How the New World of BEPS Will Impact You
The Organisation for Economic Co-operation and Development (“OECD”) and its Base Erosion Profit Shifting (“BEPS”) action items have become a noticeably referenced and discussed topic as transfer pricing increasingly enters the public consciousness and continues to dominate discussions. As such, BEPS has been critically analyzed and evaluated in many forums.
The goal here, however, is not to provide an exhaustive review for practitioners, but rather focus on a pair of key takeaways regardless of reporting thresholds and regulatory requirements: (1) the concept of development, enhancement, maintenance, protection and exploitation of intangibles (“DEMPE”) memorialized in Action Item 8; and (2) the Country-by-Country (“CbC”) requirements of Action 13.
The OECD prepared BEPS guidance for intangible assets under Action 8. BEPS Action 8 guidance addresses intangible transfer pricing issues and aligning outcomes with value creation. DEMPE, an important concept under Action 8, is used to determine the arm’s-length return to entities developing, enhancing, maintaining, protecting and exploiting intangibles. Generally, companies that perform DEMPE-related functions and contractually assume the risk for intangibles receive a share of intangible returns. Therefore, if an entity has participated in the DEMPE functions or assumes certain risks, a separate transaction must be considered. However, if no risks are assumed but the entity does perform DEMPE functions, then that entity should earn an arm’s-length remuneration.
The guidance intent is not to transfer the income away from the legal owner of the intangible asset, but rather recognize the owner has an obligation to pay for those activities it does not perform. Contracts are used as a reference point to identify the activities (responsibility and rights of an entity). However, any transfer pricing analysis must ultimately be based on actual functions performed and not solely rely on those stipulated in a contract, if a difference exists.
Intangibles face a distinction between financial risk (funding of the intangible) and operational risk (use of the funding). If the entity only controls financial risk without assuming control over operational risk, then the entity that funded the intangible would expect only a risk-adjusted return and not expect the residual income if it had not also assumed the operational risk. This is different than many transfer pricing instances in which the operations are tested under certain methods, and the residual return was allocated to the entity providing the funding. Without the control over the financial risk, an entity is only entitled to a risk-free rate of return.
BEPS specifically addresses large multi-national enterprises (“MNEs”) under Action 13. The action plan focuses on providing transparency with respect to tax reporting and disclosure, and aligning taxing rights with the functions or value-adding activity of the entity and its affiliates. The value chain must be transparent, and important people functions, risks and assets must align with value creation. BEPS addresses how entities and affiliates remunerate each other for intra-company transactions. These payments may entail transferring profits from less-favorable tax jurisdictions to ones with more favorable tax treatment. Thus, governments place importance on properly identifying companies’ profit allocations within their borders.
Action 13 coordinates transfer pricing documentation through a 3-tiered approach that includes CbC reporting, a master file and a local file. BEPS ultimate guidance and adoption into local law can be subject to revisions by the respective local taxing authority, which may be lower than the OECD guidance with a threshold of €750 million for large MNEs.
BEPS and Small to Mid-Sized MNEs
BEPS may impact your business if you have international operations. Although the OECD recognized that the threshold excluded 85% to 90% of MNE groups, it is reasonable to expect auditors, tax professionals and the respective taxing authorities will also rely upon BEPS and OECD guidance in assessing the transfer pricing policies for small and medium-sized MNEs.
As transfer pricing appears on the radars of an increasing number of tax jurisdictions, companies with an international presence must ensure each establishment is properly aligned with the proper remuneration policy, regardless of the BEPS’ guidance threshold.