Last year saw the introduction of new legislation dealing with TP, strong and consistent messages from both the previous and new Australian governments with the aim of stemming perceived erosion of the Australian tax base and profit-shifting practices of multinational enterprises and a restructuring of the ATO's compliance areas to better respond to the evolving landscape.
Not only has Australia sought to address TP through more definitive laws and their alignment with Australia's tax treaties and the OECD's TP Guidelines, new record keeping or documentation requirements with respect to TP have also been introduced and more closely aligned with the existing legislation framework.
While some things may remain the same, there has been movement in the ATO's compliance activities towards more specific areas of leakage such as payments that are often characterised as "market support payments".
New TP laws were introduced in 2013 in response to the ATO's loss in 2011 in the Full Federal Court case of Commissioner of Taxation vs SNF (Australia) Pty Ltd. In this case, the court found the existence of ongoing losses in an Australian subsidiary does not necessarily mean that the price paid to international related parties is not an arm's-length price.
This case highlighted the difficulty faced by the ATO, under the then existing TP provisions, in applying a profit-based methodology in a situation where the taxpayer was in a period of continued loss. The new legislation differentiates itself from its predecessor given its focus on profit as a key consideration in determining whether transactions between international parties have been undertaken on an arm's-length basis.
The aim of the new laws is to modernise Australia's TP rules and to ensure consistency in their application between both tax treaty and non-tax treaty cases. As with Australia's previous TP rules, the new provisions are sufficiently broad to capture non-arm's-length dealings between both related and unrelated parties.
One of the more positive outcomes of the new law has been a change of the period for amendment. The new legislation limits the period for amendment to seven years, and while this is still longer than that of the general tax provisions of four years, it is undoubtedly better than the previous situation where there was no limitation on the period to amend.
In addition the new TP legislation is aligned with the more general policy intent of self-assessment. Consequently the new rules are self-executing. This, however, places a higher degree of emphasis on taxpayers, and particularly public officers, who must form a view at the time of lodgement of the income tax return that dealings have been structured and priced on an arm's-length basis for tax purposes, for which they may be held accountable.
A key aspect of the new legislation is that it does give the ATO power to reconstruct dealings (Section 815-130), in exceptional circumstances. Exceptional circumstances include inconsistency in the form and substance of a particular arrangement and situations where the arrangement is not one that would have been entered into by independent parties acting at arm's-length. The reconstruction provisions in section 815-130 are intended to be consistent with those described in paragraph 1.65 of the OECD's TP Guidelines.
As well as specific legislation to include both trusts and partnerships (Subdivision 815-D), the new legislation also has application to entities with permanent establishments (Subdivision 815-C). The application of the permanent establishments rules in Australia provide for the allocation of income and expenses between an entity and its parts to be reflective of that between separate entities dealing wholly independently with each other.
The last piece of the new TP legislative package relates to the introduction of new record keeping or documentation standards (Subdivision 284-E of Schedule 1 of the Tax Administration Act 1953). While the new record keeping requirements are not mandatory, there is a penalty risk which may only be mitigated through contemporaneous documentation that meets a "reasonably arguable position" (RAP) standard. Once again the self-assessment regime will dictate the importance of this process to those managing tax risk and especially public officers who must make declarations in regards to the contents of annual returns provided to the ATO.
These new laws will be supported by the introduction in 2012 of the ATO's International Dealings Schedule (IDS) which must be lodged with the annual income tax return where taxpayers have international related party dealings of more than $2 million per year. The IDS requires disclosure of international related party transactions, TP methodologies, together with an indication as to the level of documentation held for any international related party dealings. The IDS is used as a risk assessment tool by the ATO to better target compliance activities and focus resources on high risk areas in its international tax programme.
Unlike the previous legislation which went relatively untested for 30 years, there is an expectation that the ATO will seek to test the new TP rules fairly early as it is the cornerstone to the Australian government's strategy on base erosion and profit shifting (BEPS). The new law will also be supplemented by the ATO issuing a number of new and revised TP rulings and practice statements. A number of these are due for release in draft form in the second quarter of this year.
Prime Minister Tony Abbott has indicated his intention to have Australia at the forefront of G20 initiatives. In his statement upon assuming the G20 Presidency, G20 2014: Overview of Australia's Presidency (December 2013), Mr Abbott signalled his government's intent in stating that "Australia will lead stronger international cooperation in the G20 to combat tax base erosion and profit shifting, including better global exchange of tax information".
The prime minister re-affirmed his views in his address to the World Economic Forum in Davos, (January 2014), where he stated that he hoped the G20 would continue to tackle businesses artificially generating profits to chase tax opportunities, noting "The essential principle is that you should normally pay tax in the country where you've earned the revenue".
The Australian government has been overt in its statements regarding its intention to use the G20 presidential term to demonstrate strong leadership in this area. Unsurprisingly, the ATO is tasked with providing major intelligence and deliverables to support these statements. Specifically a new taskforce has been set up with its focus being:
- To work with international partners to establish the purpose of Australian businesses in low-tax jurisdictions.
- Address BEPS through compliance activities, including bilateral and multilateral audits, supported by newly implemented laws.
- To understand digitalisation of the Australian economy and the implications for the tax system.
- To support Australian and OECD policy development.
In addition to annual compliance activities, including TP and its advance pricing arrangement (APA) programme, the ATO has recently launched another compliance project, ISAPS (international structuring and profit shifting), related to its BEPS strategy. Thes ISAPS project consists of around 120 risk reviews commenced in the last quarter of 2013 and continuing throughout 2014 forming the basis for an audit programme likely beginning in late 2014. The areas covered by this project are broader than just TP and include permanent establishments, thin capitalisation, controlled foreign companies (CFC), and particularly offshore trading hubs and business restructures.
While the ATO is playing down these inquiries as "big picture", the breadth of the ISAPS questionnaire does extend beyond the scope of Australian operations to trading partners and others in the group. The ATO has indicated that it will not be using formal powers (Sections 264 and 264A) at the beginning of this process, it may however, use formal powers where responses are untimely or incomplete. Apart from those taxpayers selected for this project it is also likely that other international compliance work will contain either these questions or, at least, a subset of them. In any case the ATO is likely to have a strong focus on the supply chain and the location and activities of group entities.
Given the looming dates for amendments to the OECD TP Guidelines in the areas of intangibles and documentation and the Australian government's declared interest in leading issues in TP and BEPS during its presidency of the G20, it is not unreasonable to envisage that Income Tax Regulations would be made soon after any amendments to the OECD TP Guidelines are finalised so that taxpayers and the ATO are required to have regard to such changes for purposes of preparing their income tax returns going forward.
Restructure of ATO compliance areas
With the appointment of a new commissioner of taxation in January 2013 it is not unexpected to see some changes in the ATO's internal structure. Of particular relevance is the restructure of the Compliance areas of the ATO. The major changes are to remove the small and medium enterprise and large market approach to compliance work. In its stead is a focus on Public Groups and Internationals (PG&I) and on Private Groups and High Wealth Individuals (PG&HWI).
Essentially this has changed the focus of the PG&I group from the management of around 1,300 corporates to tens of thousands. This enlarged group of taxpayers has resulted in a few problems around resourcing, particularly servicing the lower end of the market, and required a reshaping of the risk differentiation framework (RDF) that the ATO uses to classify taxpayers and their compliance risks. Information on the ATO's RDF can be found at www.ato.gov.au/Business/Large-business/In-detail/Key-products-and-resources/Large-business-and-tax-compliance-publication/?page=42. While it is expected that these teething issues will sort themselves out over time, at least in the shorter term, understanding the ATO's directions in some of its more established programmes is proving a little difficult.
Capital (or market) support payments?
Market support payments have been the subject of a number of papers over recent years, particularly in the wake of the financial turmoil. These were seen as a reasonable approach in supporting a multinational group's focus in a particular jurisdiction and to remain strategically placed to benefit from the eventual upswing in market conditions.
While these may have enjoyed some degree of success in implementation, particularly in bi-lateral activity between tax authorities, the ATO has provided its preliminary view in Tax Determination TD 2014/D1 which focuses on instances where such payments are considered to be of a capital nature.
Australian tax law differentiates both income and deductions based on an item's classification as being of a revenue or capital nature. This is important as, simplistically, the general provisions of the law provide for income and deductions of a revenue nature in the calculation of taxable income. Capital profits or losses are brought to account for Australian income tax purposes under specific, event driven, provisions.
Consequently, as TP transactions underpin the numbers of a profit and loss account, such transactions are generally considered to be of a revenue nature and income or deductions for Australian income tax purposes. However, the ATO has identified some of these types of payments to be of a capital nature, taking the view that some are for the purpose of providing financial support and more akin to capital injections to ensure sufficient operational cash flow for continued trading.
While specific marketing support strategies may be acceptable when related to products and services, it is important in the Australian context that there is sufficient nexus between the characterisation of the payment and the purpose for which it is being used.
Further changes in the landscape in 2014
Notwithstanding the changes to the TP landscape in Australia and internationally in recent years, further changes are likely to occur in 2014.
At the international level, late 2014 deliverables under the OECD's BEPS Action Plan are likely to be influential on the Australian government's thinking and the ATO's administration of TP.
Domestically, there are also a number of events that are likely to result in further changes to the TP landscape, including:
- Expected reductions in Australia's thin capitalisation safe harbour limits (for many taxpayers this will mean an effective reduction in the maximum ratio of debt to equity from 3:1 to 1.5:1);
- The government's response to the Board of Taxation's Review of Tax Arrangements Applying to Permanent Establishments; and
- Inspector-general of taxation's review into the ATO's management of TP matters.
We live in interesting times.
Tony is a partner in KPMG's transfer pricing practice with more than 15 years of experience advising multinational groups on complex transfer pricing issues. With prior commercial experience negotiating arm's-length pricing arrangements, Tony provides a practical interpretation of the complex technical rule book. Tony's abilities to influence and negotiate on behalf of clients are the cornerstone of his reputation.
Tony leads a number of transfer pricing projects across the ASPAC region that involve establishing arm's-length pricing for transfer pricing purposes. He leads a number of clients for KPMG locally and regionally in the technology and media space.
Damian is a director in KPMG's transfer pricing services practice in Melbourne.
Damian advises clients in a wide variety of industries on transfer pricing and profit attribution issues with a special focus on dispute resolution, financial services and business restructuring. Damian represented the Tax Institute in consultation with Treasury on the recent review of Australia's transfer pricing rules.
Before joining KPMG, Damian was an international tax counsel in the ATO's transfer pricing practice where he focused exclusively on international transfer pricing and cross-border related party financial dealings. He was extensively involved in the ATO's transfer pricing rulings programme and was an Australian delegate to the OECD's Working Party No. 6 and its steering group on transfer pricing from 1994 to 2003.
Sean joined KPMG in late November 2013 after 37 years with the Australian Taxation Office (ATO), 25 of which he worked in transfer pricing matters. He has a deep understanding of ATO products, processes and programs and brings to the table highly developed skills in risk analysis, negotiation and dispute resolution and in the development of transfer pricing strategies across a broad range of industries including pharmaceutical and chemicals, media and technology, telecommunications and retail and consumer products.
Sean's experience includes leadership in all forms of active compliance work including audits, risk reviews, APAs and in the resolution of this work through APAs, settlement, mutual agreement procedure or through less formal approaches. His experience in transfer pricing work also includes critical review of transfer pricing documentation and chairing ATO transfer pricing review panels to guide and support transfer pricing work in the ATO.
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