The ATO has stated that “there are significant incentives to locate intangible assets in jurisdictions with favourable tax regimes” and identified tax risks associated with non-arm’s length arrangements that:
- Migrate or artificially allocate Australian-generated intangibles to offshore related parties;
- Involve the use of intangible assets, particularly when the value of those assets is derived from or maintained by the activities of Australian entities;
- Dispose of or allocate Australian-generated intangible assets to offshore related parties and subsequently grant rights in those assets back to Australian entities.
A team of ATO topic specialists has been assigned to review significant transfer pricing issues involving intangible assets in all major reviews and audits, reflecting the current approach adopted across other specialist transfer pricing topics and industry sectors.
The ATO’s focus on intangible assets coincides with the new OECD guidance on the assessment of risk allocation, which is of particular importance in analysing transactions involving intangibles but may be difficult to analyse in practice. Taxpayers should carefully consider how evidence to support the allocation of returns from significant intangible assets can be compiled in practice.
Analysis of control over risk
New OECD guidance, ‘OECDTransfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’, requires a more detailed consideration of the parties responsible for controlling economically significant risks in an arrangement between international related parties to determine how the returns from intangible assets should be allocated between them.
Under the new OECD framework, the returns from intangible assets should be allocated in accordance with the roles played by various parties in investing in, performing functions, and controlling risks associated with an intangible asset.
The notion of control over risk is critically important in a transfer pricing analysis of intangible assets under this framework, and involves maintaining and exercising the capability to make significant decisions relating to risks associated with the intangible.
Broadly, to demonstrate the capability to make decisions, the decision makers should possess competence and experience in the relevant area, understand the impact of their decisions on the business, and have access to information relevant to the decisions.
In documenting the analysis of intangible assets, taxpayers should compile the evidence necessary to demonstrate that the parties that bear the significant risks associated with those assets have the key decision-making capability and exercise the decision-making function in relation to the relevant assets.
A first step is to identify the personnel responsible for key decisions in relation to the asset and to document the role the personnel plays in the organisation. The career experience and qualifications of the relevant personnel should also be documented to provide evidence of their capability in the relevant area.
Experience shows that this can be a challenge, for example:
- When employees collaborate on major business decisions, with review and endorsement by senior management and, ultimately, the board of an organisation. As a result, it can be difficult to reliably identify a discrete set of employees that is responsible for “key decisions” in relation to a specific asset over a period of time.
- The roles of many employees change over time. As roles change, the involvement of individuals in various “key decisions” in relation to a specific asset also often change. For this reason, in many organisations, formal role/position descriptions are impractical and are either inaccurate or not kept at all.
The exercise of the decision-making function can be demonstrated through various instruments, such as board minutes, management meeting notes, budget and planning documents, ongoing management reports, and correspondence.
The type and frequency of communication will be affected by the business stage of the relevant asset as the decision-making priorities shift in relation to the asset.
Consequently, it is critically important that any documentation compiled to provide evidence of control over risk be reviewed and updated at regular intervals to capture the changes that occur over time and that may require a reassessment of transfer pricing arrangements.
The ATO’s dedication of specialist resources will lead to increased review of the allocation of returns from intangible assets by multinational groups.
The challenges identified above in compiling evidence to support a robust analysis of intangible assets are best addressed by regular review of the facts and circumstances affecting the control of the key risks and a review of business documents demonstrating the performance of key decision-making functions in relation to the intangible asset.
Key questions that should be answered by each review include:
- What are the significant economic risks associated with the intangible asset?
- Who are the people in the organisation responsible for key decisions in relation to those risks?
- Have the significant risks or the decision-making personnel changed since the last review?
- Do we have business documents that demonstrate the actual decision making undertaken by the people responsible for the key decisions in the most recent period?
Australian taxpayers should verify that they have reliable documentation to support their transfer pricing arrangements.