In this article we discuss how to manage increased global tax transparency requirements with a focus on Country by Country reporting and analysis.
Recently adopted legislation that requires the filing of Country by Country (CbC) data to tax authorities makes your group’s tax figures available for analysis by multiple jurisdictions where the group operates.
This tax data must therefore be correct and analyzed in detail in order for you to have a full understanding of whether the reported figures could attract a tax authority’s interest. Furthermore, there are indications that the current OECD guidelines for CbC reporting are only the first step to increased global tax transparency. There are also a number of countries that have introduced local tax transparency reporting that goes further than the OECD minimum requirements, which must also be considered.
Although the filing of the CbC report is only required annually (in many cases within 12 months from the year-end closing) a proper process for CbC reporting should include at least one dry run of the figures during the current income year, before the final year-end reporting. If this is not carefully thought through, it could easily become a cumbersome process. And if the group also conducts business in countries that have introduced or will introduce requirements that go further than the OECD minimum requirements, it could be difficult to manage the reporting without a clear framework.
It is therefore imperative to decide upon and implement a timely framework for CbC reporting (i.e. tax transparency reporting), in order to achieve an efficient management process and reasonable control of the group’s information filed with the tax authorities.
When creating such a framework, it is important to consider implementing processes to address the following points:
- Updated and historical company information including permanent establishments
- Being able to track changes in business activities for all entities over time
- A firm process for gathering tax figures both for forecast and actual figures
- A process for analyzing your data to identify risks
1 Updated company information
A vital part of the CbC reporting is for the filing company to list all legal entities in the group (including permanent establishments), together with the entity information specified by the OECD. Normally it is the companies that are part of the group at year-end that are listed. However, you must also include companies that have been disposed/liquidated during the income year. You also need to consider how to manage companies that have been dissolved as a result of a merger.
An important part of the reporting processes is therefore to make sure that you can update the legal entity list with changes such as acquisitions and disposals. It is also of importance to have a full understanding of any mergers/liquidations and changes to your permanent establishments. To be able to perform dry runs and a final run, it is necessary for the group to have put in place a process for updating company data several times per year.
Since a comparison of data between years is an important part of the tax authority’s analysis, you should be able to keep track of historical entity data and be able to identify changes in the legal structure as part of any risk analysis. Disposals and acquisitions of a company or a business line (or starting/closing down a business line) could also lead to significant swings in the figures between the years which you must be able to explain. Any tool used for keeping track of the entity data must therefore have a function for searching and presenting historical entity data.
In this respect, you need to determine whether the accounting system could be prepared for CbC reporting and to what extent the legal structure corresponds to the operational structure in the accounting system. If these structures do not match, you will have to manually update the data and break up or merge accounting entities to match the legal structure. In many cases this information and other required entity information is only available on a local level. Furthermore, there is entity data that you might not find in the accounting system, such as permanent establishments and certain data linked to each company, e.g. country codes, TIN numbers etc. In addition, it is seldom possible for the accounting system to identify changes to a business line.
This justifies implementing a local reporting process in order to gather relevant data that is not ad-hoc, i.e. that is clear, has an audit trial and contains a sign-off function.
Establishing a separate process to gather, structure and sign off on entity data that cannot be found in your accounting system is therefore something to investigate.
2 Business activities
The next part of the CbC reporting is that each entity should be linked to a business activity.
At first glance it might seem trivial to gather information on business activities. However, if you have a large number of entities, you may need a process for collecting and updating changes in their business activities. It is also necessary to keep track of historical business activities if you wish to analyze historical data or receive questions on a previous years’ filing. The knowledge of what business activity(ies) each entity conducts is often found on a local level. Thus, you may have to reach out to local people to gather this information.
In some cases, an entity conducts several business activities. If this is the case, you need to think about how to include this entity correctly in your analysis, i.e. you might need to gather more in-depth information regarding an entity’s business activity than just the major business activity reported to you. This information is most likely found on a local level as well.
The above also implies that you need to consider having a process where local people report these changes to you on a current basis.
3 Figures for forecast and actual
When you have completed your entity list and identified the business activities, you need to gather the figures and link them to the right company.
There are two main scenarios when it comes to gathering the figures. One scenario is where all figures can be gathered from the group accounting system. The other is where only part of the figures can be gathered from the group accounting system or all figures used are local GAAP.
Even if all the figures can be found in the group accounting system, you will most likely need to make manual adjustments, such as adjusting reporting entities to the legal entity structure and adjusting permanent establishments.
If you cannot find all figures in the group accounting system, you need to consider implementing a reporting process to gather the required figures. Such a process could entail requesting local figures from the local source.
In addition, some countries may request CbC filing earlier than the group filing (e.g. China). In this case, it is important to identify which countries have this requirement and what figures you need to file. In order to avoid inconsistencies, you need to implement a process to ensure that the locally reported figures match the group figures which are filed later in the year.
When all figures have been gathered, a firm process should be set up where you compile and structure all figures in the required format. Such a process includes securing the quality of data and ensuring that each separate figure is linked to the correct entity/tax jurisdiction. In a scenario where you would like to proactively work to avoid presenting CbC figures that could draw the attention of tax authorities, a “forecast run” of the figures should be put in place. Implementing a forecast process opens up the possibility to mitigate risk that would otherwise be too late to address if you only analyze the figures after the year-end. There are questions you need to ask yourself in this respect. Where could you find the forecast figures? Are they easily accessible from the accounting system or do you need to collect them from other sources?
When you collect the CbC figures, you may want to collect additional figures which could help you to calculate ratios and KPIs that could not be calculated by only using the CbC figures. This enables a deeper analysis and understanding of risks in different jurisdictions and on a company level. Furthermore, some of our clients have indicated that they are of the opinion that only presenting the CbC figures as such, does not give an accurate picture of the group’s activities. An additional set of figures will help them to present a “fairer” picture and help them to dismiss and explain irregularities that do not constitute a risk, but which show up in an analysis of the reported CbC figures.
- Country by country analysis and identification of risks
An analysis of the gathered data should give you a good understanding of any irregularities that may be identified by the tax authority and which may prompt them to ask detailed follow-up questions.
Since the CbC report contains both figures and business activities, the tax authority will analyze the connection between them. Some companies conduct business activities that may raise questions if they report certain CbC figures or ratios. This makes it important for you to pre-empt the authorities by performing the same analysis on a current basis in order to avoid a situation where your CbC report contains information that attracts attention.
When conducting your analysis you may identify questions that you want to comment on in table 3 before you file.
When creating your tool for analyzing the CbC data you might want to consider, among other things, the following:
- Identify which figures (in addition to the required CbC figures) could be interesting to collect for analysis purposes
- Identify the ratios and key performance indicators that are relevant to analyze in your group broken down by business activity, e.g. turnover per employee for all entities that have specified the business activity “internal group finance”
- You must be able to analyze both on a tax jurisdiction level (the level first analyzed by tax authorities) and on an entity level, since the follow up question likely will concern the legal entities
- You must be able to compare figures between years to allow you to identify significant differences which may attract interest from the tax authorities
If you would like to mitigate risk and avoid a time-consuming process, the management of CbC reporting is not something you should take lightly. Setting up a framework and clear guidelines is therefore something that you should consider now. Even though the gathering, analysis and filing is the responsibility of a head office function, a process for gathering and signing off relevant data, in many cases, must include a reporting process with local managers contributing at least part of the data. This is of course even more important if the group includes many subsidiaries, has a diversified business, or where the amount of current changes in the legal and operational structure is significant.