May 18, 2016 | In late December 2015, the U.S. Treasury and IRS released proposed regulations for a new annual reporting requirement, Country-by-Country Reporting. Developed in response to the country-by-country (CbyC) guidelines issued by the Organisation for Economic Co-operation and Development as part of its base erosion and profit shifting (BEPS) initiative, the proposed U.S. regulations would require certain taxpayers with annual revenues of $850 million or more to file this report.
With final U.S. regulations anticipated later this year and the need to comply with CbyC reporting requirements already in place or expected in other countries, many multinational enterprise groups (MNE groups) are already working on how to implement CbyC reporting. Based upon the authors' experience, considerations for developing a practical approach to this reporting fall into two main areas—tax data management and tax data analytics—each with four steps.
As always, MNE groups may need to take on more, or fewer, work-plan items based on their specific facts. But starting with this practical “2x4” approach to implementing country-by-country reporting can help clients manage requirements and mitigate risks and their advisers plan out CbyC reporting projects appropriately.
1. Tax data management
The CbyC report needs to be built on several foundational, analytical steps. An MNE group should carefully document these steps and the logic connecting them in order to:
- Respond to changes in guidance
- Reconcile with source data and local returns on audit
- Enable them to effectively reflect any future structural operational changes in their CbyC report.
The four steps to tax data management include:
- Determine when and where to file the initial CbyC report. In the United States, CbyC reporting in 2016 will not be required, but, depending on final regulations, may possibly be permitted. A U.S.-based MNE group should consider determining whether it could or should file a U.S. CbyC report in 2016 and, if not, where and in what capacity (e.g., a foreign affiliate making a “surrogate” filing for the group or a “secondary” filing in its operating jurisdiction) it should file foreign CbyC reports.
- Identify the source data and reconcile to statutory filings. Although U.S. GAAP is convenient and, consequently, is the source data that most U.S. groups appear to be using, some MNE groups may prefer to use local statutory filings as its source data. Although statutory filing data may often be more difficult to obtain, scrub, and consistently present than U.S. GAAP data, it may be merited, for example, if they have significant foreign, as opposed to U.S., tax risk or if they are heavily regulated or otherwise audited (e.g., under foreign government contracts) in foreign jurisdictions. In either case, an MNE group should consider creating a user-friendly, sustainable process for reconciling CbyC disclosures to statutory filings.
- Perform data mapping. An MNE group should consider identifying and adopting appropriate conventions for consistently characterizing its source data and mapping such data from a one or more charts of accounts to specific columns in the second table of the CbyC report template. In some circumstances, data mapping may require judgment regarding appropriate approaches, particularly in light of evolving or only very high-level guidance to date. These approaches should be discussed, considered, and clearly documented during the process.
- Perform legal entity and jurisdiction mapping. An MNE group should also consider creating a legal entity inventory and identifying the appropriate jurisdiction to which each entity’s source data should be mapped (i.e., which rows should be identified and populated in Tables 1 and 2 of the CbyC report template). The definition of “entity” as envisioned by the U.S. CbyC reporting rules—which is closer to the U.S. tax concept of “qualified business unit” than the commercial concept of legal entities—should be considered when performing this step. Notably, some types of entities may be treated as “stateless” under the proposed U.S. CbyC reporting rules, and their data may present greater reporting sensitivities.
2. Tax risk analytics
Once data, legal entities, and jurisdictions are mapped, an MNE group should consider performing an initial CbyC dry-run report (possibly beginning with a more limited, “proof of concept” report) and applying a “fresh-eyes” look to identify potential audit risks. To the extent possible, data mapping should also be revisited to determine where alternative reasonable interpretations of the U.S. CbyC reporting rules may result in more accurate or appropriate presentation of CbyC data.
The four steps to tax risk analytics include:
- Address any technical issues that may arise from commercial or organizational issues specific to the MNE group.Does the MNE group include several different business units operating in the same jurisdiction, the data for which will need to be coordinated and aggregated? Is the MNE group engaged in highly confidential work for the U.S. or foreign governments? Has the MNE group engaged in significant acquisitions, mergers, or liquidations that must be reflected on one (or more) CbyC reports for a given period? These are just a few examples of an MNE group’s commercial realities that may not be clearly addressed by the U.S. CbyC reporting rules, which should be considered carefully as the reporting process progresses.
- Assess headcount reporting. Neither the U.S. proposed regulations nor the OECD Model instructions1 contain detailed guidance with respect to reporting mobile headcount and independent contractors. Thus, U.S. MNE groups have reasonable flexibility on reporting those items. Because the approach an MNE group takes to report headcount may demonstrate “substance” in some jurisdictions while highlighting risk, e.g., permanent establishment risk, in others MNE groups should consider performing a cost benefit analysis for reporting headcount under the various approaches permitted by the IRS and other tax authorities.
- Create an integrated BEPS documentation package. A company should consider integrating its CbyC report with its overall BEPS documentation package, particularly if the CbyC report highlights data “outliers” (e.g., significantly higher revenues per employee in one jurisdiction as compared with others) that could be supported or explained in the group’s master and local files. In addition, a company should consider reconciling its CbyC data with other disclosures (e.g., Forms 5471, APB 23 representation, local labor department filings) to help mitigate data inconsistency risks.
- Confirm your 2D view. Ultimately, tax auditors may take a two-dimensional (2D) approach to assessing risks on a CbyC report—looking for anomalies within an individual company’s CbyC report (i.e., from one country to another), as well as between the company’s report and the reports of other companies within the same or similar industries in a given jurisdiction. A company should consider benchmarking its report within its industry and within specific jurisdictions to help identify and address potential data “hot spots.”