Master file – Why should each international company prepare it?

During preparation of Local transfer pricing (TP) file for your company, has your TP consultant asked whether your group has prepared a master file? Master file is a report on a multinational/international (MNE) group or its division, usually prepared by the parent company. This file provides information on group’s international business activities and its transfer pricing policies on the most usual transactions between its members.

In our vast transfer pricing practice, we have dealt with both domestic and international clients, both SME and large companies. In our experience, the most challenging clients are international companies engaging in certain intercompany transactions each year who had not precisely defined the terms of these transactions previously. We would realise that these clients do not have adequate answers on questions such as:

  • What is the acceptable profit level for each member of the group?
  • What are transfer pricing risks for each member of the group?
  • How to avoid double taxation?
  • Is there a way to optimise intercompany transactions in order to minimise group’s effective tax rate?
  • What price should be charged when selling goods to another group member?
  • What are the costs of providing intercompany services?
  • How to calculate the price of intercompany services?
  • What should be an interest rate on intercompany loans?

Usually, when an international client cannot answer most of previous questions, preparation of local TP file takes more time and resources and, in the end, leads to higher tax risk and/or adjustment of taxpayer’s tax base. These and many other problems regarding intercompany transactions may be answered through master file. Whether it is demanded by the tax jurisdiction or not, we are going to explain why each group with international activities should prepare master file.

The purpose of master file

As it is stated previously, the goal of master file is to present transfer pricing policies for the most significant and the most common intercompany transactions within MNE group. By implementing TP policies from master file, the MNE group ensures consistent approach in solving issues on intercompany transactions each fiscal year.

In addition, master file should provide detailed information on:

  • the nature of group’s international business operations
  • overview of economic activities within the group. Namely, it is necessary to provide information how the functions are split between group members. Who is responsible for research and development (R&D)? Who creates intangibles? Who is responsible for production? Who is responsible for distribution? Who provides financing?

Master file is described in detail in OECD Transfer Pricing Guidelines (2017). The goal of master file and other transfer pricing documentation (Chapter V – Documentation) is to show transparency on tax structures to the tax authorities.  To be more specific, being transparent has following benefits:

  • MNE group signals tax authorities that it gave appropriate consideration to transfer pricing issues in order to be in line with the arm’s length principle
  • Tax authorities will deem MNE groups which are more transparent on TP policies to be less oriented towards tax avoidance and tax evasion. Therefore, such MNE groups are less prone to tax audits and consequently, tax penalties

Structure of master file

According to the OECD Transfer Pricing Guidelines (2017), the main parts of master file are:

  • The MNE group’s organisational structure
  • Description of MNE’s businesses
  • MNE’s intangibles
  • MNE’s intercompany financial activities
  • MNE’s financial and tax position

The MNE group’s organisational structure

This part of master file should include information such as:

  • Ownership structure
  • Legal structure, i.e. the list of companies which are group members
  • Geographical locations (countries) of group members
  • Overview of MNE group’s division (geographical units, business units etc.)

The main purpose of this part of master file is to identify and delineate MNE group for which TP policies will be defined. Master file may be prepared for the whole group or for the division.

Description of MNE’s businesses

Information that should be presented in this part of master file are:

  • Detailed description of MNE’s business model, including important drivers of business profits
  • A description of supply chain for the group’s largest products and services
  • A list and brief description of important service agreements between MNE members (excluding research and development agreements)
  • Description of the main geographic markets for group’s products and services
  • Functional analysis: firstly, the manner in which value is created inside the group should be described. Secondly, distribution of key activities performed, important risks assumed and important assets engaged between group members should be described
  • Important business restructurings (i.e. transfer of assets between group members), acquisitions and divestitures during fiscal year

Main goal of BEPS regulation, which includes this description of master file, is to align generating profit in the group with the process of value creation. To be more accurate, the group member who contributes more in value creation (i.e. undertakes more significant activities, engages more assets, assumes more important risks) has the right to higher level of taxable income in accordance with the arm’s length principle. In this part of master file, information on value creation is provided. After reading this chapter, we should get more clear idea which group members contribute more to value creation and therefore deserve higher level of taxable income.

MNE’s intangibles

Description of MNE’s intangibles should include following information:

  • Overall strategy of developing and exploiting intangibles. Where are main group’s research and development (R&D) facilities? Which group members manage and control R&D activities?
  • A list of intangibles owned by MNE. Which legal entities own them?
  • A list of important intercompany agreements on intangibles. Examples could be agreements on R&D, licence agreements and cost contribution agreements (CCA)
  • General description of TP policies regarding intangibles and R&D
  • Important intercompany transfers of interests in intangibles during fiscal year

In highly digitalised and globalised business environment, one of the most important profit drivers are intangibles (brand, patents, licences, market reputation, market position, relations with customers and suppliers etc.). Therefore, the group member who has contributed more to creation and development of intangibles has the right to a higher level of taxable income in accordance with the arm’s length principle. By reading this chapter, we should get information which group members mostly contribute to the creation of the group’s intangibles.

MNE’s intercompany financial activities

In this chapter, information on financing sources of MNE group and its members is presented:

  • How the group is financed? (important financing arrangements with independent parties)
  • How are financing functions distributed between group members?
  • General transfer pricing policies regarding intercompany loans and other financial arrangements

The purpose of this chapter is to provide general information on how intercompany financial transactions are structured.

MNE financial and tax position

In the final chapter, following information should be presented:

  • The MNE’s annual consolidated financial statements
  • Description of the MNE group’s existing unilateral advanced pricing arrangements (APAs) and other tax rulings which may have effect on allocation of income among countries

The purpose of this chapter is to present total MNE group’s income and the manner in which it is distributed among members.

Final remarks

WTS Serbia is one of the leading transfer pricing practices in Serbia. We have an extensive experience in providing consulting services on transfer pricing to international companies of different sizes: the largest multinational groups, emerging foreign companies and international small and medium sized enterprises. We have also provided services to companies from different sectors (manufacturing, technology businesses, financial institutions, retail, wholesale, agriculture, construction etc.). In addition, our membership in WTS Global network provides us with the opportunity to help the clients on tax issues regarding several tax jurisdictions at the same time.

In case you need consulting services on your MNE transfer pricing policy, please do not hesitate to contact our consulting team.

Master file – Why should each international company prepare it?