To address this base erosion and profit shifting, OECD issued a plan in  October 2015 with 15 separate action items that would address different  areas of potential weakness in international tax enforcement. OECD’s  revised guidance emphasizes that the transfer price should reflect actual  economic activities, such as who controls decisions related to risk and  who has the financial capacity to bear risk. Prior OECD guidelines  included risk analysis based on functions performed. Therefore, risk can be used as part of a  contract for the transfer price of an intangible asset to shift profits from  one party in a high-tax jurisdiction to a related party in a lower-tax  jurisdiction, resulting is base erosion. According to OECD and other subject matter specialists, the revised  guidelines are likely to be an improvement over prior guidelines in  reducing BEPS if it encourages MNEs and tax authorities to ensure that  transfer prices are set based on real economic activity. The guidelines  underscore the focus on supporting contractual agreements with  economic activity. As we noted  earlier, the arm’s length price is based on treating transactions between  related parties as if they were unrelated. Unrelated parties can isolate this risk while related parties  cannot and this difference in the ability to transfer risk makes the  application of the ALP more difficult. Treasury and IRS officials  stated that among the factors relevant to determining whether a purported  risk allocation has economic substance are (1) whether the pattern of the  taxpayer’s conduct over time is consistent with the risk allocation, (2)  whether the taxpayer has the financial capacity to assume the risk, and  (3) the extent to which the parties exercise managerial or operational  control over the business activities that directly influence the amount of  income or loss realized. In addition,  the revised guidance may be less likely to be effective in helping to  reduce BEPS because, without considering risk incidence, an uncertainty  about the correct transfer prices remains that could allow profit shifting. The Revised Guidelines Effect on IRS Administrative Costs is Likely Small, But The Effect on Compliance Costs for U.S. MNEs is Uncertain

OECD revisions to the transfer pricing guidelines are currently being  implemented so no data are available to estimate prospective  administrative and compliance costs for IRS and U.S. MNEs. According to Treasury officials, the revised guidance would not have a  significant effect on U.S. tax administration because current U.S.  regulations already embody both the arm’s length standard and the role  of functions performed, assets employed, and risks assumed in  determining arm’s length prices between related entities. Though evidence on how corporations shift profits in  response to tax rates varies by study, the amount is generally low. Transfer Pricing Documentation and Country-by-Country Reporting

		Country-by-Country Reporting Will Improve Transparency For Tax Authorities but May Have Unintended Consequences

One factor contributing to base erosion and profit shifting has been a lack  of consistent information on MNEs’ business activities across tax  jurisdictions. According to OECD, the new transfer pricing documentation  addresses this deficiency and benefits tax authorities by providing  information on MNEs’ business activities that can be used to assess the  risk of profit shifting and improve the deployment of audit resources. While Treasury officials said their current documentation and reporting  requirements are sufficient for transfer pricing administration, they will be  implementing one tier of the transfer pricing documentation. Administrative and Compliance Costs of Country-by-Country Reporting Are Uncertain, but Could Be Mitigated. IRS Costs to Implement and Administer CbC Reporting Are Likely to Be Similar to Costs of Other Regulatory Changes of Comparable Scope and Complexity

Because IRS does not intend to require the master file or local file  reporting of the OECD approach, its cost of adopting BEPS transfer  pricing documentation is essentially the cost of adopting CbC reporting. These operational costs will be  affected by the number of CbC Reports IRS receives from U.S. and non- U.S. MNEs in addition to the number of CbC Reports from U.S. MNEs  that IRS will need to transmit to other tax authorities. The arm’s length principle (ALP) is widely accepted for evaluating transfer  prices and is applicable in many transactions. However, this principle  has limitations that make its application to risk allocation problematic. Agency Comments

We provided a draft of this report to the Commissioner of Internal  Revenue and the Secretary of the Treasury for comment. IRS and Treasury also  provided technical comments, which we incorporated where appropriate.
Why GAO Did This Study

Globalization has increased incentives for multinational corporations to shift profits from country to country to use differences in the countries' corporate tax systems to reduce taxes. This profit shifting can lead to the erosion of U.S. and other countries' corporate tax bases, reducing tax revenues. OECD did a comprehensive analysis of corporate base erosion and profit shifting and, in the fall of 2015, issued 15 action plans to address the problem. GAO was asked to analyze the effects on the U.S. economy of adopting OECD actions.
GAO analyzed the potential effects of the two actions furthest along in implementation: revised transfer pricing guidelines and new transfer pricing documentation, including country-by-country reporting. For these actions, GAO examined (1) how likely it is that the action would reduce BEPS, (2) what is known about the potential administrative and compliance costs of the action, and (3) what is known about the potential effects the actions could have on the U.S. economy. GAO reviewed documents, conducted a literature review, and interviewed officials from IRS, the U.S. Department of the Treasury, OECD, and trade groups of industries likely to be affected by the actions.

What GAO Found

In 2015, the Organization for Economic Co-Operation and Development (OECD) issued revised guidelines, including 15 actions to help reduce base erosion and profit shifting (BEPS) of multinational enterprises (MNEs). One action focuses on transfer pricing guidance with the intent of aligning MNE profits with the location of economic activity, and preventing corporations from shifting and assigning profits to lower-taxed related corporations by artificially setting below-market transfer prices of property and services. Another action makes MNE activities more transparent, through documentation and reporting shared among countries.
Transfer Pricing Guidance : OECD's guidance emphasizes that transfer price analysis should reflect actual economic activities, such as who controls decisions related to risk and who has the financial capacity to bear the risk. This clarifies prior guidelines, which also included risk analysis based on functions, but that now focus on the parties' ability to control and finance risk. GAO found that
OECD's revised guidance may reduce BEPS if it encourages MNEs and tax authorities to ensure that transfer prices are based on real economic activity. U.S. regulations consider risk as part of the analysis of transfer prices. The arm's length principle, which treats transactions between related parties as if they were unrelated, is widely accepted for evaluating transfer prices. However, its application to risk is problematic because related parties cannot transfer risk the way unrelated parties can. Without addressing the application of the arm's length principle under these situations, uncertainty about the correct transfer prices may allow for continued BEPS.
Administration costs of implementing the guidelines will be minor according to Internal Revenue Service (IRS) officials because IRS's transfer price reviews are consistent with the revised guidance. However, taxpayer compliance costs are uncertain because they will depend on how MNEs respond to the revisions.
According to stakeholders and industry literature, U.S. employment and investment are unlikely to be significantly affected because the transfer pricing guidance affects a relatively narrow area of the tax code.
Transfer Pricing Documentation and Reporting : OECD's guidance includes new country-by-country (CbC) documentation and reporting actions where information on MNEs activities in different countries will be shared among the countries' tax authorities. GAO found that
CbC reporting may decrease BEPS because more consistent information will be available to tax authorities on the worldwide activities of MNEs.
According to IRS officials, CbC implementation costs are uncertain at this time, but can be mitigated by using existing systems and processes. However, MNE compliance costs would likely increase due to new data system needs, according to stakeholders.
The economic effect of CbC reporting is uncertain because it depends on the extent to which MNEs move business functions to low-tax countries in response to the potential increased scrutiny of BEPS.

What GAO Recommends

GAO does not make recommendations in this report. GAO provided a draft of this report to IRS and Treasury for review and comment. IRS provided technical comments, which were incorporated, as appropriate.