Master File, Local File, and Country-by-Country Report
By Kurt C. Wulfekuhler, Economics Partners, LLC
Globalization has produced tremendous gains for the world’s economies through increased trade and foreign direct investment leading to greater employment and innovation. Multinational enterprises (“MNEs”) have also become more integrated and globalization has helped them reduce their tax burdens by shifting profits to lowtax jurisdictions through transactions with related parties. Concerned that this so-called base erosion and profit shifting (“BEPS”) poses a serious risk to tax revenues, tax sovereignty, and tax fairness, the Group of Twenty (“G20”) and the Organisation for Economic Co-operation and Development (“OECD”) developed an Action Plan on Base Erosion and Profit Shifting (“Action Plan”).
Central to the Action Plan is aligning transfer pricing outcomes with value creation. That is, transactions between members of a multinational group should result in an allocation of profit that is aligned with the economic activity that produced the profit. To evaluate whether taxpayers’ transfer pricing outcomes are aligned with value creation, the OECD developed a three-tiered approach to transfer pricing documentation, consisting of:
1. Master file;
2. Local file; and a
3. Country-by-Country (“CbC”) Report. Because the CbC Report has garnered the greatest attention and because it should help direct the rest of an MNE’s transfer pricing documentation, we begin our discussion there.
The CbC Report will contain important group information not generally available in the past to all tax administrations where the MNE operates. it is required for enterprises with consolidated global revenues equal to or exceeding EUR 750 million. The CbC Report requirement will be effective for fiscal years beginning on or after January 1, 2016. It is to be filed with the tax administration for the group’s parent company. It comprises two tables: (1) an overview of the allocation of revenue, income, taxes, and other financial measures by tax jurisdiction; and (2) a list of all the constituent entities of the MNE group and their main business activities.
The master file provides a high-level overview of the group. It includes information on the MNE’s legal-entity organizational structure, business, intangibles, intragroup financing, and financial and tax positions including tax rulings. The master file is also the taxpayer’s opportunity to explain the results of the CbC Report. It can describe how the allocation of income is aligned with how the business operates globally, how transfer prices are set, and how intangibles are developed, owned, and exploited. It is imperative to get this part of the documentation right so that the taxpayer can support the resulting allocation of income within the group.
The local file contains specific information for a particular country. It includes a description of the local entity, its business and business strategy, any business restructurings or transfers of intangibles, and key competitors. It also includes descriptions of the material controlled transactions, intercompany agreements, all of the economic analysis supporting the arm’s-length nature of the controlled transactions, and copies of any advance pricing agreements or other tax rulings relating to those transactions to which the local tax jurisdiction is not a party.
Conclusion and Recommendations
The new OECD documentation guidelines mark a new chapter in transfer pricing disclosure and transparency. Tax administrations will now have access to financial and other information on entities outside of their jurisdiction. And the amount of information required in the transfer pricing master file and local files has generally been expanded.
Transparency, however, is likely here to stay so it is important for MNEs to adapt to the new regime. There are even some benefits for taxpayers from the new guidelines. For one, they help standardize local transfer pricing documentation. Understanding different local requirements has been a considerable challenge has resulted in a compliance burden through the need to engage different service providers in each jurisdiction. For sure, local jurisdictions will still have their own idiosyncrasies but completing a master file and local file will go far to meet local requirements.
A useful strategy for addressing the new transfer pricing documentation guidelines could include the following steps:
- Prepare a CbC Report. Even if the group’s sales do not meet the threshold for requiring the CbC Report, it is an important exercise for developing the master file.
- Evaluate risks. From the CbC Report identify any areas that are not consistent with the group’s transfer pricing policies and/or substance and modify accordingly.
- Develop the master file. Make sure the master file agrees with other public information about the group’s business and profit drivers (for example, Form 10-K business description). Be sure that the narrative in the master file supports the information in the CbC Report.
- Prepare the local files. Develop a local file for each relevant jurisdiction based on the material controlled transactions within the group.
- Translate as needed. Prepare the master file and local files in the global language of the group. That way, all documentation can be reviewed, understood, and confirmed by the tax function within the head office. The documentation can be translated (for example, by a translation agency) where it needs to be presented in the local language.
Following these steps will help produce transfer pricing documentation that is consistent globally and presents the MNE’s transfer pricing in the best possible light.
Kurt C. WulfekuhlerEconomics Partners, LLC, Bala Cynwyd (PA), Denver (CO), Mendham (NJ), Washington DC, USA
Published: May 2016 l Photo: Colourbox.de