Close Encounters With Public CbC Reporting

Robert Goulder

If you blinked, you might have missed it. A provision calling for public country-by-country reporting nearly made its way into Congress’s COVID-19 pandemic relief bill, the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136). The transparency debate is also heating up at the OECD level. Three cheers for that.

The disclosure of CbC reports remains a touchy matter to many of the affected companies, all of which are large multinational corporations. Let’s take a moment to probe what lies at the root of this sensitivity. To be clear, the requirement to file these reports is not a taxing provision. Other than compliance costs, there is no direct influence on a firm’s after-tax profits or earnings per share. Because the reports are already being prepared for the benefit of tax administrators around the world, there should be no additional compliance burden. On its face, public CbC reporting wouldn’t cost anyone a penny.

Disclosure presents big business with a communications challenge, not a tax problem. What’s the worst that could possibly happen? Firms that choose to shift large amounts of profit to tax havens would be found out and might feel compelled to explain their aggressive tax planning when quizzed by the media. That’s fair game.

For example, Apple CEO Tim Cook has displayed a genuine talent for rationalizing Apple’s clever tax planning. He’s had plenty of practice. By now, most retail consumers should know that Apple is proficient at profit shifting, but this doesn’t deter anyone from buying the latest overpriced iPhone. Where’s the harm? A high-profile CEO and his public relations team did the jobs for which they’re well paid.

You’ve heard similar sound bites before: A CEO steps in front of a microphone and insists that his or her company pays “all the tax that’s due,” and reminds us that their conduct was “perfectly legal.” If a multinational isn’t prepared to have those types of conversations with the press, institutional investors, or other stakeholders, they shouldn’t have gotten in bed with tax havens in the first place.

Public CbC reporting would do nothing to directly prohibit profit shifting; it simply means you can’t do so with impunity. Again, fair game. By the way, some multinationals make a point of voluntarily disclosing CbC information comparable to what appears on the formal reports. This is done as a measure of good corporate governance. The companies that do this include BHP Billiton, Rio Tinto, Unilever, and Vodafone. I wish more companies would do the same.

The case for disclosure seems naturally compelling at a time when the international consensus is being reworked through the OECD’s inclusive framework. The merits of that case are likely to strengthen this year, given how public funds are being used to bail out private enterprises like never before. All over the world, private losses are being nationalized on a historic scale — and it feels like the new normal. Moral hazard certainly isn’t what it used to be.

True, the global COVID-19 pandemic is nobody’s fault. There’s compelling justification for the sweeping public assistance we are witnessing. But it’s not unreasonable for massive bailouts to come with a few strings attached. Frankly, it would be naïve to assume that strings wouldn’t be attached. Some members of Congress have clearly been thinking about the strategic placement of those conditions. Restrictions on share buybacks are already in play and being widely discussed. Don’t be surprised if public CbC reporting is next in line.

On March 23 the House Ways and Means Committee released a 65-page draft of “contributions” to the Take Responsibility for Workers and Families Act (H.R. 6379), which was released the same day. The legislation is the House’s second attempt at a far-reaching pandemic relief bill, following the Families First Coronavirus Response Act (H.R. 6201), which President Trump signed into law on March 18. Title IV of the committee’s draft consists of measures to protect financial stability and transparent markets. Section 402 of Title IV would require a temporary ban on all share buybacks for all companies for the duration of the COVID-19 crisis. The temporary ban would apply throughout the entire economy, not just to recipients of rescue funds. The provision was motivated by frustration over the large number of share buybacks that occurred in the aftermath of the 2008-2009 federal bailouts.

Section 407 of Title IV is more targeted. It would impose binding restrictions on any recipients of federal pandemic bailout funds. According to wording on page 35, the recipients would be barred from engaging in “share buybacks, executive bonuses, golden parachutes, and federal lobbying” until the aid was repaid. If the aid is never repaid, then those activities are off limits for good.

Most important for our purposes, section 407 of Title IV (on page 36 of the committee draft) would require recipients of federal bailout funds “to annually disclose information related to human capital management, political spending, and country-by-country tax reporting.” There you have it. Who would have thought a virus could bring transparency reform?

These provisions never made it into the $2 trillion pandemic relief package that Congress eventually passed on March 27. The omission wasn’t surprising since the CARES Act was largely the work of Senate Republicans. That doesn’t mean the House provision on CbC reporting won’t creep into subsequent legislation. As generous as the CARES Act was, people are realizing that companies will burn through the authorized assistance in a matter of weeks. Another economic bailout package will soon be necessary, and next time House Democrats might be in the driver’s seat when it comes to placing conditions on the beneficiaries of federal funds. President Trump has already indicated that he’s willing to push back against Senate Republicans when it comes to buybacks.¹ Why wouldn’t he display the same flexibility for the less glamorous matter of public CbC reporting, as long as doing so provides him with the favorable optics of signing a relief bill?

At the end of the day, Trump will sign whatever pandemic response legislation Congress sends to his desk. The House is already there; the battle over disclosure will be won or lost in the Senate. Meanwhile, several Republican senators are under self-quarantine and unable to cast floor votes, making the GOP majority razor thin. A recent GOP-backed procedural vote in the Senate failed (49 to 46) for that very reason.² Deals will be required to get bills passed. Let the horse trading begin.

Better Data, Better Audits

Despite the lack of public disclosure, CbC reporting remains the crowning achievement of the OECD base erosion and profit-shifting initiative. It is one of the project’s four minimum standards. The idea for these reports didn’t come out of nowhere, however: There is a similar information-sharing regime for the oil, gas, and minerals sectors, known as the Extractive Industries Transparency Initiative. It operates on a voluntary basis. When the BEPS final reports landed in October 2015, action 13 (transfer pricing documentation) borrowed from the Extractive Industries Transparency Initiative and pushed the concept mainstream.

The OECD endorsed a three-tiered approach to documentation, consisting of:

• a master file that provides high-level detail of the multinational at the group level;

• a local file consisting of transactional transfer pricing documentation relating to each jurisdiction; and

• CbC reporting for each jurisdiction in which the group operates.

The required information typically includes the following details:

• related-party revenue;

• unrelated-party revenue;

• total revenue;

• profits or losses (before income tax);

• income tax paid;

• income tax accrued;

• stated capital;

• accumulated earnings;

• number of employees; and

• value of tangible assets (excluding cash and cash equivalents).

These are not trade secrets. They mirror some information that is contained in a tax return but are not tax returns themselves. They’re more analogous to a financial statement.

The documentation was initially meant to serve a narrow purpose: provide tools to tax administrators faced with complex enforcement challenges, especially transfer pricing risk assessment. The idea was that taxpayers under audit could no longer offer alternate narratives to tax inspectors in different countries. If they did, any inconsistencies should pop out through an inspection of the reports, which are typically filed with the revenue body of the jurisdiction in which the group parent is based. An exception allows for a surrogate parent to be appointed elsewhere under some circumstances.

Many corporations will never deal with CbC reporting. Arguably, too many taxpayers are let off the hook. The BEPS action 13 final report recommends that filing obligations apply to groups with annual consolidated revenue of at least €750 million for the prior year. For a U.S.-headquartered group, the threshold is $850 million in annual consolidated revenue.

For the system to function as intended, each country in which a multinational has operations would need to be looking at the same document, prepared according to uniform standards. The efficacy of the regime relies on preexisting mechanisms for information sharing, like treaties and tax information exchange agreements. Adherence to familiar treaty procedures gave taxpayers confidence that their information would be safely held by foreign governments.

Still, many taxpayers were skeptical about confidentiality over the long haul. A U.K.-based corporate tax director once told me that while he expects confidentiality, his company prepares its reports as if they’re going to appear on the front page of The Guardian the next morning. If the risk of negative publicity inspires a company to exercise more prudence, why isn’t that a good thing? More than one U.S. corporate tax director has joked with me that it’s only a matter of time until Tax Notes offers our readers a vast online compilation of CbC reports from around the world. We can only hope.

Why do so many academics, journalists, and nongovernment organizations favor public disclosure? The short answer is that numbers tell a story that’s otherwise hard to quantify. For instance, in 2017 the IRS revealed that U.S.-headquartered corporate groups reported $32 billion in profits on the tiny island of Bermuda while collectively reporting only 547 employees there. Bermuda, of course, has no corporate income tax.

Details like that could help developing economies that struggle to tax economic activity occurring within their own borders. For years academic researchers have argued that arm’s-length transfer pricing is badly broken, while some critics say we don’t know enough about internal corporate tax planning to reach definitive conclusions. Public disclosure could enlighten that debate by providing much-needed data, beyond what’s available in SEC filings.

Consultation and Comments

Acknowledging that action 13 broke new ground, the OECD envisioned a process of critical reassessment after five years. That five years is up in 2020. On February 6 the OECD announced a March 17 public consultation on CbC reporting scheduled for the OECD headquarters in Paris, with written comments due by March 6. The five-year review is being coordinated by the OECD Committee on Fiscal Affairs Working Party 6 (Taxation of Multinational Enterprises) and Working Party 10 (Transparency and Exchange of Information). The consultation document posed four main questions about the regime’s future:

• whether modifications to the contents of CbC reports should be made, requiring the reporting of additional or different data;

• the appropriateness of the €750 million revenue threshold;

• the effectiveness of the filing and disseminating mechanisms; and

• implementation of the BEPS action 13 package.

The March 17 consultation was cancelled because of the COVID-19 pandemic,³ although about 80 comment letters were received by the working parties. Respondents include corporate taxpayers, consultancies, and civic society groups, among others. The corporate respondents include Alimentation Couche-Tard, Anglo American PLC, AstraZeneca, China National Petroleum Corporation, Ferrovial, InterContinental Hotels, Stena AB, and the Orsted Group. Many professional service firms also submitted comments, including BDO, Deloitte Tax LLP, EY, KPMG LLP, Moss Adams LLP, and PwC. Several international law firms had their say as well, including Cuatrecasas, Flick Gocke Schaumberg, Loyens & Loeff, and Mazars. Many responses came from industry associations, including Accountancy Europe, the Association française des entreprises privées, the Confederation of British Industry, the French Banking Federation, the Federation of German Industries, the National Foreign Trade Council, the Swiss Business Federation, the Tax Executives Institute, the U.S. Chamber of Commerce, and the United States Council for International Business.

Many of these respondents voiced similar themes,⁴ noting that CbC reporting is a compliance burden and suggesting streamlining several of the required data fields. Several groups said it is premature to make big changes to the documentation regime. The comment submitted by the National Foreign Trade Council nicely summarizes this objection, noting concurrent work on the BEPS 2.0 project:

The suggestion is that any changes to the contents of these reports should await the profession obtaining a better handle on the fate of the pillar 1 (nexus and profit attribution) and pillar 2 (global minimum tax) projects. The point is well taken, but it could prove to be a long wait. There’s a general skepticism about whether the two pillars will ever come to fruition. Treasury Secretary Steven Mnuchin prefers that the reforms be styled as a safe harbor, and the world has punted on figuring out what the heck that means.

There are also calls to delay the entire project until the COVID-19 pandemic runs its course.⁶ But once delayed, would the ambitious project ever return with the same momentum? In the meantime, governments have complex transfer pricing audits with which to deal. The need for better risk assessment doesn’t grind to a halt because BEPS 2.0 is happening.

The OECD received multiple comments from investors. This group includes Norges Bank with $1 trillion under its management, HESTA Super Fund with $37 billion under management, and a coalition of U.S.-based institutional investors with $847 billion under management. The U.N.-supported Principles for Responsible Investment body also submitted comments. It is an umbrella group for so-called responsible investors, claiming more than 2,600 signatories. The self-interest of these investors seems to overlap with positions advanced by NGOs such as ActionAid, Oxfam, and the Tax Justice Network. They all favor public disclosure.

A particularly interesting comment was submitted by the BEPS Monitoring Group, written by Sol Picciotto and Jeffery Kadet.⁷ The letter praises the fact that upwards of 90 jurisdictions around the world have successfully implemented the legal and regulatory structure for CbC reporting. However, the regime still needs major enhancements. For example, among the many African nations, only Mauritius, Seychelles, and South Africa are receiving CbC reports. Coverage is also spotty in Asia, Latin America, and the Caribbean. The United States shares CbC reports with 41 other nations — a fraction of the U.S. treaty and TIEA network. The same is true for the People’s Republic of China, which shares reports with only 42 nations. Both the United States and China have withheld information exchange in some circumstances because of national security concerns.

A comment letter was submitted by a group of U.S. lawmakers. The letter-writing effort was led by Sen. Chris Van Hollen, D-Md., and Reps. Cynthia Axne, D-Iowa, and Lloyd Doggett, D-Texas.⁸ The letter focused on three proposed reforms to the CbC reporting regime. First, the 33 lawmakers call for all CbC reports to be made public. In their words:

Second, the lawmakers urged the OECD to lower the annual revenue threshold from €750 million ($850 million for U.S.-headquartered groups). This goes to the point that the reach of CbC reporting, whether disclosed or not, is unnecessarily narrow. The OECD has previously indicated that between 85 and 90 percent of multinationals are exempt under this threshold. The U.S. lawmakers agree that the threshold improperly exempts many multinationals that might be engaged in large-scale profit shifting. In their words, “a more complete picture of multinational corporate finances would improve tax administration and enforcement, especially in regard to developing countries with fewer very large corporations.”

How low will House Democrats go? We don’t know, but there’s no shortage of ideas being tossed around. The Canadian Labour Congress suggests a threshold of only €50 million in annual revenue, noting that the amount corresponds to a prior EU definition of what constitutes a large business enterprise.⁹ The BEPS Monitoring Group adds that basing the threshold on revenue figures typical of developed economies can lead to overly restrictive results in other parts of the world. In Nigeria, Tanzania, and Uganda, for example, annual revenue of $4 million is commonly used to designate a large corporate taxpayer. ActionAid proposes a revised threshold that would hinge on a multinational satisfying two of three factors:

• balance sheet assets of €20 million;

• turnover of €40 million; or

• at least 250 employees.¹⁰

The multifactored threshold is based on unrelated EU criteria for identify a large undertaking.

Third, the lawmakers encouraged the OECD to revise its platform with standards approved by the Global Reporting Initiative (GRI). This is a nuanced aspect of CbC reporting, but important to its effectiveness and accuracy. The OECD model now in place permits transactional aggregation, whereas the GRI standard is based on transactional consolidation. The latter sees through intragroup dealing and is a superior gauge of genuine economic activity. The former can be manipulated to overstate the volume of commercial activity taking place in a particular jurisdiction and can mask the true extent of a company’s profit shifting.

If the OECD fails to transition to the GRI standard, countries could take unilateral steps. A viable model for U.S. reform would see Congress enact a law — perhaps in the context of pandemic relief — giving the SEC authorization to apply GRI standards for all U.S. CbC reporting. That could be in addition to lowering the revenue threshold and requiring public disclosure for any companies that receive federal bailout funds. As mentioned, expect there to be strings attached when you nationalize private losses.

Time to Act

The disclosure of CbC reports has the potential to enlighten us about whether the geographic footprint of a company’s tax payments corresponds to the locations in which we’d expect it to have profits, as indicated by objective markers like sales, assets (tangible or otherwise), and staff. If you’ve been reading this publication for any length of time, you wouldn’t expect the ultimate resting place of profits to perfectly correlate with markers of corporate presence. But to the extent that the indicia of commercial activity are shown to no longer have bearing on where profits are stashed, we can learn something about the shortcomings of our corporate tax system and better take steps to fix the misalignment. This assumes our society is serious about taxing capital income at the entity level.

Many countries are already on board with public CbC reporting. The EU has several experiments with public CbC reporting in limited forms. The EU Capital Requirements Directive IV (CRD IV) has applied to banks and financial institutions within the European Economic Area since 2013, requiring an alternate form of public CbC reporting. Contrary to what opponents feared about decreased competitiveness and lost economic output, an analysis of CRD IV conduct by PwC found just the opposite:

The conclusion of the PwC analysis was confirmed by a European Commission economic impact assessment.¹² As stated at the outset, there’s no hard evidence that disclosure of CbC information hurts a company’s bottom line, other than the compliance costs.

In the United Kingdom, Parliament in September 2016 approved an amendment to the annual Finance Bill that empowered HM Revenue & Customs to force British taxpayers to disclosure their CbC reports on request. The power hasn’t been used yet, in hopes that routine public disclosure can be achieved at the OECD level. In the United States, the Financial Accounting Standards Board (the folks responsible for determining U.S. generally accepted accounting principles) has suggested that the primary obstacle with disclosure is rooted at the OECD level.

We’re looking at you, Working Party 6 and Working Party 10. The five-year BEPS review and public consultation is the perfect opportunity to move the ball forward. If you lead on transparency, a reluctant Congress might even follow.