At long last, the Treasury has mandated that a multinational enterprise must specifically comply with its transfer pricing reporting regime. This transfer pricing reporting process itself is a curious anomaly. While both taxpayers and tax administrations have realized transfer pricing’s prime importance, the Treasury has never developed these transfer pricing reporting rules—until now.
All too often, the IRS has long been dependent on subpart F rules or relied upon foreign-owned U.S. corporation provisions or similar tax information to obtain transfer pricing information. Now the Treasury has issued transfer pricing reporting rules beginning July 1, 2017. This transfer pricing reporting is now increasingly important, as the IRS’s roll-out process accelerates.
A word of caution is in order. Multinational enterprises need to be prepared for, and fund, their transfer pricing reporting professional costs, in addition to the much larger tax costs to governments. For example, the six-volume Transfer Pricing Handbook series reflects thousands of pages of analysis. Most importantly, the multinational enterprise needs to train and update its transfer pricing staff to face the new transfer pricing realities.
The genesis behind country-by-country reporting goes back to the U.S. government’s defeat in Societe Internationale v. Rogers, 357 U.S. 197 (1958) at the hands of the Supreme Court. The decision validated sovereign immunity as a legal construct. Abusers created bank secrecy schemes, shifting income and assets away from governments.
Soon after the Supreme Court decision, a law professor had discussed the adverse decision with a junior member of the Senate. The junior senator, Jack Kennedy, soon became president. Kennedy appointed the professor, Stanley Surrey, to become Assistant Secretary of the Treasury for Tax Policy. Surrey developed a legislative strategy, termed subpart F, as a partial remedy, capturing dividends and interest on the part of U.S. companies. Subpart F was too weak because sovereign immunity then barred internal actions within the foreign country. The base erosion and profit shifting (BEPS) process, plus enactments by more than 100 countries, now limit sovereign immunity abuses. The Organization for Economic Cooperation and Development issued 15 actions as part of its BEPS action plan. Action 13 specifically relates to transfer pricing.
Other transnational organizations are on board with BEPS. The Platform for Collaboration controls the base erosion and profit shifting attack. The Platform uses a four-plus-one membership approach. The formal Platform members are: the OECD, the United Nations, the International Monetary Fund, and the World Bank. The Group of Twenty, while not officially a member of the Platform, works together with the Platform on these tax matters.
The BEPS Action 13 process is more than Country-by-Country reporting. Section 13 requires reporting entities to prepare a master file and local file. The master file is a business’s comprehensive global overview reflecting overall profitability, the taxpayer’s business and strategy, and its transfer pricing policies. The local file contains specific transfer pricing data for each relevant country of operation.
What Countries are Planning
Each member country’s tax administration, including the IRS, requires its taxpayers to obtain country-by-country (CbC) Action 13 information. Each member country’s tax administration is to share this compiled information with other taxing jurisdictions. Each member country’s tax administration is in a position to utilize this compiled information as part of a worldwide comprehensive transfer pricing audit.
Each member country’s tax administration can utilize the BEPS CbC database to jumpstart this transfer pricing audit. Member countries’ tax administrations can effectively utilize the company’s internal CbC multinational corporation database. The member country’s tax administration can shift the transfer pricing burden of proof away from the tax administration in the event of impending tax litigation.
CbC information that the member country’s tax administration obtains enables the tax administration to initiate transfer pricing audits without undertaking an advanced analysis.
Multinational enterprises and their member country’s tax administrations will increasingly rely on transfer pricing experts to defend or challenge transfer pricing adjustments in response to a BEPS CbC information request. We expect the CbC process will cause member countries’ tax administrations to increase their transfer pricing audits exponentially. This CbC data will readily become available to each member country’s tax administration.
Transfer pricing penalties will increase more than concomitantly under section 6662 and other penalty provisions. Member countries’ tax administrations are curtailing taxpayer’s excuses. Some countries have more extreme transfer pricing penalties in addition to IRS penalty rules.
The transfer pricing provisions are truly international. Such transnational transfer pricing audits might begin offshore and wind up in the United States. The taxpayer might find itself subject to a foreign information document request. Tax practitioners who are potentially subject to offshore document requests need to address the issue from a retainer agreement context. We anticipate a rapid increase in tax malpractice as many practitioners as trying to catch up to the transfer pricing reporting and documentation.
The United States, as an OECD member and a BEPS participant, has been actively involved in curtailing both base erosion and profit shifting. BEPS Action 13, the country-by-country information, is the crux of this BEPS process. Each member country’s tax administration and its business taxpayers have essential roles impacting CbC BEPS transfer pricing reporting.
The United States, similar to other BEPS participants, is in the process of implementing its CbC Action 13 obligations. The U.S. Treasury and the IRS implemented CbC reporting on June 30, 2016 by implementing regulation 1.6038-4, 81 F.R. 42482. The IRS mandates that reporting entities must apply the Form 8975 provisions beginning July 1, 2017.
We anticipate that the IRS will begin its transfer pricing audits using this form soon after Sept. 15, 2017. For now, these transfer pricing rules exempt small enterprises having annual revenues of less than $850 million, but some countries impose a much lower threshold.