Country-by-Country Finals

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James J. Tobin, Esq.

By James J. Tobin, Esq. Ernst & Young LLP New York, New York

My focus this month is on the new U.S. regulations on country-by-country (CbC) reporting, finalized on June 29, 2016. I previously wrote on the draft OECD report under Action 13 of the Base Erosion and Profit Shifting project, which covered both CbC reporting and the transfer pricing master file and local file. Since then, the Organization for Economic Cooperation and Development issued its final Action 13 report in October 2015, provided guidance for electronic sharing of the reports in March 2016, and provided additional guidance in late June 2016, on the same day Treasury and the Internal Revenue Service issued the final CbC regulations. So lots of activity, making it clear (if there were any doubt) that CbC reporting is a reality for large multinationals. Not a surprise given the specific support/direction to the OECD on this topic from the G8 and G20. But still surprisingly quick action for the OECD, quick finalization of regulations by Treasury and the IRS, and quick action by numerous countries around the world in getting themselves organized to require and receive this data.

Not too many surprises in the final regulations (Reg. §1.6038-4), as it clearly is necessary for the United States to conform to what is set forth in the OECD final report so that U.S. multinational corporations (MNCs) can avoid individual subsidiary country submissions. (More on that later.) Accordingly, a Form 8975 will require the following information by country:

  •  Revenue generated from transactions with related parties
  •  Third-party revenue
  •  Pretax profit or loss
  •  Total cash income tax paid (including withholding tax)
  •  Total current year accrued income tax expense (excluding reserves)
  •  Stated capital
  •  Total accumulated earnings
  •  Total number of FTE employees
  •  Total net book value of tangible assets


As we now know, all of this information is to be ultimately made available to all U.S. income tax treaty and TIEA countries in which a multinational operates for purposes of allowing the countries to do a high-level risk assessment. As I pointed out previously, I don't see the need for some of the items above to fulfill this purpose — accumulated earnings, total stated capital, and total tangible assets come to mind. But the good news is the required template information has been pared back from the original OECD draft proposals. It could have been worse.

I can see from working with a good number of our U.S. clients that it will be a significant compliance burden to assemble this data for most of them. Many are working to mock up prior-year information as a test of their ability to produce the required information while measuring the time and resources it takes to do so. Determining the best data source for the information (the regulations allow a company to use applicable financial statements, local books and records, regulatory statements, tax reporting data, or management accounting data), aggregating the data for all entities per country, searching for information not otherwise reported centrally, figuring out how best to deal with accounting consolidation-type entries and purchase accounting items, and then attempting to make sure that the aggregation of data seems reasonable and makes sense vis-à-vis the company's global operations are proving to be a bigger job than most appreciated. No doubt it will get a lot bigger and more burdensome once countries start using the data for their own “risk assessment” purposes and start asking questions based on the CbC reports.

A few interesting aspects to the final regulations are worthy of comment. First and perhaps most important is the effective date. The U.S. reporting requirement will take effect for large multinationals (with over $850 million in revenue) for years beginning on or after June 30, 2016. So for calendar year U.S. parents of multinational groups the first required filing year in the United States would be 2017. For U.S. parent companies with June 30 fiscal year ends or later, the data would be required for FYE 2017. The due date for filing the information is the same as for filing the company's U.S. federal tax return for the year in question: a maximum of eight-and-a-half months after year end. This likely effectively eliminates the use of local financial statements as a potential data source for many multinationals, because many countries do not require filing statutory accounts that quickly. Not too many large U.S. groups file their tax returns much before the maximum extended due date for their returns. Those few early birds will likely need to join the pack of last-minute filers, given the additional burden of CbC reporting.

An interesting aspect of the effective date is that it does not align to the recommended date of the OECD and therefore the date that is being adopted by some other countries for primary and secondary reporting. The OECD recommended date is for years beginning on or after January 1, 2016. Thus, for example, calendar year 2016 would be in scope for the OECD but would be before the effective date under the U.S. regulations. What's the significance of this? It could be a big deal. Under the structure for reporting CbC information, companies are meant to report the complete template to their parent country tax authority, which then shares it under treaty exchange protocols. If the parent country doesn't require the information, or appropriately make it available to a subsidiary country, the subsidiary country tax authorities could directly request the CbC template from the local subsidiary of the multinational. Direct submission to subsidiary countries is generally undesirable because the information would not be confidentially protected as should be the case in a treaty exchange. Also, local country rules may vary slightly from one another, resulting in additional costs and administrative burdens to comply with individually. So, in theory a gap period could exist in the first year of implementation for those groups with a fiscal year beginning during the first six months of 2016. Fortunately, the Preamble to the final regulations and also the updated OECD guidance provide, it is anticipated that companies could voluntarily file the CbC report for 2016 in the United States and that the voluntary filing would be sufficient to eliminate the need for direct subsidiary filing. I use the term “fortunately” a bit disingenuously, as it means the work in assembling the information needs to be done a year early for these companies. However, it's better than needing to address the issue in multiple countries around the world. I'm informed by our EY BEPS Network that, as of the date I am drafting this commentary, 24 countries have adopted or proposed CbC reporting and at least another 30 are expected to introduce it shortly. And no doubt others will join the party. So, bottom line: For a calendar year U.S. company, it looks like voluntary reporting will be advisable for 2016 and thus the full CbC form for 2016 will need to be filed at the time of filing the company's 2016 U.S. tax return.

Another option for parent companies whose home countries do not require adequate reporting is to designate a surrogate parent country and file in that country, with that country's tax authority then providing the information to subsidiary countries by treaty exchange. Thus, a U.S.-parented group could in theory pick another CbC-compliant country where it has a subsidiary as its surrogate parent for 2016 and file its report there. Interestingly, the Preamble to the proposed regulations makes it clear that the United States will not accept being designated as a surrogate parent jurisdiction (other than for a parent in a U.S. territory or possession) in light of “limited IRS resources.” I was thinking, for example, that a tax-haven-parented group could file in the United States — but that's not the case. So it's likely unclear the extent to which this choice of surrogate location will be possible.

The point with respect to limited IRS resources has come up a few times recently. It has been cited as a reason for including the bright-line, 72-month recharacterization effect under the funding rule in the recently proposed §385 regulations (the IRS has limited resources to audit a principal purpose test; thus, the need for a bright line) and the recently proposed §367(d) regulations, which eliminated the concept of local goodwill (impractical to administer issues related to valuations of goodwill versus tainted intangibles). Seems like a trend? Maybe Treasury will next mandate a tax of 35% of gross revenue because they have limited resources to audit expenses? Or maybe we should all make personal contributions to keep the IRS funded to avoid more resort to arbitrary rules?

Another practical issue with respect to CbC filing is that, in order to prevent secondary filing, the United States must enter into Competent Authority agreements with countries with which the United States has either an income tax treaty or a Tax Information Exchange Agreement (TIEA) to allow for the automatic exchange of CbC reports. While the United States is not the world leader in negotiating and ratifying treaties or TIEAs, it does have around 90 of those agreements in place at the moment. The Preamble to the regulations states that the United States intends to enter into Competent Authority agreements, providing for automatic exchange of CbC information, based on the existing tax treaty and TIEA network. But that's a lot of work to do (unless the United States were to sign up for the Multinational Competent Authority Agreement recommended by the OECD, which appears unlikely). So there could be gaps where secondary filing, with its inherent downsides, will still be required.

Of course, it's questionable whether the CbC information will remain confidential in any event. For example, a European Union proposal released in April of this year would, if approved, require public filing of the CbC information, and some are concerned that information shared with scores of countries around the world might find its way into the public domain (though the U.S. has indicated that it would pause exchange of information with a country that fails to preserve confidentiality). Thus, companies should likely plan for the information to become public and likely misinterpreted. All in all, another reason to take great care in filling out the template.

Another interesting aspect of the final regulations is their treatment of partnerships, which seems a bit different from the treatment in the proposed regulations. The OECD report recommends that because a partnership will typically be treated as a flow-through entity in its country of organization, it would not itself be considered a tax resident of any country and therefore should be reported as a stateless entity. My reading of the U.S. proposed regulations was that they instead provided that the partners in a partnership should report their share of the revenue and profit of the partnership. But the final regulations also require that the partnership be reported as a stateless entity and its revenue and profits be aggregated with all other partnerships/stateless entities in the group. Thus, a potential double-up of the reporting items.

Interestingly, the above stateless treatment of a partnership would not apply to the extent the partnership operates through a permanent establishment, in which case its factors would be reported in the country of the permanent establishment. The definition of “permanent establishment” includes “a branch of a constituent entity that is liable to tax in the tax jurisdiction in which it is located pursuant to domestic law of that jurisdiction.”

Based on these rules I think we get some potentially odd results with respect to partnerships and other stateless entities in populating a CbC report. The following points come to mind:

  •  In general, a less-than-50%-owned partnership would not be a constituent entity and therefore not reported in its own right in the CbC report but flow-through income and other partnership items could be included in the income and other factors of its partners, depending on the GAAP or other data source used for those entities.
  •  It would appear that a controlled partnership owned entirely by constituent entities within a country — e.g., a U.S. partnership owned by related U.S. corporate partners where all income flows through and is taxable to the corporate partners — must be reported as a stateless entity (subject to the permanent establishment point in the next bullet) and must aggregate its factors with other stateless entities and report no tax paid on its income. Seems odd and potentially a red flag to the reader of the CbC report. The OECD guidance acknowledges this and suggests that companies may want to provide an explanation in the notes section of the report that the “stateless income” has been fully taxed in the partner jurisdiction. Still sounds like it could be perceived as a red flag and could result in additional questions from and explanations to the authorities with no underlying claim to the income.
  •  The permanent establishment carve-out from reporting the partnership's income as stateless is less than clear to me. Take the example of a U.S. partnership operating in the United States, owned by two or more related U.S. corporate partners. The operation in the United States would result in the income of the partnership being taxed as effectively connected income if owned by a foreign partner — so does that constitute a permanent establishment even though all of the partners in the partnership are U.S. corporations? I would think so and would suggest that the operation be reported as a U.S. permanent establishment and aggregated with other United States CbC information. But this would require a review of the activities of any controlled partnership by way of an “as if” permanent establishment analysis — does that mean only some but not all flow-through partnerships would be considered stateless?
  •  Partnerships that are characterized as reverse hybrids for U.S. tax purposes — i.e., partnerships checked as corporations for U.S. tax purposes but transparent in the country of formation — and that don't have a permanent establishment, would be reported as stateless entities. Per the final U.S. regulations, the revenue and income of a reverse hybrid would still also be included as revenue and income of its partners/owners for reporting purposes. But the existence of stateless entities and their factors would also need to be reported and, in any event, could well be impacted by various country legislative provisions adopted in line with the OECD BEPS Action 2 Hybrid Mismatch provisions.
  •  The requirement in the regulations to report revenue and profit of stateless entities in the factors of the partners/owners of such entities is not limited to partnerships. A corporate entity that has no country of residence would seem to also be included. However, I would expect this to be unusual, because a corporate entity likely would have a country of residence even if it is in a tax haven location — in general, tax haven entities would be reported in a separate tax haven country line for each jurisdiction even though not subject to tax under local law.
  •  If a U.S. partnership is the parent of a reporting group, it would be considered a U.S. business entity for CbC filing purposes and be required to submit a CbC report for its controlled group.
  •  Employees of a partnership would presumably be reported in their employment location if they are related to a permanent establishment, but otherwise they would be reported on the stateless entity line.


So some interesting points but still lots of other open questions, which requires companies to take reasonable positions and points of view on many interpretive aspects of the regulations. As I expected, this is proving to be much more burdensome and costly for companies to comply with than advertised. And that's even before the real first filing deadline comes and then the expected wave of local audit requests come piling in. And before likely (in my view) public disclosure of the CbC information takes place. In anticipation of both of the above, taking extra effort to figure out how best to present the information is no doubt prudent. Add that to the extra effort to deal with local country implementation of the other BEPS Action items, and it's safe to say that corporate tax departments will have their hands full.

PANEL OF CONTRIBUTORS Thomas S. Bissell, CPA Celebration, Florida David Ernick, Esq.PricewaterhouseCoopers LLPWashington, D.C. Edward Tanenbaum, Esq.Alston & Bird LLPNew York, New York Robert E. Ward, Esq. Ward Chisholm, P.C. Bethesda, Maryland Kimberly S. Blanchard, Esq.Weil, Gotshal & Manges LLPNew York, New York Gary D. Sprague, Esq. Baker & McKenzie LLPPalo Alto, California James J. Tobin, Esq.Ernst & Young LLPNew York, New York Lowell D. Yoder, Esq.McDermott Will & Emery LLPChicago, Illinois This section features brief commentary written on a rotating basis by leading international tax practitioners. Advance versions of most items are published in the “BNA Insights” section of Bloomberg BNA Tax and Accounting Center on the Web.

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