On June 29, 2016, the Treasury and the Internal Revenue Service published final regulations (T.D. 9733) requiring annual country-by- country (CbC) reporting by U.S. persons that are the ultimate parent entity of a multinational enterprise group (MNE) with annual revenue for the preceding accounting period of $850 million or more. The regulations are effective on June 30, 2016, and made several changes to the proposed regulations issued last December.
Background on CbC Reporting
The Group of 20 (G20) and the OECD, i.e., Organization for Economic Cooperation and Development, developed a model for the collection of country-by- country or CbC reporting information from large MNE groups. Being able for each member country to obtain information on worldwide transactions, revenues, and assets, etc., on a CbC basis for MNEs has obvious appeal from a tax administration standpoint and will also be of help in preventing or addressing efforts to prevent base erosion and identify and redress overly aggressive earnings stripping actions.
Under CbC reporting, MNEs will be required to provide aggregate information annually in each jurisdiction where they do business relating to the global allocation of income and taxes paid, together with other indicators of the location of economic activity within the MNE group. It will also cover information about which entities do business in a particular jurisdiction and the business activities each entity engages in. As of May 12, 2016, 39 countries have signed CbC agreements.
Proposed Regulations Issued by the Treasury and IRS in December 2015
In December of 2015, the Treasury and IRS issued proposed regulations that announcing a new requirement for certain U.S. persons that are the ultimate parent entity of an MNE group (U.S. MNE group) that had annual revenue for the preceding annual accounting period of $850 million or more. The proposed regulations were intended to be consistent with the international model CbC template developed by the G20 and OECD.
Final U.S. CbC Regulations Issued by the Treasury and IRS on June 29, 2016
Form 8975 must be filed with the ultimate parent entity's income tax return for the tax year, in or with which the reporting period ends, on or before the due date (including extensions) for filing that person's income tax return (or as otherwise prescribed by Form 8975). Treas. Reg § 1.6038-4(f). While the final regulations do not require the ultimate parent entity to create and maintain records to reconcile the information reported in Form 8975 to consolidated financial statements or to tax returns, the ultimate parent must maintain records to support the information provided in Form 8975. Treas. Reg. §1.6038-4(g).
The final regulations addressed several issues that needed clarification under the proposed regulations, including the application of the CbC reporting rules to pass thru entities and entities doing business in U.S. possessions. The final regulations include consistent rules for pass-thru entities, requiring that data for partnerships with no tax residence in any country be reported on an aggregate basis and attributed to the partners in proportion to their interest in the partnership. The regulations indicate that U.S. territories are deemed to have "fiscal autonomy" as tax jurisdictions but that parent entities resident in territories have the option to file in the United States. Under the final regulations, the definition of a business entity no longer includes decedents' estates, individuals' bankruptcy estates, and grantor trusts within the meaning of Section 671, all the owners of which are individuals. In response to a comment, the final regulations provide that foreign insurance companies that elect to be treated as domestic corporations under Section 953(d) are U.S. business entities that have their tax jurisdiction of residence in the United States.
The final regulations clarify that cash and intangible assets are not tangible assets and that trusts and estates are not "constituent entities" for which reporting is required. The final regulations also retain the rule set forth in the proposed regulations that CbC reports need not be reconciled to tax returns or financial statements.
Key Definitions Set Forth in the Final Regulations
The Ultimate Parent Entity. The ultimate parent entity of a U.S. MNE group is a U.S. business entity such as a corporation or partnership, etc., which:
(i) owns directly or indirectly a sufficient interest in one or more other business entities, at least one of which is organized or tax resident in a tax jurisdiction other than the U.S., such that the U.S. business entity is required to consolidate the accounts of the other business entities with its own accounts under U.S. GAAP, or would be so required if equity interests in the U.S. business entity were publicly traded on a U.S. securities exchange; and
(ii) is not owned directly or indirectly by another business entity that consolidates the accounts of such U.S. business entity with its own accounts under GAAP in the other business entity's tax jurisdiction of residence, or would be so required if equity interests in the other business entity were traded on a public securities exchange in its tax jurisdiction of residence. Treas. Reg. §1.6038-4(b)(1).
Business Entity. A “business entity” is any entity recognized for federal tax purposes that isn't properly classified as a trust under Treas. Reg § 301.7701-4. It includes a disregarded entity with a single owner under Treas. Reg § 301.7701-3 and a permanent establishment (PE) that prepares financial statements separate from those of its owner for financial reporting, regulatory, tax reporting, or internal management control purposes. A business entity doesn't include grantor trusts with only individual owners, decedents' estates, and individuals' bankruptcy estates. Treas. Reg. § 1.6038-4(b)(2).
Permanent Establishment. The final regulations to the CbC rule provides that a PE includes: (i) a branch or business establishment of a constituent entity in a tax jurisdiction that is treated as a PE under an income tax convention to which that tax jurisdiction is a party; (ii) a branch or business establishment of a constituent entity that is liable to tax in the tax jurisdiction in which it is located pursuant to the domestic law of such tax jurisdiction; or (iii) a branch or business establishment of a constituent entity that is treated in the same manner for tax purposes as an entity separate from its owner by the owner's tax jurisdiction of residence. Treas. Reg § 1.6038-4(b)(3).
U.S. Business Entity. A “U.S. business entity” is a business entity that is organized or has its tax jurisdiction of residence in the U.S. The final regulations expressly provide that foreign insurance companies that elect to be treated as domestic corporations under Section 953(d) are U.S. business entities that have their tax jurisdiction of residence in the U.S. Treas. Reg. §1.6038-4(b)(4).
U.S. MNE Group. The U.S. MNE Group consists of the ultimate parent entity of a U.S. MNE group and all of the business entities required to consolidate their accounts with the ultimate parent entity's account under U.S. GAAP, or that would be so required if equity interests in the ultimate parent entity were publicly traded on a U.S. securities exchange, regardless of whether any such business entities could be excluded from consolidation solely on size or materiality grounds. Treas. Reg. § 1.6038-4(b)(5).
Constituent Entity. With respect to a U.S. MNE group, a constituent entity is any separate business entity of the U.S. MNE group, except that the term “constituent entity” doesn't include a foreign corporation or foreign partnership for which the ultimate parent entity isn't required to furnish information under Section 6038(a) (determined without regard to Treas. Reg. § 1.6038-2(j) and Treas. Reg § 1.6038-3(c)) or any PE of such foreign corporation or foreign partnership. Treas. Reg. § 1.6038-4(b)(6).
Contents of Form 8975. Form 8975 will require information with respect to each constituent member or entity of the U.S. MNE Group including: (i) legal name of each constituent entity; (ii) tax jurisdiction, if any, in which each constituent entity is resident for tax purposes; (iii) tax jurisdiction in which the constituent entity is organized or incorporated (if different from the tax jurisdiction of residence);(iv) tax identification number, if any, used for the constituent entity by the tax administration of the constituent entity's tax jurisdiction of residence; and (v) main business activity or activities of the constituent entity. Treas. Reg § 1.6038-4(d)(1). Additional information will be required for the constituent entities resident in each tax jurisdiction, including: (i) revenues generated from transactions with other constituent entities of the U.S. MNE group; (ii) revenues not generated from transactions with other constituent entities of the U.S. MNE group; (iii) profit or loss before income tax; (iv) total income tax paid on a cash basis to all tax jurisdictions, including any taxes withheld on payments received by the constituent entities of the U.S. MNE group; (v) total accrued tax expense recorded on taxable profits or losses, reflecting only the operations in the relevant annual accounting period and excluding deferred taxes or provisions for uncertain tax positions; (vi) stated capital of all the constituent entities, except that the stated capital of a PE must be reported in the tax jurisdiction of residence of the legal entity of which it is a PE unless there is a defined capital requirement in the PE tax jurisdiction for regulatory purposes; (vii) total accumulated earnings, except that accumulated earnings of a PE must be reported by the legal entity of which it is a PE; (viii) total number of employees on a full-time equivalent basis in the relevant tax jurisdiction; and (ix) net book value of tangible assets (defined as excluding cash or cash equivalents and intangibles or financial assets). Treas. Reg. §1.6038-4(d)(2). The information required to be filed in accordance with Treas. Reg § 1.6038-4(d)(2) must also be provided, in the aggregate, for any constituent entity or entities that have no tax jurisdiction of residence. And, if a constituent entity is an owner of a constituent entity that doesn't have a jurisdiction of tax residence, then the owner's share of the entity's revenues and profits is aggregated with the information for the owner's tax jurisdiction of residence. Treas. Reg. § 1.6038-4(d)(3)(i).
Revenue Defined for Form 8975. For purposes of Treas. Reg § 1.6038-4(d), “revenue” includes all amounts of revenue, including from sales of inventory and property, services, royalties, interest, and premiums. It doesn't include payments received from other constituent entities that are treated as dividends in the payor's tax jurisdiction of residence. Distributions and remittances from partnerships and other fiscally transparent entities and PEs that are constituent entities aren't considered revenue of the recipient-owner. Revenue also doesn't include imputed earnings or deemed dividends received from other constituent entities that are taken into account solely for tax purposes and that otherwise would be included as revenue by a constituent entity. Treas. Reg. §1.6038-4(d)(3)(ii).
A business entity that is treated as a partnership in the tax jurisdiction in which it is organized and that does not own or create a PE in that or another tax jurisdiction generally will have no tax jurisdiction. The “stateless” entity-owner reports its share of the stateless entity's revenues and profits in the owner's tax jurisdiction of residence, even if that jurisdiction treats the stateless entity as a separate entity for tax purposes. In the case in which a partnership creates a PE for itself or its partners, the CbC information with respect to the PE isn't reported as stateless, but instead is reported as part of the information on the Form 8975 for the PE's tax jurisdiction of residence. The final regs clarify that distributions from a partnership to a partner aren't included in the partner's revenue. In addition, the final regs provide that remittances from a PE to its constituent entity-owner aren't included in the constituent entity owner's revenue.
U.S. Territories and Possessions.
The final regulations provide that a “U.S. territory ultimate parent entity” may designate a U.S. business entity that it controls, per Section 6038(e), to file on the U.S. territory ultimate parent entity's behalf the Form 8975 that the U.S. territory ultimate parent entity would be required to file if it were a U.S. business entity. A U.S. territory ultimate parent entity is a business entity organized in a U.S. territory or possession of the U.S. that controls a U.S. business entity and that is not owned directly or indirectly by another business entity that consolidates the accounts of the U.S. territory ultimate parent entity with its accounts under GAAP in the other business entity's tax jurisdiction of residence, or would be so required if equity interests in the other business entity were traded on a public securities exchange in its tax jurisdiction of residence. Treas. Reg. §1.6038-4(j).
The preamble to the final regulations acknowledges that the information contained in the CbC filings will be subject to FOIA protection as tax return information in accordance with Section 6103. Some foreign governments may strongly object to this determination. But see Section 6103(d) which permits information sharing with state tax administrators.
Senator Franken, D-Minn., objected to this protective shield that was granted U.S. MNEs. In his June 29 press release, Senator Franken stated that “Although new country-by-country reporting rules for multinational corporations "are an important step to help the IRS enforce our tax laws, they've missed the mark" because they only require private, not public, reporting.”
The reporting requirements apply to ultimate parent entities of U.S. MNE groups for taxable years beginning on or after June 30, 2016.
IRS intends to allow ultimate parent entities of U.S. MNE groups and U.S. business entities designated by a U.S. territory ultimate parent entity to voluntarily file CbC reports for reporting periods that begin on or after Jan. 1, 2016, but before the applicability date of the final regulations, under a procedure to be provided in separate, forthcoming guidance. The Treasury Department is working to ensure that foreign jurisdictions implementing CbC reporting requirements will not require constituent entities of U.S. MNE groups to file a CbC report with the foreign jurisdiction if the U.S. MNE group files a CbC report with IRS pursuant to this procedure and the CbC report is exchanged with such foreign jurisdiction pursuant to a competent authority arrangement. Treas. Reg.§ 1.6038-4(k), TD 9773 (6/29/2016) On the same day that IRS issued the final regulations the OECD released a transitional filing option to deal with late effective date of U.S. CbC regulations.
The late effective date of the regulations for U.S. MNEs is to be distinguished from the G20 effective date whereby other countries that have adopted CbC reporting requirements for annual accounting periods beginning on or after Jan. 1, 2016. The failure of the U.S. to adopt timely CbC reporting requirements may increase compliance costs because U.S. MNE groups may be subject to CbC filing obligations in multiple foreign tax jurisdictions or subject to varying CbC filing rules in different foreign tax jurisdictions, such as requirements to prepare the CbC report using the local currency or language.
In T.D. 9773, 81 FR43482-01 (6/30/2016) the Treasury and the Internal Revenue Service issued final regulations requiring annual country-by-country (“CbC”) reporting by certain U.S. persons that are the ultimate parent entity of a multinational enterprise group (“MNE”) that has annual revenue for the preceding annual accounting period of $850 million or more. The information is to be set forth in Form 8975.
Foreign Country Update
On the same day the Treasury and IRS issued the CbC regulations in final form, the OECD issued guidance recommending that other countries accept, for years beginning January 1, reports filed voluntarily in the United States and in other countries that do not require them. See Action 13 of the OECD’s base erosion and profit shifting (BEPS) Action Plan.
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