By Ronald van den Brekel, EMEIA Transfer Pricing Leader
As tax administrations around the world prepare to start exchanging country-by-country (CbC) reports next year, the OECD has released tax risk recommendations it hopes will lead to greater transparency — not increased controversy — in the future.
The OECD publication released 29 September, Country-by-Country Reporting: Handbook on Effective Tax Risk Assessment, sets out recommendations for national tax authorities to consider when introducing CbC reports into their existing tax risk assessment frameworks.
“The handbook represents the first publicly available information setting out exactly how tax authorities may use CbCR information to supplement their existing tax risk assessment protocols.“
The first CbC data, which will start to be exchanged by 30 June 2018, will provide tax authorities for the first time with a full breakdown of multinational enterprise (MNE) revenue, profits, tax and other attributes by tax jurisdiction, significantly increasing the volume and scope of information available to them. (For more information on how companies can prepare for CbCR, check out our Thought Center Webcasts on BEPS-related developments.)
To date, more than 55 jurisdictions have introduced an obligation for MNEs to file CbC reports, according to the OECD, while more than 1,000 exchange relationships between pairs of jurisdictions have been created.
Tax risks ahead
Businesses have expressed concerns in the lead-up to the CbCR introduction that the high-level data may be misinterpreted without the right context.
The responsibility now falls on tax authorities to make “effective and appropriate use” of the data contained in the CbC reports, according to the OECD. Used alongside other data collected by tax authorities and as a basis for additional inquiries, information gleaned from the CbC reports can play an important role in identifying transfer pricing and other risks.
But the OECD’s handbook also “raises cautions about the risk that simplistic and misleading conclusions may be drawn if CbC reports are used in isolation.”
The global tax picture
The detailed CbC information will provide tax administrations with a better understanding of how local entities in their country fit within the structure of large and complex MNEs, the OECD handbook says. Moreover, tax officials will be able to carry out better risk assessments, identifying possible high-risk taxpayers and arrangements, the OECD says.
The OECD says tax administrations should also use the CbC data to identify taxpayers that pose a lower tax risk and change the types of compliance interventions made as a result.
Most of the time, tax authorities will need to compare the data contained in the CbC reports with two or more different sources of information, such as the transfer pricing master file, local file, and the authority’s own knowledge and experience of the MNE’s activities and risk behavior, to find possible sources of tax risk, according to the OECD. This also holds true for uncovering patterns that indicate high- and low-risk taxpayers.
Such patterns, the handbook says, may be identified in a variety of ways, including:
- An MNE group’s profile in a particular jurisdiction may be compared with that in other jurisdictions, with part of the group (e.g., a geographical region) or with the group as a whole.
- An MNE group’s profile in a jurisdiction may be compared with that of a “typical” MNE group in the same sector (i.e., based on the profiles of all MNE groups operating in a particular sector).
- An MNE group’s profile in a jurisdiction can be compared with CbCR information for the same jurisdiction in earlier periods, allowing a tax authority to identify changes in the nature or level of activity in a jurisdiction over time.
What is particularly interesting is that the handbook sets out a series of 19 specific risk indicators (i.e., analytics tests) that could be extracted from CbC data and used with other information to determine a MNE’s overall level of tax risk.
For each risk indicator, a summary overview is also provided in the handbook, while an annex sets out what potential results could mean, as well as exploring other possible explanations.
The handbook’s statement that the existence of CbC reports will “facilitate the development of multilateral components to the risk assessment of certain MNE groups, involving the tax authority from more than one jurisdiction” foreshadows the piloting of an International Compliance Assurance Program (ICAP) by a number of jurisdictions under the OECD’s guidance.
As more and more tax administration processes become multilateral in nature, this will be an important development for companies to be aware of, and to plan for.
The handbook represents the first publicly available information setting out exactly how tax authorities may use CbCR information to supplement their existing tax risk assessment protocols. It should be expected that national tax administrations will, at a minimum, utilize the risk indicator tests as outlined in the report, while also supplementing them with their own.
With regard to taxpayers, it’s not often that they are granted any transparency into what tax authorities do with the tax and financial data submitted to them.
While it might not provide a complete picture, the OECD handbook on CbCR nonetheless provides useful guidance to those companies wishing to develop pre-submission tests to align their compliance risk assurance approaches with those likely to be adopted by the tax authorities — presumably exactly what the OECD is hoping.
The 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.
- The results in a jurisdiction deviate from potential comparables.
- The 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 that pose 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.
- Information in a group’s CbC report does not correspond with information previously provided by a constituent entity.
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