What does the new financial transactions guidance provided by the OECD mean for you?

What is it all about?

More than 18 months after the publication of its non-consensus discussion draft on Financial Transactions (BEPS Actions 8 to 10), the OECD released its ‘final’ report on the transfer pricing of financial transactions on Tuesday 11 February 2020. The original draft left some 25 areas of disagreement, representing a non-consensus position of the OECD’s Committee on Fiscal Affairs. While those areas are largely resolved by the guidance, there remain some issues that have not been definitively addressed.

Continue reading “What does the new financial transactions guidance provided by the OECD mean for you?”

Are you on top of your transfer pricing?

Scores of South African corporate companies will soon be subject to increased scrutiny and cross-border tax reporting regulations as the country aligns its tax regulations with global standards. These latest requirements are contained in two draft notes from the SA Revenue Service (SARS).

The first deals with compulsory transfer pricing documentation retention requirements for companies with revenues over R1 billion and the second introduces the Country-by-Country Reporting (CBCR) Standard for Multinational Enterprises.

The requirement stems from the OECD-led Base Erosion and Profit Shifting (BEPS) project that aims to eliminate tax planning strategies which exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations.

The OECD reports that the magnitude of the problem, according to research since 2013, is conservatively estimated at between 4% and 10% of global corporate income tax revenues, worth between US$100 billion and US$240 billion annually.

The concept of eliminating profit shifting through practices such as transfer pricing is not new, but there has been renewed vigour on a global scale to accelerate agreement and compliance. The aim of the CBCR standard, which is the second draft note from SARS mentioned above, is to improve transparency of earnings by multinationals in multiple territories.

Through this measure, countries will be able to gain a more accurate picture of whether tax liabilities in their jurisdiction are being fully met.

The upshot of the new regulations is a far more vigorous reporting requirement on qualifying companies. The regulations call for organisations to submit their first reports as from 31 December 2017 for the fiscal year starting on or after 1 January 2016.

The threshold for companies to complete country-by-country financial reports has been set in South Africa at a turnover above R10 billion, with additional provisions that throw this net a little wider.

These additional provisions apply to South African tax resident companies that are not the ‘ultimate parent entity’ of a multinational group when their parent entity is not obligated to file a report in its tax jurisdiction; when the parent entity does not yet have a tax information sharing agreement with South Africa; or that fails to share information required by the new regulations.  Despite these options, the group must still meet the R10bn first, and then if any of these apply, the SA entity will be legally obligated to report according to the CBCR standards.

The finer details and definitions of what constitutes a parent entity are quite complex, but any large corporate that is a subsidiary of a global group or a South African entity operating in multiple international markets will undoubtedly be affected. What these regulations do make very clear, though, is that many large corporations are going to have to invest considerable time and effort to ensure they comply with the new reporting standards.

Apart from adopting new processes, companies that do not have the ability to consolidate financial statements across multiple entities, particularly cross-border operations, may have to invest in the necessary technology to minimise disruption to their accounting teams.

There is little doubt that hiding or shifting profits is going to become increasingly difficult as this new era of transparency and information sharing takes effect. Ultimately, this is for the good of the local and global economy, and companies are advised to take these measures seriously and start preparing for the first reports in order to avoid disruption or non-compliance.

South Africa releases specific draft regulations for country-by-country tax reporting

puzzle-696725_960_720I have recently joined Grant Thornton’s transfer pricing team and was given the opportunity to write transfer pricing alerts for Grant Thornton. Going forward, I will be publishing my posts via the Grant Thornton database but I will also post the same articles here with the hope to get more interaction.

My first post dealt with secondary adjustment and can be found here. I will not go into any further detail as this was previously discussed, but if you would like to pick up on any points please feel free to comment below.

My second post which deals with country-by-country reporting in South Africa can be found here.  What are your thoughts on the topic? Again I would love to hear your comments so please don’t be shy and post below.

Update on BEPS from the OECD – a transfer pricing perspective

No new taxesOn the 26th of May, the OECD hosted a live webcast to provide us with an update on the BEPS Project and its 15 Action Points. You can find the archived webcast here and even better you can download the slides if need be.

Arguably only 5 of the 15 Action Points actually related to transfer pricing and only the following 2 Action Points: TP Aspects of Intangibles (Action 8) and TP Documentation (Action 13) are going to be presented to the G20 in September. This obviously means that these 2 Action Points are prioritised from a transfer pricing perspective.

In short there was a lot of public interest and 462 comments were received. I thought the following points were interesting as they are from developing countries such as South Africa. Please note the list is derived from the OECD Live Webcast slides:

  • “Excessive payments to foreign affiliated companies in respect of interest, service charges, management and technical fees and royalties;
  • Supply chain restructuring that contractually reallocates risks, and associated profit, to affiliated companies in low tax jurisdictions;
  • Significant difficulties in obtaining the information needed to assess and address BEPS issues, and to apply their transfer pricing rules;
  • Use of techniques to obtain unintended treaty benefits;
  • Wasteful tax incentives designed to attract investment; and
  • Techniques used to avoid tax paid when assets situated in developing countries sold.”

The webcast does go into more detail on the different Action Points but I thought I provide the summary from the OECD slides on the 2 transfer pricing Action Points mentioned above for the guys who do not have time to watch the full webcast.

Transfer Pricing Aspects of Intangibles 

Status

  • “Agreement within WP6 on the revised text of Chapter I and Chapter VI;
  • Chapter VI: up-to-date approach to identifying intangibles and how arm’s length considerations should be determined; and
  • The strong interaction between Section B and the work on risk, re-characterisation, capital and the related special measures is recognised in the paper.”

Next steps:

  • “Formal approval by WP6 and approval by CFA; and
  • Work on risk, re-characterisation, capital and the related special measures will be addressed by WP6 with priority.
    • This work stream together with the work on Intangibles will provide guidance on the most challenging TP issues, including excessive capitalisation, low functionality and mere contractual assumption of risk, and will develop approaches to deal with hard to value intangibles
    • The public release of a full draft report on these issues is expected in December 2014″

Transfer Pricing Documentation and CBC Reporting

Status

  •  “Consensus in WP6 that the new approach will greatly improve the access for governments to relevant information for transfer pricing purposes;
  • Agreement on a three tier approach (CbC template, Masterfile and Local File);
  • As these are new tools, experience needs to be developed to assess the effectiveness and efficiency of the tools. WP6 is uniformly of the view that a monitoring mechanism is needed to assess whether the focus of the mechanism can or should be improved in the future;
  • There is also broad recognition within WP6 that a structured and careful implementation is necessary to guarantee:
    • consistency in the approaches by governments
    • that the relevant information is available to governments for which it is relevant on a timely basis
    • that commercially sensitive information is treated confidentially
    • that the costs for both taxpayers and tax administrations are balanced
    • to secure that the information is used as intended
  • WP6 will finalise the document shortly. After that it will be sent to CFA for formal approval”

There has been quite some reaction to BEPS and how it is going to work. But I am quite excited about the new BEPS stuff and believe it will be beneficial to all countries involved.

As always let me know your thoughts!

Transfer Pricing Risk Assessment

I wrote the below blogpost last year but I thought it may be worth while to share it on this blog as the old blog does not exist any longer.

dangerAs many of you know the OECD published its “Public Consultation: Draft Handbook on Transfer Pricing Risk Assessment” on 30 April 2013 (hereon referred to as “draft handbook”). The purpose of this handbook is to provide practical resources that can be used by tax administration seeking to develop/improve its risk assessment procedure, methods and practices. However, this will also be useful for taxpayers to ascertain what exactly tax administrations may look at to determine whether a taxpayer and his current/planned cross boarder related party transaction may be at risk for further investigation.

The draft handbook is divided into the following six different sections which are discussed in more detail below:

  1. Introduction to transfer pricing risk assessment
  2. Questions to be answered in a transfer pricing risk assessment process
  3. Assessing when transfer pricing risk exists and when it does not
  4. Sources of information for conducting a transfer pricing risk assessment
  5. Risk assessment process – selecting cases for transfer pricing audit
  6. Building productive relations with taxpayers – the enhanced engagement approach

The following subsections are a summary of the sections within the draft handbook. Please note, in order to get a full understanding of the sections and problems discussed below, it is advisable to read the actual draft handbook.

Introduction to transfer pricing risk assessment

The first section provides objectives and the rational of the draft handbook. Then it describes what a transfer pricing risk assessment is and how it progresses. This section also highlights some sensitive points such as “occasional losses are a genuine feature of business life and may not necessarily be the result of transfer pricing manipulation”.

All-in-all the first section provides a high-level overview as to how the OECD believes a transfer pricing risk assessment should be performed.

Questions to be answered in a transfer pricing risk assessment process

This section deals with the fundamental transfer pricing risk assessment questions to be answered before an actual risk assessment is performed. The draft handbook states that before starting a transfer pricing risk assessment the following questions should be answered:

  • Are there material controlled transactions?
  • Is there an indication of transfer pricing risk – i.e. potential of shifting income and erode the local tax base – the types of payments that raise such issues could include:
    • Large royalty payments
    • Large rental payments
    • Large management fees
    • Large insurance payments
    • Financial derivative contracts
    • Large payments of deductible interest
  • Is the case worth an audit?
  • What specific issues need to be addressed during the audit?

Assessing when transfer pricing risk exists and when it does not

The first part of this section deals with the types of transactions in relation to transfer pricing risks and the second part deals with risk indicators. The whole section is the crux of the draft handbook.

The different types of transactions can be summarised as follows:

  • Risk arising from recurring transactions: For example, if a local taxpayer in one of the extraction industries sells all of its local country output to related parties, small pricing discrepancies in each individual sale can add up to large reductions in the local tax base. Accordingly, recurring related party transactions will be one key risk factor. Certain types of transactions (as listed above) may create more cause for caution than others.
  • Risk arising from large or complex one time transactions: A different type of transfer pricing risk can arise in connection with certain types of large and/or complex one time transactions such as business restructurings or transactions involving the creation/sale of intellectual property.
  • Risk arising from taxpayer behavior in governance, tax strategies or ability to deliver compliance: This risk factor stems from the taxpayer’s behavior rather than the nature of its transaction. I.e. is the taxpayer compliant?

In addition to the different types of transactions identified above a quantitative evaluation of the amount of potential tax at stake should form part of the risk assessment process. What is the point of performing a long lasting audit if the outcome may only provide a few bucks to the tax administrations?

The following is a summary of the risk indicators observed from related party transactions that may indicate higher transfer pricing risk, and therefore, in the opinion of the OECD support a decision to conduct a thorough audit:

  • Profitability/Financial results: The following points may indicate a higher transfer pricing risk in relation to profitability/financial results:
    • If the profitability/financial results of the company under review substantially differ to:
      • those of industry standards or potential comparable companies
      • its related party of the tested (i.e. same) transaction in the other tax jurisdiction
      • the whole of the group’s performance
    • If the company under review is a consistent loss maker, or if the company under review makes recurring low profits or low returns on investment.
    • If the profit trends of the company under review are contrary to market trends.
    • If from a group’s perspective of the company under review, a large portion of the overall income is allocated to a lower tax jurisdiction where few economic activities take place.
  • Transactions with related parties in low-tax jurisdictions: Even though there may be commercial reasons for trading with or in low-tax jurisdictions any sizeable transaction has a high potential for non-arm’s length pricing.
  • Intra-group service transactions: Intra-group service transactions may be one of the most frequently occurring transfer pricing issues. Depending on the nature of these service transactions and the charges made for them, the issues can have either large or limited significance.
  • Royalty, management fees, and insurance premium payments, particular to entities in low tax jurisdictions: These payments can be used to erode the local company’s tax base and as such these payments are always seen as more risky.
  • Marketing or procurement companies located outside countries where manufacturing takes place: There is a risk in these types of transactions in the sense that the taxpayer is strategically accumulating income in such marketing/procurement companies in excess of the income that can be justified by the economic activity in those companies.
  • Excessive debt and/or interest expense: Excessive debt can be used to erode the tax base, particularly when the interest is paid to related entities in low tax or conduit jurisdictions.
  • Transfer or use of IP to/for related parties: This is a topic on its own but in short when transferring an income-producing intangible, determining its arm’s length value is crucial. This process is very difficult and as such poses risks in relation to miss pricing of the IP.
  • Cost contribution arrangements: Similar to IP this is a difficult subject especially when creating unique or valuable IP. Cost contribution arrangements are seen as complex and as such pose a greater risk to tax administrations.
  • Business restructurings: This topic has been a hot topic around the world for quite some time. Transfer pricing issues arising with regard to business restructurings can be very complex and require a thorough transfer pricing audit.

Lastly the second part of this section gives a brief description of non-tax factors that may distort pricing and the importance of contemporaneous transfer pricing documentation.

Sources of information for conducting a transfer pricing risk assessment

This section illustrates the information sources available to conduct a transfer pricing risk assessment. The following is a list of sources that may be available to different tax administrations:

  • Specific tax return disclosures – information returns
  • Contemporaneous transfer pricing documentation
  • Questionnaires issued to selected taxpayers
  • Taxpayer’s file and audit records of previous years
  • Publicly available information regarding the taxpayer (such as internet searches, commercial databases, press reports & trade magazines and security analysts’ reports
  • Site visits and meetings with company personnel
  • Customs data
  • Patent office
  • Exchange of information under tax treaties
  • Necessary legal provisions to facilitate access to information
  • Obtaining information relating to foreign associated enterprises
  • Obtaining information relating to domestic potentially comparable businesses

It is important to note that even though tax administrations may not use every available information source, none of the information sources available to the tax administration should contradict each other – be it through supplied information or publicly available information. For example taxpayers may provide tax authorities with low profit margins (or even losses) due to inefficiencies or a downturn in the economy, however, when looking at publicly available information, such as financial statements or websites, the information available may depict a different story as this information is mainly trying to please stakeholders (i.e. show a good investment).

It is important to note that tax administrations do not only look at tax returns.

Risk assessment process – selecting cases for transfer pricing audit

This section outlines the procedures and steps that a tax administration should follow to conduct a risk assessment. It is important to note that a risk assessment process should be consistent and regular and that all personnel involved must have a clear understanding of that process. Common steps in the risk assessment process may include the following:

  • Assembling quantitative data from tax returns, transfer pricing forms and contemporaneous documentation provided by the taxpayer
  • High level identification of possible transfer pricing risk by analysing processed quantitative data
  • High level quantification of potential risk
  • Reviewing qualitative information in contemporaneous information and gathering of additional intelligence from public sources
  • Tentative decision as to whether to proceed
  • More in depth risk review including analysis of functional and comparability descriptions in contemporaneous documentation
  • More detailed quantification of potential risk
  • Initial interactions with taxpayer personnel
  • Preparation of draft risk assessment report
  • Decision as to whether to proceed with an audit, including decisions regarding issues to target in the audit
  • Internal review and quality control processes, including central committee review if such a committee is used
  • Prepare final risk assessment report

Additional to the above process tax administrations use transfer pricing specialists or if needed industry specialists within their risk assessment process.

Building productive relationships with taxpayers– the enhanced engagement approach

The last section of the draft handbook mentions that several countries have adopted programmes intended to increase the amount of real time engagements with taxpayers on transfer pricing issues. The objective of such programmes is to increase communications between taxpayers and tax administrations to avoid long audits and save costs for both. Examples of some of the programmes are summarised within the draft handbook.

Closing remarks

The above is merely a summary of the draft handbook on transfer pricing risk assessment with a few examples. If you have any questions, concerns or recommendations please feel free to comment below. My personal view is that such a handbook is great for both tax administrations and taxpayers alike as it helps tax administrations to follow a simple process in their risk assessment and it provides full disclosure for taxpayers as to how a tax administration will assess risk.

On 23 September 2013 the OECD published comments received on the new Draft Handbook on Transfer Pricing Risk Assessment, which you can find here.

Happy reading!