In April, the IRS released a practice unit on country-by-country (or "CbC") reporting. The purpose of the document is twofold: (i) describe the background of CbC reporting and (ii) provide guidance to IRS personnel on the use of CbC reports "in the IRS high-level transfer pricing risk assessment process." Although the practice unit repeatedly stresses that the IRS will not audit CbC reports, there is potentially less to this claim than meets the eye.
Background on CbC Reports. Country-by-country reporting is a concept that arose from the OECD's BEPS project and was incorporated into US law. BEPS Action 13 introduced three tiers of transfer-pricing documentation: a master file, a local file, and a CbC report. The US declined to require the first two types of documentation on the theory that similar information is already required under IRC section 6662. (That said, the practice unit does say that the IRS may obtain master files and local files from foreign taxing authorities.) But CbC reports were incorporated into US law in 2016 (see Treas. Reg. § 1.6038-4).
Under current law, US taxpayers that are the ultimate parents of multinational groups with annual revenues of $850 million or more must file a Form 8975 and accompanying Schedules A. These documents—which are, collectively, the CbC report—require aggregate tax information relating to the global allocation of income, taxes paid, and the location of economic activity.
Although the practice unit focuses on CbC reports required by US law (i.e., for US parents), the IRS also receives the CbC reports of certain large foreign parented multinationals with US subsidiaries through the "exchange of information" process in tax treaties. How the IRS reviews and uses these reports is beyond the scope of this practice unit.
The CbC Risk Assessment. According to the practice unit, the CbC report "is a tool [for the IRS] to identify potential transfer pricing risk." Before an audit, the IRS may use the report to determine whether a tax return has indicators of transfer pricing risk such that an audit is warranted. Once an audit begins, the IRS may also use the report "to evaluate the transfer pricing risk of related party transactions in general or to further evaluate a significant related party transaction already identified."
The practice unit says that IRS personnel might be able to evaluate the following risk factors from the CbC report:
- There is a high value of related party revenues in a particular jurisdiction,
- There is significant revenue but little substantial activities in a particular jurisdiction,
- Intellectual property is separated from related activities within a group, and
- A group has activities in a jurisdiction that poses a BEPS risk.
The practice unit contains some specific information about these risk factors that will help taxpayers perform a self-assessment of their audit risk (a concept we discussed in a prior post).
An Audit of the CbC Report? The practice unit emphasizes that "examiners should not audit" the CbC report. It also explains that examiners should not ask the taxpayer to reconcile the amounts in the CbC report to the tax return.
Despite that comforting language, there are reasons for skepticism. To begin, the practice unit observes that the taxpayer is required to maintain records to support the information in the CbC report, and the practice unit tells examiners that they can (and presumably should) request that information. What is more, the practice unit reminds examiners to consider whether penalties apply for filing a materially inaccurate CbC report. It is unclear how the examiner could determine whether such a penalty applies without an audit of the report.
Given the ambiguity, taxpayers would be well-advised to consider getting out ahead of the issue. It is worth considering whether to include a slide in the transfer pricing overview presentation at the beginning of the audit on how the CbC report is compiled. That approach could head off any misguided attempt by the IRS to audit the taxpayer's CbC reporting.
Visit us at mayerbrown.com
Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe - Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.
© Copyright 2020. The Mayer Brown Practices. All rights reserved.
This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.