Master File in Transfer Pricing – Detailed Guide

What is a Transfer Pricing Master File

The master file is one component of a three-tiered documentation approach that includes: (1) a master file containing standardised information relevant for all MNE group members; (2) a local file referring specifically to material transactions of the local taxpayer; and (3) a Country-by-Country Report containing certain information relating to the global allocation of the MNE group’s income and taxes paid together with certain indicators of the location of economic activity within the MNE group. ¹

The master file should provide an overview of the MNE group business, including the nature of its global business operations, its overall transfer pricing policies, and its global allocation of income and economic activity in order to assist tax administrations in evaluating the presence of significant transfer pricing risk. ²

In general, the master file is intended to provide a high-level overview in order to place the MNE group’s transfer pricing practices in their global economic, legal, financial and tax context. ³

Purpose and Strategic Objectives of the Master File

In producing the master file, including lists of important agreements, intangibles and transactions, taxpayers should use prudent business judgement in determining the appropriate level of detail for the information supplied, keeping in mind the objective of the master file to provide tax administrations a high-level overview of the MNE group’s global operations and policies. ⁴

The master file is not intended to require exhaustive listings of minutiae (e.g. a listing of every patent owned by members of the MNE group) as this would be both unnecessarily burdensome and inconsistent with the objectives of the master file. ⁵

For purposes of producing the master file, information is considered important if its omission would affect the reliability of the transfer pricing outcomes. ⁶

Blueprint of the MNE Group

The information required in the master file provides a “blueprint” of the MNE group and contains relevant information that can be broken down into five categories: a) the MNE group’s organisational structure; b) a description of the MNE group’s business or businesses; c) the MNE group’s intangibles; d) the MNE group’s intercompany financial activities; and e) the MNE group’s financial and tax positions. ⁷

Required Information in the Master File

Organisational Structure

The master file must include a chart illustrating the MNE group’s legal and ownership structure and geographical location of operating entities. ⁸

This structure should be presented as a diagram illustrating the legal structure of the whole group, including the holding percentages applicable to each entity, as well as the geographical location of the entities. ⁹

Business Description

The master file must contain a general written description of the MNE’s business including: important drivers of business profit; a description of the supply chain for the group’s five largest products and/or service offerings by turnover plus any other products and/or services amounting to more than 5 per cent of group turnover. ¹⁰

The required description could take the form of a chart or a diagram. ¹¹

Service Arrangements

A list with a brief description of important service arrangements between members of the MNE group, other than research and development services, including a description of the capabilities of the principal locations providing important services and transfer pricing policies for allocating services costs and determining prices to be paid for intra-group services must be included. ¹²

Geographic Markets and Functional Analysis

The master file must include a description of the main geographic markets for the group’s products and services; a brief written functional analysis describing the principal contributions to value creation by individual entities within the group, i.e. key functions performed, important risks assumed, and important assets used; and a description of important business restructuring transactions, acquisitions and divestitures occurring during the fiscal year. ¹³

Intangibles

The regulation stipulates that the master file must contain information about MNE’s intangibles (as defined in Chapter VI of OECD Guidelines) including: a general description of the MNE’s overall strategy for the development, ownership and exploitation of intangibles, including location of principal R&D facilities and location of R&D management. ¹⁴

Intangible Assets Listing

The master file must include: a list of intangibles or groups of intangibles of the MNE group that are important for transfer pricing purposes and which entities legally own them; a list of important agreements amongst identified associated enterprises related to intangibles, including cost contribution arrangements, R&D service agreements, principal research service agreements as well as licence and royalty agreements; a general description of the group’s transfer pricing policies related to R&D and intangibles; and a general description of any important transfers of interests in intangibles amongst associated enterprises during the fiscal year concerned, including the entities, countries and compensation involved. ¹⁵

Intercompany Financial Activities

With regard to MNE’s intercompany financial activities the master file must set forth: a general description of how the group is financed, including important financing arrangements with unrelated lenders; the identification of any members of the MNE group that provides a central financing function for the group, including the country under whose laws the entity is organised and the place of effective management of such entities; and a general description of the MNE’s general transfer pricing policies related to financing arrangements between associated enterprises. ¹⁶

Financial and Tax Positions

The master file must include the MNE group’s annual consolidated financial statement for the fiscal year concerned if otherwise prepared for financial reporting, regulatory, internal management, tax or other purposes; and a list and brief description of the MNE group’s existing unilateral advance pricing agreements (APAs) and other tax rulings relating to the allocation of income amongst jurisdictions. ¹⁷

Preparation Methodology

Line of Business Presentation

Taxpayers should present the information in the master file for the MNE group as a whole. ¹⁸

However, organisation of the information presented by line of business is permitted where well justified by the facts, e.g. where the structure of the MNE group is such that some significant business lines operate largely independently or are recently acquired. ¹⁹

Where line of business presentation is used, care should be taken to assure that centralised group functions and transactions between business lines are properly described in the master file. ²⁰

Even where line of business presentation is selected, the entire master file consisting of all business lines should be available to each jurisdiction in order to assure that an appropriate overview of the MNE group’s global business is provided. ²¹

Cross-References to Existing Documents

When the requirements of the master file can be fully satisfied by specific cross-references to other existing documents, such cross-references, together with copies of the relevant documents, should be deemed to satisfy the relevant requirement. ²²

Timing and Update Requirements

Filing Deadlines

The best practice is to require that the local file be finalised no later than the due date for the filing of the tax return for the fiscal year in question. ²³

The master file should be reviewed and, if necessary, updated by the tax return due date for the ultimate parent of the MNE group. ²⁴

Annual Review Process

It is recommended that transfer pricing documentation be periodically reviewed in order to determine whether functional and economic analyses are still accurate and relevant and to confirm the validity of the applied transfer pricing methodology. ²⁵

In general, the master file, the local file and the Country-by-Country Report should be reviewed and updated annually. ²⁶

It is recognised, however, that in many situations business descriptions, functional analyses, and descriptions of comparables may not change significantly from year to year. ²⁷

Implementation Framework

Local Legislation Requirements

It is recommended that the master file and local file elements of the transfer pricing documentation standard be implemented in each jurisdiction through local legislation or administrative procedures and that the master file and local file be filed directly with the tax administrations in each relevant jurisdiction as required by those administrations. ²⁸

Country-Specific Implementation Examples

China Master File Requirements

Public Notice 42 requires a China resident enterprise to prepare a master file if it has cross-border related-party transactions, and either: (i) the ultimate holding company of the multinational group to which it belongs has prepared a master file; or (ii) the enterprise has related-party transactions (whether cross-border or domestic) in excess of RMB 1 billion. ²⁹

The deadline for preparing the master file is 12 months after the fiscal year end of the group’s ultimate holding company. ³⁰

The master file should be submitted to tax authorities within 30 days of request. ³¹

Language Requirements in China

The master file must be prepared in the Chinese language. ³²

Accordingly, if the group has already prepared a master file in another language, it must be translated into Chinese and supplemented as necessary. ³³

Germany Master File Requirements

Alongside the country-specific, company-related transfer pricing documentation (local file, i.e., factual and transfer pricing analysis), taxpayers which are part of “large” multinational groups must also prepare a “master file,” in OECD terminology. ³⁴

This requirement affects only taxpayers that belong to multinational groups with group revenue of at least 100 million euro in the previous fiscal year. ³⁵

Hong Kong Master File Requirements

IRO Part 9A, §58C, specifies the transfer pricing documentation requirements in Hong Kong. ³⁶

Division 2 of Part 9A requires a Hong Kong entity of a group in the extended sense to prepare, for each accounting period, a master file and a local file in accordance with Schedule 17I and to retain the files for a period of 7 years. ³⁷

Ireland Master File Requirements

The Irish legislation requires that “records as may reasonably be required” must be maintained and must be available upon request by Revenue for the purposes of determining whether the profits or gains or losses have been computed on an arm’s length basis. ³⁸

A master file must be prepared if the total revenue of the worldwide group exceeds €250 million and a local file must be prepared if the total revenue of the worldwide group exceeds €50 million. ³⁹

Brazil Master File Requirements

These Regulations established a three-tier structure based on an intercompany transaction materiality which defines the master file and local file requirements based on the total amount of the intercompany transactions (outbound and inbound) for the prior year of the one covered by the local file. ⁴⁰

Tier 1 – intercompany transactions exceeding BRL500M (or USD87.3M at USD1/BRL 5.88) requires the master file and local file. ⁴¹

Relationship Between Master File and Local File

Complementary Documentation

The master file (i.e. a documentation prepared at group level) provides an overview of the entire group of companies. ⁴²

The local file-this documentation is prepared at the level of each entity of the group that carries out transactions with affiliates. ⁴³

Some of the information that should be presented in the local file can be taken from the master file. ⁴⁴

Cross-Referencing Between Files

Where a requirement of the local file can be fully satisfied by a specific cross-reference to information contained in the master file, such a cross-reference should suffice. ⁴⁵

Materiality Standards

Transaction Materiality Thresholds

Not all transactions that occur between associated enterprises are sufficiently material to require full documentation in the local file. ⁴⁶

Tax administrations have an interest in seeing the most important information whilst at the same time they also have an interest in seeing that MNE groups are not so overwhelmed with compliance demands that they fail to consider and document the most important items. ⁴⁷

Thus, jurisdictional transfer pricing documentation requirements based on Annex II to Chapter V of these Guidelines should include specific materiality thresholds that take into account the size and the nature of the local economy, the importance of the MNE group in that economy, and the size and nature of local operating entities, in addition to the overall size and nature of the MNE group. ⁴⁸

Measuring Materiality

Measures of materiality may be considered in relative terms (e.g. transactions not exceeding a percentage of revenue or a percentage of cost measure) or in absolute amount terms (e.g. transactions not exceeding a certain fixed amount). ⁴⁹

Individual jurisdictions should establish their own materiality standards for local file purposes, based on local conditions. ⁵⁰

Strategic Importance for Tax Compliance

Documentation Quality Impact

Taxpayers should also anticipate that their transfer pricing documentation will be reviewed to determine whether it is adequate and reasonable, including whether the taxpayer failed to adequately search for or consider material information or failed to follow the best method rule in selecting and applying the method. ⁵¹

Moreover, the overall quality of the transfer pricing documentation can influence the examination team’s view of the method used in the analysis and the reasonableness of the taxpayer’s reliance on that transfer pricing documentation. ⁵²

Thus, strong documentation may result in the examination team determining that its transfer pricing examination resources may be more appropriately used to evaluate other taxpayers or may help the examination team explain why a penalty is not appropriate even if there is an adjustment. ⁵³

Master File in Risk Assessment

Transfer Pricing Risk Evaluation

Effective risk identification and assessment constitute an essential early stage in the process of selecting appropriate cases for transfer pricing audits or enquiries and in focusing such audits on the most important issues. ⁵⁴

Because tax administrations operate with limited resources, it is important for them to accurately evaluate, at the very outset of a possible audit, whether a taxpayer’s transfer pricing arrangements warrant in-depth review and a commitment of significant tax enforcement resources. ⁵⁵

Particularly with regard to transfer pricing issues (which generally are complex and fact-intensive), effective risk assessment becomes an essential prerequisite for a focused and resource-efficient audit. ⁵⁶

Risk Assessment Tools

There is a variety of tools and sources of information used for identifying and evaluating transfer pricing risks of taxpayers and transactions, including transfer pricing forms (to be filed with the annual tax return), transfer pricing mandatory questionnaires focusing on particular areas of risk, general transfer pricing documentation requirements identifying the supporting evidence necessary to demonstrate the taxpayer’s compliance with the arm’s length principle, and co-operative discussions between tax administrations and taxpayers. ⁵⁷

Practical Applications

Functional Analysis Support

The typical process of identifying the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations requires a broad-based understanding of the industry sector in which the MNE group operates (e.g. mining, pharmaceutical, luxury goods) and of the factors affecting the performance of any business operating in that sector. ⁵⁸

This information is likely to be included as part of the master file as described in Chapter V in support of a taxpayer’s analysis of its transfer pricing, and provides useful context in which the commercial or financial relations between members of the MNE group can be considered. ⁵⁹

Profit Splitting Factors

In addition to the Local File, which should contain a detailed functional analysis of the taxpayer and its relevant associated enterprises, the MNE group’s Master File might be a useful source of information relevant to the determination of appropriate profit splitting factors. ⁶⁰

As is set out in Annex I to Chapter V, the Master File should include information on the important drivers of business profit, the principal contributions to value creation by entities within the group, and key group intangibles. ⁶¹

However, it should be borne in mind that the Master File is intended only to provide a high-level overview of an MNE group, and not granular or detailed information as to all of the group’s transactions. ⁶²

Business Restructurings Documentation

Restructuring Disclosure Requirements

In the master file (see Annex I to Chapter V), taxpayers are asked to describe any important business restructuring transactions occurring during the year. ⁶³

In addition, in the local file, taxpayers are asked to indicate whether the local entity has been involved in or affected by business restructurings occurring during the year or immediately past year and to explain the aspects of such transactions affecting the local entity (see Annex II to Chapter V). ⁶⁴

Pre-Transaction Documentation

As part of their transfer pricing documentation, MNE groups are recommended to document their decisions and intentions regarding business restructurings, especially as regards their decisions to assume or transfer significant risks, before the relevant transactions occur, and to document the evaluation of the consequences on profit potential of significant risk allocations resulting from the restructuring. ⁶⁵

Cost Contribution Arrangements

CCA Reporting in Master File

The transfer pricing documentation standard set out in Chapter V requires reporting under the master file of important service arrangements and important agreements related to intangibles, including CCAs. ⁶⁶

It would be expected that in order to comply with these documentation requirements, the participants in a CCA will prepare or obtain materials about the nature of the subject activity, the terms of the arrangement, and its consistency with the arm’s length principle. ⁶⁷

Implicit in this is that each participant should have full access to the details of the activities to be conducted under the CCA, the identity and location of the other parties involved in the CCA, the projections on which the contributions are to be made and expected benefits determined, and budgeted and actual expenditures for the CCA activity, at a level of detail commensurate with the complexity and importance of the CCA to the taxpayer. ⁶⁸

Penalties and Compliance Incentives

Documentation-Related Penalties

Many jurisdictions have adopted documentation-related penalties to ensure efficient operation of transfer pricing documentation requirements. ⁶⁹

They are designed to make non-compliance more costly than compliance. ⁷⁰

Penalty regimes are governed by the laws of each individual jurisdiction. ⁷¹

Penalty Protection Mechanisms

Care should be taken not to impose a documentation-related penalty on a taxpayer for failing to submit data to which the MNE group did not have access. ⁷²

However, a decision not to impose documentation-related penalties does not mean that adjustments cannot be made to income where prices are not consistent with the arm’s length principle. ⁷³

Another way for jurisdictions to encourage taxpayers to fulfil transfer pricing documentation requirements is by designing compliance incentives such as penalty protection or a shift in the burden of proof. ⁷⁴

Language and Translation Requirements

Language Flexibility

The necessity of providing documentation in local language may constitute a complicating factor with respect to transfer pricing compliance to the extent that substantial time and cost may be involved in translating documents. ⁷⁵

The language in which transfer pricing documentation should be submitted should be established under local laws. ⁷⁶

Jurisdictions are encouraged to permit filing of transfer pricing documentation in commonly used languages where it will not compromise the usefulness of the documents. ⁷⁷

Translation Requests

Where tax administrations believe that translation of documents is necessary, they should make specific requests for translation and provide sufficient time to make such translation as comfortable a burden as possible. ⁷⁸

Confidentiality and Data Protection

Confidentiality Obligations

Tax administrations should take all reasonable steps to ensure that there is no public disclosure of confidential information (trade secrets, scientific secrets, etc.) and other commercially sensitive information contained in the documentation package (master file, local file and Country-by-Country Report). ⁷⁹

Tax administrations should also assure taxpayers that the information presented in transfer pricing documentation will remain confidential. ⁸⁰

In cases where disclosure is required in public court proceedings or judicial decisions, every effort should be made to ensure that confidentiality is maintained and that information is disclosed only to the extent needed. ⁸¹

Information Security Framework

The Confidentiality and Information Security Management Toolkit (2020) produced by the Global Forum on Transparency and Exchange of Information for Tax Purposes provides guidance to jurisdictions to ensure that their legal framework on the confidentiality of taxpayer information is adequate and protects the confidentiality and appropriate use of information exchanged under an international exchange agreement. ⁸²

Exemptions for Small and Medium Enterprises

SME Simplification Measures

A number of jurisdictions have introduced in their transfer pricing documentation rules simplification measures which exempt small and medium-sized enterprises (SMEs) from transfer pricing documentation requirements or limit the information required to be provided by such enterprises. ⁸³

In order not to impose on taxpayers costs and burdens disproportionate to the circumstances, it is recommended to not require SMEs to produce the amount of documentation that might be expected from larger enterprises. ⁸⁴

SME Information Requests

However, SMEs should be obliged to provide information and documents about their material cross-border transactions upon a specific request of the tax administration in the course of a tax examination or for transfer pricing risk assessment purposes. ⁸⁵

Document Retention Requirements

Retention Periods

Taxpayers should not be obliged to retain documents beyond a reasonable period consistent with the requirements of domestic law at either the parent company or local entity level. ⁸⁶

However, at times materials and information required in the documentation package (master file, local file and Country-by-Country Report) may be relevant to a transfer pricing enquiry for a subsequent year that is not time barred, for example where taxpayers voluntarily keep such records in relation to long-term contracts, or to determine whether comparability standards relating to the application of a transfer pricing method in that subsequent year are satisfied. ⁸⁷

Storage Format Flexibility

Because the tax administration’s ultimate interest would be satisfied if the necessary documents were submitted in a timely manner when requested by the tax administration in the course of an examination, the way that documentation is stored – whether in paper, electronic form, or in any other system – should be at the discretion of the taxpayer provided that relevant information can promptly be made available to the tax administration in the form specified by the local rules and practices in each jurisdiction. ⁸⁸

Comparables and Regional Analysis

Local vs Regional Comparables

The requirement to use the most reliable information will usually, but not always, require the use of local comparables over the use of regional comparables where such local comparables are reasonably available. ⁸⁹

The use of regional comparables in transfer pricing documentation prepared for jurisdictions in the same geographic region in situations where appropriate local comparables are available will not, in some cases, comport with the obligation to rely on the most reliable information. ⁹⁰

Whilst the simplification benefits of limiting the number of comparable searches an entity is required to undertake are obvious, and materiality and compliance costs are relevant factors to consider, a desire for simplifying compliance processes should not go so far as to undermine compliance with the requirement to use the most reliable available information. ⁹¹

Developing Country Considerations

Implementation Challenges

The international guidelines above were designed by the countries involved in the BEPS Project for adoption by them in the context of their own transfer pricing legislation, priorities, capabilities and experience. ⁹²

It cannot automatically be assumed that these OECD/G20 guidelines should be adopted in their entirety by every developing country. ⁹³

Compliance Burden Considerations

Developing countries can assume that, in the future, MNEs will prepare the master file and that large MNEs will prepare the CbC Report. ⁹⁴

Requiring these documents to be delivered to the local tax administration in a developing country should therefore impose no marginal compliance burden on the MNE. ⁹⁵

Interaction with Advance Pricing Agreements

APA Disclosure Requirements

There is an interaction between the obligation to spontaneously exchange information on this category of rulings and the transfer pricing documentation requirements under Action 13. ⁹⁶

In particular, the master file will contain a list and brief description of the MNE group’s existing unilateral APAs and other tax rulings relating to the allocation of income amongst countries. ⁹⁷

The local file will contain a copy of existing unilateral and bilateral/multilateral APAs and other tax rulings to which the local jurisdiction is not a party and which are related to the relevant material controlled transactions. ⁹⁸

Broader Coverage of Rulings

However, the obligation to spontaneously exchange information on unilateral APAs and other transfer pricing rulings could potentially cover a wider range of transfer pricing rulings than those captured in the local file and the master file. ⁹⁹

For example, only rulings related to “relevant material controlled transactions” will be contained in the local file which creates a higher threshold than that required under Action 5. ¹⁰⁰