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In this edition: the OECD held two public consultations on matters relating to transfer pricing; the German parliament adopted a measure to combat base erosion achieved through the deduction of royalties emanating from "special tax regimes" that are not compliant with BEPS Action Item 5; India released additional guidance on Action Item 13 implementation; Malaysia released updated guidance on the implementation of CbC reporting; and the IRS released two practice units addressing APAs for outbound and inbound tangible goods transactions.
OECD Held Public Consultations on PEs and Transactional Profit Splits
Continuing the work started under the BEPS Project, the OECD held two public consultations on matters relating to transfer pricing. The consultations, held on November 6-7, 2017, specifically addressed additional guidance on the attribution of profits to permanent establishments (PEs) and on the revised guidance on the transactional profit split method at the OECD Conference Center in Paris. The consultations addressed the contents of two discussion drafts published in June 2017, and subsequently the OECD requested practitioners to provide written comments on the drafts.
These discussion drafts had been developed by the OECD to replace the discussion drafts published for comments in July 2016, which had attracted little consensus. With regards to PEs, the BEPS Action 7 Report (Preventing the Artificial Avoidance of Permanent Establishment Status) recommended the development of guidance on the application of the OECD Model Tax Convention’s Article 7 (Business Profits) to PEs resulting from the changes in the Report, while taking into account new transfer pricing guidance arising from BEPS Action Items 8-10, in particular the work related to intangibles, risk and capital.
This summer's discussion draft on the attribution of profits to PEs described high-level general principles in the circumstances addressed by the BEPS Action 7 Report, as well as including examples illustrating the attribution of profits to permanent establishments arising under Article 5(5) relating to dependent agency PEs and from the anti-fragmentation rules in Article 5(4.1) of the Model Tax Convention.
Commentators at the consultation were drawn from a range of backgrounds, including industry, the private sector, civil society, and academia. A number of tax practitioners and representatives of industry organizations called for greater clarity on the attribution of profits to PEs, particularly in respect to the order of the application of Article 7 and the transfer pricing article, Article 9 (Associated Enterprises) of the Model Tax Convention.
Special attention was given to the concept of "significant people functions" under the Authorized OECD Approach (AOA) described in the OECD's 2010 Report for attributing profits to PEs under Article 7 as compared with the "risk control functions" described in the OECD Transfer Pricing Guidelines (TPG) when interpreting Article 9. The misalignment and lack of precise interchangeability of these two concepts of the AOA and the TPG were repeatedly highlighted as opening the potential for differing outcomes under an Article 7 and an Article 9 analysis.
Andrew Cousins, a director in Duff & Phelps' European transfer pricing practice, urged the OECD to work towards aligning the standards, which he saw as providing considerable benefits in the form of clarity and administrative simplification when applied to dependent agent PEs.
Cousins observed that, "the TPG have moved on significantly since the 2010 Report was written and it is now time to consider whether the AOA would benefit from a coordinated revision to align it with the TPG. From a compliance perspective, operating two incompatible versions of the arm's length principle in parallel is a recipe for confusion and conflict."
Germany Adopts an Anti-Base Erosion Measure to Combat Tax Deductions Through Royalties
The German parliament has adopted a measure to combat base erosion achieved through the deduction of royalties emanating from "special tax regimes" that are not compliant with BEPS Action Item 5. This measure was designed as a treaty override, to stop (and catch) treaty shopping structures, but also eliminates double taxation by excepting royalties paid to a foreign affiliate caught under the German controlled foreign corporation (CFC) regime. The German anti-base erosion measure for royalties directly references BEPS Action Item 5 (and the guidance therein), but does not take into account the optional grandfathering through to June 30, 2021, allowed by that Action.
This measure will come into effect as of January 1, 2018. It operates by applying the following questions to assess whether the tax-deductibility of royalties paid should be restricted in Germany:
Is the effective tax rate of the licensor on the royalty income paid by the German entity less than 25 percent? If "yes," proceed to (2) below.
Is that rate of less than 25 percent due to a “special tax regime” (e.g., Patent Box rather than the normal rate)? If "yes," proceed to (3) below.
Is that "special tax regime" lacking substantial business activity (i.e., classified as a modified nexus under Action Item 5)? If "yes," apply deductibility restriction in (4) below.
Restrict deductibility of royalty payments by the amount by which the licensor’s rate falls short of 25 percent. For example, if the licensor benefits from the UK Patent Box rate of 10 percent, only 40 percent of the royalty payments would be deductible.
This new measure would not affect normal low-tax regimes (e.g., Eire at 12.5 percent trading rate and UK at 19 percent normal rate), but instead be targeted toward their pre-BEPS Action Item 5 non-nexus IP regimes. To the extent that a special IP regime (e.g., Irish Knowledge Development Box, Italian Patent Box, UK Patent Box, etc.) complies with Action Item 5 and meets the modified nexus test, then the royalty payments would continue to be fully deductible in Germany.
India Releases Additional Guidance on Action Item 13 Implementation-Sets Reporting Deadline of March 31, 2018
On October 31, 2017, the Central Board of Direct Tax ("CBDT") published Notification No. SO 3497(E), which addresses the Master File and country-by-country ("CbC") reporting requirements, as specified under Action Item 13 of the Organization for Economic Cooperation and Development ("OECD")'s Inclusive Framework on Base Erosion and Profit Shifting ("BEPS").
The new rules will be applied to financial year 2016 -2017, and the annual corporate tax filing deadline is three months after the fiscal year end. With many Indian enterprises having a fiscal year end of December 31, Master File and CbC reporting should be completed before March 31, 2018.
Details pertaining to CBDT Notification No SO 3497 are available here. The key considerations stemming from the Master File and CbC reporting guidance are summarized below:
A Master File needs to be prepared when a company meets the following thresholds:
Consolidated group revenue exceeds INR 500 core (approximately USD 77 million); and
For the aggregate value of international transaction:
During the accounting year, as per books of accounts, exceeds INR 50 crore (approximately USD 7.7 million); or,
In respect of purchase, sale, transfer, lease or use of intangible property during the accounting year, as per the books of account, exceeds INR 10 crore (approximately USD 1.5 million).
The information required in the Master File needs to be disclosed in Form 3CEAA or Form 3CEAB, as follows:
For one Constituent Entity ("CE") in India, the group may prepare Form 3CEAA. Form 3CEAB is not required.
If there are more than two CEs in India, the group may designate one CE to prepare / furnish Form 3CEAA. Form 3CEAB needs to be filed at least 30 days prior to the due date for filing Form 3CEAA.
The Master File requires detailed information, including the functional analysis of all CEs that contribute at least 10 percent of the revenues/assets/profits of the group, identification of the top 10 unrelated lenders, and a list of all entities engaged in the development and management of intangible property.
CbC reporting is required when the consolidated group revenue reaches INR 5,500 crore (approximately USD 846 million).
CbC reporting requirements and due dates may be different depending on the circumstances. The general guidelines for such treatment are summarized in the table below.
Applicable Due Date
Parent entity or alternate reporting entity is an Indian resident in India
Form 3CEAD, which is broadly the same as BEPS Action Plan 13.
For FY 2016-2017:3 months after fiscal year end (e.g., March 31, 2018, for December 31 year-end companies)
CE resides in India but Parent entity is not an India resident
Form 3CEAC to the Director General of Income-Tax (Risk Assessment).
At least 2 months prior to the due date of Form 3CEAD – i.e. January 31, 2018
If there is no agreement for exchange of CbCR or systematic failure, need to prepare Form 3CEAD for every accounting year.
Form 3CEAD: March 31, 2018
nounced in the new rules.
One important thing to note is that the final rules have lowered Action Item 13's threshold for preparing Master File and CbC reporting. Furthermore, the final rules also require more detailed information than that recommended under Action Item 13, creating an additional burden on multinational corporations to customize the Master File and CbC reporting to fulfill the transfer pricing documentation requirements in India.
Malaysia Releases Updated Guidance on Country-by-Country Reporting
The Inland Revenue Board of Malaysia (IRB) has released updated guidance on the implementation of CbC reporting in Malaysia, primarily concerning the local requirement to notify the IRB of the identity of the reporting entity for CbC reporting purposes. The notification requirement applies for financial years beginning on or after January 1, 2017, for groups where consolidated revenue exceeds MYR 3 billion (approximately USD 735 million) in the prior year.
Notification of the reporting entity, which should be made in writing, is due by the last day of the reporting financial year (e.g., for companies with a year-end of December 31, 2017, the notification needs to be made by December 31, 2017). In practice, the identification of the reporting entity for CbC reporting purposes is not always a straightforward matter, so it is imperative that multinationals address this question early on. The IRB has released sample notification letters both for (i) cases where the reporting entity is the Malaysian taxpayer; and, (ii) where the reporting entity is an entity other than the Malaysian taxpayer.
The release of the notification of reporting entity requirement, combined with other recent developments across South East Asia, demonstrates the region’s increasing focus on BEPS Action Item 13 implementation. The implication of the region’s focus on implementing the BEPS standards set out by the OECD is a much greater transparency of transfer pricing systems to tax authorities. Thus, it is imperative that multinational enterprises ensure that their operating models and transfer pricing systems are aligned with the new guidance (e.g., aligned substance and return across the group supply/value chain).
IRS Releases Two APA Practice Units for Outbound and Inbound Tangible Goods Transactions
On November 8, 2017, the IRS Large Business and International division (LB&I) released two practice units addressing advanced pricing agreements (APA) for outbound and inbound tangible goods transactions.
An APA is a voluntary agreement entered between a corporate taxpayer and the relevant tax authority. APAs enable corporate taxpayers to predetermine transfer pricing methodology for future years and potentially for prior years in consultation with tax authorities. The goal of an APA is to reduce repetitive administrative work and provide certainty for the taxpayer when filing their tax returns each year. The practice units are resources and training materials designed to educate IRS agents on tax concepts, specific types of transactions that they may encounter, and share knowledge among IRS employees. Practice units are not meant to be official directives by the IRS. IRS examiners may use alternative approaches not prescribed in the practice units when examining tax issues and disputes.
The two recently released practice units focus on determining a price for tangible goods exchanged by related parties. In the first practice unit, LB&I explains the APA filing process regarding an inbound tangible goods transaction for a U.S. taxpayer. The first practice unit uses an example of a U.S. entity distributing tangible goods manufactured by its Japanese parent company to illustrate APA procedures. In the second practice unit, LB&I explains the APA filing process for a U.S. taxpayer for outbound tangible goods transaction. This practice unit describes a U.S. Parent Company distributing tangible goods purchased from a foreign subsidiary in Japan to explain the steps involved in requesting and obtaining an APA.
The two practice units provide examples and discussions of the requirements for filing and maintaining an APA submission, starting with the initial prefiling stage through review of the APA annual reports. The practice units identify the issues that can be addressed in an APA submission and when IRS examiners should advise U.S. taxpayers to consider filing an APA. The practice units address the procedures outlined in Revenue Procedure 2015-41, 2015-35 I.R.B. 263, which is relevant for any APA request filed after December 29, 2015.
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