In this edition: the Secretary of the Treasury releases the annual report concerning Advance Pricing Agreements (APA), the Organization for Economic Co-operation and Development (OECD) releases additional guidance aimed at consistent implementation of Country-by-Country (CbC) reporting, the UN releases transfer pricing manual on developing countries, and the Australian Government passes legislation to increase late lodgement penalties for Australian Significant Global Entities (SGEs).
Treasury Releases APA Annual Report
On March 27, 2017, the Secretary of the Treasury released the annual report concerning Advance Pricing Agreements ("APA") and the Advanced Pricing and Mutual Agreement ("APMA") Program for the 2016 calendar year. The report includes (1) information on the structure, composition, and operation of the APMA Program, (2) statistical data on APAs filed, executed, pending and withdrawn since 1991, and (3) general descriptions of various elements of the APAs executed in 2016, including types of transactions covered, transfer pricing methods used, and completion time.
The report discloses that 98 complete APA applications were filed with the APMA Program in 2016, indicating a significant decrease from the 183 complete applications filed in 2015. Likewise, the number of executed APAs declined from 110 in 2015 to 86 in 2016. Of the 86 executed APAs, 41 percent were new (i.e., not a renewal of a prior APA). Approximately 76 percent of the executed APAs were bilateral. No multilateral APAs were executed in 2016.
Consistent with 2015, nearly three quarters of the executed bilateral APAs in 2016 involved bilateral agreements with either Japan or Canada. Moreover, 85 percent of all executed APAs were for transactions occurring in either the manufacturing or wholesale/retail trade industries, and 78 percent of the covered transactions involved either the sale of tangible goods or the provision of services. As of December 31, 2016, 398 APAs were pending, with approximately 42 percent of those being renewals of prior APAs.
Most noteworthy from the Treasury's report is that in addition to the decrease in APA applications filed, the number of APA applications withdrawn increased to 24 during 2016. This is up from 10 withdrawn applications in 2015 and the most since 2002, when 26 applications were withdrawn. This may be indicative of taxpayer dissatisfaction with the lengthy APA process. While the amount of time taken to complete new and renewal APAs has not increased relative to last year, unilateral and bilateral APAs took an average of approximately 38 months to complete, with unilateral APAs taking approximately 24 months and bilateral 42 months.
It will be interesting to see what next year's report reflects related to the number of new submissions and the number of withdrawals given that the potential for tax reform might make taxpayers regret being a party to a long-term binding agreement. It is possible that the withdrawal spike in 2016 reflects, in part, this concern.
A final item of interest in the report relates to submissions for bilateral APA requests with India. On February 16, 2016, the Internal Revenue Service began accepting bilateral APA applications between the United States and India, resulting in an uptick of APA applications filed involving India. This follows the United States and Indian competent authorities' joint announcement in January 2015 that they had reached agreement on a framework for resolving longstanding competent authority cases involving Indian-resident affiliates performing information technology-enabled services or software development services. Of the 84 bilateral APA applications filed in 2016, 34 percent were for an APA between the United States and India.
Further information on the APA annual report is available here.
An OECD Update
On April 6, 2017, the Organization for Economic Co-operation and Development ("OECD") released additional guidance aimed at consistent implementation of Country-by-Country ("CbC") reporting under Action 13 of the Base Erosion and Profit Shifting ("BEPS") Action Plan ("the Guidance"). Such guidance comes as an update to the earlier versions released by the OECD in June 2016 and December 2016 which were also designed to assist various jurisdictions in introducing consistent domestic rules with regards to BEPS Action Plan 13.
The earlier Guidance provided clarifications on the application of CbC reporting to investment funds and partnerships; the impact of currency fluctuations on the minimum threshold for applicability of CbC reporting requirements and the transitional filing options and reporting requirements for multinational enterprises (MNEs) that would voluntarily file in the parent company jurisdiction.
In the updated Guidance:
- The definition of "Revenues" has been clarified to include extraordinary income and gains from investment activities for the purposes of reporting "Revenues" in the CbC report.
- For purposes of determining whether an MNE Group meets the minimum threshold of Euro 750 million for CbC reporting, the inclusion of extraordinary income and gains from investment activities would be contingent on the applicable accounting rules. For instance, for financial entities which may not record gross amounts from certain transactions under the applicable accounting rules, the term 'revenue' would mean the net amount from a particular transaction.
- The impact of third-party minority shareholding for purposes of determining applicability of the Euro 750 million threshold has been clarified. If the accounting rules in the jurisdiction of the Ultimate Parent Entity1 require proportionate consolidation in the presence of minority interests, the MNEs may be allowed to pro-rate revenues for purposes of applying the minimum threshold.
- Clarification is provided regarding the accounting principles that are to be adopted by an MNE Group for purposes of CbC reporting. Specifically, the accounting principles must align to the accounting standards already being used by the Group for consolidation purposes if the equity interest of the Ultimate Parent Entity are traded on a public securities exchange. Other MNEs may be free to choose between local GAAP of the Ultimate Parent Entity or IFRS as their governing accounting standard.
- Clarification is provided that, for purposes of the CbC report, related parties or associated enterprises should be interpreted as "Constituent Entities" as defined in BEPS Action Item 13 report2.
These clarifications will likely be a useful reference for many MNEs (and their tax advisors) who have an impending deadlines to file the first CbC report for fiscal year 2016.
On a separate note, Mr. Jefferson VanderWolk, the Head of Tax Treaty, Transfer Pricing & Financial Transactions Division at the OECD mentioned in the TPMinds conference held in London last month that the OECD is hopeful to release the revised draft on Profit Split Method this summer.
Further information on the additional OECD Guidance is available here.
UN Releases Transfer Pricing Manual on Developing Countries
The United Nations Committee of Experts on International Cooperation in Tax Matters issued a second edition of its Practical Manual on Transfer Pricing for Developing Countries (2017) (the "Manual") in April 2017.
The first edition of the Manual published in 2013 sought to address the need in developing countries for guidance on the policy and administrative aspects of transfer pricing. While the principles laid down in the Manual are not binding in nature, the aim is to provide guidance to policy makers and administrators, as well as to aid taxpayers in their dealings with tax administrations.
The second edition endorses the same underlying objectives and further details some of the concepts and country experiences. The new edition of the Manual was also updated to address the outcome of the OECD Action Plan on Base Erosion and Profit Shifting ("BEPS") and other modern-day transfer pricing issues.
Some of the key changes to the Manual include:
- A discussion of the three-tiered documentation approach (i.e. local file, master file and Country-by-Country report) outlined in the BEPS Action Item 13 report in the context of developing countries' tax administrations.
- New chapters on intra-group services, cost contribution arrangements and the treatment of intangibles.
- A new subsection in the 'Methods' section referred to as the "sixth method" or "commodity rule".
- The addition of Mexico to the discussion of various countries' practices and experiences, and updates to the same for other countries.
With respect to the "sixth method", the Manual discusses the application of a transfer pricing method which relies on quoted (rather than actual transaction) prices for commodities to price commodity transactions between associated enterprises, reducing the reliance on third-party comparables. This approach was first adopted in practice by certain tax authorities in Latin America (including Argentina, Brazil, Ecuador, and Urugay), and seeks to resolve difficulties associated with finding data on comparables in developing countries as well as to stem perceived BEPS-enabling pricing behaviors that may occur when trading entities with little substance are used in intercompany transaction structures (and when actual transaction characteristics are consequently difficult to observe). The sixth method is certainly easy to apply and administer, but the Manual recognizes that it may not always lead to results that are consistent with the arm's length principle since it does not consider the economic circumstances associated with specific intercompany transaction being analyzed. The sixth method is also outlined in the OECD's draft toolkit for identifying financial data in developing countries (discussed in the last edition of the Transfer Pricing Times here).
A major theme in the Manual is the difficulty and compliance burden that can arise for taxpayers and tax administrations in developing countries in identifying possible comparables and obtaining detailed information. The chapters discuss general approaches and best practices whereas the country practices outline specific provisions which address the issue of compliance burden. Similar to the OECD's draft toolkit for identifying financial data in developing countries, the Manual also discusses the use of safe harbors by tax administrations to reduce the need of comparable sets.
Further information on the Manual is available here.
Further Australian TP Developments – the Train Keeps on Rolling
On April 4, 2017, the Australian Government passed legislation to increase late lodgement penalties for Australian Significant Global Entities ('SGEs'), up to a maximum AUD 525,000 per item of documentation. This change has significant implications, given that CbC reporting in Australia places the onus on the taxpayer to lodge the Master File, Local File, and CbC Report in a new XML submission format, discussed below.
Additionally on April 4, Australia's Diverted Profits Tax Act 2017 was passed, effective for fiscal years commencing on or after July 1, 2017 (see prior Transfer Pricing Times issues). In this regard, the ATO is preparing both a law companion guide and practical compliance guide for taxpayers.
On April 20, 2017, the Australian Tax Office ('ATO') released further guidance to assist the electronic lodgement of the documents required under CbC reporting legislation. This guidance builds on previous guidance (see prior TP Times issuances), and provides the underlying specifications for business management software to enable generation of a valid XML file. The ATO has developed a combined Local File / Master File XML schema, whilst the CbC Report is lodged separately, as set out in an OECD XML schema.
Also in April 2017, the Federal Court of Australia rejected an appeal from Chevron Australia Holdings Pty. Ltd, and ruled that it was required to pay AUD 340 million in unpaid taxes, interest and penalties, as assessed by the ATO in relation to a USD 2.5 billion inter-company loan received in 2003 (see prior TP Times issuances). The loan reduced the tax paid by Chevron in Australia, and allowed a Group's USA-based finance subsidiary to make material profits on the difference between the low external borrowing rate of 1.2% and the high internal lending rate of 9%. This ruling is expected to both "influence and empower" the OECD's BEPS-related reforms, and more tax authorities are now expected to target multinationals over interest deductions.
Soon after the decision's release, the OECD has confirmed its intention to publish guidance on the application of the arm's length principle to intra-group finance transactions in early 2018.
Further information on ATO guidance on the updated Australian CbC reporting XML schema is available here.
1 As defined under Article 1.6 of the model legislation
in the BEPS Action 13 report.
2 Annexure III of Chapter V of Transfer Pricing Documentation and Country-by-Country Reporting, Action 13: 2015 Final Report (pg 31)
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