In this short article, we explain what the Local File is and when you need to create one. We also give an overview of the items that need to be included in the Local File.
Please note that the Local File is just one part of the documentation requirements that apply to MNEs. You can read more in our general article on transfer pricing documentation.
What Is A Local File?
For national governments, it is not always clear what goes on in large companies with activities in multiple countries. However, these activities can affect their tax income because of the transfer pricing policy used.
In an attempt to achieve more transparency, the OECD updated in 2015 the documentation requirements in the Guidelines. Since then, MNEs are required to provide insight in their transfer pricing policy in the form of a Master File and a Local File. Large MNEs are also required to create extensive Country-by-Country Reporting (CBC).
The Master File provides a high-level overview of the MNE group’s global business structure and activities. It also explains the global transfer pricing policies.
The Local File is meant to support the Master File. The Local File relates to a specific taxpayer in a specific country. This is usually a single legal entity. It delivers a more detailed overview of the related party transactions that are entered into by this taxpayer. It matches the intention of the transfer pricing policy of these transactions with the actual (financial) result.
The Local File thus provides local tax administrations the info they need to determine whether the terms and conditions of related party transactions are at arm’s length.
When Do You Need A Local File?
Well, that really depends on the country where your company operates.
The OECD has not given a specific threshold for the preparation of a Local File. Therefore, it is important is to look at the domestic legislation in the countries that you operate. In a lot of countries, no Local File is required in case certain thresholds aren’t met.
For example, in South-Korea you only need to prepare a Local File if:
(i) the volume of cross-border related-party transactions exceeds KRW 50bn (≈USD 42.5m); and
(ii) the sales revenue exceeds KRW 100bn (≈USD 85m).
So, depending on local legislation, the preparation of the Local File can be voluntarily or mandatory. When mandatory, it should be considered as a tax compliance requirement.
As a result, your first step would be to carefully assess whether the preparation of a Local File is mandatory.
What Needs To Be Included?
As mentioned, the Local File is intended to deliver a more detailed overview of the related party transactions that are entered into by a specific taxpayer. In addition, it harmonizes the transfer pricing policies with the actual (financial) result.
This is reflected in the information that needs to be included.
Below is a summary of the points you have to address in your Local File:
Regarding the local entity
- A description of the management structure of the local entity, a local organization chart, and a description of the individuals to whom local management reports and the countries these individuals maintain their principal offices.
- A description of the general business and business strategy pursued by the local entity. This includes an indication whether the local entity has been involved in a business restructuring or intangible transfer in the present or immediately past year and an explanation of the effects of such transactions.
- A description of the key competitors
Regarding the controlled transactions
For each material category of controlled transactions in which the entity is involved, the following information needs to be provided:
- A description of the context in which such transactions take place. Examples of controlled transactions are the purchase of goods, provision of services, loans, financial and performance guarantees, licenses of intangibles and procurement of manufacturing services.
- The amount of intra-group payments and receipts for each category of controlled transactions involving the local entity (i.e. payments and receipts for products, services, royalties, interest, etc.) broken down by tax jurisdiction of the foreign payer or recipient.
- An identification of associated enterprises involved in each category of controlled transactions, and the relationship amongst them.
- Copies of all material inter-company agreements [link] concluded by the local entity.
- A detailed comparability and functional analysis of the taxpayer and relevant associated enterprises with respect to each documented category of controlled transactions, including any changes compared to prior years.
An indication of the most appropriate transfer pricing method with regard to the category of transaction and the reasons for selecting that method.
- An indication of which associated enterprise is selected as the tested party, if applicable, and an explanation of the reasons for this selection.
- A summary of the important assumptions made in applying the transfer pricing methodology.
If relevant, an explanation of the reasons for performing a multi-year analysis.
- A list and description of selected comparable uncontrolled transactions (internal or external), if any, and information on relevant financial indicators for independent enterprises relied on in the transfer pricing analysis, including a description of the comparable search methodology and the source of such information.
- A description of any comparability adjustments performed, and an indication of whether adjustments have been made to the results of the tested party, the comparable uncontrolled transactions, or both.
- A description of the reasons for concluding that relevant transactions were priced on an arm’s length basis based on the application of the selected transfer pricing method.
- A summary of financial information used in applying the transfer pricing methodology.
- A copy of existing unilateral and bilateral/multilateral
- Advanced Pricing Agreements and other tax rulings to which the local tax jurisdiction is not a party and which are related to controlled transactions described above.
Supporting financial information
- The annual financial accounts of local entity for the fiscal year concerned. If audited statements exist, they should be supplied and if not, existing unaudited statements should be supplied.
- Information and allocation schedules showing how the financial data used in applying the transfer pricing method may be tied to the annual financial statements.
- Summary schedules of relevant financial data for comparables used in the analysis and the sources from which that data was obtained.
Important Points For Preparing Your Local File
When preparing your Local File, it is advisable to take into account the following:
- Make sure that the Local File is consistent with the Master File and any other transfer pricing documentation to avoid questions from local tax authorities.
- Make sure that the Local File is available in time to avoid fines and penalties. The idea of transfer pricing documentation is to keep it up-to-date. It should not be made at the end of the year like annual regular accounts (or worse, when the authorities ask for it).
- Make sure to update financial information annually
- Make sure that the Local File is consistent with financial information such as annual accounts
One Easy Step Towards Your Local File
If you want to know if your firm needs to provide transfer pricing documentation, or if you are in need of a solid Local File, the easiest first step is to contact us.