Explanation of new chapter in Income Tax Rules, 2002 - Transfer Pricing CbC reporting

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1. Summary

1.1) The government of Pakistan via Finance Act 2016 formally introduced documentation and implementation of transfer pricing concept in Income Tax Rules, 2002. However, the implementation of Country-by-Country Reporting (CbCR or CbC reporting) was yet to be finalized.

1.2) In this regard Federal Board of Revenue issued a 'draft' notification No. S.R.O 421(I)/2017, dated the 5th June, 2017 detailing the procedure for CbCR and transfer pricing documentation for Multinational Enterprises (MNE's) with regard to transactions between associates.

1.3) The qualifying Companies and establishments were supposed to comply with the transfer pricing documentation requirements from 1 July 2016. However, as regards to CbCR requirements the same are to be implemented for financial years ending on or after 1 July 2017.


2. Organisation for Economic Co-operation and Development (OECD):


2.1) Although the concept of transfer pricing has always been there since the introduction of arm length principle as prescribed under section 108 of the Income Tax Ordinance, 2001 providing powers to the FBR to distribute, apportion or allocate income, expenditures or tax credits between associates in respect of transactions not made in accordance with the arm’s length principle. 

2.2) However, after the Organisation for Economic Co-operation and Development (OECD) introduced the concept of Base erosion and profit shifting (BEPS) detailing tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. 

 2.3) Pakistan being a member of Inclusive Framework of OECD on developing standards on BEPS is also required to develop a monitoring process for the four minimum standards (Actions 5, 6, 13 and 14). Action 13 of BEPS standards relates to CbC reporting. This became prime reason for incorporation of CBC reporting in the tax laws of Pakistan.

3. S.R.O. 1191(1)/2017 dated 16 November, 2017:


3.1) Federal Board of revenue vide S.R.O. 1191(1)/2017 dated 16 November, 2017 finalized the documentation procedure of CBC reporting by inserting a whole new Chapter - VIA in the Income Tax Rules, 2002.

3.2) The OECD's model of transfer pricing has been adopted in the new chapter consisting of following three-tiered approach:
  • CbCR;
  • Master File; and
  • Local File
3.3) Following information for each country where entities of the Multinational Enterprise (MNE) group operate is must for CbCR: gross income, profit/loss before tax, income tax paid, accrued income tax, the nature of the group entities’ core business operations, and other measures of economic activity. 

3.4) Activities of all entities in each country should be separately disclosed. 

4. System Understanding

4.1) Ultimate parent entity (UPE):
If the ultimate parent entity (UPE) is a resident and the consolidated MNE group turnover equal to or exceeds €750 million, the UPE must prepare and submit a CbCR form to the FBR within 12 months as of the last day of the financial year. 

4.2) Group Entity:
A resident entity that is part of an MNE group should also file a CbCR with the Pakistan tax authorities in one of the following cases:
  • The UPE is not required to submit a CbC report in its country of residence;
  • The UPE is required to submit a CbC report, but there is no automatic exchange of CbCR between Pakistan and the country of residence of the UPE; or 
  • The UPE is required to submit a CbC report, and there is an automatic exchange of CbCR, but due to a systematic failure, no effective exchange of information takes place.
4.3) As discussed above the CbC report is applicable for financial years ending on or after 1 July 2017. 

4.4) Every qualifying Pakistani group entity which is member of an MNE group will be required to prepare a master file and every Pakistani group entity will be required to prepare a local file if it meets the following threshold:
  • Master file: MNE group turnover of more than PKR100 million;
  • Local file: Related party transactions of more than PKR50 million 
4.5) Penalties for non compliance ranges between PKR 2,000 per day of default to 50,000/- under various provisions of the said topic. It may also be 1% of value of transaction or 5% of tax depending on case to case.

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