Much has been said about the impending changes in a Multinational Corporation’s (“MNC’s”) responsibilities to document and comply with the OECD’s Base Erosion and Profit Shifting (“BEPS”) Action 13. Many practitioners have rightly fretted about the challenges of producing the Country-by-Country (“CbC”) report, the potential vagueness of what really is required in the Master File, and the nuances that will be required by different countries for an acceptable Local File.
All of these are important issues with such a fundamental change. Now that we have some experience in actually trying to implement these changes, I’ve detailed some other issues that we have discovered and initial conclusions we’ve reached that may not be so obvious - but which may be important to consider when transitioning your documentation process in the coming months.
The initial Master File will become the most important transfer pricing document for an MNC.
The Master File outlines your philosophy towards transfer pricing. The MNC explains what it considers to be its key value drivers, categorizes its intangible assets, and differentiates its functions and risks.
The Master File is the MNC’s tax opinion that justifies the outcomes of its transfer pricing policies. It forms the basis of all subsequent conversations with revenue authorities. It potentially limits flexibility in addressing specific issues and outcomes that are outside the “norm.”
The Master File will be a much larger challenge to revise significantly after its initial creation. It will also (obviously) have to provide a narrative that is consistent with the current and future allocation of system income, which will now be clearly presented to tax authorities in the CbC report.
If the CbC can be considered the tax authorities’ weapon of choice in setting up transfer pricing adjustments, a well-crafted Master File can be considered the MNC’s response to support its outcomes in a fully transparent compliance world. Getting those facts and the narrative right is critical for future success.
Interested readers may ask “what is so different about that from prior TP documentation?” The answer is that those details have historically not been explained on a system-wide basis, thus allowing for alternative approaches, inconsistencies, and evolving interpretations of the MNC’s value chain for each related party transaction.
The Master File needs to align with management’s view and public disclosures.
Despite occasional experiences to the contrary, tax authorities should respect management’s view of the business - particularly if that view is consistently communicated in public forums.
Management’s perspective is provided in great detail in the disclosures of public companies. For example, if the MNC states publicly that there is great value in the technology IP that the company has developed and significant risk to future cash flows related to keeping up with changes to that IP, then those facts can potentially form the basis of the Company’s Master File position regarding its value chain.
Likewise, if management has spoken and written of competitive advantages associated with its sales team and its extensive distribution and customer service networks, the MNC will need to carefully reconcile those views with potentially low returns for local sales offices.
In any case, the first thing any MNC should do in the development of its Master File is pull and review any and all recent public documents that involve management expressing its views of the business.
Further, the MNC’s tax team should be sure to have input on public disclosures from management to ensure that the transfer pricing documentation and financial disclosures remain aligned.
Now is the time to better align functions, risks and outcomes.
The current audit environment for transfer pricing is as negative as I’ve seen in the past 20 years of practice. The fiscal authorities are aggressively challenging the pricing of even simple intercompany transactions.
The OECD and many member countries have agreed a timeframe for Taxpayers’ to produce Master File, CbC, and Local File reports for tax years beginning January 1, 2016. That means that Taxpayers won’t be required to produce these documents until well into 2017.
MNCs should use the interim period to effectively prepare for these requirements by making changes to their intercompany relationships to better withstand the obvious challenges to come.
An example of this type of pre-BEPS planning has been the migration of IP from pure holding companies to trading hub companies with sufficient substance to manage the “DEMPE” (Develop, Enhance, Maintain, Protect, Exploit) functions necessary to continue to justify high returns associated with the ownership of that IP.
MNCs have numerous other planning options to limit the impact of BEPS. Some of these are relatively easy for a tax team to implement (e.g. ensuring intercompany agreements are in place and properly reflect risks taken by related party entities). Other changes are more complex and potentially costly (e.g. moving key functions from one entity to another; converting commission agents to buy-sell distributors).
The challenge for the tax team to consider is whether the existing intercompany arrangements hold up to the increased scrutiny of a fully-transparent transfer pricing compliance environment and a significantly changed regulatory scheme that re-defines what can be considered acceptable arm’s length transfer pricing. Our initial experiences indicate that will be better to “get in front of this train” and use the next year to improve intercompany relationships to be more BEPS-compliant so that the Master File, CbC and Local Files will be defensible in the new environment.
The Legal Media Group has named Dan as a “Leading Transfer Pricing Advisor” consistently in client surveys since 2001, and he and the practices he has led have received numerous other awards. He co-developed and has taught “Valuation Principles in Transfer Pricing” for the ASA’s Center for Advanced Valuation Studies.
Dan has practiced transfer pricing since 1993. He became partner at KPMG in 1998, and practiced both in the U.S. and the United Kingdom. Dan ultimately led both the Economic Valuation Services practice and Global Transfer Pricing Services practice, and practiced in both the U.S. and the U.K. He joined Duff & Phelps in 2006 and held numerous leadership positions; including leading the entire Financial Advisory segment. Dan founded Peters Advisors LLC in 2009 and merged that firm with Economics Partners in 2015.