Since 2013, the Organization for Economic Cooperation and Development (OECD) has been working on changing the tax landscape under its base erosion and profit shifting (BEPS) initiatives. There is a growing perception that governments lose substantial corporate tax revenue because profits are shifted to favorable locations and that traditional international tax principles are no longer adequate to respond to the increasing globalization of international business transactions. Hence, there is a need for the international community to develop appropriate measures to address this problem.
According to the OECD, current domestic tax rules are no longer relevant to modern economic and financial activities. These rules, as formulated in the early 20th century, were developed in a business environment typified by a lower degree of economic integration across borders. Ultimately, they are unsuited to current business models characterized by high intellectual property value, rapid information, and complex communication systems.
Four years after the publication of its initial reports, many member countries have embraced the OECD-BEPS project by adopting its guidelines and implementing local rules in concert with the OECD’s recommendations. One area of significant impact to large Multinational Enterprises (MNEs) is country-by-country reporting (CbC) under Action 13 of the BEPS guidelines.
In essence, CbC requires MNEs to provide an annual report, the CbC report, which breaks down key elements of the financial statement by jurisdiction. A CbC report provides local tax authorities visibility to revenue, income taxes paid and accrued employment, capital, retained earnings, tangible assets and activities of the MNE. This information is vital to assess transfer pricing pursuits and allocation of tax audit resources.
CbC applies to MNEs with combined revenue of €750,000 ($850,000) or more.
The implementation of CbC depends on the countries adopting it and their individual timetables to integrate this new rule into their legal system. Some countries have already implemented the CbC report for the fiscal year starting January 1, 2016, which means that the report should be filed within 12 months of the relevant year end.
The U.S. has been hesitant in adopting the OECD guidelines, particularly with the CbC reporting, as companies raised concerns over corporate information falling into the wrong hands, citing privacy issues. Nevertheless, the Department of Treasury and the IRS issued guidance in June this year in compliance with BEPS Action 13.
Treasury regulations T.D. 9773 (CbC reporting regulations) now require certain U.S. business entities that are the ultimate parent entity of a U.S. MNE group to file Form 8975 annually with the IRS. Form 8975 requires the ultimate parent entity of a U.S. MNE group to report information on a country-by-country basis related to the group’s income and taxes paid as well as certain indicators of the location of the group’s economic activity. The CbC reporting regulations apply to reporting periods of ultimate parent entities of U.S. MNE groups that begin on or after the first day of the first taxable year of the ultimate parent entity that begins on or after June 30, 2016.
As mentioned, the final regulations require large U.S. multinational companies to prepare and file an annual federal Form 8975, Country-by-Country Report, and Schedule A, Tax Jurisdiction and Constituent Entity Information. Form 8975 and Schedule A are to be attached to business entities’ income tax returns by the due date (including extensions). For example, the form and schedule must be attached to Forms 1120, 1065, 1065-B, 1120S, 1120-L, 1120-PC, 1120-REIT, 990-T, and 1041, when applicable.
States may also require that Form 8975 be attached to their business entity tax returns. For example, California conforms to the information reporting requirements imposed under Internal Revenue Code §6038, and as a result the new Form 8975 filing requirements apply to California taxpayers subject to the provisions of §6038. Therefore, California taxpayers required to file federal Form 8975 (and Schedule A) with the IRS must attach a copy of federal Form 8975 (and Schedule A) to their California return. If federal Form 8975 (and Schedule A) is not provided when required by a state, significant penalties may be imposed.
The CbC report filed with the IRS is shared with other tax authorities through information exchange agreements. The U.S. intends to limit the use of the information in the report and plans to incorporate this limitation into the competent authority arrangement pursuant to which the reports are exchanged.
The key issue for MNEs is the allocation of resources to address and comply with this new requirement. With most tax departments already spread thin, gathering data, determining processes and developing technology to create the reports seem a daunting task. Take action now–identify the need, design a system, and build the processes.
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