Impact of BEPS on transfer pricing documentation (Action 15)

OECD issued the Final Reports on the 15 Action points announced under Base Erosion and Profit Shifting (BEPS) Projectproviding governments with much needed ammunition to close the gaps in the existing international rules that allow corporate profits to “disappear” or be artificially shifted to low/no tax environments, where little or no economic activity takes place and rules that could lead to “Fair” share of tax for each tax jurisdiction where multinational enterprise (MNE) operates.

This holistic approach to tackling BEPS behavior is supported by transparency requirements agreed under Action 13. In a major step toward improved transparency on MNE operations, the requirements for transfer pricing (TP) documentation have been substantially revised (Action 13).

TP analysis depends on access to relevant information. The access to the TP documentation provided by Action 13 will enable the TP guidance to be applied in practice, based on the relevant information on global and local operations in the master file and local file. In addition, the CbCR will enable better risk assessment practices by providing information about the global allocation of the MNE group’s revenues, profits, taxes, and economic activity. CbCR is a “minimum standard” that has been agreed upon by participating countries and reflects a commitment to implement the common template for CbCR in a consistent manner.

Taken together, these three documents (CbCR, master file and local file) makes it easier for tax administrations to identify whether MNEs have engaged in TP and other practices that have the effect of artificially shifting substantial profits into tax-advantaged environments. The reporting guidelines also contain three Model Competent Authority Agreements to facilitate the exchange of CbCR among tax administration. These are based on the Multilateral Convention on Administrative Assistance in Tax Matters, bilateral tax conventions and Tax Information Exchange Agreements (TIEAs).

Implementation of Action 13 on TP documentation

Several countries have already discussed, adopted or amended local TP documentation requirements, and some of them have introduced the master file/local file approach. With regard to CbCR, some countries have either implemented or implementation is in progress. However, several countries are expected to implement CbCR as it represents a “minimum standard” of BEPS.

In September 2015, China issued consultation draft to update TP rules in a post-BEPS environment. The draft will replace the main body of rules governing TP in China. The consultation draft seeks to implement Action 13’s three-fold approach to documentation, comprising the master file, the local file and the CbCR. The consultation draft will also require companies to prepare so-called Special Files for intra-group services, cost sharing arrangements and thin capitalization.

The three-tier disclosure requirement recommended by OECD significantly enhances the information required to be disclosed by MNEs vis-à-vis current disclosure requirements. Given the enforcement environment in India, the master file/local file may still be called for by tax authorities, as necessary or relevant, for the determination of the arm’s length price (ALP) of the international transactions of taxpayer during the course of TP audits. According to the OECD guidance, the master file and local file are to be delivered to the local tax administration, while the CbCR may be shared only through government-to-government exchanges.

Possible approach for India

There are material gaps between OECD’s prescribed TP documentation under the master file/local file approach, as compared to what is currently prescribed in Rule 10D of the Income-tax Rules, 1962 (the Rules). Some of the significant gaps (i.e., information required according to master file/ local file but not according to Rule 10D) are as follows:

  1. Master file: Global organization structure, key profit drivers, description of main geographic markets, global supply chain, business changes, IP strategy, listing of IP, TP policy regarding IP, group financing policies and TP relating to the same, unilateral APAs and tax rulings
  1. Local file: Detailed business strategy, competitors, inter-company agreements, reasons for performing multi-year analysis, APAs and tax rulings

Since the BEPS package on Action 13 requires master file/local file to be delivered directly to the local tax administration, Indian TP documentation rules is likely to require amendments to enable the Indian tax administration to request taxpayers to file documentation in accordance with the master file/local file.

It is recommended that the Indian tax administration follow the OECD’s model legislation and guidance (to the extent relevant) while implementing CbCR. The key features of the OECD guidance are:

  1. As a general rule, CbCR will need to be filed by the ultimate parent of a MNE group with the tax administration of the jurisdiction where the ultimate parent is based. There may, however, be exceptions to this general rule in certain circumstances, which the OECD recognizes.
  1. CbCR should be a separate template and not part of TPD.
  1. CbCR sharing should be only through government-to-government exchanges.
  1. CbCR to apply where consolidated turnover of MNE group is > €750 million (approx. INR5,500 crores).

The template should be in accordance with that prescribed by OECD without any country-specific modifications.

Best practices that taxpayers may need to consider while implementing the Action Plan 13

With new OECD Guidance indicating that the first required CbCR is to cover financial year starting April 2016 to March 2017, it is important that MNEs begin to prepare for the same proactively and implement necessary changes in their IT systems to capture information required for reporting.

Taxpayers will need to be prepared to explain and support both sides of a transaction, even if they have applied a one-sided TP method. Otherwise, with increased visibility into profits earned by an MNE in different jurisdictions, tax authorities may be encouraged to split profit between entities using a factor of the tax authority’s choice. In order to avoid such a result, taxpayers should make sure that the result from any one-sided analysis is consistent with the value creation by respective entities involved in the transaction. In essence, the taxpayers are advised to consider the following in light of the final report on Action 13:

  • Revisit and review operations and business structures to identify areas of potential TP risks;
  • Review existing TP documentation and judiciously assess gaps vis-à-vis recommended guidelines;
  • Keep the impact of BEPS project in mind whenever businesses are undergoing change;
  • Proactively evaluate option of entering into an Advance Pricing Agreement (APA) with tax administration to gain certainty around the TP arrangement of inter-company transactions at the right time.

Concluding thoughts

The impact of the BEPS project is expected to be far-reaching and profound, triggering changes to domestic laws and regulations in India. There is a significant opportunity for the Government of India as well to align some of its existing documentation rules to bring it at par with global standards. On the other hand, the pressure on tax authorities is likely to increase significantly in order to judiciously analyze the additional details disclosed by taxpayers and form conclusions. One may expect that with substantial information available at the disposal, both with the taxpayers as well as with the tax authorities, the intensity of TP audits and the approach of dealing with TP of inter-company transactions are bound to be affected.

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