SKP Tax Alert
14 October 2015 | Volume 8 Issue 17
OECD launches final reports on BEPS Action Plan

In what is widely considered to be one of the most fundamental changes in the international tax framework of this century, on 5 October 2015, the Organisation for Economic Co-operation and Development (OECD), presented a set of final reports on 15 action points aimed at curbing Base Erosion and Profit Shifting (BEPS) practices perceived to be undertaken by multinational corporations/enterprises.

The OECD kick-started its work on the comprehensive BEPS Project in February 2013, with specific requests from G20 countries, assuring to frame action plans for addressing the weaknesses in international tax rules. The 15-point Action Plan was published in July 2013, focusing on the development of tools that countries could use to shape 'fair, effective and efficient tax systems', based on three core principles – coherence, substance and transparency.

In the interim, the OECD has been releasing public discussion drafts for the proposed actions, and gathered comments for the same from various stakeholders – corporates and the business community, consultants, tax advisors and various other government and non-governmental authorities.

It is noteworthy that developed as well as developing countries across the globe are a part of this important project along with international organisations such as the International Monetary Fund, the World Bank and the United Nations. It is also observed that more than 12,000 pages of comments were received on 23 discussion drafts published by the OECD.

Transfer pricing focus areas

Actions 8–10: Aligning transfer pricing outcomes with value creation
The work under Actions 8–10 of the BEPS Action Plan is aimed at ensuring that transfer pricing outcomes are better aligned with value creation of the multinational group (MNE). The key recommendations of the OECD under Actions 8–10 are as follows:
  1. With respect to intangibles, the report clarifies that legal ownership alone does not necessarily generate a right to all (or in fact, any) of the return that is generated by the exploitation of the intangible. The group companies performing important functions, controlling economically significant risks and contributing assets, will be entitled to an appropriate return reflecting the value of their contributions.
  2. Pointing towards risk allocations, the report specifies that risks contractually assumed by a party that cannot exercise consequential control over the risks, or does not have the financial capacity to assume the risks, will be allocated to the party that does exercise such control and does have the financial capacity to assume the risks.
  3. Importantly, the recommendations require careful study of the actual transaction between the associated enterprises by analysing the contractual relations between parties in combination with the conduct of the parties. In circumstances where the transaction lacks commercial rationality, the guidance continues to authorise the disregarding of the arrangement for transfer pricing purposes.
  4. The guidance also addresses the situation where a capital-rich member of the group provides funding but performs few activities. It specifies that if the associated enterprise does not practically control the financial risks associated with its funding, then it will not be allocated the profits associated with the financial risks and it may be entitled to no more than a risk-free return.
  5. In effect, the reports direct that based on the accurate description of actual transactions, the group companies performing important functions, controlling economically significant risks and contributing assets, will be entitled to an appropriate return reflecting the value of their contributions.
  6. G20 and OECD countries will continue to work together in 2016 on the transfer pricing aspects of financial transactions, finalising the guidance on the practical application of transactional profit-split methods and the approach on hard-to-value intangibles. Further work is also being undertaken to develop approaches to transfer pricing in situations where the availability of comparables is limited.
Action 13: Transfer pricing documentation and country-by-country reporting
The BEPS report on Action 13 recommends a three-tiered documentation approach that consists of:
  1. A master file containing standardised information relevant for all group members of MNE;
  2. A local file referring specifically to material transactions of the local taxpayer; and
  3. A country-by-country (CbC) report containing certain economic information within the MNE group
The report recommends that the first CbC reports be required to be filed for MNE fiscal years beginning on or after 1 January 2016.

In order to give some leeway to small and medium-sized enterprises, CbC reporting will be applicable for MNEs with annual consolidated group revenue equal to or exceeding EUR 750 million; whereas no such monetary threshold is applicable for the maintenance of master and local file documentation.

The master file and the local file will be delivered by MNEs directly to local tax administrations. CbC reports should be filed in the jurisdiction of tax residence of the ultimate parent entity and shared between jurisdictions through automatic exchange of information, pursuant to government-to-government mechanisms such as the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, bilateral tax treaties, or Tax Information Exchange Agreements.

The OECD had already released a CbC Reporting Implementation Package, which contained model legislation that countries could use to implement CbC reporting conventions along with model Competent Authority Agreements that countries could use to facilitate cross-border exchange of information between tax authorities.

Notably, the OECD specifies that tax administrators should not use the information included in the CbC report as a substitute for a detailed transfer pricing analysis of individual transactions and prices based on a full functional analysis and a full comparability analysis.

Impact on the Indian transfer pricing environment
The BEPS Project's objective of ensuring that transfer pricing outcomes are aligned with value creation of the MNE group is in fact in line with India's long-standing position on transfer pricing matters.

Although the Indian tax administration is considered to be one of the most stringent transfer pricing regimes at present, the BEPS Project's outcome will further help India in formally adopting the OECD's major recommendations in an effective manner.

In terms of documentation, current Indian transfer pricing regulations do not provide for the maintenance of information contained in the master file and the CbC template. The Indian government will most probably soon frame rules to accommodate these recommendations. India's Finance Minister Arun Jaitley has already endorsed the OECD's efforts in the areas of BEPS and the automatic exchange of information during the 49th Annual Commonwealth Finance Ministers Meeting in Lima, Peru.
SKP Insights: Key take-aways for your business
In this evolving global environment, it is no longer possible for MNEs to look at value creation, transfer pricing and tax planning strategies in isolation – it is essential for all of these to be harmonious.

Furthermore, the three-tier documentation as recommended by the OECD would be quite extensive and could require deep expertise as well as a planned approach for mapping and collation of details. In fact, business processes and accounting systems should be made robust to generate transfer-pricing-related details and the audit trail in real time with clear departmental responsibilities, in order to comply with the enormous requirement. Larger companies may even be required to consider technology solutions to collect, store, analyse, and prepare the CbC template and master file.

Essentially, companies whose finance departments are effective at risk-based decision making will be best equipped in this environment. Keeping long-term interests in mind, one should perform a self evaluation and ask various questions such as:
  • Is the nature of the group business clearly defined?
  • How much international and domestic transfer pricing is involved in the business?
  • Do we have transfer pricing documentation that demonstrates the transfer pricing and tax positions?
  • What is the company's global supply chain policy?
  • Does that policy have substance for each function performed and risk assumed in each local taxing jurisdiction?
  • Is the transfer pricing documentation in line with the economic reality of the current supply chain in each jurisdiction and the supply chain as a whole?
  • Do we have a robust system to align group-level as well as country-specific economic details and generate convincing audit trail documents?
  • Do the existing business models need to be altered in view of the BEPS report outcomes?
In this era of increasing transparency and cooperation among governments (primarily due to the tight global economic situation), the uncertainty of how different nations adopt the OECD recommendations and the extent of the impact on compliances and transfer pricing requirements from MNEs will need to be handled diligently. Meanwhile, dispute-avoidance and resolution measures such as Advance Pricing Agreements (APA) and Mutual Agreement Procedures (MAP) could be evaluated as effective tools to gain certainty.

With respect to tax administration, a possibility of increased scrutiny by the tax authorities may be inevitable as the high-level/big picture economic information of companies will be at their disposal. At a more practical level, MNEs would be increasingly required to explain their business realities and demonstrate the economic value-creation activities to the tax authorities.

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