This article is written by Vera Zhuravleva and Michael Kratz. Vera ([email protected]) is a Senior Manager and Michael ([email protected]) is a Consultant in the International Services Practice of RSM Netherlands with a focus on Supply Chain Management and Transfer Pricing services.
In recent years, the international tax landscape has placed increased emphasis on transparency and information exchange. The most well-known transparency initiative was Country-by-Country Reporting (CbCR), requiring that certain large internationally active companies provide information of their global allocation of profit, taxes paid and other information indicative of economic activity such as employee headcount per entity. As of October 2021, the CbCR initiative has resulted in over 3000 activated bilateral exchange agreements, with the first automatic exchanges of information occurred in June 2018.
Other transparency initiatives in Europe, which are at varying degrees of implementation, include DAC 6 (relating to reportable cross-border arrangements), DAC 7 (relating transparency of digital platforms) and DAC 8 (relating to administrative cooperation and exchange of information). Whilst the details of these transparency initiatives are all different, the central theme of transparency and disclosure remains front and centre. In addition, in some countries domestic legislation empowers tax authorities to request certain information relating to a taxpayer’s foreign affiliates.
Whilst the purpose of the above-mentioned initiatives is to enhance transparency vis-à-vis the taxpayer and tax-authorities, the latest initiative is focused on enhancing transparency for the public. On 11 November 2021, the European Parliament formally approved the proposed Public CbCR Directive, which will become binding on Member States once signed and published in the Official Journal of the EU. Public CbCR will enter into force 20 days after publication and Member States will have 18 months to transpose the Directive into their local legislation.
Public CbCR will require EU based multinational enterprises (MNEs) with revenues exceeding €750 million and non-EU based MNEs doing business in the EU through a branch or a subsidiary to publicly disclose (on a country-by-country basis) information of their allocation of profit, taxes paid and other information indicative of economic activity. Such public disclosures will need to be made with respect to all 27 EU Member States and all jurisdictions on the EU list of non-cooperative jurisdictions for tax purposes (i.e. countries appearing on the so-called EU black list and grey list). Aggregate figures would also have to be provided for operations in other tax jurisdictions in the rest of the world.
Accordingly, the Public CbCR initiative not only places group information at the disposal of tax authorities, but also exposes the group to public scrutiny and opinion which (if unfavorable) can result in reputational harm and potential financial consequences far exceeding any transfer pricing adjustment, penalty or interest.
Moving forward cautiously
Public CbCR brings with it a new set of challenges and associated risks which internationally active companies need to effectively manage and mitigate against if they want to avoid negative public scrutiny. Recently, the Pandora Papers investigation has demonstrated the strength of journalistic collaboration and investigation in exposing the harmful tax practices of wealthy individuals and corporations.
With the advent of Public CbCR, journalists will no longer need to rely on leaks as the group’s information will be delivered right into their hands. Reviewers of such information not having access to the relevant supporting documentation may incorrectly reach conclusions of tax avoidance or evasion where this is in fact not the case. Therefore, it is crucial that the data disclosed in the CbCR return reflects a fair amount of profits recognized in all jurisdictions of the group’s presence.
We recommend companies to analyze their CbCR, detect the possible tax risks and ensure that the issues identified are carefully analysed and fixed before their CbCR becomes public. Further, a central and tactical approach to transfer pricing is critical. Even though the CbCR legislation is already in place for a few years, in practice we see that many internationally active companies still follow the local compliance-based approach where they only think about transfer pricing when it comes to meeting local transfer pricing reporting requirements. Such compliance-based approach is no longer sustainable – with public transparency coming into play, transfer pricing is becoming more and more a strategic rather than a reporting task.
Public CbCR could be viewed only as a first step in public transparency measures. If such initiative is proven to be effective, there could be additional and similar measures at a regional and local level for companies of a smaller size. The above-mentioned principles to approach intercompany pricing will help companies of any size to manage their TP and reputational risks related to public transparency and prepare for the future. Clear internal processes and usage of tools that facilitate intercompany calculations, segmentations, analyses and monitor transfer pricing data can help to ensure consistency with the global TP framework at a local level.