Tax transparency on allocation of group profits in the light of Public CbCR 

Taxation has a key role for medium and large multinational companies in the process of developing a sustainable business model. Disclosure of complex tax information and transparency on profit allocation to group entities is key to this transformation process and will become a reality with new reporting standards and EU disclosure obligations. 

The Global Reporting Initiative (GRI) 207 tax standard, already applicable since 1 January 2021, includes guidance for organisations to disclose how tax aspects are managed and their impact, information on tax revenues and business activities in each jurisdiction where the group operates. 

EU Directive 2021/2101 concerning disclosure of income tax information by certain undertakings and branches, adopted on 24 November 2021 and transposed in the legislation of EU states enforced the public Country-by-Country Report (CbCR) concept. In most EU States, the first public CbCR reports will cover the financial year commencing on or after 22 June 2024, but there are exceptions like Romania where the report will cover financial year starting with 1 January 2023. The public CbCR must be published within 12 months of the balance sheet date of the financial year for which the report is drawn up.  This means groups operating in Romania will have an early reporting obligation by 31 December 2024, compared to other EU countries. 

In this context, multinational groups should try to assess the impact new public tax information will have on the different stakeholders, in particular on the public opinion, and whether there is enough guidance to process such information. 

Why is tax transparency important? 

The EU Commission’s view on the importance of tax transparency is outlined in EU Directive 2021/2101.  

The Commission considers the new tax reporting obligations respond to EU citizens calls for economic fairness, transparency and actions against corporate tax avoidance, which are required for the smooth functioning of the single market. 

Disclosing tax information will generate interest from civil society, which would ideally improve the trust of citizens in the fairness of the EU and national tax systems. At the same time, the increased public scrutiny on tax matters may impact the reputation of certain multinational groups perceived to adopt aggressive tax practices.  

The allocation of group profits to local entities within the EU, which translates, to some extent, to the amount of tax multinational groups contribute to local economies, is central to the tax transparency initiative and has been subject to public scrutiny for several years.  

What is the role of CbCR in the tax transparency process? 

The CbCR is a mandatory reporting tool for multinational groups with annual consolidated revenues above EUR 750 million, first introduced by the OECD BEPS Action 13.  

It contains standardised information on the activity of group companies, revenues and tax position. Notably, it includes details on related and unrelated party revenues, profit (loss) before income tax and actual income tax paid for each group entity.  

This overview is designed to enable an assessment of whether allocation of group profits to local entities is aligned with value creation and arm’s length principles, from a tax and transfer pricing perspective.  

Until 2024 only the banking, extractive and logging industry had the obligation to publish CbCR information, while in-scope groups operating in other sectors submitted their reports only to tax authorities (some may have voluntarily published some information).  

In most cases, the report was used by the authorities to perform risk assessment analyses, focused on assessing if local group entities received a fair share of the group’s profits considering their functional profile. 

By introducing public CbCR, the EU Commission is seeking to promote a better-informed public debate regarding the level of tax allocated to Member States by certain multinational groups operating in the EU, and the impact this process has on local economies.  

Public CbCR is a significant milestone for tax transparency as the public and other stakeholders will be in a better position to understand the activities, footprint, structure of multinational groups including their commitment to ensuring that profits and tax are aligned with economic value creation. 

However, some questions might well be raised on how the public will interpret the financial information included in the CbCR, and whether uninformed interpretation will cause negative effects for certain groups.  

How should CbCR data be interpreted? 

The issue of group profit allocation to local entities is complex and subject to interpretation, with each jurisdiction normally seeking to tax a larger portion of the group’s profits. The generally accepted rule for allocation is the arm’s length principle, which requires prices of intra-group transactions to be comparable with prices applied between independent parties in similar circumstances.  

Although the public CbCR includes relevant information on each subsidiary’s activity and taxable revenues, this should be incorporated into the tax authorities risk assessment framework and analysed in connection with other data – such as the tax declarations or local transfer pricing reports – to draw a pertinent conclusion. However, this additional information is unlikely to be available to the public in an easily accessible form. 

Otherwise, if the CbCR is used in isolation there is a significant risk that simplistic and misleading conclusions may be drawn¹.  

In 2017 the OECD issued the Country-by-Country Reporting Handbook on Effective Tax Risk Assessment, which is a tool prepared initially to help tax authorities identify transfer pricing and BEPS related risks, by using the CbCR alongside with other local or group data. It advises that CbCR information should not be used by tax authorities to perform transfer pricing adjustments. 

The Handbook identifies several potential tax risk indicators which tax authorities should further investigate. These include, among others, cases when:  

• the results in a jurisdiction deviate from potential comparables or from market trends,  

• there are jurisdictions with significant activities but a low level of profits (or losses),  

• jurisdictions that have high profits but low level of tax accrued.  

More complex red flags include situations when: 

• a group has activities in jurisdictions which pose a BEPS risk,  

• intellectual property is separated from related activities within a group  

• cases when the group includes dual resident entities or entities with no tax residence. 

The Handbook emphasis the need for an in-depth analysis before drawing conclusions based on the risk indicators. For example, situations when the local group entity has significant activities in a jurisdiction, but low levels of profit (or losses) may lead to the conclusion that profits attributable to that entity may have been shifted to a jurisdiction where they are taxed more favorably. However, this case might be explained by the fact that some activities within a group may be more asset-intensive or staff-intensive than others (e.g. administrative functions may have a low profit per employee compared to the group)². 

In principle, all the risk indicators identified in the Handbook can be explained by economic and commercial reasons, provided the group is able to offer reasonable and documented arguments.  

Multinational groups should further investigate the risk of simplistic interpretations of public CbCR data by the public and other stakeholders, as these interpretations could lead to incorrect conclusions about tax policies. These groups should be ready to provide additional explanations of the economic reasons behind their reported results. The GRI 207 tax reporting standard and its guidance are instrumental in this effort.  GRI 207 promotes disclosure of the reasons for difference between corporate income tax accrued and the tax due if the statutory tax rate is applied to profit/loss before tax. 

Key takeaways 

The EU has taken a lead role in implementing the tax transparency process.  This will generate a sustainable transformation process for multinational groups in respect of financial accountability and the reporting of tax compliance. 

The public CbCR report is a key part of this initiative, however access to tax data raises specific concerns for groups from a reputational risk perspective and shows tax transparency is not a risk-free process. It is very important to explain sensitive data included in the public CbCR. 

Multinational groups should build a narrative around the data CbCR reports and offer additional support for its interpretation. The data will likely be subject to public opinion scrutiny on issues concerning the appropriate allocation of profits to local group entities and how and when tax on those profits is paid. It is essential to develop a tailored communication strategy regarding tax risk indicators. 

We advise groups to prepare a supplementary document based on the GRI 207 tax reporting standard to include additional support for the interpretation of the CbCR report.