Now that the tax return deadline for U.S. multinationals on a calendar year has come and gone, and the first batch of country-by-country (CbC) reports have been filed, many taxpayers are now taking the opportunity to reflect on exactly how CbC data can be interpreted by tax authorities and what the next steps are.

Data Interpretation 

In asking how the CbC data can be interpreted, many taxpayers are turning it around and looking at how the data is likely to be misinterpreted.  Due to the guidance that has been provided about what data is included, there is definitely the potential for misinterpretation.

Let’s start with the aggregation of the financial data.  For many multinationals, this will not be a significant issue, but for some it may cause a serious distortion of the revenue data.  Take for example, an industrial products manufacturer that has manufacturing entities and distribution entities in the same jurisdiction.  Rather than selling directly to customers, the manufacturer sells to the in-country distributor which sells to customers.  By aggregating the financials, and not eliminating the intercompany transactions, the CbC report will overstate the total and related party revenue in each jurisdiction.  In one case, the total revenue has nearly doubled, and the intercompany revenue significantly overstated.  Although the notes to the CbC report can be used to clarify the data, upon first glance, it can lead a tax authority to infer that there is much more cross-border activity than actually exists.

Secondly, the cash income tax paid in the review year may contain items that relate to tax in prior years, such as refunds or payments related to open audit, or that taxes related to the year under review will be paid in the following period.  Thus, there may be little correlation between the profit earned in a given year and the taxes paid in the review year.  Tax authorities will obviously know what the statutory rates are in all of the jurisdictions, but variances in taxes paid from what can be calculated using the statutory rate could lead to additional questions from authorities.

Lastly, depending on the countries in which a multinational operates, there can be differences in financial and tax year-ends, such as Indian subsidiaries of a U.S.-parent.  The Indian subsidiary may make adjustments between January and March that relate the prior calendar year, but would not necessarily be reflected in the CbC report.  The task of aligning all the data in all jurisdictions to meet the year-end of the CbC filer can be a large task for the preparer and can cause discrepancies in the CbC report relative to local financials.

What’s Next

Given the gap between filing the CbC report for U.S. multinationals and when the Master File is required in most jurisdictions, taxpayers can use this time to strengthen the Master File and prepare any necessary explanations of the CbC data.  A balance needs to be struck between providing support for the CbC report and not providing unnecessary information.  The OECD has obviously given guidance for what should be included in the Master File, but it can also be an opportunity to address any potential misinterpretations.

One hope that taxpayers can have is that the CbC report is not viewed in a vacuum by the tax authorities, and that the Master File and Local File can also provide additional support to the company’s transfer pricing.