Multinationals in new era of transparency
Country by country reporting is set to have quite a dramatic impact on the international corporation tax system
Sometimes it’s the most prosaic phrases that turn out to have the most far-reaching effects. “Fiscal space”, for example, will probably haunt more than a few Irish politicians for years to come.
Country by country reporting (CBCR) – or Action 13 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project as it is otherwise and even more prosaically known – is another one of those seemingly innocent terms that hides its teeth behind the pursed lips of ordinariness.
Even its definition appears designed not to frighten any horses. Under Action 13, multinationals headquartered in OECD and G20 countries with consolidated revenues of at least €750 million will be required to submit a CBCR report to the tax authority in the country where their parent companies are located.
They will have to report their place of incorporation, tax residency, revenues, profits, taxes paid, capital employed, number of employees, and details of business activities by entity on a country-by-country basis.
The measure was only produced by the OECD last October, and Ireland was one of the first countries to adopt it in the 2015 Finance Act. This means that all qualifying companies headquartered here will have to file CBCR reports in 2017.
So far so not very exciting. Perhaps 100 very large companies will have to change the way they report their activities. But that’s only the beginning. It’s what happens to the data and the way it is shared around the world that really matters.
“It’s all about transparency, and companies can’t really argue too hard against it”, says PwC tax partner Joe Tynan. “Companies already file some sort of accounts in every country where they trade or have a presence, and they give turnover, employee numbers, details of tax paid, and so on. If you are a revenue authority, you already see what’s happening in your own country. Now you will be able to see what’s happening in every other country. This is very powerful.
“Up until now you only had one piece of the jigsaw,” Tynan says. “Now you will be able to see the whole picture. Before this you didn’t have access to other countries’ information. If you are the Irish Revenue, you can’t ask the Irish subsidiary of a US multinational what it is doing in other countries. But that’s going to change. This is going to have a very significant impact on companies.”
One return shared
The way the new system will work is quite elegant. Instead of companies filing multiple returns in multiple countries they will file one master return where the parent is located. This will contain tables of information about the company’s operations in different locations around the world. The receiving tax authority will then share the information with the other countries covered by the return within six months of receiving it.
“The CBCR filing will contain a number of tables covering countries around the globe,” says Deloitte tax director Gerard Feeney. “The filing will be made in the parent company’s tax jurisdiction. Irish companies will file with Irish Revenue and then, as part of the information exchange, the data will be shared with the other countries within six months.”
That’s when the tax authorities’ real work will begin. Up until now an authority in one country wasn’t really in a position to know what level of profitability a multinational might be declaring in another jurisdiction. They had no real way of knowing if they were getting their fair share of tax from those companies. This is one of the key issues driving the whole BEPS process.
“At a macro level, what’s been happening for a number of years is that a lot of countries in Europe have been looking at multinationals and asking if they have been getting their fair share of taxes from them,” says KPMG tax partner Conor O’Sullivan. “These tax authorities have been looking at the tax structures of these companies, but they found they didn’t really have enough tools in their armoury to do it. And that led to the OECD BEPS process.”
This has resulted in a set of rules which more or less state that taxable profits should be where the corporations concerned have real substance and tangible assets. But, as O’Sullivan points out, there is an almost philosophical question around the nature of substance.
“What if you have invested millions in the development of a brand or a technology?” he says. “The debate has been had and there is now more emphasis on people and tangible assets and less on intellectual property. Intellectual property still matters, of course, but not as much as in the past.”
CBCR is the mechanism which will allow tax authorities to establish where the substance is actually located. “Most tax authorities don’t have the resources to audit every company, and even if they did it would be very difficult for them to uncover the data they need,” says O’Sullivan. “CBCR brings more transparency.”
And with that transparency comes knowledge.
“The tax authorities will get this information and use analytics to see if they are getting their fair share,” says Feeney. “If they find a company is doing similar things in two countries but paying more tax in one than another, the tax authority concerned might say there is a lack of consistency.
“The key thing that lots of companies are looking at now is ensuring consistency across the globe for different activities,” says Feeney. “Under CBCR, it will become evident very quickly if a lot of profits are being made where there is not much substance or where the company has no employees. Tax authorities are getting a lot smarter with their data analytics and are using it to identify companies for audit.”
“Tax authorities will be able to analyse the filings and the system will throw up red flags against the companies, which are showing different rates in different countries,” says EY tax partner Joe Bollard. “They will begin to see trends after a few years. It will allow them to direct audit activity in a certain direction. It is not meant to be a substitute for transfer pricing audits and analysis – it will be a trigger.”
This is a very important issue for those companies that have evolved varying ways of doing business in different countries.
“Companies may have developed in different ways in different countries,” Tynan says. “They might offer distributors a 6 per cent margin in one country for historic reasons and only 5 per cent in another. This will affect the level of profits in each country, and companies are going to have to be ready to explain this and articulate the underlying reasons for these differences.
“These issues are going to be exposed to each different revenue authority. Any little inconsistencies will have to be explained.
“If turnover is the same in two countries but profits are much different, there could be problems,” he adds. “Companies don’t realise the problems they are going to face in terms of explaining how custom and practice developed in different countries over time.
“There might also be a case where a company has a lot of IP in some type of haven and therefore a lot of profits in a country where it has no employees. This might be quite legal, but you are going to have to be able to explain it and defend it, and some countries might claim that they should be able to tax at least a share of those profits.”
It also comes down to the price charged in different countries for the same products, according to EY tax partner Joe Bollard. “There is a lot of subjectivity about the right price and the right share of profits,” he says. “A lot of this comes down to valuation and transfer pricing decisions. Situations might arise where a tax authority says the price being charged to sell a product into their country is too high, and that it should be lowered to give a higher profit resulting in a higher tax take.”
The question is, what happens after that. Does the company simply pay more tax or does it adjust its profits in the country where the products were manufactured and seek a recompense from the tax authority there?
“That tax authority might have to give a refund, but the process can take a long time. The company may not agree with the first decision and may not accept that it is fair and reasonable. If this is the case, they can seek a review under the Mutual Agreement Procedure. But there is still a chance that they could end up with double taxation.
“The impact of all BEPS changes on transfer pricing will be a contentious issue and will be key fact of life for multinationals and not just those in low tax jurisdictions.”
Keep it confidential
There is also the issue of what happens to the information once it has been shared with the different tax authorities. Companies naturally want the data to remain confidential, but there is a growing feeling that it should be made public. UK chancellor of the exchequer George Osborne is among the recent converts to this cause.
Bollard doesn’t see this as likely, however.
“There is some agitation that it should be made public,” he says. “But the OECD decided on balance that it should be kept private. The EU is still considering whether to make it public. A lot of people are sceptical as to whether a proposal to make it public would have the support of Ecofin. A lot of countries, such as Germany, have already said that the EU should not go further than the OECD recommendations.”
Regardless of whether the data is made public or remains confidential to the tax authorities, CBCR will mean interesting times for the major multinationals in the years ahead. Some of them may have to change their entire business models to cater for it.
What CBCR means for Ireland
While no one really knows what the ultimate impact of CBCR on our foreign direct investment offering will be, there is a school of thought that it could be good for Ireland.
“Unlike most of our counterparts, we have aligned our tax regime to BEPS,” says EY’s Joe Bollard.
“The 12.5 per cent rate is only available if you have a substantial presence here and it is not a negotiated rate, it is a standard rate. If a multinational is looking at where to establish an overseas presence for the first time, they will look at Ireland’s track record of success and the Department of Finance’s tax strategy of the three Rs – rate, regime, and reputation.
“The department is saying we don’t do deals, we are BEPS compliant, and we are a good global citizen. Businesses will locate where they can best align their business and tax objectives and Ireland offers the whole package.
“Ireland could well become a lot more attractive as a result of this. The key thing is that these changes are not being implemented at the same time around the world and it is very important for Ireland to keep pace.”
Conor O’Sullivan of KPMG agrees. “Historically, Ireland has had no gimmicks in its tax system. We tax people on their operations here, and you only get the 12.5 per cent rate if you have real substance here. The Department of Finance and the Irish Government have played a difficult pitch pretty well. They came in for some criticism when they changed the law regarding the residency of companies here. This was presented as being about transparency and certainty.
“It has gone down well to date with most US companies. In all of this uncertainty, if you are investing you are likely to pick the country which guarantees you the least uncertainty.”
“This would suggest we could do well out of this”, O’Sullivan adds. “Some companies might say they want to bring their IP onshore and they might bring it to Ireland because they already have a lot of substance here. And if they start wrapping more substance around their Irish operations that can only be good.
“On the other hand, do the firms have the senior decision makers here? A lot of companies say they have that already. But if they need to move senior people out of the US there is a question around how attractive Ireland is to them. Our pretty horrific personal tax rates are well known; it is not so much the rates as the point at which you start paying them.”
Still, Deloitte tax partner Declan Butler also identifies this potential problem when it comes to substance.
“Let’s call a spade a spade,” he says. “We are a country of 4.5 million people and we don’t produce nearly enough top class graduates to run global businesses here. And it’s not such a desirable place for global CEOs to move to.
“Our penal income tax rates make it more likely they will have head offices elsewhere in Europe than here.
“The personal tax rate is a real problem. I saw a software company turn to the UK rather than Ireland a few months ago because they couldn’t get people to come here. BEPS doesn’t allow you to just have a few board meetings in a country with the executive decision-making taking place somewhere else. You need the decision makers on the ground, and that’s going to be a challenge for Ireland.
“The sooner that message gets out there, the better.”