The Organization for Economic Cooperation and Development’s revised guidance on transfer pricing to prevent base erosion and profit shifting, or BEPS, by multinational companies will have minor administration costs for the Internal Revenue Service, according to a new government report, although the impact on the companies is uncertain.
The report, by the Government Accountability Office, examined the potential impact of the OECD BEPS initiative’s revised international transfer pricing guidance on both the IRS and U.S. multinationals. The OECD issued a BEPS action plan in 2015 aimed at discouraging multinationals from shifting corporate profits from country to country to exploit the differences in various tax regimes. Part of the action plan included new guidance on transfer pricing, that is, determining the price of shifting property between related parties.
The OECD wanted to align multinational profits with the location where the economic activity takes place, to prevent corporations from shifting and assigning profits to lower-taxed related corporations by artificially setting below-market transfer prices on their property and services. Another part of the action plan aims to make the activities of multinationals more transparent by requiring more documentation and reporting to be shared among countries, known as country-by-country reporting.
The OECD's revised guidance stressed that transfer price analysis should reflect actual economic activities, for example, who controls decisions related to risk and who has the financial capacity to bear the risk. The new guidance clarifies previous guidelines by the OECD, which also included risk analysis based on functions, but now focuses on the parties’ ability to control and finance risk.
The revised guidance could reduce base erosion and profit shifting if it encourages multinationals and tax authorities to ensure the transfer prices are based on real economic activity, according to the report. U.S. regulations already consider risk to be part of transfer pricing analysis. But multinationals may still continue to shift their profits since there’s some uncertainty about the underlying principle.
“The arm’s length principle, which treats transactions between related parties as if they were unrelated, is widely accepted for evaluating transfer prices,” said the report. “However, its application to risk is problematic because related parties cannot transfer risk the way unrelated parties can. Without addressing the application of the arm’s length principle under these situations, uncertainty about the correct transfer prices may allow for continued BEPS.”
IRS officials do not expect the costs of administering the new guidance to be particularly onerous, at least for the agency, because the IRS's own transfer price reviews are consistent with the revised guidance. However, taxpayer compliance costs are uncertain, the GAO acknowledged, because the costs will depend on how multinationals respond to the changes. But the GAO foresees little impact on macroeconomic trends in the U.S.
“According to stakeholders and industry literature, U.S. employment and investment are unlikely to be significantly affected because the transfer pricing guidance affects a relatively narrow area of the tax code,” said the report.
As for the new country-by-country, or CbC, reporting requirements in the OECD guidance, those could be costly for some multinational enterprises, as they are designed to discourage base erosion and profit shifting to low-tax countries.
“CbC reporting may decrease BEPS because more consistent information will be available to tax authorities on the worldwide activities of MNEs,” said the report. “According to IRS officials, CbC implementation costs are uncertain at this time, but can be mitigated by using existing systems and processes. However, MNE compliance costs would likely increase due to new data system needs, according to stakeholders. The economic effect of CbC reporting is uncertain because it depends on the extent to which MNEs move business functions to low-tax countries in response to the potential increased scrutiny of BEPS.”
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