Global Tax Reporting Conundrum Looms for U.S. Companies

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Kevin A. Bell

A complex web of government relationships allowing the Internal Revenue Service to exchange confidential taxpayer information will likely have a few holes, with significant reporting consequences for U.S. multinational companies as they approach an Oct. 16 deadline.

The IRS’s recently released draft agreements for exchanging U.S. companies’ global tax and profit reports with foreign tax authorities generally follow the OECD template. However, there are a few differences that may make negotiations with some countries challenging, practitioners told Bloomberg BNA.

The IRS is racing to negotiate approximately 100 competent authority agreements—government-to-government agreements for exchanging taxpayer information—so that U.S. multinationals can file their reports of global taxes and profits for 2016 with the IRS rather than with foreign jurisdictions.

The U.S., unlike many other countries, hasn’t signed the Organization for Economic Cooperation and Development’s Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports (MCAA).

U.S. taxpayers will be filing their first country-by-country reports with the IRS at the time they file their tax returns, David Ernick, a principal at PricewaterhouseCoopers LLP in Washington, told Bloomberg BNA April 24. This year the extended due date for filing tax returns is Oct. 16, he noted.

100 Agreements

Practitioners expressed some relief at the new draft competent authority agreements. The IRS needs to get the final agreements in place soon in order for the U.S. filing of country-by-country reports to satisfy the obligations of U.S. multinational enterprises in other jurisdictions for 2016.

“The fact that the IRS had not publicized its progress in getting the CAAs in place was making a lot of taxpayers nervous,” Michael Plowgian of KPMG LLP in Washington told Bloomberg BNA April 21.

Ernick said that because the U.S. hasn’t signed the MCAA, the IRS is negotiating bilateral competent authority agreements. “There are close to 100 of those that have to be negotiated on a bilateral basis, with our tax treaty and TIEA partners.”

There are two separate IRS model competent authority agreements— one relying on tax treaties and one relying on tax information exchange agreements (TIEAs) as the legal basis for exchange.

Action 13 of the international 15-point plan for fighting large-scale tax avoidance by multinational companies, the Action Plan on Base Erosion and Profit Shifting (BEPS), calls for companies to report to government taxing agencies on taxes paid and profits earned in each country of operation, and for countries to automatically exchange that information while ensuring confidentiality.

‘Awesome Challenge’

Ernick said it will be “an awesome challenge” for the IRS “to get all the competent authority agreements negotiated in time.”

The PwC practitioner, a former Treasury Department official, also said it its unlikely that other countries will sign on to the IRS’s boilerplate language without a second thought. “No one signs anything without reading it,” he said. “And no one signs anything without comparing it to something similar that they’ve recently signed.”

Plowgian acknowledged that the IRS needs to get the competent authority agreements signed with a lot of jurisdictions in a short amount of time, but said their similarity to the OECD version is likely to help. “The fact that the IRS models are very similar to the OECD model and the multilateral competent authority agreement may make it easier for other jurisdictions to get comfortable with the agreements pretty quickly.”

57 Jurisdictions

Fifty-seven jurisdictions have signed the MCAA, “so many jurisdictions should be willing to sign a similar agreement with the IRS,” Plowgian said.

Carol Doran Klein, vice president and international tax counsel at the United States Council for International Business, agreed with Plowgian. “I have compared the OECD version with the U.S. version and I think most of the differences are due to the fact that this is an agreement based on a bilateral treaty as opposed to the Convention on Mutual Assistance in Tax Matters.”

Doran Klein said the multilateral framework requires a slightly different approach to some aspects of the competent authority agreements, “but on the substance of the agreements, I think this is essentially the same as the OECD version, so countries that are willing to sign that should be OK with the U.S. version.”

Doran Klein also said the confidentiality safeguards put in place under the Foreign Account Tax Compliance Act may be a useful foundation for the new agreements. “I think the IRS believes that they will be able to piggyback the confidentiality safeguards on the prior work that was done on FATCA, so they should be able to sign these CAAs with countries that are signing onto the OECD and that have FATCA agreements in place,” she said. “So, the IRS may be able to finalize a number of agreements quickly.”

Filing With Foreign Jurisdictions

Ernick said foreign jurisdictions might not have the same motivation as the IRS to quickly sign the bilateral competent authority agreements by Oct. 16. “If they drag their feet and don’t get it done in time, the consequence is that the secondary mechanism applies and U.S. companies will have to file there directly—which the foreign jurisdiction may not view as a bad thing.”

Doran Klein said some companies are facing deadlines for notifying the country in which they have a constituent entity about which entity will be the reporting entity. “If the CAAs are not in place, then companies are concerned that they cannot give an effective notification, even though they anticipate that an agreement will be in place” by the time the country-by-country reports of global taxes and profits are due to be exchanged.

The OECD has provided some suggested solutions, Doran Klein said. “But getting the CAAs in place would eliminate those issues for U.S. reporting entities with respect to those countries with notification requirements.”

No Substantive Differences

Barbara Mantegani of Mantegani Tax PLLC in McLean, Va., parsed the draft U.S. agreements and the MCAA side by side. “Other than some language that you would expect to be different due to the different types of documents they are—multilateral with many signatories versus bilateral with only two signatories—there are no substantive differences, and in fact a lot of the language is exactly the same.”

The only thing that struck Mantegani was that while the OECD document uses the term “will” to describe actions taken under the agreement—"will exchange,” “will notify” and “will request"—the U.S. documents use the terms “intend to” or “is expected to,” as in “the Competent Authorities intend to exchange reports” in Section 2, or “the Competent Authority is expected to provide notice of receipt” in Section 4.2.

“I thought that might be a quirk of U.S. drafting that we always use conditional language” in memorandums of understanding, “but I looked at the Canada MOU for arbitration and the French MOU for arbitration and the agreements use the words ‘will’ and ‘shall’ throughout, so I do find the conditional language in the draft MCAAs to be puzzling,” Mantegani said.

Redlining

A foreign competent authority will almost certainly do a “redline” comparison of the draft competent authority agreements from the IRS against the MCAA, said Ernick. “And they will find, not surprisingly, that it is not exactly the same—if it was, then the U.S. could have just signed the MCAA.”

Ernick said there are a couple of places where the IRS makes clear that a term is defined with reference to the U.S. Treasury regulations.

The draft agreements from the IRS also include a requirement that one competent authority notify the other within 15 days of successful receipt of a file containing the country-by-country report, Ernick said.

The IRS draft agreements, unlike the MCAA, further make clear that country-by-country reports can only be used by the “tax administration” of the government receiving them—and defines that term. The apparent purpose is that other parts of the government shouldn’t be getting access to and using the country-by-country reports, he said.

Ernick concluded that there are “probably no differences that are a big deal, but those differences and the process of understanding them will slow things down.” It might help, he added, if the IRS before finalizing the model agreements did its own comparison and prepared a standard explanation of the differences.

Transfer Pricing Adjustments

Regarding transfer pricing, section 5, paragraph 2 of the draft U.S. models say that the “tax administration should not base transfer pricing adjustments on the CbC report"—the country-by-country global tax and profit report.

The equivalent language in the OECD version of section 5, paragraph 2, says that “consequently, transfer pricing adjustments will not be based on the CbC report.”

Doran Klein pointed out that “will not” is stronger language than “should not,” adding that “in my view it would be better for the U.S. model to track the OECD model on this language.”

Fiscal Year

Plowgian identified a few substantive differences between the IRS model and the OECD model. One that jumps out, he said, is that the IRS model defines the term “fiscal year” to clarify that for U.S. multinationals it means the reporting period as defined in the relevant U.S. Treasury regulations. “The definition clarifies that the accounting period of the U.S. parent entity for financial statement purposes controls,” Plowgian said.

Many multinationals have entities in various jurisdictions that have different fiscal years, and there has been confusion about which reporting period controls for country-by-country reporting purposes, he said.

Constituent Entity

Plowgian said another substantive difference is that the IRS models define the term constituent entity, in the case of a U.S. multinational group, as having the same meaning as under the U.S. regulations.

The U.S. regulations generally follow the OECD model, except that they provide that a foreign entity that isn’t subject to reporting under U.S. tax code Section 6038(a)—generally, a control standard—isn’t included as a constituent entity, he said. In general, if an entity is consolidated under U.S. generally accepted accounting principles (GAAP)—and therefore included under the OECD standard—it will also be controlled and subject to reporting under Section 6038(a).

In some cases, however, an entity may be consolidated under U.S. GAAP and not controlled for purposes of Section 6038(a). This is the case with some variable interest entities, Plowgian said. “It is not clear whether other jurisdictions will object to the constituent entity definition when they discuss the CAA with the IRS.”

Exchange Mechanism

The BEPS Action 13 guidance adopted by the U.S. and other countries requires the ultimate parent company of a multinational group to file its country-by-country report in its tax jurisdiction of residence on behalf of the entire group. If the parent’s tax jurisdiction has no competent authority agreement in place for exchanging the information, however, a subsidiary in the group would have to file the report in its tax jurisdiction of residence—or would have to designate a “surrogate” parent in another jurisdiction.

For each country, the U.S. would have to have in place both a legal instrument authorizing the exchange of tax information with another country—a tax treaty or a TIEA—and a competent authority agreement.

Foreign filings would need to comply with the requirements in those jurisdictions and the information wouldn’t be protected under U.S. tax treaties or TIEAs.

Secondary Exchange Mechanism

U.S. multinationals need to file their country-by-country reports with the IRS. Unlike some of its foreign counterparts, the IRS has a reputation for keeping tax information confidential. If the information leaks, the consequences for multinational companies are dire: trade secrets made available to competitors, criticism in the press and harm to customer-facing businesses.

Ernick said if the IRS competent authority agreements aren’t negotiated on a timely basis, the unfortunate consequence is that the so-called secondary mechanism can kick in, and U.S. companies will need to file their country-by-country reports directly in one or more foreign jurisdictions, or through a “surrogate parent entity” filing in one foreign jurisdiction.

According to the OECD model legislation for country-by-country reporting, competent authority agreements need to be negotiated no later than 12 months after the last day of the reporting fiscal year of the multinational group, Ernick said.

The former Treasury official said not every country is implementing country-by-country reporting consistent with the OECD’s recommendations. “So depending on how the CBC rules of foreign countries are worded, the competent authority agreements may need to be negotiated by October 16, 2017, in order to turn off reporting under the secondary mechanism,” he said.

Negotiating Schedule

Ernick said it would be helpful to taxpayers “if we could know more about the schedule and expected coverage of the negotiation of these competent authority agreements. Have any been negotiated yet? Will they all be completed by the relevant deadline, which may be as early as October 16, 2017, for some countries?”

Ernick said it would also be helpful to know if there are any U.S. tax treaty or TIEA partners with whom the IRS won’t negotiate a competent authority agreement for exchanging the country-by-country reports.

Protections in Place

Presumably the IRS will conduct due diligence to make sure a foreign jurisdiction has appropriate protections in place to ensure confidentiality and won’t inappropriately disclose country-by-country reports of U.S. companies to others, Ernick said. “That due diligence process will take time and slow down the negotiation process.”

It also means that some jurisdictions may fail the due diligence process and the IRS therefore wouldn’t negotiate a competent authority agreement with that country, he said. “Unfortunately, that would mean U.S. taxpayers doing business in such a country would have to file their CBC reports directly in that country—in a country which the IRS would have said they don’t trust it to keep the CBC report confidential.”

That “would obviously be a bad result,” he said.

Monitoring

Ernick said U.S. companies still have work to do to prepare for country-by-country compliance obligations, and that work will be ongoing and evolving. “They have to have pulled all their data to fill out the CBC report and struggled with all the definitional questions raised by the limited guidance released to date.”

Companies have to monitor ongoing guidance on country-by-country implementation, both from the IRS and the OECD, he said. “They’ve got to monitor which countries around the world have implemented CBC reporting and see if they’ve got filing and notification requirements that must be satisfied.”

If a company misses the notification deadline, that jurisdiction won’t accept a country-by-country report through the exchange process “and you’ve got to file there directly,” Ernick said.

To contact the reporter on this story: Kevin A. Bell in Washington at kbell@bna.com

To contact the editor responsible for this story: Molly Moses at mmoses@bna.com

For More Information

The IRS's model country-by-country reporting agreement on the basis of a tax treaty is at https://www.irs.gov/pub/fatca/us_model_cbc_caa_dtc.pdf.

The IRS's model on the basis of a TIEA is at https://www.irs.gov/pub/fatca/us_model_cbc_caa_tiea.pdf.

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