Country-by-Country – Not So Simple After All

By James J. Tobin, Esq.

Ernst & Young LLP, New York, NY

Output from the ambitious OECD Base Erosion and Profit Shifting
(BEPS) project is starting to reach the light of day. One of the
first significant releases relates to lucky Action Item 13 on
transfer pricing documentation. A discussion draft was released on
January 30, 2014, focused on the transfer pricing master file and
country-by-country reporting. Not surprising that this is the first
Action Item to progress, given the G8 and G20 support for a common
template for reporting by multinational corporations (MNCs) on
their global allocation of income, taxes paid, and economic
activity.  The OECD discussion draft repeats upfront the
statement from the 7/19/13 BEPS Action Plan that reporting
requirements should take into account the compliance costs for
business and the discussion draft seeks comments in various areas
to help get input on those burdens.  However, as discussed
below, in my view the draft asks for way more information than is
reasonable and, if not modified, would create huge compliance costs
and burdens for multinationals.

Given the specific reference to the global template in the G8
directive, I figured that would be the first and main focus of
Action Item 13. And although when you really think about it, such a
template is a good bit tougher than it might seem, I kind of
figured it was the relatively easier part of this Action Item to
produce and get consensus on within the OECD working group.
Therefore, I was a bit surprised that the discussion draft focused
on both the master file approach (which I consider much more
comprehensive and potentially tougher to agree on) and the
country-by-country template.

The OECD had previously released its proposals regarding the
master file approach and the discussion draft largely incorporates
those proposals, with some expansion. I'm not a transfer pricing
specialist but it seems to me that the list of actions to be
included in the master file is a bit of an exercise in what might
be "nice to have" with little deference to figuring out what
currently is produced by MNCs or to the potential costs of
producing a lot of "nice to have" new stuff. I do like the idea of
a common standard for a centrally produced global master file and a
common approach for local country files to supplement the master

Given that local transfer pricing documentation rules are now
present in over 50 countries with little overall consistency in
approach, in theory the use of one global master file and a
consistent local country file approach could help MNCs streamline
their compliance obligations. However, as proposed, I fear the
global file asks for lots of stuff that is not presently produced
by most MNCs and the local country file approach will not
effectively replace existing local country documentation
requirements, such that I have no real confidence that the widely
varied existing country documentation rules will be aligned. I'll
leave it to my transfer pricing colleagues to take up the cause
with more specific comments about the master file/local file
approach as I want to focus this commentary on the proposed
country-by-country template.

The purpose of the template has consistently been described as a
high level risk assessment tool for tax authorities which should
not be overly burdensome to businesses. The discussion draft
clearly acknowledges this. However, the discussion draft also
states that "the information in the country-by-country reporting
template would not constitute conclusive evidence that
transfer prices are not appropriate" (emphasis added). I would
suggest that a high level risk assessment tool should not
constitute any evidence at all. I hope the OECD clarifies this
point, lest we see local country assessments from some of the more
aggressive tax authorities starting with some apportioned income
amount that is inappropriately based on the high level template
factors. To my mind, one of the most significant concerns is that
the template may result in tax authority fishing expeditions based
on a misunderstanding of the context of the country-by-country data
or, even worse, may result in the misuse of the information by tax
authorities to draw inappropriate conclusions without even feeling
the need to fish.

So what's in the proposed template? My initial thoughts about
the content of a high-level risk assessment template were much more
limited than the thoughts reflected in the OECD's discussion draft.
The G8 guidance was for a template to include country information
on income, taxes paid, and economic activity. I figured that this
could be limited to three key items - pre-tax net income, local
corporate income tax, and employee levels. These three seemed like
a good collection of factors to consider. In doing risk assessment,
presumably tax authorities would be watchful for companies that
report significant net income, pay little tax, and don't have a lot
of local employees in a particular country. So my three factors
would be a good indicator of situations that deserve further
attention and that MNCs should be prepared to explain.

Even envisioning just these three items, I was concerned that
there would be a lot of open issues to be dealt with and that it
would require significant effort for MNCs to produce the template.
Let's be clear - while this type of data would certainly be
available at any MNC, there is no other purpose for assembling this
information in this form. Thus, it all would have to be produced
solely to satisfy the template requirements. Questions and issues
that come to mind for these three items include those set forth

Net Income. Pre-tax net income seems clearly an
item the OECD and G8 had in mind for the template.  Questions
arise as to what the data source for determining the net income
should be. The discussion draft refers to net income from local
audited statutory accounts. This seems somewhat reasonable as a
number that local tax authorities could verify, to give them
confidence in the other country income amounts. However, these
income amounts would be computed under differing local country
GAAPs and would be in differing local currency. And as stated
above, no MNC really has any other need to accumulate the local
statutory numbers so this would be a new process/new burden. Also,
as the OECD acknowledges, because the timing for filing statutory
accounts varies and can be as late as more than a year after the
end of the fiscal year, no question there would have to be a time
delay in producing the template if it is to be populated from this
data source.

The OECD requested comments on other data sources for this
information which to me could include consolidating GAAP schedules
or tax returns. Any data, including statutory account data, would
have some inherent complications, such as the double counting of
certain income arising from dividends or equity earnings inclusions
in holding structures, the likely exclusion of certain
consolidating GAAP adjustments such as business impairments or
purchase accounting adjustments that are not pushed down to the
local level, etc. But for purposes of a high-level comparison for
risk assessment, this should be ok, right? I would strongly favor
allowing MNCs to choose the particular data source that would be
easiest to produce and simply requiring identification of the
source chosen and consistency in the use of the same data source
year to year.

Taxes. With respect to taxes, the key question to me
was whether the measure should be cash tax paid or accrued tax for
the year. Accrued tax more closely correlates with pre-tax income.
Cash tax typically includes some prior year tax paid with the
filing of a local tax return, audit adjustments, and other items
unrelated to current year profits. For many companies, it likely
would take more effort to compile. But taxes paid was the term used
in the G8 directive so that's what the discussion draft requires.
Interestingly, the discussion draft also contains two additional
columns of requested tax information. Because the first tax column
includes only taxes paid to the country of organization, a second
column is included for taxes paid to other countries. And a third
tax column requests withholding tax amounts. Presumably in most
cases the amount of withholding tax would be the same as the amount
of taxes paid to other countries. The only instances of taxes paid
to countries other than the country of organization I can think of
other than withholding taxes would be situations involving foreign
permanent establishments (PEs) and situations where a company's tax
residence is other than its country of incorporation. Because PEs
are to be reported only in the country of the PE, maybe only these
residence-outside-the-country-of-incorporation situations make up
the difference between the second and third tax columns? Seems a
bit of a narrow issue that wouldn't justify an additional column in
a general template of such broad application. And if that is what
they intend to capture, significant explanation likely is

Employees.  I like the focus on number of
employees. It should be relatively easy to assemble - but it
requires accessing data from the HR system as opposed to the
financial information system, so again it will require some work,
of course. But it would be easy to understand. Of course, mere
comparisons of headcounts would not be a reliable metric for
evaluating income allocations. But again, for high-level risk
assessment, it would be a starting point for inquiry/scoping.

If it were up to me, my Simple Tobin Template would end here,
with net income, taxes, and employees. And there would still be
lots of questions and a real need for interpretive "regulations" on
a myriad of issues: definition of a "controlled group," how to
handle M&A transactions, how to treat 50/50 joint ventures, how
to deal with partnerships, how to deal with private equity fund
ownership, how to deal with tax refunds, definition of "employee,"
etc., etc., etc. One would hope that guidance on detailed issues of
this type could be rather liberal because, as long as MNCs used a
consistent approach from year to year, the comparative information
would provide a meaningful basis for the high-level risk

So the Simple Tobin Template would be complete at this point,
but the OECD discussion draft template is far from done. Let me
elaborate on the additional requirements which, in my view, go
beyond the high-level risk assessment purpose of the template and
in fact in some cases require data that I cannot fathom how one
could use for risk assessment.

The first additional requirement, which was a surprise to me, is
for entity-by-entity reporting and not merely country-by-country
reporting, as the name would suggest. Why that would be necessary
for high-level risk assessment is hard to see.  A real world
truth is that multinational groups consist of way too many legal
entities, a consequence of in some cases M&A activity over the
years, in some cases legal risk management, and in other cases just
the passage of time with no focus on entity rationalization. 
We and other firms have a big practice in helping companies focus
on cost savings through legal entity rationalization - so we see
how many excess legal entities there are in typical groups. As an
example, one client we recently helped take an inventory of
entities had over 1600 legal entities, about 200 in the United
Kingdom alone (a country where eliminating entities is not an easy
task) and over 300 in the United States. Both countries operate a
consolidated or group tax system - so what purpose would be served
in terms of "high level risk assessment" in requiring all 500-plus
companies to be separately listed on the template and requiring
entity-level data items, like allocated group taxes, to be
extracted? Comments on this point were sought in the discussion
draft; comments will be received.

Moving on to the other "excess" items requested in the OECD
draft template - those beyond the three-item Simple Tobin Template.
No doubt to the drafters these were at least "nice to have" items,
but to my mind they at best should be considered duplicative of the
overall master file and some fall into the category of "why would
they really want this" and others "how could I even figure it
out."  Okay, I may be a bit biased toward my simple

The first of these excess items is the requirement to report
revenue in addition to net income. I can understand this one as
having the appearance of "nice to have" information.  The
relationship of profit to revenue could be useful in analyzing risk
- if it were a like-to-like activity comparison. To me, at best
this would be a master file item where data is meant to be
developed and assembled on a business line basis. Aggregate entity
information or country information will include different business
segments and multiple functions, such as sales, services,
licensing, financing, holding, etc., which all have very different
profiles of gross-to-net income percentages, thus leading to
outputs that would be meaningless for high-level risk purposes but
that could give the impression of meaningfulness, thus resulting in
more harm than good to the overall process.

Another item in the OECD draft template is stated capital and
accumulated earnings. I'm not sure what I would conclude from
having access to this data. Is high profit realized with low
capital a bigger risk flag than high profit with high capital? I'm
not sure. And low capital could be a consequence of regular
dividends.  Is that a high- or low-risk factor and does it
depend on who receives the dividends? I put this one in the "why
would they want this" category, as it doesn't seem like it's
helpful enough to be considered "nice to have."

In the employee category, total employee expense is a second
measure. The template directions specify that this includes
non-cash employee costs such as option and share schemes.
Presumably, the OECD wants just the amount for such employee
expense that is reported in the local books/statutory accounts of
the country affiliates and not an over-the-top valuation exercise
with respect to non-cash compensation that differs from the
accounting measurement. As a paranoid guy, I'd certainly like for
that to be made clear. But even then a total compensation number
will be tough to define and therefore tough to assemble. I cannot
see tax authorities gaining additional risk insights from having
employee cost data in addition to employee headcount, or at least
not meaningful enough insights to justify imposing on MNCs the
burden of producing this not-easy-to-assemble data.

The next column requires the disclosure of tangible assets. The
instructions helpfully state that "tangible assets for this purpose
do not include cash or cash equivalents, intangibles or financial
assets." I could imagine information on tangible assets could be of
interest in some industries - maybe shipping and mining, for
example. But even there the disclosure of the historic book values
of such assets renders analysis of such template data meaningless.
Such industry relevance, if it exists, would to me best be dealt
with in the master file. To require this completely artificial data
point in the template for all industries does not seem reasonable
to me. And if it were required, there likely would have to be a lot
more definition and guidance for little purpose and at significant

The next six columns are all for intercompany payments - for
royalties (to and from), for interest, and for service charges.
Again, overkill I think. Imagine a 1600-entity matrix of all
intercompany payments! The local documentation requirements/local
file portion of the master file documentation would certainly
contain more useful data on related-party payments and receipts.
Insight into similar payment flows outside the local country could
indeed be relevant information. But in my view such information
would not be relevant enough to justify weighing down the simple
template with these six columns.

It seems that the OECD has not yet reached agreement on this
first, relatively easy, Action Item, as the discussion draft states
at the outset that it does not necessarily reflect consensus views
of either the Committee on Fiscal Affairs or Working Party 6 on
transfer pricing. Since the OECD has emphasized that the BEPS
project will proceed by consensus, obviously it would have been
much more efficient for the taxpayer community if a
consensus document had been released. Why waste our time
asking for comments on proposals that some OECD members have
already questioned?

Overall the OECD's first attempt at BEPS output has missed the
KISS (Keep It Simple, Stupid!) principle by a good margin. The
discussion draft does seek comments on many issues - I counted 16
areas where specific requests for input were included, which is
almost as many as there are columns where data is required. 
So now we have a starting point. It's usually easier to take things
out than to put new ones in (one hopes). I'd encourage active
engagement by the profession and the business community to reach a
reasonably simple and meaningful result.

This commentary also will appear in the April 2014 issue of
 Tax Management International Journal.  For
more information, in the Tax Management Portfolios, see Levey,
Carmichael, van Herksen, Patton, Levi, Krupsky, and Kellar, 890
, Transfer Pricing: Alternative Practical Strategies
(Chapter 7, "Transfer Pricing - A Case Study (Methods and
Documentation)"), and Culbertson, Durst, and Bailey, 894
, Transfer Pricing: OECD Transfer Pricing Rules and
Guidelines, and in Tax Practice Series, see ¶3600, Section 482
- Allocations of Income and Deductions Between Related



views expressed herein are those of the author and do not
necessarily reflect those of Ernst & Young LLP.