PwC Reviews CbC Reporting Obligations of U.S. Exempt Entities

The IRS on June 29 issued final regulations (TD 9773) requiring annual country-by-country (CbC) reporting for US-parented multinational enterprise (MNE) groups. Similar regulations have been adopted or proposed in other countries, and more tax jurisdictions are expected to do so in the upcoming months. The CbC reporting rules in the United States and worldwide generally are aligned with the recommendations in the OECD's 2015 Final Report for Action 13 (Transfer Pricing Documentation and Country-by-Country Reporting), issued in October 2015.

The stated purpose of CbC reporting is to help the IRS and foreign tax authorities perform high-level transfer pricing risk identification and assessment. While it may seem unusual that tax-exempt entities would represent significant transfer pricing risk given their tax-exempt status, there are no explicit exclusions for any specific industry sectors or groups in the final US CbC reporting rules. Therefore, US-parented tax-exempt organizations that are considered MNEs potentially are subject to CbC reporting in the United States.

The final US CbC reporting regulations include an exemption from revenues that may put some tax-exempt organizations below the $850 million annual revenue threshold for filing a CbC report with the IRS. However, other countries may not provide a similar exemption and therefore may require direct local filing of CbC reports under a so-called 'secondary mechanism' for filing.

Thus, while as a result of the US exemption, some US-parented tax-exempt entities may not be required and may not be able to file a CbC report with the IRS, they still may have foreign filing obligations, without the confidentiality protections from filing with the IRS. In addition, the $850 million revenue filing threshold in the United States (including the exemptions available for tax-exempt organizations) should be closely reviewed, as indirect investments and how investment operations are held could impact how the threshold is calculated.

The CbC reporting regulations have imposed significant new compliance burdens, and US companies that have not already started to prepare should do so immediately. Tax-exempt organizations should consider the full implications of this new transparency requirement, given that even in the most typical structures that are not motivated by tax planning, CbC reports may show significant amounts of so-called 'stateless income.'

In detail

In recent years, the global economic climate has put many governments under pressure to generate higher tax revenues to fund increased spending programs and to reduce budget deficits. This pressure has included an increasing focus from investors, civil society organizations, the media, and others for companies and individuals to be seen as making their contribution to the public purse. For some, increased transparency around tax is viewed as an essential part of addressing these issues.

Action 13 of the Organisation for Economic Co-operation and Development (OECD) Action Plan on Base Erosion and Profit Shifting (BEPS) strives to provide tax administrations with information to conduct transfer pricing risk assessments and examinations through increased transfer pricing documentation requirements. The OECD released its substantive recommendations under Action 13, establishing two new transfer pricing reporting requirements for MNEs -- the new CbC report and the master file report -- and recommending various changes to the so-called local file reporting requirements.

The CbC report requires aggregated financial and tax data on a country-by-country basis, with the stated goal to facilitate transfer pricing risk assessment. The master file aims to provide a complete picture of the MNE's global operations, including an analysis of profit drivers, supply chains, intangibles, and financing. Finally, the local file will provide detailed information relating to specific intercompany transactions.

The final IRS regulations require annual CbC reporting for US-parented MNE groups. (See PwC's Tax Insight of July 6, 2016.) The final regulations adopt -- with only a few significant changes -- proposed regulations issued December 23, 2015 (REG-109822-15), taking into account certain written comments the IRS received, as well as comments made during a public hearing on May 13, 2016. The IRS has not implemented master file reporting, although US-parented MNEs will have to prepare a master file for any country in which they are doing business that implements master file reporting.

Who -- Persons required to file CbC reports under final IRS regulations

A US business entity that is the ultimate parent entity of a US MNE group and all the business entities required to consolidate their accounts with the ultimate parent entity's accounts must file the US CbC report (new Form 8975) where annual consolidated group revenues equal or exceed $850 million. Specifically, an ultimate parent entity of a US MNE group is a US business entity that owns, directly or directly, a sufficient interest in one or more other business entities (constituent entities) at least one of which is organized or tax resident outside the United States, such that the US business entity (1) must consolidate the accounts of the other business entities with its own accounts for financial reporting purposes under US generally accepted accounting principles (GAAP), or (2) would be required to consolidate accounts if equity interests in the US business entity were publicly traded on a US securities exchange.

A constituent entity included in Form 8975 is any separate business entity of a US MNE group. The term includes permanent establishments defined under the applicable treaty, but does not include a foreign corporation or foreign partnership for which the ultimate parent entity is not required to furnish information under Section 6038(a) or any permanent establishment of such foreign corporation or foreign partnership.

What -- Information included in CbC report (IRS Form 8975)

The financial information to be provided in the US CbC report, on a country-by-country basis, includes:

• Revenues generated from other constituent entities (related-party revenues)

• Revenues not generated from other constituent entities (third-party revenues)

• Profit (or loss) before income tax

• Income tax paid on a cash basis to all tax jurisdictions

• Accrued tax expense recorded on taxable profits (or losses), for the relevant accounting period (excluding deferred taxes or provisions for UTP)

• Stated capital

• Accumulated earnings

• Employees -- to be reported on a fulltime equivalent basis for the constituent entity in its tax jurisdiction; independent contractors may be included

• Net book value of tangible assets other than cash or cash equivalents.

• The complete legal name of the constituent entity

• Any tax jurisdiction in which the constituent entity is resident for tax purposes

• The tax jurisdiction in which the constituent entity is organized or incorporated (if different from the tax jurisdiction of residence)

• Any tax identification number used for the constituent entity by the tax administration of the constituent entity's tax jurisdiction of residence, and

• The main business activity or activities of the constituent entity.

When -- Filing date for CbC report (IRS Form 8975)

The US CbC Report on Form 8975 must be filed for a tax year with the ultimate parent entity's income tax return for the tax year on or before the due date, including extensions, for filing that person's income tax return. This is an earlier filing deadline than that proposed by the OECD, which was one year from the last day of the fiscal year of the ultimate parent of the MNE.

As for the effective date of the new CbC reporting requirements, the final regulations apply to reporting periods beginning on or after the first day of a tax year that begins on or after June 30, 2016.

That effective date creates a so-called 'gap year,' during which US-parented MNEs could be required to file the CbC report directly in foreign jurisdictions. That result could occur because other countries have adopted CbC reporting rules for annual accounting periods beginning on or after January 1, 2016, requiring reporting of CbC information by constituent entities of MNE groups with an ultimate parent entity resident in a tax jurisdiction that does not have a CbC reporting requirement for the same annual accounting period.

The final regulations address the gap year problem by allowing US ultimate parent entities to file, on a voluntary basis, Form 8975 for reporting periods that begin on or after January 1, 2016 and before June 30, 2016, in accordance with a procedure to be provided in separate, forthcoming guidance. On the same day that the final regulations were released, the OECD issued 'Guidance on the Implementation of Country-by-Country Reporting,' recommending that other countries accept reports filed voluntarily in the United States and in other countries for years beginning on or after January 1, 2016.

Observation: The IRS is working with other countries seeking to reach agreement that constituent entities of US MNEs will not have to file a CbC report in such foreign jurisdictions if the parent files a Form 8975 with the IRS in accordance with the forthcoming procedure and the CbC report is exchanged with the foreign jurisdiction subject to a Competent Authority agreement.

Where -- Filing place

Under the OECD Model CbC Legislation provided in the Action 13 Report, the primary filing mechanism is that the ultimate parent entity will file the CbC Report in its jurisdiction of residence. Thus, in the first instance, US MNEs will file Form 8975 with the IRS with their tax returns. Other countries in which such US MNEs are doing business will receive the CbC reports from the IRS through exchange of information provisions in tax treaties or tax information exchange agreements (TIEAs), assuming there also is a bilateral competent authority agreement to effectuate the exchange.

Observation: The IRS intends to incorporate limitations on use of the CbC information into the competent authority agreements for exchange of information. US CbC Reports are considered 'return information' under Section 6103, and are subject to strict confidentiality rules -- meaning that tax authorities with which the IRS exchanges CbC reports must take all reasonable steps to ensure that there is no public disclosure of confidential information in CbC reports and that they be used only for tax risk assessment purposes.

Secondary mechanism

Thus, filing (only) with the IRS under the primary mechanism is important for US MNEs, so that they only have to file an annual CbC report once (with the IRS), which would be protected by the confidentiality provisions of US tax treaties and TIEAs, consistent with Section 6103. However, the primary mechanism is backstopped by a secondary mechanism in the OECD Model CbC Legislation, whereby any constituent entity of an MNE group must file the CbC report (covering the operations of the entire MNE group) directly with the tax authority in its local jurisdiction.

Direct local filing of CbC reports would apply under this secondary mechanism when either: (1) the ultimate parent entity is not required¹ to file in its jurisdiction of residence a CbC report that is consistent with the requirements of the Action 13 report, or (2) the jurisdiction of residence of the ultimate parent entity cannot exchange CbC reports with another jurisdiction (either because there is not a tax treaty or TIEA in place, or there is not a bilateral competent authority agreement to effectuate the actual exchange of the CbC reports). Consequently, US MNEs will be required to file CbC reports directly in foreign jurisdictions in which they are operating if either: (1) the reporting on Form 8975 somehow materially deviates from the requirements of the Action 13 report or (2) they are doing business in a country with which the United States does not have currently in force either a tax treaty or TIEA, along with a bilateral competent authority agreement.

Special considerations for tax-exempt organizations

Background

As noted, the stated purpose of CbC reporting is to assist in transfer pricing risk assessment (though no guidance is provided, either in the final regulations or the OECD's Action 13 Report, as to how the data provided in the CbC report is to be used in assessing transfer pricing risk). Consequently, it may seem unusual that tax-exempt organizations could be subject to CbC reporting, since organizations generally exempt from tax would seem to have little transfer pricing risk.

However, there is no general carveout, either in the final regulations or in the Action 13 report, for tax-exempt (or any other) organizations. The only exception to CbC reporting is for MNEs below the annual group revenue threshold. In fact, the Action 13 report (which many countries are using as the model for their domestic CbC reporting requirements) explicitly states that no general carveouts to CbC reporting should be recognized.²

New exclusion

However, the IRS final regulations include a provision which appears to be an effort to exempt certain tax-exempt organizations with annual revenues -- unrelated business taxable income (UBTI) -- below the $850 million general filing threshold from CbC reporting. Treas. Reg. sec. 1.6038-4(d)(3)(ii) provides that the term revenue includes only revenue that is included in UBTI as defined in Section 512 for a constituent entity that is an organization exempt from taxation under Section 501(a) because it is an organization described in Section 501(c), 501(d), or 401(a), a state college or university described in Section 511(a)(2)(B), a plan described in Section 403(b) or 457(b), an individual retirement plan or annuity as defined in Section 7701(a)(37), a qualified tuition program described in Section 529, a qualified ABLE program described in section 529A, or a Coverdell education savings account described in Section 530. That provision was not in the proposed regulations.

From the perspective of CbC reporting with the IRS, that provision excludes from revenues everything except UBTI only with regard to a 'constituent entity' that is tax exempt under Section 501(a) -- not with regard to the whole MNE group. So, for example, if an ultimate parent entity that is a tax-exempt organization described in Section 501(a) has other constituent entities that are not qualifying tax-exempt entities, they would not seem to be covered by this exemption, and all their revenues (even that included in non-UBTI) would be included for purposes of assessing the $850 million revenue threshold. Assuming those constituent entities that are not exempt under Section 501(a) have revenues over the $850 million threshold, the US MNE group that includes such a tax-exempt organization would be subject to filing the CBCR with the IRS.

However, a more significant potential issue with this attempted exemption from CbC reporting by the IRS is whether other countries would agree to or recognize such an exemption. As noted above, many countries already have implemented CbC reporting, generally based on the framework set forth in the Action 13 Report. That report does not include such an exemption and, as noted earlier, states that no general exemptions from CbC reporting should be recognized, other than the annual revenue threshold. We are aware of no country implementing CbC reporting with a similar exemption for tax-exempt organizations.

Observations

The interaction of the exemption for certain tax-exempt organizations in the final regulations with the operation in other countries of the secondary mechanism under the Action 13 Report could produce troublesome results.

As discussed above, direct local filing under the secondary mechanism can be required when an ultimate parent entity is not required to file in its jurisdiction of residence a CbC report that is consistent with the requirements of the Action 13 report. If other countries view the rules in the final regulations as materially deviating from the requirements of the Action 13 Report they could require direct filing with the local tax authority under the secondary mechanism.

Consequently, while at first glance the final regulations might appear to provide a generous exemption from CbC reporting for certain US tax-exempt organizations, the regulations in reality may result in onerous foreign CbC reporting requirements. Importantly, such direct local filings would not include any of the confidentiality protections provided by US treaties or TIEAs, and would require compliance with the substantive local rules implementing CbC reporting.

One potential avenue for US tax-exempt organizations to avoid such local filings under the secondary mechanism could exist if the IRS were to allow voluntary filings of CbC reports without taking advantage of the exclusion from revenue described above. However, that raises the issue, also discussed above, of whether other countries would accept a voluntarily filed CbC report and not require local filing under the secondary mechanism. It also is not clear that such voluntary filings would comply with the requirements of the final regulations as they currently stand, or if they will be amended to allow such voluntary filings.

Needed actions

Additionally, tax-exempt organizations with investment platforms should evaluate carefully the accounting treatment of such investments (e.g., fair value, equity method, and consolidation accounting) to identify the constituent entities potentially subject to CbC reporting. Tax-exempt organizations should carefully approach the calculation of the revenue threshold, since investment platforms and how investment operations are treated for financial accounting purposes could impact how the $850 million UBTI threshold is calculated. Also, with regard to consolidated groups within the investment structure, the revenue threshold should be separately analyzed to assess potential other non-US CbC reporting obligations.

Practical considerations for all taxpayers

All US MNEs (not just tax-exempt organizations) subject to CbC reporting should carefully review both the Final Action 13 Report and both the final regulations from the IRS. In putting together their own internal 'action plan' for compliance with CbC reporting, most US taxpayers, not surprisingly, are focusing primarily on compliance with the final regulations. The most urgent event forcing action appears to be the deadline for the first filings of CbC reports -- which for calendar-year US taxpayers electing voluntary reporting would be September 15, 2017.

In addition, most countries have adopted the OECD Model CbC legislation included in the Final Action 13 Report provides that all constituent entities must notify the local tax administration whether they are the ultimate parent entity or surrogate parent entity, and if not, which entity is the 'reporting entity' by the end of the reporting fiscal year of the ultimate parent entity of the MNE group -- which could be as early as December 31, 2016. The purpose of that requirement presumably is that the local tax authority wants to know how and when it eventually will be receiving the CbC report -- through direct filing from a local constituent entity at the time of filing of its tax return, or at a later point in time through exchange of information with the tax authority in the jurisdiction of the ultimate parent entity or a surrogate entity.

Regardless, as a practical matter it can be easy to overlook this local country notification requirement and not realize the urgency of the impending potential deadline to file. Adding to the burden, based on an initial PwC survey of local country implementation of CbC reporting, it appears that there are inconsistent and unclear explanations of how the local country notifications are to be made (e.g., there is no standard form or language to do so, and not much guidance provided on the location where notifications are to be filed). The fact that jurisdictions around the world are still proposing or modifying rules for local implementation of CbC reporting calls for continuous monitoring of such implementation.

Observation: Complying with the new CbC reporting requirements may prove quite onerous in terms of simply being able to gather the data to populate the CbC template. Our experience to date has shown varying levels of readiness among taxpayers, depending on the capabilities of existing IT and ERP systems.

In addition to complying with CbC reporting requirements by the impending deadlines, taxpayers should consider how the information on the CbC report may be used in practice by tax authorities to assist in transfer pricing risk assessment. Given the overall focus of the OECD's BEPS project on so-called 'stateless income' and 'profit shifting,' significant amounts of income in low-or no-tax jurisdictions may attract attention, especially if unaccompanied by significant 'substance' in terms of number of employees or value of tangible assets, for example.

The final regulations provide that tax jurisdiction information with respect to constituent entities that do not have a tax jurisdiction of residence, or 'stateless entities,' would be aggregated and reported in a separate row of the CbC report. A business entity that is treated as a partnership in the tax jurisdiction in which it is organized and that does not own or create a permanent establishment in that or another tax jurisdiction generally will have no tax jurisdiction of residence. Consequently, the tax jurisdiction information for these entities is to be reported in the 'stateless' row of the CbC report. The regulations further provide, however, that each owner of a stateless entity (such as a partner) also must report its share of revenue and profit in the information for the tax jurisdiction of its residence. The rule applies irrespective of whether the stateless entity-owner is liable to tax on its share of income in its tax jurisdiction of residence. This 'double counting' of some items, including them both in the stateless line of the CbC report and in the jurisdictions of the partners, is intentional. Consequently, any MNE group utilizing entities treated as partnerships or otherwise transparent in the jurisdiction in which organized may show significant amounts of so-called 'stateless' income -- even though such income is not truly 'stateless,' in the sense that it may be fully taxed in the hands of the partners.

Additionally, tax authorities may resort to a straightforward ratio analysis to utilize the data from the CbC template, simply comparing fractions like revenue per employee or pre-tax profits per employee, and focusing on the outlying jurisdictions. Taxpayers should do a 'dry run' of collecting the data to populate the CbC report and conduct a similar ratio analysis before filing, in order to determine if any steps should be taken to mitigate perceived transfer pricing risk.

Observation: There are concerns that the new environment of increased transparency may mean that the CbC reports to be filed by taxpayers ultimately may be available not just to tax authorities, but to the public as well. Although the initial concerns have been with respect to potential unauthorized 'leaks' of CbC reports filed and shared among tax authorities, those concerns may be mooted by the potential for mandatory public disclosure of CbC reports. The European Commission has developed a proposal for mandating public disclosure of the CbC report and other financial data, which (if adopted) could apply to US MNEs doing business within the EU. Similar bills have been introduced in the US Congress.³ Tax executives may wish to communicate these sorts of proposals throughout the rest of their organization, including the C-suite, as well as to develop a plan to address the reputational risks which may arise from such public disclosures.

The takeaway

The US CbC report (Form 8975) represents the next step toward global tax transparency, as the United States prepares to simultaneously exchange CbC reports with treaty and TIEA partners with which it enters into Competent Authority agreements.

Although the final US CbC reporting rules only require filing for a tax-exempt organization if its constituent entities report more than $850 million in UBTI, this does not mitigate an organization's responsibility to file in foreign geographies, as most foreign jurisdictions do not have a similar attempted carve-out for tax-exempt entities. In addition, the calculation of the filing threshold in the US needs to be closely reviewed as indirect investments and how they are held may impact how the threshold is computed.

The impact of the new CbC report is significant in terms of the amount and type of information to be collected and included in transfer pricing documentation. Penalties may be assessed by local tax authorities to the extent a taxpayer does not prepare proper documentation.

Accordingly, taxpayers should start assessing their ability to comply with these new requirements, the potential of the new documentation requirements to trigger increased transfer pricing disputes, and the potential for public disclosure of sensitive commercial information. US tax-exempt organizations may need to file a CbC report by the due date of their 2016 tax returns.

In addition, requirements already exist in foreign jurisdictions that all constituent entities notify the local tax administration whether they are the ultimate parent entity or surrogate parent entity, and if not, which entity is the 'reporting entity' by the end of the reporting fiscal year of the ultimate parent entity of the MNE group -- which could be as early as December 31, 2016. This looming deadline highlights that for US tax-exempt organizations preparing to comply with the new CbC reporting requirements, the time for action is now.

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² "It is considered that no exemptions from filing the Country-by-Country Report should be adopted apart from the exemptions outlined in this section. In particular, no special industry exemptions should be provided, no general exemption for investment funds should be provided, and no exemption for non-corporate entities or non-public corporate entities should be provided."

³ For example, on September 22, 2016 Rep. Mark Pocan (D-WI) introduced the Corporate Transparency and Accountability Act, with the stated goal "to shed light on tax avoidance and profit shifting activities." The proposed legislation would require the disclosure of CbC and bottom-line information about companies' taxes to "increase transparency for investors and the general public."