Written by Darrel Pearson and Claire M.C. Kennedy
2016 was the first year of the new transfer pricing reporting regime called Country-by-Country Reporting (CbCR). It will be a major new tool for revenue authorities and will undoubtedly lead to greater audit activity and more transfer pricing disputes as it begins its implementation around the world, including in Canada.
Although BEPS was aimed primarily at income taxation of multinational enterprises (MNEs), it will have significant customs duty and compliance effects too, especially for companies with extensive inter-company supply chains. Here we highlight what customs compliance managers need to know to ensure they understand the impact of BEPS on their responsibilities and the company's customs liabilities, that is, to ensure they are BEPS ready.
What is BEPS?
BEPS stands for Base Erosion and Profit Shifting and refers to tax planning by MNEs that inappropriately reduces the corporate tax base in high-tax jurisdictions where they operate (this is the "base erosion" part of the name) and shifts income to low tax jurisdictions or even creates non-taxed income ("profit shifting"). In 2013, the Organization for Economic Co-operation & Development (OECD) initiated the BEPS Action Plan to counter these planning techniques. The Action Plan was built around 15 Action Items with transfer pricing directly implicated in four of them.
Which Countries are Participating in BEPS?
Most major economies, both developed and emerging, are participating in BEPS, including the U.S., Europe, Canada, Australia, and most Asian and South American countries, including China, Japan, India, South Korea and Brazil, Argentina and Chile. If your company has a global supply chain through which you import goods, services, and intellectual property (IP) rights, you will be affected by BEPS.
Is BEPS Mandatory?
Some BEPS Action Items have minimum standards that countries must meet; others recommend best practices or common approaches. Countries may adopt different ways of implementing the BEPS recommendations, some of which will result in complex rule changes.
What is Country-by-Country Reporting (CbCR) and the Automatic Exchange of Information?
One of the most impactful BEPS measures will be new transfer pricing documentation standards with a three-tiered approach that includes the third tier, or country-by-country report (CbCR), for large MNEs (>€750-million annual turnover). The three tiers are:
- Master File: High-level information on global business operations and TP policies, complete with org chart, description of intangibles, and financial and tax information.
- Local File: More detailed information specific to each country where the MNE conducts business, including detail on specific related-party transactions involving that country.
- CbC Report: A detailed report comparing revenues, assets, activities and employee count, etc. in each country. CbC Reports are usually filed by the parent company with the revenue authority in its headquarter country and will be exchanged as noted below.
This BEPS Action Item is a mandatory item. 2016 is the first year for which CbCReports must be filed, no later than December 31, 2017.
In addition, almost 60 countries have also already signed on to the automatic exchange of information with the result that CbCRs will be automatically exchanged by the revenue authority in the filing (headquarter) country with its counterparts in other countries in which the MNE does business. Counties not (yet) participating in the automatic exchange, notably the U.S., will exchange bilaterally under tax treaties.
What Will Be the Impact of CbC Reports?
It is widely expected that CbCR will generate extensive audit activity by revenue authorities. In particular, they will be looking for cases where large revenues are earned in a country relative to the number of people employed there or taxes paid. This may be indicative of aggressive planning to avoid PE status or other measures that revenue authorities consider not appropriate.
How Will CbCR Impact Customs?
CbCR is not simply an audit tool for income tax authorities. Customs authorities have made transfer pricing of goods, services and license fees a target of audit activities for many years as they have endeavoured to identify and capture as dutiable undervalued goods and overvalued non-dutiable services and royalties/license fees. Detailed (or granular) transfer pricing studies and policies will become even more important as customs authorities take advantage of the CbC reporting requirements to even more closely examine transfer pricing documentation.
Making Customs Compliance BEPS Ready
Canadian MNE importers should determine if their company is filing a CbCR and ensure that the customs as well as income tax impacts are considered by reviewing current transfer pricing practices and documentation to ensure they are BEPS compliant and are consistent with the company's customs valuation practices. Customs managers should prepare themselves for increased Canada Border Services Agency customs valuation audit activities by seeking the advice of transfer pricing/customs legal counsel under the umbrella of solicitor-client privilege.