Compliance with base erosion and profit shifting action 13: Insights from tax consultants and tax officials

Abstract

To combat firms exploiting transfer pricing as a tool for tax avoidance, the Organisation for Economic Co-operation and Development (OECD) introduced the Base Erosion and Profit Shifting Action 13 (BEPS 13), enhancing tax transparency and the exchange of information with tax authorities. Interviewing senior-level transfer pricing advisors and tax officials, we investigate how and why multinational enterprises (MNEs) respond to this new regulation. By conducting this research, we contribute to the scarce literature assessing the impact of tax disclosure to tax authorities and, specifically, the implications of BEPS 13. The study finds that MNEs attach more importance to tax compliance and are more averse towards tax avoidance, which is mainly driven by higher audit pressure. Additionally, MNEs experience additional costs to comply with the different implementations in countries, centralise tax data with IT systems within the organisation, and set up multilateral Advance Pricing Arrangements (APAs) and Mutual Agreement Procedures (MAPs). To avoid (other forms of) tax avoidance being considered by companies, policymakers should address these concerns of increased compliance costs.

1

Introduction

Tax avoidance activities lead to a loss of 100–240 billion USD, which is the equivalent to 4–10% of the global corporate income tax revenue (OECD, 2019). Firms exploit transfer pricing (TP) as a tool for tax avoidance, involving countries with low tax rates and tax havens, to maximise their after-tax profits (e.g. Bartelsman & Beetsma, 2003; Clausing, 2003; Heckemeyer & Overesch, 2017; Klassen et al., 2017; Sikka & Willmot, 2010; Zinn et al., 2014). Based on French firm-level data, Davies et al. (2018) reveal that intrafirm export prices to tax havens are on average 11% lower than arm's-length prices, which suggests that destination-specific pricing is an important element of companies’ TP strategies. Moreover, this form of base erosion and profit shifting (BEPS) is more pronounced for larger multinational enterprises (MNEs).

To tackle BEPS activities and enhance tax transparency and the exchange of information, the Organisation for Economic Co-operation and Development (OECD) introduced 15 Action Points, of which Action 13 applies a new standardised three-tiered TP documentation approach (master file, local file, Country-by-Country [CbC] report). This Action Point mainly aims at increasing the amount of private available information to tax authorities worldwide. The OECD finalised the TP documentation requirements by 2015, and EU member states were expected to adopt these rules as of 1 January 2016 (EU, 2016; OECD, 2015a).

Research on how MNEs respond to stricter monitoring by tax authorities is scarce, and empirical findings provide mixed evidence regarding its impact on deterring tax avoidance. For example, Hoopes et al. (2012) show that US companies take less aggressive tax positions when enforcement is stronger. By contrast, Towery (2017) indicates that companies do not change their behaviour after new information is required to the US Internal Revenue Service. Concerning the specific impact of the BEPS 13 requirements, Joshi (2020) states that introducing a private CbC reporting would deter corporate tax avoidance. In particular, it would result in an increase of 1–2 percentage points in consolidated GAAP effective tax rates among affected entities; however, regulations have a limited effect on tax-motivated income shifts. Additionally, Olbert and De Simone (2022) show that CbC reporting causes firms to change their investment activities to substantiate their tax avoidance activities in Europe while decreasing their aggressive tax practices.

In a literature review mapping the pros and cons of CbC reporting to tax authorities, Oates and Tuck (2019) conclude that in addition to potential positive effects, such as reducing companies’ tax avoidance, this reporting may also have dysfunctional consequences, such as additional costs for providing more detailed information and the prospect of increased disputes.

In this study, we interview senior-level tax partners in the field of TP to investigate the extent to which BEPS 13 entails an attitude change among MNEs. In particular, we ask how the risk of audit, penalties and possible disputes could play a role in their decision to be compliant or not. Finally, we gain insight into the different components of BEPS 13, which MNEs consider costly. As an alternative approach, we also interview senior tax officials to probe for their insights on this topic. Our study makes several contributions. First, we respond to the general call by Dyreng and Maydew (2018) to explore how different types of tax disclosure impact companies’ behaviour. Second, we contribute to the limited empirical literature assessing the impact of BEPS 13. As the quantitative studies of Joshi (2020) and Olbert and De Simone (2022) suggest that BEPS 13 could deter tax avoidance, closely examining ‘how’ and ‘why’ companies perceive the introduction of BEPS 13 is worthwhile; by applying a qualitative approach, we meet this unexplored research opportunity in the literature. Moreover, through this study, we test the literature review by Oats and Tuck (2019) which reveals the advantages and disadvantages of CbC reporting, in practice.

The remainder of the paper is structured as follows. Section 2 describes the main characteristics of the three-tiered documentation requirements. Section 3 provides a theoretical framework explaining why companies tend to be tax compliant. Section 4–6 present the methodology and findings. Section 7 discusses, concludes and formulates some policy recommendations.

2

TP documentation according to BEPS 13

The issues surrounding “base erosion and profit shifting” have gained an unprecedented degree of attention from both the public and policymakers – in particular, G20 leaders and the OECD. The response of the OECD to such behaviour was the development and implementation of a plan against BEPS that included 15 actions. The main objective of the BEPS Action Plans is to align taxation with economic substance, along with increased transparency and coherence in the domestic regulations that affect cross-border activities (OECD, 2015a; OECD, 2019).

Prior to the release of BEPS Action 13 related to transfer pricing documentation, both taxpayers and tax administrations were less familiar with using documentation. They mainly relied on the previous Chapter V of the transfer pricing guidelines, in which a reasonableness in the documentation process and a need for more cooperation were formulated. However, the guidelines did not provide a list of documents to be included, nor did they include any guidance for processing the documents. Most countries applied at least some general rules on transfer-pricing documentation, and in some countries, no regulation was in place. Given the increase of intra-group trade and the scrutiny of tax avoidance by tax administrations and the general public, tax administrations were not satisfied with the information provided by the documents and considered them as inadequate for their risk assessment and audit procedures. Therefore, three objectives were formulated with the introduction of BEPS 13. First, transfer pricing compliance would be more consistent among countries and reduce compliance costs. Further, tax administrations would dispose of more information to conduct a transfer pricing risk assessment. Finally, more useful information would be available to conduct a thorough audit (OECD, 2015a; Schön, 2015). In particular, Action 13 on ‘Transfer Pricing Documentation and Country-by-Country Reporting’ requires firms to provide relevant information on their global income allocation, economic activity, and the amount of taxes paid across the countries where they are active. This is achieved by applying the new standardised three-tiered documentation approach: master file, local file and country-by-country (‘CbC’) reporting (EU, 2016; OECD, 2015a).

First, the master file requires MNEs to provide high-level standardised information on their global business operations and TP policies relevant to all MNE group members. It provides a ‘blueprint’ grouped in five categories: (i) organisational structure; (ii) description of the business; (iii) intangibles; (iv) intrafirm financial activities; and (v) financial and tax positions. Given these five categories, MNEs should not provide exhaustive listings and should use prudent business judgement in determining the appropriate level of detail for the information supplied (OECD, 2015a).

Second, the local file complements the information provided in the master file with details on intercompany transactions between the local affiliate and associated enterprises in other jurisdictions. It assists in identifying whether the taxpayer has complied with the arm's-length principle or not. The information includes comparability analysis and the selection of the most appropriate TP method (OECD, 2015a). In general, each country should establish its thresholds for master- and local-file purposes, taking into consideration the size and nature of the local economy (EU, 2016; OECD, 2015a).

Third, CbC reporting is one of the core elements of a high-level TP risk assessment tool and requires MNEs, whose consolidated group revenue is more than EUR 750 million, to report annually on the global allocation of the income and taxes paid. Additionally, the MNE group should submit indicators of the location of economic activity among the tax jurisdictions in which it operates. The report also requires a listing of all the constituent entities for which financial information is reported (EU, 2016; OECD, 2015a).

The master and local files are advised to be delivered directly to the local tax administration. The CbC reporting should be filed in the jurisdiction of the parent company's tax residence and shared by automatic exchange of information. The multilateral competent authority agreement on the exchange of CbC reports ensures that all tax authorities have access to the same disclosures, irrespective of local requirements.¹ This will allow tax administrations to conduct a better tax risk assessment posed in their jurisdictions (OECD, 2015a; OECD 2019).

However, the extent to which countries have implemented the three-tiered approach into national legislation differs. In general, deviations between countries occur on the timing of the three files’ legal effectiveness, the thresholds for documentation obligations, duties for notification and filing, amounts of penalties and language requirements (KPMG, 2024).

Since we select Belgian interviewees for our study, a concise description of the country's context is useful. Belgium was an early adopter of BEPS 13 as it implemented the master, local and CbC files into national legislation on 1 January 2016. Moreover, its local file is characterised by a detailed questionnaire on the cross-border intra-group transactions. In contrast to other countries such as France or Germany, the submission of the master and local files is compulsory and not on request. Penalties range between EUR 1,250 and EUR 25,000 and are limited compared to countries such as Italy and Luxembourg. Luxembourg, for example, may impose a penalty of EUR 250,000 for incorrect or late filings (KPMG, 2024).

3

Tax compliance: theoretical framework

The central question in our study is to what extent companies comply with the new BEPS 13 rules. Tax compliance can be defined as the taxpayer's decision to comply with tax laws and regulations and pay taxes accurately and in time (Alm, 2018; Okafor, 2023). Fig. 1 presents the theoretical framework that can play a considerable role in explaining companies’ tax compliance decisions. We rely on this framework – including the rational actor, tax morale and institutional views – to analyse the results of our interviews in the discussion and conclusion section (Section 7).

Fig. 1.

Theories explaining tax compliance.

Source: own illustration.

In the context of BEPS 13, companies are dependent on external tax consultants as TP is particularly burdensome and complex (Klassen et al., 2017). In particular, tax consultants file the documentation, offer industry knowledge and interact with tax authorities. This happens in close cooperation with in-house executives offering operational knowledge (Cools and Plesner Rossing, 2021). The literature relying on the ‘client advocacy’ approach shows that tax advisors are highly influenced by their clients when making tax decision processes and outcomes (Bobek et al., 2010; Bobek Schmitt et al., 2014; Spilker et al., 2016). From this perspective, the theories explaining companies’ tax compliance in Fig. 1 also apply to tax advisors as they represent their clients’ interests. In what follows, we discuss the rational actor theory, tax morale and institutional theory in more detail.

3.1

Rational actor theory

The standard economic model of tax (non)-compliance is represented in the neoclassical model of Allingham and Sandmo (1972). In this model, taxpayers are rational actors maximising the utility of the taxable income by weighting the benefits of compliance with the utility of tax non-compliance. This implies that as long as the benefits of tax non-compliance outweigh the costs of being detected or caught, the taxpayer will declare less than their actual income. Moreover, the model posits a negative correlation between the level of tax avoidance and the probability of detection, tax rates and penalty rates (Allingham & Sandmo, 1972). However, Webley et al. (1991) and Alm et al. (1992) observe some ‘anomalies and paradoxes’ which do not match the predictions of the rational actor theory. For example, some tax compliance is performed even when the deterrence probability is zero. Moreover, some tax evasion is in place even when tax compliance can be fully enforced. In brief, the neoclassical model of Allingham and Sandmo (1972) predicts different degrees of tax (non) compliance compared to what is observed in practice. According to Torgler (2007), the rational actor theory does not explain the nonpecuniary factors in the taxpayer's decision. A relevant nonpecuniary factor influencing the taxpayer's decision is tax morale.

3.2

Tax morale

Behavioural economists state that taxpayers are influenced by ethical and social norms through interactions and typically behave in a less self-interested (rational) manner. Moreover, a society that is purely based on economic rationality might encounter issues of moral hazard, which leads to a crisis of the moral environment. Organisations who sought their own profit without considering the harm caused to third parties were part of financial scandals, such as Enron and Barclays (San-Jose et al., 2022) or fiscal scandals mentioned in the Paradise and Pandora papers. ‘Tax morale’, which can be defined as the intrinsic motivation to pay taxes, has a considerable role in explaining tax compliance decisions (Hashimzade et al., 2013; Torgler, 2007). Hence, the concept of tax morale has become crucial in empirical research showing that higher levels of tax morale are associated with higher levels of tax compliance (Brink & Porcano, 2016; Sumartaya & Hafidiah, 2014; Torgler, 2007). Moreover, governments could influence tax morale by stating that paying taxes is ‘the right thing to do’ (Alm, 2012). Publicising cheaters and emphasising the tax compliance role as ethical form of behaviour through mass media could also improve tax compliance. As such, the taxpayer's tax morale – and by consequence, tax compliance – are determined by formal and informal institutions. These relevant factors are reflected in institutional theory.

3.3

Institutional theory

Formal features of the institutional environment are laws, regulations, polity and judiciary. A social contract exists between taxpayers and the government. Positive actions by the government, such as transparency of public spending, direct democracy and local autonomy, lead to higher tax compliance (Luttmer & Singhal, 2014; Sipos, 2015). Moreover, according to Filippin et al. (2013), tax enforcement influences tax morale and, by consequence, tax compliance.

Additionally, a range of informal institutional factors, such as social responsibility and tax fairness, are relevant to explain a taxpayer's decision to be compliant (Alm & Torgler, 2006). Trust in the tax authorities also seems to play an important role in increasing compliance with tax obligations (Kaplanoglou et al., 2016). Other research has shown that taxpayers may also be influenced by their peers’ behaviour (Frey & Feld, 2002), the company's reputation (which is associated with socially responsible behaviour) (Gallemore et al., 2014; Singh & Madhvendra, 2021) and cultural and social norms (Luttmer & Singhal, 2014).

4

Methodology

To select our interviewees, we adopted a ‘purposive sampling approach’ (Miles et al., 2014) and selected senior-level tax partners who are professionals in the field of TP and taxation of top and mid-sized consulting firms in Belgium. The tax directors’ primary responsibilities are tax compliance and other tax-related arrangements (Armstrong et al., 2012; Brühne & Schanz, 2018). Additionally, consulting firms are extensively involved in the preparation of TP documentation (Cools & Plesner Rossing, 2021). Hence, conducting interviews with tax consulting firms to investigate how MNEs respond to the BEPS 13 regulation is reasonable.

The purposive sample was augmented by ‘snowball sampling’, where interviewees identified other tax partners and directors who fit the research criteria (Marshall, 1996) of profound knowledge and involvement in the field of TP. In a first step, we conducted 13 face-to-face interviews with tax consultants² from April 2019 to June 2019. To obtain more meaningful answers, we forwarded the topic list (see Appendix 1) to the interviewees in advance. The interviews were conducted in English and took place at the interviewees’ offices, which establish a familiar and comfortable environment for the participants (Creswell & Creswell, 2017). The interviews had an average duration of 115 minutes. Each interview was audio-taped and transcribed with the permission of the participants, who signed a consent form. We obtained approximately 1,490 minutes of audio recording and 330 pages of transcription. An overview of the interview characteristics with tax consultants is shown in Table 1 (see interviewees 1–13). Additionally, we interviewed five tax officials to explore an alternative approach. For this discussion, we refer to Section 6.

Table 1.

Overview interviews.

Interviewee Number	Interviewee	Location	Interview length
1	TP Partner	Brussels	2:04:46
2	Tax Partner	Brussels	2:15:14
3	Senior Manager	Brussels	1:48:35
4	Director	Brussels	1:20:36
5	International Tax Partner	Ghent	1:59:23
6	Tax & TP Partner	Vilvoorde	1:56:18
7	Attorney-at-law Tax	Brussels	1:01:35
8	TP Partner	Ghent	2:42:59
9	Tax and Accountancy Partner	Ghent	1:48:17
10	Tax Director	Ghent	1:21:33
11	Tax & Legal Services Partner	Brussels	1:47:58
12	Tax Partner	Brussels	2:29:33
13	Tax Partner	Aalst	2:12:32
14	Tax Official (audit)	Brussels	1:52:54
15	Tax Official (audit)	Brussels	2:53:17
16	Tax Official (APAs)	Brussels	1:22:14
17	Tax Official (international relations)	Brussels	1:15:49
18	Tax Official (APAs)	Brussels	1:19:14

To analyse the data, we applied grounded theory as a general method of comparative analysis (Glaser & Strauss, 2017). The principle of this approach is to discover theory from raw data, which are systematically obtained from the interviews. We coded 330 pages of transcription through the NVIVO software.³ In line with the grounded theory approach, coding was done in several stages. During the first coding stage, approximately 180 codes were assigned. Subsequently, we manually identified and combined the codes of similar concepts to avoid repetitions. Thereafter, we repeatedly compared different codes, again combined them and reduced the number of codes (Glaser & Strauss, 2017) to 139 unique codes. Moreover, all authors discussed the codes, and agreements or disagreements were taken into consideration. Our total of 139 codes lies within the academically suggested range of 50–300 codes (Lichtman, 2013; Miles et al., 2014).

The final coding structure reveals eight parent nodes or main topics, mainly (i) adjustments made by companies; (ii) auditing, penalties and disputes; (iii) evolution and comparison of TP documentation; (iv) importance to be compliant; (vi) optimisation recommendations; (vii) organisational structure and (viii) strategy. These topics will help us structure, discuss and relate the interviews’ findings in the next section.

5

Findings

5.1

Importance TP and compliance

Owing to market globalisation, multinationals have become more integrated all over the world, leading to an increasing number of intercompany transactions; this emphasises the importance of TP (Zinn et al., 2014). Our interviews showed that all 13 tax consultants claimed that the focus on TP has increased substantially in the last years. Interviewee (IV) 7 stated,

Ten years ago, I think people were not thinking about transfer pricing. It has been such a hot topic in the last 10 years. In particular, the five years’ focus of tax authorities is more and more on transfer pricing – the awareness, the knowledge of the transfer pricing of tax authorities is just much more developed.

The interviewees agreed that the increase in TP awareness among companies and tax authorities can be seen as a positive consequence of the BEPS 13 regulation. Furthermore, 9 out of 13 tax consultants highlighted that even smaller companies, which are not obligated to prepare TP documentation, are now much more aware. According to IV 12,

[...] the whole debate and focus on TP have created much awareness. And what I noticed now is an increased awareness amongst medium-sized internationally operating companies, even though they are strictly speaking not required to have transfer pricing documentation in place [...].

Further, the interviewees observed a noticeable change in attitude towards the compliance of medium-sized and large family corporations active cross-border. A possible change towards TP documentation in family-owned enterprises would be relevant as, according to Poza (2013), 80% of companies in Europe are family-owned. IV13 mentioned,

Family enterprises were a bit reluctant to do transfer pricing documentation. Not because they wanted to hide things, not because they need things to hide, not because they did not want to respect the rules. However, [...] they had a feeling that once it (transfer pricing documentation) was documented, it would not be easy to change. They wanted to keep this liberty of adapting the (company's) structure where they thought there was a business reason, not a tax reason. They had the feeling that they were giving up some freedom [...], and now they do not have a choice.

In line with the recent finding of Brühne and Schanz (2018), two interviewees also indicated that the introduction of BEPS 13 causes tax compliance to be part of the overall business strategy and important in high-level decisions:

Now, we see that these topics, certainly as a result of BEPS 13, have moved in the organisation, and it is something which the board of directors and also the CEO is concerned about as of today. That is certainly an evolution which results from BEPS 13. (IV 5 and IV 12)

5.2

Tax planning

As a result of more stringent requirements, obligations and procedures, tax avoidance is being replaced by an increasing focus on tax compliance. This means that taxation would be in accordance with value creation, real activity and substance alignment, which is the principal statement of the OECD concerning TP (Cools & Emmanuel, 2006; Klassen et al., 2017; OECD, 2015c; Piantavigna, 2017; Schön, 2015). Ten tax advisors reveal that the tax planning is less compared to before BEPS 13 and that companies are spending more time on compliance:

Several loopholes have been closed as a consequence of BEPS. [...] So that reduces the opportunity for tax planning. Last but not least, there is the whole climate about tax, and that is where I would like to refer to ‘pay your fair share of tax’. A low-tax jurisdiction without substance and a large profit is just not sustainable anymore. That is a general tendency. Everybody knows that. (IV 7)

By contrast, a minority of the interviewees (2 out 13) stated that the proportion of tax planning costs to overall tax compliance costs has increased. They believe companies might still look for some other solutions in tax planning. For instance:

[...] using the right deductions which are in place in the right countries and putting their people which you need there. So, the pure tax avoidance – they are taking care of it, but it is not that it stopped. It is putting more substance in place than before to make sure that operational reality, profits allocations are fine, but it has not stopped there. (IV 1).

Multinationals are focusing on restructuring the business to either have more substance in low-tax jurisdictions [...] now maybe they (companies) move more into locations with a low tax rate, and they try to put people there to support the profit that sits there. They still seek not to pay too much tax. (IV 8)

5.3

TP compliance costs

Our findings show that compliance with detailed requirements of BEPS 13 demands a lot of resources and effort from corporations. Eleven out of 13 interviewees mentioned that TP compliance is more time-consuming than it used to be before BEPS 13. Moreover, 8 out of 13 interviews stated that the main disadvantage of BEPS 13 is the compliance burden imposed on companies:

So that depends on how the multinational is organised and the tax control framework that is in place. In general, I would say that […] time needed has increased. (IV 3)

[...] TP compliance costs have increased significantly more than just the overall compliance costs. (IV 12)

Moreover, all tax consultants indicated that MNEs must face considerable start-up costs when preparing BEPS 13 for the first time. In line with Hanefah et al. (2001), we further reveal that compliance costs for small firms are more burdensome than those for large firms. Additionally, according to Cressy (2000), these costs are regressive to the size of the firm and higher for small and medium enterprises (SMEs). Some of the interviewees mentioned that TP compliance costs are generally higher for smaller firms, in terms of time and costs, than for larger MNEs:

[...] for smaller MNEs time to spend in proportion has increased more because they did not do a lot before. They started from almost 0 (had no prior TP reporting), and now they are spending some time. (IV 6)

The OECD (2010) shows that the application of TP rules for smaller MNEs may be more complicated than for larger firms and therefore more burdensome. This finding is important as high compliance costs can decline international competitiveness (Göndör, 2011; Sandford, 1995). Several interviewees insisted on having compliance costs proportional to the business size:

It is important that the documentation [...] is in a proportion of the size (of an enterprise). Therefore, I am convinced that the documentation for a smaller company has to be more hands-on than for a big company. I think it is not fair that a small company has to do benchmarks which cost 10,000 EUR or 20,000 EUR. (IV 5)

Another observation made by all interviewees is that companies’ external TP costs have increased as they outsource TP compliance more to external advisors. As IV 1 highlighted,

We more often see that it is (TP compliance) being outsourced […]. Because it is quite difficult to have it internally, considering that everything is evolving very rapidly. So, if you have, let's say, a group active in 40 different countries, BEPS 13 TP documentation requirements have been implemented in those 40 countries in a different way. […] I think most of the companies do externalise it, but nevertheless, they have to have people internally reviewing everything.

Moreover, outsourcing to external advisers is more common for smaller MNEs, which is in line with the findings of Cools and Plesner Rossing (2021). IV 8 claimed that

Smaller firms are more forced to work with outsourcing because they do not have the in-house capabilities, and it depends again on which country they are dealing with [...]. Whereas bigger ones – they have these models. They try to insource people to do compliance monitoring.

When we asked the interviewees about specific costs related to the local and master files and CbC reporting requirements, some interesting insights emerged. First, the ‘local file’, which contains detailed information concerning the intercompany transactions of the local group entity, was highlighted as most burdensome (8 out of 13). According to IV 2, costs for local files vary between 3,000 and 10,000 EUR. Several participants saw the local file as the most intense one:

[…] you have differences in activities, differences in transfer pricing methods, different types of transactions. You have the quantitative aspects that you need to put in amounts. So, the local file is highly intense because it is a much more locally deviating factor. Depending on how many countries, of how many entities you have – that also raises the complexity. So, if you have to group between resources and budgets for the big groups, it is primarily local files.

Second, the ‘master file’ provides high-level information regarding the group's global business operations and should be available in all countries where the MNE operates. According to IV 2, the cost for the preparation of the master file varies from 5,000 EUR up to 50,000 EUR, whereas according to IV 6 and 8, the range varies between 3,000–25,000 EUR and 25,000–75,000 EUR, respectively. Despite the variation in costs, most interviewees agreed on the importance of the master file as it gives a full picture of the multinational itself:

You have to differentiate the first time you do it and the subsequent years. The master file is highly intense because it goes to the heart of your business operations. That's just one document. Once you have that document, starting to prepare local files is normally quite easy. (IV 4)

Finally, CbC reporting applies to parent companies with gross consolidated turnover exceeding EUR 750 million, which would require information such as gross income, profit before tax, income tax paid, and accrued for all entities for each country where the group entity operates (OECD, 2015a). Only 2 out of 13 interviewees stated that the CbC report is the most burdensome, at least for the multinationals who meet the threshold. IV 7 explained that

[...] they have to collect all the financial information from all the various entities, from all the various countries. And if you have many countries in your group, it is a lot of work to collect information and also to get the information aligned [...].

However, other participants believed that CbC is less burdensome as it is something to be done only once for the entire group.

Tax harmonisation – standard rules incorporated in different tax jurisdictions – and a model template for CbC reporting should lessen compliance costs. However, 7 out of 13 interviewees stated that divergent implementation of the master and local files in different countries leads to extra compliance costs and adds complexity. For instance, participants 2 and 6 emphasised a diverse interpretation of the rules in different countries and the lack of harmonisation:

The rules differ: what needs to be in the file, then also in some countries you need to file it. In other countries – you do not need to file it, you need to keep it available. The deadlines differ. […] But it is a bit of a missed opportunity by the OECD that the roll-out of local files was not done in a more harmonised manner because it creates costs uncertainty and a lot of management time to deal with that. (IV 2)

[…] it has gone in many directions, especially concerning the local and master files, thresholds, penalties and type of data that have to be included, and that is a pity. (IV 6)

As also discussed by Bénassy-Quéré et al. (2014), about half of the interviewees recommended increased standardisation, making TP rules more consistent, and making policymakers put more effort into finding an easier and more cost-efficient way to certainty about TP.

5.4

Organisation TP documentation

Another tendency noticed by the tax consultants is the increase in more centralised forms of organisation. This allows integrating managerial decision-making across multiple domestic markets. Interviewee 7 stated,

I guess that businesses will try to centralise the transfer pricing knowledge within the group and set up a central transfer pricing responsible team to make sure that everything is aligned within the group, that is, to manage and control the transfer-pricing policy, centralise the documentation and ensure a consistency that is absolutely an evolution. It has already existed, of course, for many years, but I think that will be the tendency.

Moreover, 7 out of 13 interviewees explicitly stated that the centralised approach is more straightforward in terms of TP documentation:

Because you will have much more standardised transactions, all the entities work with the central entity. We will have a well-defined role. We will be working within well-defined operating guidelines that come from the principal. So, building documentation for one entity that we can replicate for the other entities is much easier.

Consequently, MNEs move more towards automated IT tools to analyse intercompany transactions or assist in centralising TP policies:

I think more and more will be automated. I think we are looking at more efficiency, and that is why the software tools come in. […] MNEs incur large software costs in project management tools, making sure that they meet all the deadlines for all the countries they are active in. (IV 1)

Over the years, tools for international TP have been increasingly implemented; however, MNEs consider them time-consuming and expensive. Furthermore, the fragmentation of the enterprise resource planning (ERP) system complicates the automation of documentation files (Hemling et al., 2022). According to IV 9, a solution towards more cost efficiency could be to implement ERP tools that allow to monitor margins in different countries. Moreover, one fully integrated ERP system within the company was referred to be more convenient compared to several ERP systems. For instance, for the data-gathering purposes of acquired companies’ CbC reporting, having one ERP system, rather than several ERP systems that are not yet harmonised, is preferable (IV 9).

Conversely, according to IV 11, most smaller companies will not be required to introduce or adapt software tools for TP report purposes:

SMEs will not need this complex software tools to be able to manage its transfer pricing, but they had to put transfer pricing reports in place [...]. Smaller companies – they have another level of cost. […] The nature of the cost will be different for an SME. There are fewer software costs or even no software costs.

5.5

Auditing, penalties and disputes

In line with Ackerman and Hobster (2002), the results show that 10 out of 13 interviewees consider TP the number one international tax concern. MNEs tend to fear TP audits and its implications as these are considered burdensome and time-consuming. Most interviewees consider audit risk as an important driver of why companies comply with TP regulations.

Being compliant in general is one of the key concerns of group Tax Advisor or a group CFO, even group management. And when not in compliance, there are the risks of being audited and getting TP adjustments. That's when problems may start. (IV 12)

Conversely, five participants stated that when a company has an adequate TP policy and documentation in place, it is usually not afraid of the TP audit as it is well prepared. Furthermore, IV 1 even emphasised the advantages of BEPS for MNEs as ‘good momentum’ to map all intercompany transactions before a TP audit takes place. Thus, from the companies’ perspective, BEPS 13 could be a way to better manage TP audit risk.

Additionally, BEPS 13 discloses more information to tax administrations than ever before, which gives tax administrations more opportunity to inspect related-party transactions. Twelve interviewees mentioned that BEPS 13 will enable more targeted TP audits. This will probably eliminate random audits and provide a range of variables to analyse and identify taxpayers for an audit:

For the tax authorities, there is also an advantage […] they are doing an assessment on which companies to audit based on a data mining system. […] now in the TP documentation you will see the volumes and types of inter-company transactions. For tax authorities, it will be easier to grab the ‘low hanging fruit’ type of MNEs which have to be audited. […] It is (audit) more targeted. (IV 1)

Half of the participants also highlighted the importance of penalties depending on the specific country. For example, countries such as Italy and Luxembourg have substantial penalties compared to other EU countries. However, compared to penalties, the risk of being audited is considered a more significant driver for compliance:

If you do not comply for a few times, the penalties become significant. I would say that the risk of getting audited should be a bigger driver than the penalty. (IV 12)

Moreover, penalties may increase the risk of a TP audit. According to IV1:

It is not always the amount itself. In Belgium, if you do not complete the form you get a penalty, and the first is 1 250 EUR. [. . .], but it increases the risk of having a transfer-pricing audit, and that is what they fear. I think the penalties, in combination with the fact that it is a trigger for more detailed audit, is what they fear, leading to adjustments that they have not foreseen.

The interviews indicated that possible TP disputes and litigation need to be avoided as they are lengthy and costly. To mitigate potential risks, companies can opt for an Advance Pricing Arrangement (APA), which attempts to prevent TP disputes from arising by determining criteria for applying the arm's-length principle to transactions in advance of those transactions taking place. A prior agreement concerning TP can be unilateral between one tax administration and one taxpayer, or bilateral/multilateral between two or more tax administrations (OECD, 1999). An APA does not only save time and money for the taxpayers and tax authorities, but it also reduces the risk of TP tax audit for several years (Borkowski, 2000). In line with the findings of Osborn and Khripounova (2016), all tax consultants mention that, owing to the increased information disclosure and exchange between countries, the number of APAs will rise. The interviewees expected this increase to be more pronounced for multilateral ones:

There will be an increase of bilateral APAs also to avoid discussions because we cannot predict what tax authorities are going to do between now and five years from now. Business wants to buy certainty, and you can buy certainty with a bilateral APA.

We do see bilateral APAs are on the rise. As for unilateral APAs, I would say are on a decline. They are being scrutinised, and the fact that they are being exchanged is creating many questions in all other countries. [. . .] Belgium is looking at the rulings that are being obtained in other countries, and they do ask questions to local companies based on the rulings that the group has been getting in other countries. (IV 8)

Although most interviewees claimed that unilateral APAs are under pressure, some believed that unilateral APAs are still an excellent tool that can be adopted smartly by applying unilateral APA in a country with the highest TP risk (IV 6). Additionally, IV 11 declared that unilateral APAs are preferential as they take less time compared to bilateral and multilateral APAs:

It is better to go for two unilateral APAs than for one bilateral APA most of the time because bilateral takes longer. So, normally, typically, clients opt for two unilateral agreements.

An alternative dispute resolution could be to apply for a mutual agreement procedure (MAP). The objective of such a MAP is to negotiate and rectify an incorrect application of the international tax treaties to avoid double taxation for both tax authorities of the contracting states (OECD, 2015b). In our study, six interviewees explicitly mentioned that the number of MAPs is increasing and that this evolution of interaction between tax authorities is to be encouraged:

We see an increase in MAP procedures because more TP adjustments are applied in one country. It has an impact – it creates double taxation. So, in any event, it creates more focus on mutual agreement procedures. (IV 7)

So now, what we see is that the Belgian tax authorities are discussing directly with the Dutch authorities to try to agree on a position that they will take, and that is done before the Belgian tax authorities will tax the Dutch company. So, they will first discuss this, really on a case-by-case basis. They are doing this now for several client files and this is sort of a test that they are doing to try and listen to each other's view on matters, to try to learn from each other… That's a very good evolution. (IV 13)

Despite the MAP's potential, the same interviewees also pointed to shortcomings. The main ones cited are that the processing time is too long and costly, that not all cases end with a full resolution of the double taxation and that not all countries include a binding arbitration clause:

They are concerned with the length of the procedures, which are relatively lengthy – that can be improved. One of the action points of BEPS was also to try to improve that, but it remains a concern for them. As I said in the mutual agreement procedure, not all double tax treaties have an arbitration conventional/clause which obliges the two countries to come to an agreement. So, no obligation exists at the European level, and that could also be a problem. (IV 1)

6

Alternative perspective: Tax officials

Although this study focuses on BEPs 13 from a business-oriented perspective, including an alternative stakeholder's view is enriching. As tax officials are on the other side of the spectrum, interviewing them would lead to different or new insights. In particular, we interviewed five senior officials of the Belgian tax authority with a profound knowledge of TP in the fields of audit, international relations or APAs (see interviewees 14–18 in Table 1). The same methodology was applied as described for the tax consultants in section 4. The interviews took place at the interviewees’ offices and were audio-taped, transcribed and coded with their permission. To connect with the tax consultants’ answers, a similar topic list was sent to the tax officials in advance. Although similar themes were questioned, more attention was paid to the topics of audit and APAs as this concerned their daily job activities. See Appendix 1 for the tax officials’ topic list.

6.1

Evolution TP strategy

All tax officials confirmed the tendency that companies are more aware of TP compliance. As IV 15 pointed out:

I think they really find it important. That is for sure. I have the impression that the companies really want to be compliant with the BEPs 13 documentation. That is my impression.

All tax officials agreed that most companies want to be TP compliant. Companies’ substance alignment has increased, and the BEPs 8-10 and BEPs 13 were helpful to this end owing to their increased transparency. However, three out of five officials also indicated that some companies do not change their behaviour of prioritising shareholder value but try to find other loopholes or search for ‘alternative’ substance. Then, in this respect, tax officials are more critical than the consultants interviewed:

What is the definition of substance? If there is really nothing, there is nothing. But they try to, perhaps fake is too hard, create some alternative substance. …. I have had companies with two administrative people in a country, and they say that all important decisions are taken in that board meeting, so there is substance. That is the level of discussions we have now. (IV 14)

With regard to companies’ reputational concerns of tax planning, tax officials did not find it to be a widespread concern among companies but rather an issue to specific companies:

When it becomes too hot for the companies, or they fear some publicity around the APA that is going to be concluded, which they believe will not be accepted by the public, they withdraw. (IV 17)

Some companies have even public CbC … especially in the business to consumer market, especially in that kind of area, they do that. Because then they have their reputation. (IV 15)

6.2

TP documentation and compliance costs

Although BEPs 13 allows tax inspectors to conduct a much more targeted audit, all five officials admitted that the introduction came with high compliance costs for companies. Especially for SMEs who had just passed the thresholds, BEPs 13 was highly burdensome as no TP documentation had been in place before. This view aligns with the findings of the tax consultants’ interviews. Further, the tax officials considered the local and CbC files to be the costliest ones for companies and noticed that, in practice, owing to the high complexity, these BEPs 13 requirements are outsourced to Big 4 and medium consulting firms. According to them, the tax advisory sector is highly involved in all TP-related issues:

They do not have the knowledge in house. It is too complex. I do not think they are capable to do it themselves… …immediately the big four consultants are involved. Per definition. (IV 14)

Interestingly, all tax officials indicated that TP documentation and management control systems are in general highly centralised at the headquarters within groups. For the parent and associated companies, gathering all data is not easy, and the need for appropriate IT platforms is a big issue. One of the officials even suggests that, despite opportunities, the CbC file is not always shared smoothly with the local entities:

And now with the CbC and the local file… that is why I think that the TP documentation is also interesting for the local entities… that they have the global picture and are more aware of their profitability […] What I also have my doubt about, if they (local entities) see the CbC report,… because a lot of headquarters keep that to themselves. (IV 15)

6.3

Audit, penalties and disputes

According to the tax officials, the BEPs 13 documentation gives helpful insights and improves the audit process to a great extent. In particular, the Belgian tax authority developed a new tool to integrate the information of the three files to better select companies with high TP risk. Further, the audit itself has become more targeted, and the use of more tailor-made questionnaires is an example.

Similar to the tax advisors, the tax officials indicated that companies undoubtedly fear an audit, mainly owing to the fact that a considerable amount of money is involved in TP; by contrast, in Belgium, companies do not seem to be afraid of penalties. Thus, two out of five tax officials suggest getting rid of the disconformity between penalty thresholds in different countries to create a same level playing field:

The penalties which are foreseen are meaningless. I think the first infraction is 1,000 euro or something. The third one 20,000 euro… the tax administration is not powerful, you know. (IV 14)

… I believe we have to have the same level playing field. That is the only good approach. (IV 15)

With regard to the evolution of the APAs, the view of the tax officials differed, to some extent, from that of the tax consultants. On one hand, they agreed that the demand by companies for unilateral APAs is decreasing; on the other hand, tax officials are more cautious about the evolution of bilateral and multilateral APAs compared to tax advisors. In particular, they are more likely to expect a similar number in the future or only a slight increase. Two tax officials provided interesting insights into why unilateral APAs are less attractive for companies nowadays:

We see that the European Commission is looking for rulings that we gave to multinational companies, and they are seeing if there is not state aid…. So, that was another kind of fear by companies. (IV 16)

We upload these files (rulings) directly in the exchange ETR database of the European Commission […] It is unilateral, so we do not know what the other country will do, and it happens that in other countries… they do not agree with the outcome of the Belgian tax authorities. (IV 18)

Concerning bilateral and multilateral APAs, tax officials stated that the number has remained rather stable over the years. Bilateral APAs are by far more numerous, whereas only a handful multilateral APAs are into force. However, a tax official pointed out that multilateral APAs could become more popular if new regulations concerning the digital economy (pillar 1) were to be introduced as more countries would be involved as a result of putting taxing rights where the end consumers are located. Nevertheless, the processing time to finalise bilateral and multilateral APAs is problematic. According to IV 17,

[t]o get the approval with regard to bilateral and multilateral APAs, it took an average of 15 months for EU countries and 27 for non-EU countries.

Finally, the tax officials mentioned a huge increase of MAP TP cases. An explanation for this increase is the greater probability of having a TP audit in many countries and, by consequence, a higher probability of double taxation:

… if you see the other countries also, they are building a team specialising TP… And even in Belgium now, we have 40–50 people specialising in TP auditing. Thus, the more auditors you have, the more tax audits, the more double taxation risk exists. (IV 17)

Nevertheless, companies prefer to avoid a MAP. Despite the mentioned obstacles of APAs (and downward trend of unilateral APAs), this instrument remains attractive owing to the legal certainty it offers to companies. All tax officers agreed that APAs will not disappear.

7

Discussion and conclusion

In this study, we interviewed 13 tax experts from leading consulting firms to explore MNEs’ attitude towards the new BEPS 13 regulation and to investigate to what extent this leads to (more) TP compliance. Moreover, to gather the insights of an alternative stakeholder about this topic, we interviewed five senior tax officials. A synthesis of the key findings is presented in Fig. 2. When analysing MNEs’ responses to BEPS 13, we paid attention to the evolution of TP compliance costs and examined the relationship with TP planning. Moreover, we gained interesting insights into the role audits, penalties and dispute resolution mechanisms could play in the decision to be BEPS 13 compliant.

Fig. 2.

Key findings and recommendations for policy makers.

Source: own illustration.

From all interviews, we observe that the focus on TP compliance has increased substantially in the last years. Moreover, several interviewees pointed out that BEPS 13 causes TP compliance to become important in high-level strategic decisions. Another appealing finding is that even smaller companies and family firms, which are often not obligated to prepare TP documentation, are nowadays much more aware; however, these companies regret the stringency of the documentation requirements and prefer more flexibility. Multinationals are also increasingly aware and emphasise the importance of paying their fair share, in addition to endorsing the principle of substance. However, a critical note was raised by the tax officials stating that companies might still look for tax planning solutions despite the increased focus on TP compliance. MNEs could, for example, look for other loopholes or restructure their business to move more substance to low-tax jurisdictions. Nowadays, tax inspectors often discuss whether the indicated substance by companies is real. Therefore, despite BEPs regulations, the fight against tax avoidance remains important.

With regard to the compliance costs associated with the introduction of BEPS 13, we found that it demands considerable resources and efforts from corporations. Companies faced considerable start-up costs, which were more burdensome for smaller firms. In addition to increased internal monitoring costs, the more stringent documentation requirements also caused companies to outsource TP compliance to external advisors owing to the burdensomeness and complexity of the filing. In addition to filing the documentation, these external advisors also offer industry knowledge and interact with tax authorities. Both the tax consultants and tax officials loathed the divergent implementation of the master and local files in different countries (i.e. different filing obligations, thresholds, deadlines and penalties), which leads to more complexity and compliance costs. In general, the local file was considered the most intensive and burdensome. Moreover, the master file was seen as intensive but deserves sufficient attention as it provides an overview of all business operations. A tendency noticed by the participants is the centralisation of TP documentation. To assist in obtaining this goal, MNEs have expressed their need for automated and centralised IT tools, which are, however, costly. A critical note added by the tax officials is that documentation such as CbC is not always voluntarily shared with all group entities; however, it would be an opportunity to have a global picture and map out TP risks.

An important reason why companies want to be TP compliant is the fear for TP audits. BEPS 13 discloses more detailed information to tax administrations, which allows them to better target specific taxpayers for an audit. As a result of a TP audit, substantial adjustments can be required, which is time-consuming and burdensome for companies. The interviews suggested that penalties could act as a trigger for an audit but that it is mainly the audit itself that companies fear. Moreover, both tax consultants and officials highlighted that the amounts of penalties – and by consequence, their efficiency – varies to a great extent between countries, which implies a need for harmonisation.

Finally, the interviewees stressed the importance for companies to avoid TP disputes and litigation. To mitigate possible risks and build in more tax certainty, MNEs prefer to apply for Advance Pricing Arrangements (APAs). However, owing to the increased exchange of information between tax authorities, unilateral APAs have become riskier, and their number is decreasing. From this perspective, tax consultants found that companies opt more for bilateral and multilateral APAs. A considerable benefit of these types of APAs is that they can provide tax certainty, which is a key concern for companies. Nevertheless, tax officials have not yet noticed a substantial increase in the number of bilateral or multilateral BEPs; an important explanation is that the procedure can take up to 2 years. The number of Mutual Agreement Procedures (MAPs) – a mechanism which enables tax authorities of contracting states to consult each other to resolve issues of double taxation – is rising. The more frequent use of this dispute resolution mechanism results from increased tax audits and adjustments worldwide. Though taxpayers consider the possibility of MAPs beneficial, several interviewees indicated that the procedure is lengthy, voluntary in some countries and does not guarantee the resolution of double taxation.

With reference to the theoretical framework explained in Section 3, as suggested by the interviews, rational actor theory, institutional theory and tax morale are relevant in explaining why companies want to be BEPS 13 compliant. In line with the neoclassical model of Allingham and Sandmo (1972), our findings show that MNEs act as rational actors weighting the costs and benefits of TP compliance with those of non-compliance. In general, the cost of being detected seems to outweigh that of complying. Moreover, the results show that the institutional environment plays an important role in applying this balancing act. In particular, formal features such as the introduction of the BEPS 13 documentation rules, a more targeted tax enforcement by increasing the audit risk and a higher chance of litigation push companies to be compliant. Additionally, our study indicates that informal factors such as social and ethical norms, trust and reputation (Alm & Torgler, 2006; Luttmer & Singhal, 2014) become more influential in taking tax decisions. This could have a positive effect on the tax morale of companies – in other words, they could be more intrinsically motivated to pay their tax as they think it is fair and socially responsible.

Finally, the results gained from the interviews can have important implications for policymakers. First, actions could be taken to reduce compliance costs for companies. Points of attention are a more harmonised implementation of the BEPS 13 rules in different countries. Among others, these rules differ regarding the filing obligation, thresholds, content, deadlines and penalties, which causes considerable complexity and costs for MNEs. Additionally, less stringent documentation requirements could be applied for smaller firms to align compliance costs more in proportion to firm size. Moreover, supporting companies in developing and financing centralised ERP systems could be helpful to reduce compliance costs for companies. The interviewees saw benefits in the MAP to combat disputes about double taxation. However, optimisations such as reducing the processing time, including a mandatory arbitration clause and applying the BEPS 14 minimum standards (e.g. peer review) are necessary.

This study has limitations. We approached senior-level tax partners from consulting firms, instead of the companies’ internal tax experts, to conduct our interviews. Nevertheless, as these tax consultants are highly involved in MNEs’ TP compliance, as also indicated by the interviewed tax officials, we believe that their insights largely reflect those of their clients. Another caveat that we cannot rule out is the possibility that some of the interviewees’ answers may be socially desirable. However, by addressing this topic from an alternative perspective when questioning tax officials, we try to counter this and provide a more nuanced story. Finally, although our qualitative study yields interesting and valuable results, these should be taken with caution. A large-scale survey on the measurement of BEPS 13 compliance costs would be an interesting avenue for further research and could add to our findings.

CRediT authorship contribution statement

Annelies Roggeman: Writing – review & editing, Writing – original draft, Validation, Supervision, Methodology, Investigation, Formal analysis, Data curation, Conceptualization. Leila Aro-Sati: Writing – original draft, Software, Methodology, Investigation, Formal analysis, Data curation, Conceptualization. Isabelle Verleyen: Writing – review & editing, Validation, Supervision, Conceptualization.