EU Public Reporting Prompts Transparency for Multinational Firms

The EU’s public country-by-country reporting obligations for in-scope multinational enterprises may prompt several transfer pricing challenges due to public perception of the PCbCR.

Unlike the OECD’s CbCR, which aims to provide tax administrations with relevant information for high-level transfer pricing risk assessments, the EU rules aim to enable citizens to assess MNEs’ tax strategies and see how much they contribute to welfare in each jurisdiction.

The public has shown increasing interest in corporate social responsibility and in ensuring that large MNEs also pay their fair share of taxes and contribute to society. Under the EU rules, in-scope MNEs must annually report on their websites profits and tax paid specified for each EU jurisdiction where they are active. They also must report specifications for jurisdictions included on the EU list of non-cooperative jurisdictions.

Though the EU rules share similarities with the Organization for Economic Cooperation and Development’s, the data is more limited because the public reporting rules consider the balance between being transparent and remaining competitive in the market.

Identifying Red Flags

PCbCR data enables the public to identify red flags by applying certain financial ratios that can provide meaningful information about companies.

As an example, two ratios that can be used to assess the transfer pricing applied in a specific jurisdiction of an MNE are the profit per employee ratio and the profit compared to revenue ratio.

The profit per employee ratio is calculated by taking the reported profit (loss) before income tax divided by the reported number of employees in a specific jurisdiction as presented in the PCbCR.

A high ratio in a specific jurisdiction, such as a jurisdiction with high profits and few employees, could raise questions on whether the profit reported in that jurisdiction is in line with the arm’s-length principle. This might make it easy to conclude that a jurisdiction may not have the so-called significant people functions to report high profits—and that the results may not be in line with the general perception of the arm’s-length principle at first glance.

PCbCR data can also be used to determine the profit compared to revenue ratio, which is calculated by taking the reported profit (loss) before income tax divided by the reported revenue in a specific jurisdiction.

For instance, a low ratio in a specific jurisdiction—such as a jurisdiction with low profits and significant revenue—could be a red flag that an MNE might be “shifting” profits from a higher-tax jurisdiction to lower-tax jurisdiction.

A relatively high ratio in a specific jurisdiction—such as a jurisdiction that reports significant profits and significant revenue—combined with a low effective tax rate and/or a limited number of employees could also signal a red flag.

Consequences for MNEs

Public reaction to the PCbCR for companies applying the transfer pricing principles correctly can influence MNEs’ behavior. Hard data as included in the PCbCR may cause public pressure.

Consequently, an in-scope MNE may feel pressured to adjust its applicable transfer pricing (even though it applies correct transfer pricing). MNEs may adjust their group transfer pricing policies to present figures that are more desired by the public, which could result in applying prices that don’t align with the arm’s-length principle.

Public opinion also may eventually increase the risk of being challenged on the transfer pricing by tax authorities. The tax authorities might feel pressured to start a transfer pricing audit, or even to change previously accepted transfer pricing standards.

If the MNE doesn’t alter its transfer pricing policy, PCbCR can lead to questions from the public and, consequently, having to explain more to the public.

To better inform the public and prevent premature conclusions, in-scope MNEs may consider presenting additional information on the figures presented in the PCbCR.

For example, it may help to explain in more detail why certain ratios seem unaligned with the arm’s-length principle at first sight. MNEs also could consider preparing a Q&A with common questions that may arise when assessing the PCbCR.

The EU reporting rules may also lead to adverse commercial consequences because all the newly available published information may result in a competitive disadvantage for in-scope MNEs.

Publicly available information can influence a company’s commercial position. For instance, suppliers can derive valuable information from the PCbCR that may impact the MNE’s bargaining power in procurement negotiations.

PCbCR appears to meet demands of the public by revealing information regarding MNEs’ contributions to society. At the same time, this may result in transfer pricing challenges for in-scope MNEs.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jacoline Kleijn is a tax adviser and member of the Loyens & Loeff international tax practice group.

Maurice van Klaveren is a tax adviser and member of Loyens & Loeff’s multinationals practice group and of its transfer pricing team.

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