In a publication of Ashfaq Tola Member Tax Reform Commission (TRC), tax expert highlighted serious implications of FBR's SRO 144(I)/2018 dated February 09, 2018, which amended Chapter VIA of the Income Tax Rules, 2002.
Currently, awareness about Base Erosion and Profit Shifting (BEPS) and CbCR is considerably low among the masses. The situation is equally grim for the employees working in the industry who would be designated with the responsibility to assist companies in complying with the CbC reporting requirements. Therefore, Pakistan business groups are faced with an urgent need to develop a knowledge base on CbCR and share the same within their group, tax expert cautioned.
He explained that the countries with Transfer Pricing legislation ordinarily follow the Transfer Pricing Guidelines of Organization for Economic Cooperation Development ("OECD") for Multi National Entity ("MNE") groups and tax administrations which provide guidance on the application of the ALP. OECD has also recommended country-by-country reporting to address Base Erosion and Profit Shifting ("BEPS").
Sixty-eight (68) countries have welcomed the transfer pricing rules and have signed the Competent Authority Agreement on Exchange of Country-by-Country reports. Competent authority agreement means an agreement between authorized representatives of those foreign jurisdictions that are parties to an international agreement with Pakistan. The rules of nearly all countries allows related parties to set prices in any manner, but also permits the tax authorities to adjust those prices where the prices charged are at non-arm's length principle.
Ashfaq Tola said that an important pre-requisite for effective implementation and use of CbCR is adequate automatic exchange arrangements for exchanging CbCR filed in one jurisdiction with other jurisdictions where CEs of the MNE group are tax residents. Furthermore, to ensure that tax administrations are willing to do such an exchange, it is important that countries have robust data confidentiality systems in place to safeguard taxpayer's information. Accordingly, in the Pakistani scenario, before Pakistani administration proceeds with execution of such exchange arrangements with other countries, it is required that Pakistan government revisits its data safety norms to ensure that it is aligned with the internationally recognized standards. This practice will help ensure that other countries are willing to enter into information exchange treaties with Pakistan.
According to the expert, Country-by-Country Reporting (CbCR), is likely to have impact on both FBR and the MNEs based in Pakistan. It will have long term impact on the taxpayer.
By the implementation of documentation and reporting requirements, the taxpayers will be burdened with additional tasks of preparing "Master File" and "CbC Reports" in addition to the already existing local documentation requirements under ITO and Income Tax Rules, 2002. For the business houses affected by the documentation and reporting requirements, it would be an added burden to gather data for the entire group, to develop competencies for compiling such vast financial and non-Financial data, and to report the same in the required template.
Another factor that requires consideration is that in some cases, the CbC Report is required to be filed by the taxpayer, even though the Parent Entity or the Surrogate Entity might be filing the same in their own country. Such a requirement may result in an exponential increase in the number of taxpayers who will be filing CbC Reports in Pakistan. Such enhanced documentation requirements will evidently attract significant costs and administrative challenges for the MNEs, Ashfaq Tola said.
Moreover, in case the country of resident of neither a parent nor a surrogate entity has signed the competent authority agreement, it would be virtually impossible for the constituent entity residing in Pakistan to file the Master File as the constituent entity might not have the requisite information itself being small in size as compared to MNE group to which it belongs, Ashfaq Tola said.
Ashfaq Tola said that Pakistan has moved towards a risk-based approach for TP assessment purposes. The main objective behind development of CbCR template was to provide an overview of MNE group's global allocation of income, economic activities, and taxes in one standardised format. Such standardised report will help in conducting effective risk assessments. Once CbC report submissions begin, it is likely that the preliminary screening for risk assessment will become more severe and vigorous as the FBR's access to critical taxpayer data would enhance. Furthermore, tax authorities would be in a better position to identify any mismatch in value creation and allocation of income.
Such effective assessment will help in identifying the high-risk TP areas and other BEPS related issues. It may also help in shifting away the focus from widely litigated, redundant TP issues. While such an approach will make the tax administrations more effective and capable of comprehensive analysis, it may also bring some breather for the taxpayers suffering from unending TP litigations.
OECD in Action 13 has made it clear that CbCR data is not to be used as a substitute for a detailed TP analysis of individual transactions. It has encouraged that ALP be determined on the basis of a comprehensive functional analysis and comparability analysis. It has further described that the information in the CbCR does not constitute conclusive evidence on its own about the fact that whether transfer prices are appropriate or not. Therefore, it suggests that the same should not be used by tax administrations to propose TP adjustments based on a global arithmetic apportionment of income.
However, with access to details pertaining to MNE group such as income, asset base, employee strength, kind of business activities carried on, etc., taxpayer may be faced with another imminent challenge of tax administration proposing to allocate group profits among various jurisdictions and proposing to apply profit split method to analyse the arm's length nature of the controlled transactions, in ignorance of OECD's recommendations.
From the taxpayer's perspective, it is imperative that tax authorities refrain from such prima-facie analysis. Else taxpayers are likely to be burdened with the challenge to tackle new and aggressive assessment strategies as the CbCR data might be treated as definite information for the purpose of amendment of assessment under sections 122(5) and 122(5A) of ITO.