There is certainly no shortage of publicity regarding the impact of BEPS and FATCA on transfer pricing and how to best address these significant new requirements. This has spurred considerable attention to predicting exactly what the future holds and how to prepare for it. At this same time, many new rules are similar to historic requirements that a taxpayer maintain global transfer pricing positions that are supported with logic, facts, and documentation. As we continue to see how these rules will be applied, the question remains whether multinationals in today’s environment should focus entirely on the future or return to basics?
Since the first transfer pricing guidelines were issued by the IRS and OECD, most countries, including the US, have adopted a contemporaneous documentation requirement which remains relatively unchanged as other global transfer pricing rules have greatly evolved. Multinational corporations prepare this documentation for each taxing jurisdiction where there is either a registered subsidiary or a permanent establishment. This same documentation also provides compliance with SOX 404 and financial statement reporting requirements including FIN 48.
A key element of the contemporaneous documentation requirement is a risk analysis that describes and allocates business risks amongst the related parties. This risk allocation is the foundation of the intercompany profit allocation where the related party bearing the majority of the risks in the economic relationship is entitled to the lion’s share of the profits. The better the quality of the overall documentation and the closer the nexus between this risk analysis and the income allocation the stronger the taxpayer’s position becomes.
Progressive taxpayers have long understood that creating and maintaining strong and appropriate transfer pricing documentation ensures that the taxpayer controls any narrative of its pricing and business practices. This prevents a tax authority from creating alternative theories about a taxpayer’s intercompany relationships and standards of comparability. To the extent a taxpayer presents a taxing authority with documentation that does not support or accurately reflect their facts or reporting positions the higher the chances are of a unilateral transfer pricing adjustment and related penalties being forced upon them.
Like existing rules, the new rules address risk allocation. Specifically, the OECD BEPS Guidelines set out this analytical risk framework:
STEP 1 – Identify the economically significant risks of the business.
STEP 2 – Determine how the economically significant risks are contractually assumed.
STEP 3 – Perform a detailed functional analysis of the economically significant risks to determine which entity controls the risk and has the financial ability to bear the risk.
STEP 4 – Consider whether the contractual assumption of risk identified in Step 2 is consistent with the entities’ conduct identified in Step 3.
STEP 5 – Where the contractual assumption of risk is not consistent with the entities’ conduct, reallocate the risk to the party that assumes it based on conduct in Step 3.
STEP 6 – Perform a transfer pricing analysis based on the delineated transactions after re-allocating risk.
These specific requirements as laid out above may be new but they don’t materially depart from what taxpayers have been historically required to do. The real change will be to taxpayers that have not adequately analyzed and documented their facts and performed a risk analysis on a jurisdictional basis in a sufficiently detailed manner to defend their existing intercompany profit allocations.
For all multinational taxpayers, the immediate focus should be a renewed understanding of intercompany relationships requiring the tax team to have an even closer relationship with the business product development, operation, and supply chain teams. This ensures that detailed facts and risks are understood and, more importantly, support the taxpayer’s tax positions. The need for an ongoing and close relationship with business teams cannot be understated due to the fluid nature of global business practices and the problems that can arise when these practices deviate from reported tax positions. Taxpayers must now be able to adjust and adapt tax positions at least annually in potentially multiple jurisdictions or risk having any deviations pointed out on audit.
This updated risk analysis requirement is woven into a bevy of new information reporting requirements under both FATCA and BEPS. A cursory glance at the new business and financial data that now must be filed annually significantly exceeds the information historically reported and certainly that which is publicly reported. Gathering and reporting this newly required jurisdictional data is loaded with practical difficulties well beyond the scope of this article but it is important to note that information that is now required greatly exceeds a simple updated transfer pricing report.
What remains unchanged is that tax leadership cannot allow any deviation from their actual business practices and the newly required intercompany reporting disclosures to shift control of the transfer pricing narrative away from the taxpayer and give a taxing authority room to create their own models of intercompany profit allocation. Agreement of all reported information with intercompany profit allocations is necessary. It is not a new goal but it has certainly become tougher to meet due to significantly increased annual reporting requirements.
This article posed the basic question whether BEPS or FATCA requires a look to the future or a return to the transfer pricing basics? The answer is mixed. The requirement of a detailed functional fact and risk allocation analysis tailored to the local country is not new nor is the knowledge that much more detailed information may be required in the event of an actual audit or examination. What is new is the significantly increased level of detail now required to be reported annually and how to best gather and present that data. That is a very big change and one that will keep tax departments busy now and for some time to come.
To learn more about FJV’s transfer pricing practice and our considerable experience with this important topic and how it impacts your business and tax positions, please contact FJV Tax or visit us at fjvtax.com.
This article was previously published by the Tax Career Digest.