Multinational CFOs take heed: Country-by-Country Reporting will deliver challenges, but also some advantages.
Country-by-Country Reporting (CbCR) is topical in tax circles globally, and CEOs, FDs and other business leaders working within large multinational entities in South Africa would also do well to take note of recent developments. Michael Hewson, director at Graphene Economics, a specialist African transfer pricing advisory firm, outlines what South African multinationals need to know.
What is CbCR?
Base Erosion and Profit Shifting (BEPS) has long been an area of concern for the Organisation for Economic Cooperation and Development (OECD), which defines BEPS as: “Tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations.”
Various multinationals have come under fire for doing this over the last few years, including some large global brands. Through what’s known as “aggressive tax structuring”, companies have been accused of gaming tax systems to maximise profits, while potentially depriving tax authorities of revenue.
To address the risks associated with BEPS, revenue authorities from over 100 countries are working together in various ways. One of these is Country-by-Country Reporting. It requires multinationals with consolidated revenue in excess of approximately €750 million to provide information relating to their activities in each country in which they operate in a report.
This is the first time that companies have had to report this type of information in such a consolidated manner and provide details regarding revenue, profits, number of employees, and tax paid and payable per jurisdiction, among others.
Although multinationals produce accounts as though they are one entity, each entity within the business is taxed separately. This makes it difficult to get a big picture overview of what’s happening in the group. Country-by-Country Reporting aims to change that.
What impact will CbCR have on MNEs?
The intention is that CbC reports need to be submitted to a revenue authority (often this will be the revenue authority where the ultimate parent entity, or UPE, is based). That revenue authority will share it with other revenue authorities that have complied with certain protocols (agreed to by members of the Inclusive Framework on BEPS including South Africa).
Each authority will be able to analyse the information to perform a risk assessment based on the relevant information relating to the entire multinational group.
What this means is that multiple tax authorities will receive information about multinationals’ worldwide operations. Such information might expose these organisations’ weaknesses and any aggressive tax structures (for example, setting up treasury companies or IP companies in low tax jurisdictions without having real or sufficient substance in those locations). Even where aggressive tax structuring was not the intention, it may identify inconsistencies in the multinational group’s operations or remuneration across the different countries.
To avoid penalties and potential reputational damage, multinationals need to be proactive. If there is any concern about their tax structures, these should be re-evaluated. In certain instances, they may even need to adapt their operating models.
Upsides of CbCR
It’s not all bad news. While the CbC Report is a compliance tool, which might be viewed as an administrative burden by some, it does effectively provide a snapshot of the company’s operations. This can indicate where transfer pricing in a particular country needs to be analysed in more detail. For example, where some countries’ operations are making losses compared to other similar countries, it is worthwhile investigating whether the reason for losses relates to intercompany transactions, or external factors.
Furthermore, while information sharing will benefit revenue authorities looking to boost tax transparency, over the longer term it can also play a meaningful role in assessing the impact of tax policies.
The current state of CbCR
In May 2018, the OECD released the first annual CbC peer review reports, the purpose of which is to assess the domestic legal and administrative framework for CbCR currently in place in each participating jurisdiction.
The first report presents the outcome of the review of 95 jurisdictions, including 14 in Africa (and including South Africa), which each provided legislation or information pertaining to the implementation of CbC reporting. Sixty jurisdictions have already introduced legislation to impose CbCR filing obligations. The remaining jurisdictions, including South Africa, are working towards finalising their domestic legal framework with the support of the OECD.
Where legislation is in place, the implementation of Country-by-Country Reporting has been found largely consistent with the Action 13 minimum standard (the multinational reporting template). Some jurisdictions have received recommendations for improvement on certain aspects of their legislation and work has already begun to bring the provisions concerned in line with the standard.
The OECD has indicated that following the first exchanges of CbC reports, work will begin on analysing how CbC reports are used by tax administrations in assessing Transfer Pricing and other BEPS-related risks.
Planning next steps
Multinationals should ensure that they understand and manage the risks relating to CbCR. It’s important to understand that even if the UPE is responsible for reporting in the company’s “home” country, group entities in other jurisdictions need to be aware of how their country will be represented.
For example, let’s say a company’s UPE is reporting in the United Kingdom and the bulk of its revenue is generated there, but it has a South African branch that looks after a specific aspect of the business. When it comes to filing a CbC report, the company is unlikely to be focusing explicitly on the South African entity, as it represents a small percentage of its profits. But, for the South African entity, which may still be generating significant revenue in a local context, it’s important to ensure that the information contained in the group CbC report is accurate and that any potential questions that it raises about the South African operations can be addressed., as the tax authorities will be sharing information.
As Country-by-Country Reporting is a new requirement that is still developing, it is advisable that multinationals take a proactive approach to it, and that they consider expert advice in assessing potential risk areas and ensuring compliance in their tax structures, transfer pricing strategies and draft CbC reports.