Country-by-Country Reporting: A Path to Transparency, Or a Prelude to a Formulary Apportionment Approach?

The OECD's plan to combat base erosion and profit shifting recommends 15 actions in the international tax arena that would reduce incentives for multinational corporations to shift income to low- or no-tax jurisdictions. While some of those actions involve drastic overhauls to international tax law, practitioners are most concerned about the call for country-by-country reporting as a means of increasing transparency. This “deceptively simple” provision could have the most profound impact of all, critics say, because it heralds an implicit shift from the arm's-length standard to a formulary approach.  

By Alex M. Parker  

Oct. 28 -- Although the Organization for Economic Cooperation and Development's action plan to combat base erosion and profit shifting calls for several drastic overhauls to international tax law, transfer pricing practitioners are most concerned about a sleeper issue: the plan's call for extensive country-by-country reporting.

“This one potentially has the most impact of any in the BEPS action plan,'' former Treasury official David Ernick told Bloomberg BNA. “The implications for the changes to the transfer pricing rules could be enormous if this happens.”

Action 13--which mirrors recommendations from the OECD's white paper on documentation--calls for a reexamination of transfer pricing documentation, with an eye toward deepening the disclosure rules and widening the system into a uniform global standard, rather than the patchwork of individual contemporaneous documentation required by different countries.

Supporters of country-by-country reporting say that it will shine a brighter light on tax avoidance strategies used by large multinational corporations--and if that changes tax behavior, so much the better.

But while the documentation would be for the purpose of risk assessment, not enforcement, some practitioners fear it might have the political and practical effect of drastically altering transfer pricing practices--and lead to the eventual abandonment of the arm's-length standard.

“This is deceptively simple, it looks like a very commonsense recommendation. I would think that compared to the other items, this is more likely to be implemented,” Aydin Hayri of Deloitte in Washington, D.C., said. “This is, at the end of the day, relatively simple. And that's why it's kind of dangerous.”

Item 13 states:

The rules to be developed will include a requirement that [multinational enterprises] provide all relevant governments with the needed information on their global allocation of the income, economic activity and taxes paid among countries according to a global template.  


The OECD white paper on transfer pricing documentation, released July 30, goes into further detail on country-by-country reporting, including as a possible option a two-tiered structure comprising a local file with country-specific reporting and a master file with a global blueprint of an organization's finances

“This is, at the end of the day, relatively simple. And that's why it's kind of dangerous.”


Aydin Hayri, Deloitte

“The masterfile portion of the documentation would seek to elicit a reasonably complete picture of the global business, financial reporting, debt structure and tax situation of the [multinational enterprise] to enable tax authorities to identify the presence of significant transfer pricing risks,” the white paper states.

The paper calls for reporting in five categories--group structure, nature of the business, intangibles, financial activities, and financial and tax positions. Under the plan, businesses would be required to report on their profit drivers, related-party service arrangements and all business restructurings in the past five years, as well as list all applicable unilateral, bilateral or multilateral APAs, among other requirements. Companies also would be required to create a geographic layout of their structures, including numbers of employees and profits by country.

Such information could not be used as evidence of transfer pricing violations, in and of itself; rather, it would be a tool for risk assessment--for tax authorities to determine the most efficient use of their resources for audits. But many observers are skeptical that the documentation would have such a limited role in enforcement actions.

“The concern that I think exists is, it would just be too great a temptation,” said Ernick, now with PricewaterhouseCoopers LLP in Washington, D.C.

“It's giving everyone a fishing rod and saying, 'Go fishing,' ” Hayri said.

Political Implications

Aside from the incentives for tax authorities, the global blueprints would be grist for political debates, already raging, over alleged tax avoidance and base erosion. Companies and their accountants, already weary from the attention, fear that bad headlines could become a new normal.

“If you had full reporting, particularly of country-by-country results, that could have political implications, which would lead to greater assertions of taxing authority by source countries,” said David Rosenbloom of Caplin & Drysdale, a former international tax counsel for the U.S. Department of Treasury.

Because country-by-country reporting would shift the focus from individual transactions to global allocation, some of its harshest critics claim it would effectively negate the arm's-length standard in favor of a formulary approach.

“If you had full reporting, particularly of country-by-country results, that could have political implications, which would lead to greater assertions of taxing authority by source countries.”


David Rosenbloom, Caplin & Drysdale

While claiming that the arm's-length standard has flaws that cause intangibles to be undervalued and income to be shifted away from the economic activity that generated it, the BEPS action plan nevertheless affirms the standard and rejects proposals to replace it.

“The importance of concerted action and the practical difficulties associated with agreeing to and implementing the details of a new system consistently across all countries mean that, rather than seeking to replace the current transfer pricing system, the best course is to directly address the flaws in the current system, in particular with respect to returns related to intangible assets, risk and over-capitalisation,” the action plan states.

But while supporting the arm's-length standard, OECD officials haven't exactly given it ringing endorsements. Pascal Saint-Amans, head of the OECD's Center for Tax Policy and Administration, recently described himself as “agnostic” on the arm's-length principle, claiming the discussion should shift away from critiques and defenses of the standard and toward the larger issues.

On the issue of whether the OECD is shifting away from the principle, Saint-Amans told those attending an International Tax Review conference in September, “I don't care.”

“Let's work to make sure we get what we want, which is to limit the risks of recharaterization,” Saint-Amans said (22 Transfer Pricing Report 729, 10/3/13).

'Wavering Support' for Arm's-Length Principle

Ernick said the OECD's support of the arm's-length principle is “wavering,” and that the country-by-country reporting system would encourage companies to allocate their global income according to a formula.

“That information is really not relevant to determining transfer pricing risk, if your transfer pricing is based on the arm's-length principle,” Ernick said. “The question they're essentially asking is, 'Does your allocation of profits around the world line up as it would if you had used a formulary approach?' … They're kind of mixing apples and oranges.”

Hayri noted that the OECD “for many years continued to believe in the primacy of the transactional methods. You just look at the price or the margin of the individual transaction.” If country-by-country reporting is adopted, “it's all going to be driven by profitability, and it will all be driven by profitability comparisons across jurisdictions. … It would turn into a global profit split for each taxpayer, and it will be a global profit split done by each tax administration.”

In addition to worrying about a move away from the arm's-length standard, companies face the possibility that country-by-country reporting will multiply, exponentially, inquiries from countries that are looking at the same data and asking the same questions.

“The old system may not be ideal, but at least there's a certain scope limitation,” Hayri said. “[Country-by-country reporting] is all formulated as if all of these tax administration are very nice--they don't compete with each other, they are trying to figure out, 'what could we do best to make life easier for taxpayers?' In reality, they are all really fiercely competitive with each other for tax revenue.”

Advocates of Formulary Apportionment

Not all agree that country-by-country reporting would be a fundamental shift in transfer pricing practices.

“It's not information that internationals don't have. They have to file these returns, based on transfer pricing principles. All that country-by-country reporting will do is to make this public,” said Reuven Avi-Yonah, director of the international tax program at the University of Michigan Law School. “It doesn't have anything to do with formulary apportionment. It's based on the arm's-length system.”

But an advocate of formulary apportionment, who claims that the current arm's-length model is too easily manipulated, acknowledges that country-by-country reporting may be a modest step in that direction.

“It would show the presence and extent of any disconnects between where business activity is conducted and where income is treated as earned for tax purposes,” said Michael Durst, a former director of the U.S. Internal Revenue Service's Advance Pricing Agreement Program and a contributing editor to Bloomberg BNA. Durst has advocated switching from the arm's-length standard to a formulary approach

Country-by-country reporting has already seen a trial run, of sorts, with documentation requirements for the oil, gas and mineral extraction industry included in The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. No. 111-203). Penned by Sen. Richard Lugar (R-Ind.) and Sen. Ben Cardin (D-Md.), the provision aims to curb the “resource curse”--the tendency for natural resource-rich countries to see little economic growth while extraction industries record significant profits.

The provision requires extraction companies to report all payments to governments on a country-by-country basis, in the hope that such information will better track the movement of oil and gas dollars--as well as reveal possible corruption.

“It would show the presence and extent of any disconnects between where business activity is conducted and where income is treated as earned for tax purposes.”


Michael Durst

But despite being enacted into law three years ago, the requirement has yet to take effect. A Securities and Exchange Commission rule, based on the law, was immediately challenged in court by the American Petroleum Institute, the U.S. Chamber of Commerce and other business groups. The plaintiffs claimed that the requirements were onerous and extended beyond the law's scope and that enforcing them could prevent companies from doing business in countries that do not allow disclosure of such information--although some stakeholders, such as the nonprofit Oxfam, have disputed whether any countries have such policies.

The plaintiffs also claimed that the law was never intended to make the information public--despite statements to the contrary from the bill's authors--and that such public disclosures violated their First Amendment rights.

U.S. Rule Vacated

On July 2, the SEC rule was vacated by Judge John D. Bates of the U.S. District Court for the District of Columbia. Bates ruled that the SEC erred by requiring public disclosure of country-by-country government payments--the word “public” does not appear in the law, he noted--and that it acted “capriciously” by not including an exemption for countries that prohibit disclosure. The SEC had argued that such an exemption would only encourage countries to enact disclosure prohibitions, or to interpret current provisions more stringently so as to call for such prohibitions.

The SEC declined to appeal the ruling, but is expected to release an updated rule, although extent of the planned changes to the rule is not known.

On Oct. 3, the OECD requested comments from the business community regarding its documentation white paper. Those responses were released Oct. 31 (See the related article in this issue.) Business representatives will meet with the OECD Nov. 12-13 for a consultation on the rules.

The BEPS action plan calls for an aggressive, two-year timetable to consider and adopt guidelines based on its recommendations.

Despite the momentum, some remain doubtful that the global community can come to a consensus on country-by-country reporting--or on uniform reporting standards.

“I'm something of a skeptic. A lot of this is going to depend on political will in the countries,” Rosenbloom said. “It requires countries to do things which the countries are not likely to perceive as being in their own interest.”

To contact the reporter on this story: Alex M. Parker in Washington at

To contact the editor responsible for this story: Dolores W. Gregory at