Q & A on understanding new tax changes.
Vertex’s Chief Tax Office provides insight regarding the impact of tax regulations, policy, enforcement and emerging technology trends on global tax department operations.
1) What information must be disclosed on the new CbC reporting template and what do CEOs need to know?
The Organisation for Economic Co-operation and Development (OECD) released the final version of its recommended Action 13 country-by-country (CbC) reporting template in September 2014 as part of its Action Plan on Base Erosion and Profit Shifting (BEPS).
Multinational entities (MNEs) will use this new CbC reporting template to report their income, taxes paid, and other indicators of economic activity. The intent is to improve the risk assessment capabilities of taxing authorities by providing them the country-by-country information of multinational companies at an early stage. According to the template, MNEs must report annually and for each tax jurisdiction in which they do business:
- The amount of revenue, profit before income tax, and income taxes paid and accrued.
- Total employment, capital, retained earnings, and tangible assets in each tax jurisdiction.
- Finally, MNCs must identify each entity within the group doing business in a particular tax jurisdiction and describe the business activities of each entity.
For the first time, taxing authorities throughout the world will be able to ascertain how multinational companies allocate their income and tax payments to a specific country, and other countries as well. The template will also serve as an essential tool for taxing authorities to identify and select companies to be audited. The potential for increased transfer pricing audit activity is an expected outcome of the CbC filings when they begin for tax years beginning January 1, 2016 in some countries. Countries expected to adopt for 2016 include Spain, Germany, United States, United Kingdom and Australia.
2) What areas of concern does the new CbC reporting template pose for CEOs?
Complying with BEPS country-by- country reporting will lift up three areas of concern for CEOs of multinational corporations:
- Significantly increased resource demands on tax departments in order to prepare the data for the new CbC reporting template, and manage the increased audit activity that will result from this new requirement;
- Significant data management challenges in gathering the data required on the CbC report as well as a recommended best practice of reconciling public financial statements, legal entity books, and local tax returns, to the CbC templates;
- Potential risk that confidential information provided in the template will eventually be disclosed to the public through information leaks or formal disclosure requirements by individual countries
3) Is this a data management challenge or a resource challenge?
It’s both.
Preparing the CbC reporting template and dealing with the additional audit activity it is likely to cause will place significant resource demands on the tax department.
“Country-by-country reporting will severely test how corporate tax departments manage their financial data in complying with these new reporting requirements.”
To ensure accuracy and provide a defensible audit trail, country-by-country reporting will necessitate a reconciliation of (1) the multinational company’s public financial statements to (2) its legal entity books and accounts (as reported in all currencies and in all accounting standards) to (3) the local tax returns prepared and filed to (4) the filed country-by-country template reports.. Country-by-country reporting will now place greater stress on this disconnection between the accounting systems and the income tax reporting process.
Absent internal system changes, additional time-consuming manual processes and resources will now be required on an annual basis. As a result of CbC reporting inquiries, increased tax examinations, and the likely increase in manual processes necessary to prepare the template, the overall availability of additional human resources becomes an even greater and more pressing issue for corporate tax departments.
4) What corporations will be required to file in response to the CbC reporting template?
All multinational entities will be required to file the annual template, unless the group has less than €750 million (approximately $840 million) of consolidated financial revenue for the preceding year.
5) What is the deadline for CbC reporting requirements?
The OECD has recommended that multinational entities file the initial template for fiscal years beginning on or after Jan. 1, 2016. A multinational entity is required to file the template within one year after the close of its fiscal year. For example, a calendar-year company would be required to file its initial template for 2016 by Dec. 31, 2017.
6) What countries have agreed to participate in this new reporting requirement?
According to Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration, the hope is that all OECD member and extended member countries will adopt the new reporting requirement. To date, countries that have publicly indicated they will adopt or have passed legislation to adopt include the United States, India, South Africa, Brazil, Spain, Germany, United Kingdom, and Australia. Each week there are new announcements about additional requirements from adopting countries.
7) What are the potential concerns?
a) Increased Audits, Transfer Pricing Disputes and Double Taxation
One must assume that the template itself will be audited by the various taxing authorities because of its inherent importance to them as an initial audit risk assessment tool. As a result, companies should expect immediate inquiries (and thereby additional time required to respond to these initial inquiries) regarding the information being provided in the country-by-country templates. In addition, full-scale audits should also be anticipated over whether a company has a tax presence in a particular country in which income tax returns are not being filed. Also, expect increasing audits from emerging and developing countries. Since these countries rely heavily on tax revenue from multinational companies to fund their government programs, and since much of this country-by-country information was not available to their taxing authorities in the past, additional tax audit management resources will likely need to be devoted to these countries.
Other expected results of the CbC reporting template are increased transfer pricing-related disputes with the taxing authorities and the incidence of double taxation on the same income, especially if the OECD’s other transfer pricing BEPs action plan changes are adopted in final form. Many believe these changes will cause an erosion of the longstanding arm’s-length transfer pricing principals by some aggressive tax authorities. The focus of transfer pricing audits would therefore shift to an MNE providing information on its global value chain and its allocation of income, economic activity, and taxes paid among countries that generally will be unrelated to the specific transfer pricing arrangement. Ultimately, this could lead to more cross border disputes. And without adequate competent authority rules, could result in increased double taxation, a very costly result.
b) Increased Tax Controversy & Reputation Risk
Multinational companies are (rightly or wrongly) seen by many as undermining the credibility of the tax system. Most global executives are aware of cases where publicly traded companies have had to openly respond to governments and to the press about their tax affairs. Therefore, it would be prudent to plan for an uptick in tax controversy due to the CbC reporting template and this escalation of tax disputes could lead to greater reputational risk.
c) Increased Data Security Risk
The reporting requirements also represent a real risk that confidential information provided in the template will eventually be disclosed to the public through information leaks or formal disclosure requirements by individual countries.
The country-by-country report will be filed with the tax administrator in the MNEs ultimate parent’s tax jurisdiction. Thereafter, that tax jurisdiction is responsible for submitting the template to other tax jurisdictions in which the group operates. The primary method for automatically exchanging the template between tax administrators will be using government-to-government mechanisms, such as bilateral tax treaties and tax information exchange agreements. There is a lurking vulnerability of information mismanagement between governments.
“Confidentiality is a significant concern. Many tax practitioners believe that at least some taxing jurisdictions will make the information reported publicly available.”
And with the number of governments that will be receiving this information on an annual basis, leaks to the press are inevitable. Add to that the increased scrutiny and involvement of bloggers, social activists, and nongovernment organisations and the risk is very real. A public release of the country-by-country information would effectively require a multinational company to respond in public as to how its public financial statements are reconciled to the template. If the template contains unintended errors or estimates that could be misinterpreted, unfair reputational risk to the company could result.
Therefore, the question is whether MNEs can rely on governments to keep their information secure and assure confidentiality, and whether they can depend on countries installing the appropriate safeguards and information-transfer controls.
8) What are the recommended next steps for a CEO of a multinational corporation?
Treat this as a Strategic Issue for 2016
There is a natural tendency for corporations to place new reporting requirements “on the back burner” because of other ongoing challenges and priorities. However, the lead time necessary to evaluate and prepare the company’s internal systems and processes for this historic reporting shift in transparency should not be underestimated. Given the potential impact on the MNEs worldwide tax profile, the preparation of the CbC template should not simply be considered to be another compliance burden. Instead, it should be viewed as a strategic risk management issue. In order to mitigate audit and reputational risk, corporate tax departments will need to continually take a proactive approach to CbC reporting.
Assess IT and Tax Resource Needs
It is critically important that corporations immediately assess whether their existing financial accounting systems will allow their companies to comply with these new reporting requirements. Many companies will also need to actively consider technology solutions to collect, store, analyze, and prepare the CbC templates in an accurate and defensible fashion. And corporate tax departments should evaluate their internal processes and whether additional staff may be required to deal with the additional compliance and tax audit management requirements that will likely arise as a direct result of the CbC template.
Of course, all of these added costs will need to be factored into the corporate budget and discussed with senior management, audit committees, and other stakeholders as soon as possible.
Prepare for Global Risk Management
Finally, the inevitable escalation of tax disputes as a result of the CbC reporting template, BEPS-like unilateral action being taken today by countries and their auditors, inconsistencies in the way governments apply transfer pricing standards and the soon-to-be new BEPS guidance; coupled with the real on-going issue of the lack of confidentiality; will all likely lead to greater reputational risks for the MNEs. More than ever, the MNE’s tax planning strategies will need to be carefully thought through in advance by the corporate tax department due to this new paradigm shift in transparency; and openly discussed on an ongoing basis with its senior management and the Board of Directors.
*Authored by members of the Vertex Chief Tax Office:
Bill Brennan, M.S. in Taxation, CPA
Nancy Manzano, M.S. in Taxation, CPA
Robert Norton, M.S. in Taxation, CPA
Bernadette Pinamont, J.D., CPA
Unique in the tax technology industry, Vertex’s Chief Tax Office (CTO) provides insight regarding the impact of tax regulations, policy, enforcement and emerging technology trends on global tax department operations. The Vertex CTO group consists of former tax executives from various Fortune 500 multinationals, who bring their in-house tax and industry expertise to Vertex’s solution development, services and customer interactions.