly Italy comes to mind. The local file and master file aren’t required, but they are strongly recommended for penalty protection. If you submit the master and local files, they must be in a specific format in terms of chapters and paragraphs and sub paragraphs. The structure is mandatory. Also worth noting: documentation must be submitted in Italian.

Mimi Song: Now, you’re certainly not going to get that from a generic file. Not a chance. David, what other countries have differing requirements in the OECD recommends?

David Bokuvac: Other countries? Well, for sure Australia, the U.S., Brazil, as you mentioned earlier, China, Thailand, Germany, France, Mexico, Malaysia all have different requirements than what the OECD recommends. I mean, China mandates different requirements than Mexico; Mexico with different requirements than Germany; Germany different than Italy, and so on. So really to be audit proof and comply with the local tax authorities, not the OECD, that’s the one.

Mimi Song: Nicole works with a lot of clients and so, Nicole, can you think about a specific example where you started working with a client and you were surprised to see how vulnerable they actually were given what they gave you? Given what they said about their generic reports and when you actually started to work on it, what did you uncover?

Nicole Sciutto: Sure. So we had a client who submitted a Canadian report and it was not localized. It was centered around North America, it was more of an OECD generic style report. And they came to us because they had to pay to get it localized to the Canadian-specific requirements.

Canada is very specific that they, you know, look at a certain kind of benchmark range, and they just have very specific documentation about what they want to see in their reports. And the same client actually had a Denmark report and in Denmark, they had the same sort of issue! They submitted a local generic report and that was thrown out by the Danish tax authority. Denmark again, also has very specific requirements. They look at a five year range, which is really pretty uncommon for most countries, and that was an issue for them. So they came to us to do it the right way.

Mimi Song: Right. And actually I think in one of our earlier news updates, we had learned how Denmark actually applies a penalty regardless of whether or not there’s an adjustment. If you don’t have documentation

Nicole Sciutto: Wow.

Mimi Song: It’s actually um, somewhere around the equivalent to 35,000 us dollars. So it’s pretty steep and significant. So generic reports are clearly leaving multinationals, especially vulnerable right now. Nicole, can you give us some of the statistics related to audit stuff?

Nicole Sciutto: Absolutely. So in the UK in 2017, they collected one point $6 billion in adjustments and added 150 auditors to staff. Also in 2017, Canada collected $7 billion in adjustments and added a hundred additional auditors to staff. That same year, Poland issued 500 transfer pricing audits, which was an increase from 134 in 2016.

Mimi Song: I actually read a recent article in TPE Week and Kim Boylan, the head of the global transfer pricing practice at White & Case. She was quoted as saying, “You have to rethink your documentation for every deal in case you get audited.”

So you have to keep an audit-ready file on every deal you do. Now, David, clearly the audit environment has changed. What are the ramifications of a potential transfer pricing adjustment?

David Bokuvac: Well, you know, clearly it hurts your bottom line. I mean, that goes right to operating income. It comes right out of operating and culminate and it hurts your brand too. It hurts your brand and you know, no matter what aspect you’re looking at, but especially amongst the, the, the tax authorities, now you’re kind of looked at it in a suspicious way. And, you know, under BEPS with all of the information sharing, Hey, you know, you’re going to get known as the company to hit for an adjustment.

Mimi Song: Right? And there’s a lot of articles out there right now, sort of villainizing companies that are, that are taking advantage of tax arbitrage situations, companies like Amazon or Starbucks. For example, with Starbucks, in 2012 they made headlines – not for new takes on mocha lattes, but because of the huge protests and boycotts and basically, the general animosity the company received in the U.K. when customers were learning that Starbucks actually paid very little taxes despite having hundreds of stores in the country.

David Bokuvac: Yeah, absolutely. Well, in that case they didn’t even do anything illegal.

Mimi Song: Exactly. And you have all sorts of unique local regulations on a country by country basis with different thresholds and documentation requirements, different types of information, local comparable requirements, deadlines. It’s actually quite a headache.

David Bokuvac: Yeah, local documentation is more work. There’s no question. I mean, if you do it right though, there are upsides of doing the documentation. I mean, one of the things that it’s really good for is it really is the best place to explain your business. I’ve worked with clients in the past that have undertaken transfer pricing projects not only for the documentation, but because they really wanted to have a really good functional definition of their business and provide a place for the whole organization to learn about it. It’s also the best place to build a case that you’re practicing business fairly. If you prepare the paperwork and adequately, you’re missing a huge opportunity to defend your transactions. But if you have insufficient documentation like generic reports, it’s as we’ve mentioned: it’s a huge red flag for tax authorities.

Mimi Song:  Yeah. So we talk about insufficient information. So Nicole, what exactly does David mean by insufficient information in a report?

Nicole Scuitto: Sure. So there’s many different ways in which your report can be insufficient, but the number one is that a generic report, hits just about all of those ways. So some of these things are local comparables can be missing. The benchmarks can be calculated wrong. We’ve seen reports that don’t list transaction-specific comparables when they’ve been requested. We’ve seen reports that omit functional detailed analysis. Reports have come in with tested parties from too broad a range. There’s numerous inconsistencies across the reports.

Certain jurisdictions like things a certain way and these things can be things like weighted averages calculated a certain way, ranges calculated certain way, or including a certain number of year’s worth of data: the Excel calculated intercore tile versus the IRS and your calculated core tile. We’ve seen reports that are missing information about the corporate group. That’s a really common one.

All of this, or even just one piece of it will actually qualify the report as insufficient documentation also has to be consistent. And I think that’s why I think a lot of our clients will get into a case where at one point or another they may have been prepared a generic report because it’s sort of like a copy paste of that report to all the different locations. But what we like to do is write the reports so that they are localized to each and in every jurisdiction, but we don’t forget about that sharing of information that comes with BEPS. So although these reports are localized to two different jurisdictions, they speak to the same story, should those auditors or examiners ever share those documentations.

Mimi Song: Yeah. And that’s, that’s really important, right? If we’re mitigating exposure to potential risk of audits. Can you give us some specifics? What are some of the local regulations that you actually might be seeing as, as insufficient or incomplete in a, in an documentation?

Nicole Sciutto: A few examples that come to mind of what we’ve seen recently. We saw a Canadian report missing Canada’s requirement on assumptions, strategies, and policies. If  any of that that influenced the documentation of the transfer prices. For Singapore, we had a report that was missing a required discussion of the group’s business model supply chain of products and services and the financial statements. We often see reports that were prepared in accordance with section 482 regulations. But the transfer pricing, contemporaneous record requirements outlined in 6662 are missing it.

Mimi Song: Well those are the 10 principle documents versus 42, which actually outlines the methods to be applied.

Nicole Sciutto: That’s right.

Mimi Song: Tha’s where that differentiation comes from. It’s actually really fascinating because there was a situation for Canada where one of the clients sent us their existing study and they actually did it in-house. They pulled the section of the regulations and basically answered each of those questions with one line answers. And normally transfer pricing reports are, are on average — how many pages, Nicole?

Nicole Scuitto: Oh, many, many hundreds.

Mimi Song: This was a one page document and – just by virtue of being a one page document, doesn’t mean that it was insufficient documentation. The reason it was insufficient though is in any tax regulations, it’s like a treasure hunt because the regulations could say you need components one, two, three, four, five… And then when you dig into each of the components for component two you have to go to another section of the regulations to get the practical application.

And then within that there were like 10 additional components. So I think that’s what was lacking in that situation. So to your point, and you know, we always see a lot of components that are missing.

Nicole Sciutto: I think it’s worth mentioning that it’s not always a bad idea to do documentation in-house. You just need to know what goes in the report and you need the tools to prepare it. We’ll often see people who say, “I have a good view of my business and I can prepare this documentation…” But what’s missing is they don’t know specifically what the report is requiring.

Mimi Song: So clearly we’ve noticed these errors right off the bat. We’ve noticed these challenges and the differences and the nuances on our case-by-case basis. The real question is how long will it take for the tax authorities to start keying in on these errors in the report and asking for that additional level of information. So how do you know your transfer pricing reports contain the necessary information required by the local countries, Fiona?

Fiona: Assuming you have nothing else to do, you can devote all of your time to staying on top of changing regulations, deadlines, requirements… and spend your days researching and updating documents. That’s what I do.

David Bokuvac: Yeah. Well, and that’s not going to happen. I mean, you definitely need a more realistic approach. Right? And one of the best ways to do it is he is enlisting technology to do the job for you or at least facilitate doing job. Right? Our AI, over the Fiona platform, really allows you to produce efficient, customized, local transfer reports. So they’re hyperlocalized and comply with each country’s individual regulations. It is a fraction of the time and cost to do it with technology than to do it a traditional way with consultants.

Mimi Song: So now that we’re talking about AI, Fiona, are you ready to start your stuff?

Fiona: Like you have to ask.

Mimi Song: Tell me about the documentation requirements for Germany.

Fiona: Happy to help. Of course Germany follows the OECD guidelines, you know: a master file, a local file, and a country by country report. However, as you might expect, Germany has a few pesky additions. The German tax or authorities want your report to include an executive summary of the entire company contracts, essential intangibles owned and used by the taxpayer, and the names of company employees who have decision making power over business relationships.

And if that weren’t enough, they also want a description of the value chain and the taxpayer’s contributions to it. Aren’t you glad you’re not the one who has to read through all of that?

David Bokuvac: Fiona, tell me about the economic analysis requirements in Belgium.

Fiona: My pleasure. In Belgium, pan-European comparables are acceptable so you can stray outside of Belgium a bit. However, the tax authorities do want a single-year analysis and weighted Excel into a quarter mile range when it comes to comparables.

David Bokuvac: Thanks Fiona. You know, the secret to transfer pricing documentation really comes down to two things, organization and obviously better information. The transportation technology that we offer allows you to bring transfer pricing in-house. So goodbye, generic reports. Goodbye, pricey consultants. You can do everything in-house and generate completely compliant reports in every jurisdiction for every type of transaction everywhere around the world for every one of your legal entities. And you can save money in the process and you know, you’re presenting tax authorities with the information that is legally required that they want to see in the format they want to see it.

Mimi Song: And you can display real information based on your individual situations. I love how the Fiona platform actually shows which regulations impact you. Because it’s one thing to have a whole report that tells you what all the country requirements are, but it’s a completely different thing to see it customized based on your facts and circumstances.

… And then the ability to produce reports that are fully compliant in a matter of hours, versus days and weeks. And having it all centrally located – is super beneficial.

Nicole Sciutto: I couldn’t agree with you more. Maybe. I think gone are the days of waiting months for your consultant to get you a report. Transfer pricing is an efficient do it yourself job these days. If you use this sort of platform, it allows you to prepare better comparable searches, better economic analyses, local regulations… The results are just more accurate because our technology can sort through more information than you ever could or would want to.

Mimi Song: Yeah. It’s kind of a paradigm shift though, right? Because you know, the one click comp search and Fiona’s ability to do that better than we can. It’s, it all of a sudden creates so much efficiencies. I don’t even know what to do with all my spare time. Right. David?

David Bokuvac: Well, you’ll have a lot of spare time when you’re using Fiona.

Mimi Song: Yeah, that’s true. Now, what do multinationals need to do with their generic reports and where can they do with those now? I mean basically they paid a lot of money. What, what are some of the options, David? What do you think?

David Bokuvac: Well, you know, paper airplanes are fun. You can learn some origami… You know your kids can use it for scrap paper. Uh… there’s lots of stuff you can do. Like you know… you could wallpaper your wall.

Nicole Sciutto: A doorstop?

David Bokuvac: Well, a nice doorstop actually to that point and they call it…

Mimi Song: That reminds me! When we were the first [iteration of] CrossBorder Solutions — I love this story by the way, David, this is [CrossBorder CEO Don Scherer]’s story. When we were at the first CrossBorder Solutions and Don was trying to sell our first customer, Pepsi.

He basically produced boxes of reports for them and said, “Here are all your transfer pricing studies. If you like them, keep them. If you don’t, use them as a doorstop.”