U.S.-based multinational companies are continuing to expand
their global footprint, which increases tax risks for financial
reporting purposes. These risks have never been greater or more
frequent. Therefore, U.S. regulators such as the Public Company
Accounting Oversight Board (PCAOB), FASB and the SEC have
increasingly focused on the foreign earnings of U.S.-based
companies in an effort to increase transparency and accuracy in
financial statement reporting. Additionally, the Organization for
Economic Co-operation and Development (OECD) recently released its
Action Plan on Base Erosion and Profit Shifting (BEPS), a project
designed to ensure that multinational companies pay their fair
share of taxes. As a result of these and other related
developments, U.S.-based multinational companies should carefully
manage the tax risks arising from doing business abroad.
Since these tax risks are largely a function of the amount of
foreign earnings generated by U.S.-based multinationals, our
discussion will start there. A July 2015 report issued by the U.S.
Senate Committee on Finance International Tax Reform Working Group
observed that 54% of the income of U.S. multinational companies in
2012 was earned outside the U.S. In its April 30, 2015, report, the
Congressional Research Service (CRS) stated that U.S. companies
generated $1.2 trillion in overseas profits in 2012, with $600
billion attributed to seven tax havens. Additionally, the CRS
reported that the amount of the overseas profits was significantly
higher than the amount of hiring and investment made by U.S.
companies in these foreign countries, an indicator of possible
profit shifting to lower-tax jurisdictions. Therefore, regulators
are understandably more focused on the financial statement
implications of the taxation of foreign earnings.
Regulators are also continuing their focus on the financial
statement assertion by many U.S. multinationals that some or all of
their foreign earnings are "indefinitely reinvested"
outside the U.S., and therefore they aren't required to provide
for deferred taxes on the undistributed foreign earnings. These
indefinitely reinvested earnings outside the U.S. are substantial.
A March 2015 Bloomberg News analysis of the securities filings by
U.S. multinational companies revealed that approximately $2.1
trillion of their profits are held offshore under the
"indefinitely reinvested exception." Therefore,
regulators are looking closely at management's assertions
regarding undistributed foreign earnings. U.S. lawmakers are also
concerned that indefinitely reinvested foreign earnings have
contributed to recent inversion transactions.
BEPS project intensifies tax risks
Risks associated with doing business abroad are not new. BEPS
generally refers to tax planning strategies that exploit gaps and
mismatches in tax rules to shift profits to low-tax jurisdictions.
Although these practices are often lawful under current tax laws,
the OECD has addressed their fairness. In 2013, the OECD began a
comprehensive and globally coordinated action plan to address BEPS
issues, noting that this was vital to ensure that profits are taxed
where economic activities occur and where value is created. This
BEPS Action Plan was released in October 2015 and includes 15
specific action items intended to equip lawmakers with the tools
and resources to more effectively tax profits, whether generated by
U.S multinationals or others.
Although the OECD is not a law-making authority, its
recommendations are expected to result in changes in local country
tax laws, tax treaties and OECD transfer pricing guidelines. These
changes could put existing tax planning, structuring and transfer
pricing outcomes at risk. Therefore, companies with a global
footprint must remain vigilant about the financial statement
implications resulting from these changes. These include the
following:
- The financial statement impact of tax law changes, as of the date of enactment, must be reported as a discrete event for purposes of U.S. GAAP.
- New information related to the recognition and/or measurement of unrecognized tax benefits may arise from tax law changes, increased transparency measures and more-aggressive tax examinations.
- Material risks may emerge from proposed changes to legislation, regulations, treaties, etc., which require an early warning in the management discussion and analysis (MD&A) section of SEC filings.
- The effective tax rate may increase to the extent that existing tax planning, structuring and transfer pricing outcomes need to change to align with the location of economic activities and value creation.
To enhance transparency for tax administrators, the OECD included country-by-country (CbC) reporting requirements in its BEPS Action Plan. As recommended, multinational enterprises with global revenues equal to or greater than 750 million euros will be required to compile and report the following information annually to relevant tax jurisdictions:
- The global allocation of revenue, profits, and taxes paid and accrued.
- Information about the geographical location of economic activity, such as employment, capital, accumulated earnings and tangible assets.
- Information about each entity within the multinational group, including the name, country of incorporation, tax residence and nature of business activities.
The goal of CbC reporting is to provide tax administrators with
information to assess transfer pricing and other BEPS-related
risks. Since the final BEPS reports were released in October, many
countries have enacted or proposed legislation and/or regulations
requiring CbC reporting effective for any tax year beginning on or
after Jan. 1, 2016. Beyond dealing with the significant compliance
burden of compiling and preparing such reports, companies should
anticipate more cross-border controversies with taxing authorities,
which may increase the risk of double taxation.
Given the comprehensive nature of the BEPS project, any foreign
earnings, including those that are indefinitely reinvested, are at
risk for increased scrutiny and taxation. If so, a company may
experience an increase in its effective tax rate.
Doing business in the EU increases risks
No doubt, the BEPS project is putting unprecedented public
attention on corporate tax affairs, with potential reputation and
financial statement risks. Other notable global developments are
not officially BEPS-related, yet essentially expose and potentially
eliminate base erosion and profit shifting by multinationals.
For example, the European Commission's decision is pending
related to whether Amazon.com's arrangement with Luxembourg and
Apple Inc.'s arrangement with Ireland constitute illegal state
aid under European Union (EU) law. Generally speaking, in
accordance with the EU's state aid requirements, EU member
states are not allowed to grant companies selective benefits that
are not available for other taxpayers and that distort, or threaten
to distort, competition within the EU. If the European Commission
rules against either of these arrangements, it can force the EU
member state to recoup back taxes for 10 years from each company,
reflecting the amount of the illegal state aid. In light of the
pending decision, Apple disclosed in its SEC filings that if the
European Commission concluded against Ireland, Apple's
liability "could be material."
The European Commission also announced in October its decisions
that the Netherlands and Luxembourg had granted rulings to
Starbucks and Fiat, respectively, which were illegal under EU state
aid rules. The European Commission ordered both countries to recoup
as much as 30 million euros from each company to remove the
competitive advantage each had unfairly enjoyed. Both the
Netherlands and Luxembourg have announced they will appeal the
commission's decision.
And in January 2016, the European Commission ruled that the Belgian
government would be required to recover up to 700 million euros in
unpaid taxes from about 35 multinationals that it says have
benefited from illegal tax breaks under the Belgian excess profit
tax regime. One of the affected companies, Zoetis Inc., provided
its preliminary view of the financial statement impact in a press
release stating that if the decision is upheld on appeal, its
effective tax rate will increase from 28% to 33% for 2016.
The European Commission also announced in December that it is
formally investigating whether two tax rulings granted by
Luxembourg to McDonald's constitute illegal state aid. These
European Commission investigations certainly increase the financial
statement uncertainties and risks for U.S multinational companies
that have rulings with EU member states or have benefited from
certain EU tax structures, such as the Belgian excess profit tax
regime.
Regulators' response to increased risks
With the financial statement considerations in mind, the PCAOB,
FASB and the SEC have increasingly focused on financial reporting
in this area. On May 7, 2015, the PCAOB, for example, issued the
Audit Committee Dialogue, which highlighted its concern
regarding the audit risks associated with undistributed foreign
earnings. In October, the PCAOB inspection staff stated they will
pay more attention to income tax accruals in light of the
increasing risks associated with U.S. issuers' growth in
profits in lower-tax jurisdictions, undistributed foreign earnings
and cash held overseas.
As part of its ongoing disclosure framework project, FASB
tentatively concluded in February 2015 that a reporting entity
should be required not only to disclose income before taxes between
domestic and foreign earnings (a current SEC requirement), but also
to further disaggregate foreign earnings, whether or not
indefinitely reinvested, by jurisdictions that are significant in
relation to the total income before taxes. It also tentatively
concluded that a reporting entity should disclose separately the
accumulated amount of indefinitely reinvested foreign earnings for
any foreign jurisdiction that represents at least 10% of the total
amount of accumulated indefinitely reinvested foreign earnings. It
is also not surprising that the SEC's Division of Corporation
Finance (CorpFin) indicated at the 2015 AICPA Conference on Current
SEC and PCAOB Developments, held in December, that it will continue
to concentrate on income tax disclosures related to foreign
earnings in its filing review.
Take action to manage risks
Given the financial statement implications pertaining to the taxation of the foreign earnings of U.S.-based multinational companies, Grant Thornton LLP recommends that companies do the following:
- Take a fresh look at their existing MD&A discussion and income tax footnote disclosures to determine whether they provide sufficient transparency to meet the information needs of investors and analysts, including how indefinitely reinvested foreign earnings affect reported earnings, foreign and domestic liquidity needs, and foreign asset composition (including cash). Even in advance of any FASB changes, companies may want to consider a separate disclosure by jurisdiction, if considered individually significant, of foreign earnings before income tax and the accumulated amount of indefinitely reinvested foreign earnings.
- Ensure that they have the appropriate internal controls and processes, both in design and operating effectiveness, to identify, evaluate, record, document and disclose the financial statement impact of the changing global tax environment.
- Evaluate enhancements in technology and systems, workflows, and data flow to improve the performance and productivity of the tax function.
- Develop a formal global tax risk management policy and a defined and recurring risk assessment process. The policy should be approved by the board and be consistent with the enterprise-wide strategy and culture. The policy, along with defined ownership, will make it easier to identify, evaluate and communicate whether any tax risks are acceptable from an enterprise perspective. The defined risk assessment process will be used, on a recurring basis, to identify, assess, plan, monitor, mitigate, control and communicate any tax risks.
- Regularly engage in tax risk discussions with the company's audit committee and develop a communication plan to be used if a company faces unanticipated reputational risks.
In summary, more than half of the earnings of U.S. multinationals are generated abroad, with many companies having a strategy to further increase their global footprint. As they execute on their strategy, U.S. multinationals need to be fully equipped and engaged to address the financial statement risks associated with the rapidly changing global tax landscape
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