This Is How a Local File of the Future May Look Like

Borys Ulanenko

What is local file? How TP documentation framework looks like now?

Under the BEPS project, OECD undertook a review of transfer pricing documentation standard and introduced a universal approach to a local file, master file, and Country-by-Country report. Since 2015, the majority of the countries updated their local file requirements to meet the OECD standard (or introduced new requirements where they did not exist). We discuss the BEPS Action 13 and transfer pricing documentation in Module 16 of our course
Even though the OECD (and domestic legislation of many jurisdictions) prescribes the local file content, it is still relatively "soft", i.e. the local file standard looks more like "table of contents". At the same time, the level of detail is mainly dependent on the taxpayers' approach. For example, one company may decide to prepare a detailed local file and include 20 pages of functional analysis, while another taxpayer may take a less rigorous approach and just have a table summarizing the functional analysis. Technically, both companies will be compliant with the local file requirements.
Another issue with the local file is that it is usually a lengthy "word" document that is written like a story. That is why a local file is not a great tool for tax administration risk assessment. Tax office needs first to request the documentation (in the majority of countries, the local file is submitted on request only), and then to read and analyze it carefully to identify potential deviations from the arm's length principle. 
That is why some tax authorities go beyond standard local file requirement and introduce additional filing obligations, like TP forms that we discussed in another blog post.

One country decided to revolutionize the TP requirements

Due to the weaknesses of the OECD local file standard, Poland decided to expand its transfer pricing compliance rules. Starting from the year 2020, Polish taxpayers will be obliged to prepare and submit the TPR-C form. The form is a hybrid reporting standard that combines the data traditionally reported in the local file with information usually disclosed in TP forms. Here is a list of information that must be included in TPR-C:
  • General information about the taxpayer – standard for all tax forms.
  • Financial indicators of the taxpayer – companies have to calculate and provide actual operating margin, net cost plus, return on assets and return on capital. This information can immediately be used to identify companies with financial results that significantly deviate from market trends.
  • Transactional information (per transaction), including: 

· Type of the transaction (purchase/sale of goods/services, financial transactions, IP transactions, etc.)

· Functional profile of the counterparty (limited risk / full risk entity)

· Amount of the transaction

· Transfer pricing method applied to the transaction

· Depending on the method and type of the transaction, you may have to:

· Indicate the minimum and maximum price of the item transferred, as well as minimum and maximum arm's length price (for the CUP method)

· Indicate the profit level indicator (for profit-based methods), the tested party, actual value of the PLI, information about the benchmarking study you are using (including the geography of comparables and the arm's length range)

· For financial transactions, you need to indicate the debt amount, interest amount, interest rate, references to the floating indicators (like LIBOR), the margin applied on top of the floating rate, etc.

In essence, the TPR-C is a tabularized local file, where taxpayers need to convert their classic "local file story" into dry and concrete data. Note that TPR-C does not replace the local file obligation, but is an additional requirement (the local file is submitted on a request basis). 
Immediate consequences of the TPR-C
First, tax administration receives a tremendous amount of information that is highly standardized. Doing risk assessment and finding deviations becomes a straightforward task. For example, the tax authority can immediately identify transactions that are: 
  • Material
  • Conducted with low-tax jurisdictions
  • Have suspicious financial results (e.g. tested party is a limited risk company that has negative result) 
As a consequence, tax audits can become much more targeted and specific. 
Second, taxpayers face a tremendous compliance burden. Thresholds and materiality safe harbours are low, and taxpayers with controlled transactions of a few hundred thousand euro are falling under standard TP documentation and TPR-C requirements. As a result, even small companies now have to prepare and submit the form with an indication of TP methods, PLIs, benchmarking studies, etc. 
We doubt that similar requirements will be introduced soon in other jurisdictions, as it may seem that the compliance burden is disproportionate to the potential benefit. However, it is difficult to deny that the information gathered by tax authorities provides a truly unique perspective and control, and allows making risk assessment very effective. Therefore, we can expect other governments to consider the introduction of more standardized, tabularized transfer pricing forms that will include much more information than in the past. And taxpayers need to be ready for it.    
What are your experiences with new transfer pricing reporting standards that go beyond BEPS Action 13? Share them with us!

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