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ICAP: A New Paradigm in Transfer Pricing Certainty

Transfer pricing is increasingly viewed as a top concern for tax audits. Disputes in this area can be expensive, time-consuming, and disruptive, and they can significantly affect the performance of multinational enterprises (MNEs). Previously, Advanced Price Agreements (APAs) were the primary tool for MNEs seeking to ensure certainty in transfer pricing. The Organisation for Economic Co-operation and Development (OECD) has recently established a new program aiming at assisting MNEs manage transfer pricing risk so called the International Compliance Assurance Program (ICAP). Similarly, to APAs, ICAP is a voluntary program intended to help MNEs managing transfer pricing risks proactively.

This article will provide with a brief background, followed by an overall explanation of ICAP, then give a high-level comparison between ICAP and the APA option, and some final thoughts on what can be expected in terms of its adoption.

The OECD BEPS Plan

The BEPS (Base Erosion and Profit Shifting) Plan originally published in 2015 consisted of a series of 15 specific action items developed by the OECD to address issues related to tax avoidance by multinational enterprises (MNEs). As of today, over 137 countries have joined (participant countries) the OECD/G20 Inclusive Framework on BEPS created in 2016 as a broader effort to implement the BEPS Plan recommendations [1]. At their core of the BEPS Plan is the increase of tax transparency. Specifically, Action 13: Country by Country Reporting (CbCR) [2] and Action 14: Mutual Agreement Procedure (MAP) provide minimum standard recommendations to enhance tax transparency.

The CbCR requires the parent of MNEs to disclose aggregate data on the global allocation of income, profit, taxes paid, and economic activity amongst tax jurisdictions in which MNEs operate in such a standardized way that can be shared with tax administrations for use in high-level transfer pricing and BEPS risk assessments. Whereas, the MAP seeks to improve the resolution of tax-related disputes between jurisdictions [3]. The first exchanges of CbCRs took place in June 2018. According to the OECD, tax administrations are incorporating CbCRs into their tax risk assessment and assurance processes to get a better understanding of the risks their jurisdictions are exposed to. Precisely, the CbCRs are expected to be a key element of the alternatives available to provide greater tax certainty to MNEs, including the OECD ICAP.

OECD ICAP

The OECD ICAP was launched to be a voluntary risk assessment and assurance program that helps MNEs to obtain increased certainty over their transfer pricing and other international tax issues. The first roll-out of ICAP was announced in December 2020, following two pilots initiated in 2018 and 2019 [4]. Its main goals include being a faster and clearer route to multilateral tax certainty for MNEs as well as an effective and collaborative alternative to dispute resolution to reduce the inventory of MAP cases. It also aspires to prevent unnecessary tax disputes while using tax authorities resources efficiently.

Currently, 22 countries currently participate in the ICAP process [5]. The OECD is continuing to work to expand the number of participating countries, particularly in Asia, Africa, and South America.

The ICAP process comprehends 3 stages: Stage I – Selection (two application deadlines each year March and September), Stage II – Risk Assessment and Stage III – Outcomes. During the Selection Stage, the ICAP process is initiated with a request from an MNE group to its lead tax administration which ultimately decide if they will join the MNEs group’s ICAP (between 4 to 6 weeks). The Risk Assessment Stage starts with the delivery of a standard package of documentation (between 20 to 36 weeks). During the Outcomes Stage, each tax administration will issue an outcome letter containing the outcomes of its risk assessment, concluding if the covered transactions are considered low risk in which case tax administration does not anticipate any additional enquiries to be needed for the periods covered by the risk assessment (between 4 to 6 weeks).

The following figure prepared by the OECD summarizes the ICAP process.

Figure 1: The ICAP Process [6]

ICAP in the United States

[7] Soon after the OCDE released ICAP Frequent Asked Questions (FAQ) on its website in 2021, the Internal Revenue Service (IRS) did the same showing its support to this initiative while providing further information.

The IRS recommends starting with an initial consultation before submitting the application package which typically includes the MNE Group’s most recent CbCR, master file, transfer pricing reports and financial statements. IRS will review all transfer pricing transactions in which the United States is a counterparty, even if the jurisdiction in which the counterparty is located is not participating in ICAP. While transactions subject to pending and completed bilateral APAs will be excluded from review in ICAP.

There is no fee for an U.S. MNES to participate in the ICAP, however the acceptance cannot be guaranteed. IRS will consider several factor in assessing suitability for ICAP as for instance the type and materiality of the MNE group’s covered transactions and the MNE group’s transfer pricing examination history with the IRS.

In the case the IRS concludes that a transaction is no low-risk and instead presents a potential compliance risk, it will not necessarily lead to an examination. An optional issue resolution process is offered for the MNE and the relevant tax administrations to reach an agreement within the ICAP process on the tax treatment of a covered transaction. Furthermore, issues that cannot be resolved in ICAP may be addressed through other traditional dispute resolution processes as appropriate, bilateral/multilateral APA.

In April 2023, the IRS released the memorandum to IRS Treaty and Transfer Pricing Operations (“TPPO”) titled “Interim Guidance on Review and Acceptance of Advance Pricing Agreement (APA) Submissions” which created a prefiling review process regarding the suitability of the case for the APA process. Under this new approach the IRS will review the taxpayer APA request with the potential outcome of the recommendation for the taxpayer’s case to the alternative solutions of ICAP or joint audit. The IRS is expected to soon release the highly anticipated revised APA revenue procedure.

ICAP versus Other Alternatives to Increase Tax Certainty

The OECD’s Transfer Pricing Guidelines recognizes the APAs [8] as the best tool available to increase the level of transfer pricing certainty between jurisdictions, since they have proved to be able to reduce double taxation situations and proactively prevent transfer pricing controversies.

ICAP and APA programs have similarities, both are voluntary tools aiming at increasing transfer pricing certainty. Both programs require taxpayer participation and the involvement not only of professional staff with deep understanding of transfer pricing procedural aspects but also entail discussions between governments. This latter may discourage the adoption of unreasonable positions by participant governments on the transfer pricing issues.

ICAP and APA programs can also differ significantly. The level of legal certainty an MNE group obtains from ICAP is less than from an APA, however the timeframe for an ICAP risk assessment is considerable shorter, 6 to 12 months compared with 3 to 4 years for a bilateral APA. ICAP potentially covers all of an MNE group’s transfer pricing positions risks in covered jurisdictions, rather than only over specific transactions included in an APA. Also, under ICAP, risk assessment opinion is typically provided by 6 to 8 tax administrations, rather than just 2 under a bilateral APA. ICAP can be considered more advantageous in relation to costs, since preparing and participating in the program are low compared to the costs of participating in APAs. In addition, ICAP do not require as many resources from MNE since its documentation requirements generally include information MNEs have already available and interaction with tax administration is more expeditive.

The ICAP is not a replacement for a bilateral or multilateral APA, but may complement these tax certainty tools by providing a straightforward alternative to greater risk mitigation for certain intercompany transactions. Furthermore, the ICAP may help to identify the transactions worthy to be covered under an APA and also may be a less resource intensive alternative for an APA renewal.

Conclusion

Despite the ICAP program is still new and the number of ICAP processes conducted is relatively small, it has already been welcomed by an increasing number of tax authorities and has proved itself to be a viable multilateral transfer pricing certainty option. Statistics about the ICAP program recently released by the OECD [9] show the ICAP is not only faster than APA and MAP processes but also can offer the option of informal dispute resolution.

The ICAP alternative may be more attractive to MNEs than APA in certain circumstances.

For further information please contact:

Sophia Castro
Transfer Pricing Manager
Marcum LLP*, Windsor,Colorado, USA
Email: sophia.castrojurado@marcumllp.com

[1] Action 8, addressing intangibles; Action 9, providing guidance on the allocation of risks and capital in transfer pricing arrangements; Action 10, proposing changes to the transfer pricing rules related to low-value intra-group services; and Action 13, recommending a new standard for transfer pricing documentation.

[2] Action 13 introduced a three-tiered approach for transfer pricing documentation, including the preparation of not only a CbCR but also a master file, and a local file.

[3] Action 14 consists of 21 elements and 12 best practices in the following four key areas: i. preventing disputes; ii. availability and access to MAP; iii. resolution of MAP cases; and, iv. implementation of MAP agreements.

[4] In February 2021, the OECD Forum on Tax Administration (FTA) released the ICAP Handbook, prepared based on feedback from tax administrations and MNE groups, including those with direct experience from the two pilots run in 2018 and 2019 with 8 and 19 participating tax administrations respectively.

[5] Australia, Austria, Belgium, Canada, Colombia, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Luxembourg, Netherlands, Norway, Singapore, Poland, Russia, United States, Spain, and United Kingdom.

[6] Downloaded from https://www.oecd.org/tax/forum-on-tax-administration/ICAP-awareness-session-2021-presentation.pdf

[7] Source: International Compliance Assurance Program (ICAP) Frequently Asked Questions downloaded from https://www.irs.gov/businesses/international-businesses/international-compliance-assurance-program-icap-frequently-asked-questions.

[8] APAs are a voluntary legally binding agreements between a taxpayer and the tax administration determining transfer pricing methodology for future years. APAs can be unilateral (between the taxpayer and one tax authority) or bilateral BAPA (between the taxpayer and two or more tax authorities).

[9] ICAP Results and Statistics (October 2023) presented during the OECD Tax Certainty Day webcast released by the OECD on November 14, 2023.

*Marcum LLP is the exclusive associated partner of ECOVIS International for accounting, tax and audit in the United States of America.

Expectations for the Mexican Fiscal Year 2024

For the fiscal year 2024, no changes are expected to the Mexican tax framework. This means that there will be no new taxes created or existing tax rates increased. There will also be no changes to the Income Tax Law (ITL), Value Added Tax Law (VATL), Special Tax on Production and Services Law (STPSL), or Federal Fiscal Code (FFC). Additionally, there will be no changes to the existing tax incentives.

Despite the lack of changes to the Mexican tax framework, there are a few other considerations which should be noted by taxpayers for the 2024 fiscal year.

1. International tax agreements: The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) and the Agreement to Avoid Double Taxation of the Pacific Alliance (AAP) will come into effect in Mexico in 2024. These agreements will impact how taxes are applied to cross-border transactions.
2. Case laws of the judicial bodies: During 2023, the Mexican judicial bodies issued a number of rulings on tax matters. These rulings will be binding in future cases involving similar issues. Some of the most relevant rulings include:
   1. Controlling beneficiary (Ultimate Beneficial Owner (UBO)): The courts upheld the constitutionality of the power of the tax authorities to request information on controlling or UBO’s under the Tax Administration Miscellaneous Resolution.
   2. Technical assistance is not a business profit for Income Tax Treaty between Mexico and the Netherlands purposes: Income earned by a resident of the Netherlands from technical assistance will not be considered business profits. In this regard, it was resolved that, if the concept of technical assistance is not included in the Agreement or within the income regulated separately therein, it does not mean that said income is business profits and, therefore, under the terms of the Agreement itself, the meaning attributed by domestic legislation must be taken into consideration and applied. In this sense, domestic legislation, on the one hand, defines technical assistance as an independent personal service and, on the other, establishes that it is not a business activity; thus, for the purposes of the Agreement, the income derived from said assistance should not be considered business profits, but in addition the income obtained by a tax resident of the Netherlands, due to technical assistance services, must be taxed in Mexico as royalties, subject to 25% withholding.
   3. Proof of the actual conducting or materiality of transactions: The evidence, proofs, or records which demonstrate the materiality of transactions supported by CFDI’s (tax receipts or invoices) must be objective and reasonable in accordance with the nature of the transaction being verified, the specific formal conditions of the act, and the characteristics of the fact to be proven. The tax authorities cannot require evidence that is excessive or disproportionate.
   4. Cancellation of CFDI: The courts ruled the unconstitutionality of the provision that prohibits the cancellation of CFDI in subsequent periods to those in which they were issued. Nonetheless, it is important to note that this unconstitutionality judgement does not have general effects, so it only applies to taxpayers who filed a timely or within the legally established deadlines the appropriate means of judicial protection (constitutional trial).
   5. Civil offset is not a form of payment of VAT: Civil offset is not a form of payment of VAT which grants to taxpayers the right to request a VAT refund of the balance in favor or crediting of the tax. This is because offset only determines when the VAT obligation arises, but does not generate its credit, since for this the VAT must have been effectively paid to the tax authorities. Therefore, it is important to take this criterion or case law into account and, if necessary, avoid compensation operations that credit or transfer VAT, since the tax authorities may reject refunds that have not been subject to verification powers, as well as make observations of the creditable VAT determined in the monthly payments, and even if they were to deny the creditable VAT, they may also pretend to reject IT deductions linked to said VAT.
   6. VAT crediting on the capitalization of liabilities: For the VAT crediting and refund of the balance in favor to be granted, the tax must be paid in cash, bank transfer, or check, which also is met when the tax has been filed or declared and paid to the tax authorities, without authorizing the payment of the tax through the capitalization of the liability or debts, through the equity issuance, since this is not authorized in the VAT Law. In that sense, if it is intended to cover the tax through the issuance of shares, it does not meet the requirements to be considered effectively paid and, therefore, the refund of the balance in favor that may be generated does not proceed nor its crediting.
   7. Deducibility of investments: Investments are deductible when they are paid and according to the maximum amortization percentages established in the ISR Law.
3. Electronic audit: The new forms of auditing by the tax authorities through electronic means will continue, mainly the cross-checks between tax returns submitted and the issuance of electronic tax receipts that are in the possession of the tax authorities. Therefore, it is advisable that taxpayers conduct periodic tests to ensure that there are no errors in the information reported to the tax authorities.
4. Nearshoring: From October 12, 2023, to 2024, tax incentives will be applicable for income tax purposes in nearshoring operations of taxpayers located in Mexico from key sectors of the export industry. These incentives consist of the immediate deduction of investment in new fixed assets and the additional deduction of training expenses. This will allow foreign companies to see Mexico as a favorable destination to establish their operations and take advantage of the tax benefits granted. These incentives will be applicable, under certain requirements, for investments that taxpayers maintain in use for a minimum period of two years immediately following the year in which the immediate deduction is made.

For further information please contact:

Cristina Contreras
Tax Manager
ECOVIS Mexico, Mexico City, Mexico
Email: cristina.contreras@ecovis.mx

Kennya Ramírez
Tax and Legal Consultant
ECOVIS Mexico, Mexico City, Mexico
Email: kennya.ramirez@ecovis.mx

New Beneficial Ownership Reporting Requirements for Small Businesses

Starting on January 1, 2024, certain small businesses will be required to disclose information about their beneficial owners to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). The new requirements, implemented by the Corporate Transparency Act and related Treasury regulations, are meant to combat money laundering and other illicit activity by making it difficult for bad actors to hide their identities through the creation of shell companies.

The beneficial ownership reporting requirements will apply to entities formed after January 1, 2024, as well as to existing businesses.

Which Companies Must Disclose Beneficial Ownership Information?

“Reporting Companies” are entities that must make beneficial owner disclosures to FinCEN. Reporting Companies include:

• domestic entities that are created by filing a document with a secretary of state or similar office; and
• foreign entities that are registered to do business in any state or tribal jurisdiction through the filing of a document with the secretary of state or similar office.

Exemptions

There are 23 exemptions from the Reporting Company definition listed at 31 CFR §1010.380(c)(2), which generally exempt entities that are already subject to similar reporting requirements. For example, entities that file reports with the Securities Exchange Commission are exempt, as are banks, insurance companies, registered Investment Advisors and pooled investment vehicles managed by registered Investment Advisors. Tax exempt entities, including charitable and split-interest trusts described in §4947(a) of the Internal Revenue Code, are also exempt.

Additionally, there is an exemption for “large operating companies.” To fall under this exemption, the company must:

• employ more than 20 full-time employees in the United States;
• have an operating presence at a physical office in the United States; and
• have more than $5 million in gross receipts or sales in the United States, as reflected on a United States income tax return.

Finally, a wholly owned or controlled subsidiary of most exempt entities will also be exempt from the definition of Reporting Company.

Trusts

Although trusts are not explicitly exempt from the Reporting Company definition under the regulations, other than charitable or certain split-interest trusts, most trusts do not meet the definition of Reporting Company as they are not created by the filing of a document with the secretary of state or any similar office. However, the trustee, grantor and/or beneficiary of a trust may be considered a Beneficial Owner and subject to the reporting requirements, as discussed below.

Who Qualifies as a Beneficial Owner?

A “Beneficial Owner” is any individual who either (i) owns or controls at least 25% of the ownership interests of a Reporting Company or (ii) who, directly or indirectly, exercises substantial control over a Reporting Company.

Ownership or Control of Ownership Interests:

To determine whether an individual owns or controls at least 25% of the company’s ownership interests, the Reporting Company should consider equity, and any instruments that convert into equity, to be ownership interests that are held, directly or indirectly, by the relevant individual. Additionally, Reporting Companies should treat all options as presently exercised when determining whether an individual meets the 25% threshold.

As discussed further below, in some situations, the ownership interests held by an entity may be imputed to the individual holding interests in such entity.

Substantial Control:

The regulations incorporate a very broad definition of “substantial control.” For instance, control can be exercised through board representation, ownership of a majority of the voting power of a Reporting Company or other relationships or contracts. The regulations indicate that an individual has substantial control over a Reporting Company if such person:

• serves as a senior officer of the Reporting Company;
• has authority over the appointment or removal of senior officers or a majority of the board;
• directs, determines, or has substantial influence over important decisions of the company; or
• has any other form of substantial control over the Reporting Company.

What if an Individual Holds Ownership Interests of a Reporting Company though an Intermediate Entity or Multiple Intermediate Entities?

An individual may indirectly own or control an ownership interest in a Reporting Company through “any contract, arrangement, understanding, relationship or otherwise.” In particular, an individual might indirectly own or control an ownership interest in a Reporting Company through ownership or control of one or more intermediary entities which separately or collectively own or control ownership interests of the Reporting Company. For example, an individual who holds a 30% interest in a Reporting Company through a limited liability company that is wholly owned and controlled by the individual will be deemed a Beneficial Owner of the Reporting Company.

If the intermediary entity is exempt from the definition of Reporting Company under the regulations, then an individual who would qualify as a Beneficial Owner of the Reporting Company exclusively by virtue of such person’s ownership interests in such exempt entity does not need to be listed as a Beneficial Owner of the Reporting Company. Instead, the name and information of the exempt entity can be listed. Notably, this exemption from Beneficial Ownership reporting does not apply to individuals who exercise substantial control over the Reporting Company. In that case, the individual would still need to be listed as a Beneficial Owner of the Reporting Company.

What if an Individual Holds Ownership Interests of a Reporting Company through a Trust?

A trustee, beneficiary and/or grantor of a trust may indirectly own or control ownership interests of a Reporting Company held by a trust.

In particular, the trustee of a trust will be considered to own or control any ownership interest in a Reporting Company that is held in the trust.

The beneficiary of a trust will be deemed to control any ownership interests held by the trust if the beneficiary:

• is the sole permissible recipient of trust income and principal; or
• has the right to demand a distribution of or withdraw substantially all of the trust assets.

A grantor or settlor of a trust who has the right to revoke the trust or otherwise withdraw trust assets will also be deemed to control any ownership interest held by the trust.

Even if a trust is designed in such a way that the beneficiary or grantor does not legally control the relevant ownership interests, such person may have substantial control over the Reporting Company, triggering the reporting requirement. Substantial control can be direct or indirect and can arise from “contract, arrangement, understanding, relationship, or otherwise.” So if a beneficiary is using its relationships with trustees to control the actions of the Reporting Company, such beneficiary’s information may still need to be reported to FinCEN.

When do Reporting Companies Need to Make Filings with FinCEN?

If a Reporting Company is formed on or before December 31, 2023, then the entity must file a report with FinCEN between January 1, 2024 and January 1, 2025. If a new Reporting Company is formed on or after January 1, 2024, that entity must make a filing within 30 days of creation of the business (for domestic Reporting Companies) or within 30 days of registration within the United States (for foreign Reporting Companies).[1]

As described below, Reporting Companies must disclose information about the company itself as well as the Beneficial Owners of the company. If any of the disclosed information related to the Reporting Company or Beneficial Owners changes after a filing is made, an updated filing must be made with FinCEN within 30 days of the change.

What Will be Disclosed to FinCEN?

Reports made to FinCEN will include basic information about the Reporting Company: its name (including any trade or DBA name), address, jurisdiction of formation or registration and tax identification number. It will also include the name, date of birth, and residential address of the Beneficial Owners as well as a unique identifier from a U.S. passport, state driver’s license, state, tribe or other government identification document or a foreign passport. All Beneficial Owners will also be required to submit a copy of the document from which the unique identifier was obtained.

The same information required of Beneficial Owners will also be required for each “Company Applicant” of Reporting Companies formed on or after January 1, 2024. The Company Applicant is the individual who (i) directly files the document which creates or registers the entity and (ii) if different from the person described in (i), the person who is primarily responsible for the filing of the document that creates or registers the entity If the disclosed information related to the Company Applicant changes after the initial filing is made, the Reporting Company will not be required to submit an updated filing to FinCEN.

Who Can View the Information Disclosed to FinCEN?

Reports made to FinCEN are held in a secure database that can only be accessed by certain Federal and state agencies. The agencies must make a specific request and follow special procedures to view the beneficial ownership information collected by FinCEN. Financial institutions can also view beneficial ownership information if the Reporting Company consents to such access.

Penalties for Violations

It is unlawful for a Reporting Company to fail to file a report with FinCEN, and it is also unlawful to report incorrect information. Any person that refuses to provide required information, fails to file a report or reports incorrect information may be subject to civil fines of $500 for each day of noncompliance and could be fined up to $10,000 or imprisoned for two years, or both.

For further information please contact:

Marissa Higdon
Pryor Cashman*, New York, NY, USA
Email: mhigdon@pryorcashman.com

[1] On September 27, 2023, FinCEN issued proposed rule RIN 1506-AB62 that would extend the 30-day initial filing requirement to a 90-day requirement, but only for entities formed in the 2024 calendar year. Public comments.

Ecovis cooperates with Pryor Cashman LLP (www.pryorcashman.com), a full-service, US-based law firm with offices in New York City, Los Angeles and Miami.