The commencement of other BEPS measures, such as the diverted profits tax (DPT), and their interaction with Australian TP provisions means that the focus on TP is continuing to increase.
Overlaying this is the increased focus on transparency. The expectations regarding transparency from the Australian Tax Office (ATO) have continued to increase through new compliance requirements and initiatives. Taxpayers that are significant global entities (SGEs) already have or shortly will lodge their first country-by-country (CbC) reports, providing the ATO with a large amount of new information to better analyse taxpayers and identify strategic patterns and trends. The ATO will also be able to access CbC information from other tax authorities with exchange treaties very soon, which should facilitate further international collaboration on the international affairs of taxpayers by tax authorities.
The ATO has also provided additional or updated guidance with respect to various TP-related matters. This guidance, which focuses on intra-group debt, procurement hubs and the potential application of the DPT, seeks to communicate the criteria or situations in which the ATO considers particular international arrangements to be relatively high or low risk. Further guidance is expected later this year in relation to other key TP areas such as guarantee fees and derivatives.
This country update discusses the above matters in further detail.
As part of the 2018 to 2019 federal budget, for income years commencing on or after July 1 2018, the definition of an SGE will be broadened to include members of large multinational groups headed by private companies, trusts and partnerships. It will also include members of groups headed by investment entities. This may result in foreign investment funds and foreign pension funds being deemed SGEs.
Significant global entities are subject to CbC obligations and this may result in a disconnect between the manner in which a multinational classifies an Australian operation for CbC purposes in its headquarter jurisdiction compared to how this operation may be classified in Australia. Careful monitoring will be required to ensure that taxpayers are abreast of any potential issues and additional compliance requirements that may arise from this change.
ATO justified trust reviews
A key phrase in the OECD paper on tax control frameworks is 'justified trust' – a concept of using tax control frameworks to justify trust in taxpayers getting their tax calculations correct and managing their tax affairs in a way in which the tax authority or other stakeholders may have faith. The ATO has noted that the purpose of justified trust is to build and maintain community confidence that taxpayers are paying the right amount of tax, and to allow the ATO to focus its resources in the right areas.
The ATO notes that to achieve justified trust, "we seek objective evidence that would lead a reasonable person to conclude a particular taxpayer paid the right amount of tax. This is a higher level of assurance than confirming certain risks do not arise".
Through the undertaking of streamlined assurance reviews, the ATO has indicated that it will seek to review the affairs of taxpayers earning revenues greater than $250 million. This initiative is expected to result in approximately 1,000 taxpayers being subject to review over the next four years, with taxpayers potentially subject to greater scrutiny should tax risks be identified. It is important to note that the reviews have already started and the ATO is in the process of gathering the relevant information and evidence and completing the reviews for various taxpayers. A sample of questions that the ATO may ask are publicly available, divided into four categories being:
- Alignment between accounting and tax rules;
- Tax governance and risk management;
- Significant and new transactions; and
- Tax risks flagged to market.
Among other things, the reviews are expected to focus on the existence, application and testing of a tax risk management and governance framework at the Australian level, as well as substantial transactions and their associated tax outcomes. As such, the existence and quality of taxpayers' TP documentation (including information regarding the global value chain in its entirety) is an important component of demonstrating justified trust as part of these reviews.
These reviews occur over a short time period, with most being finalised within six months, at which point a decision is made by the ATO as to whether to escalate any identified tax risks. As such, it is of greater importance that taxpayers are prepared with contemporaneous documentation and evidence before such reviews occur, as the ATO's expectation is that requested information will be provided in a comprehensive and timely manner. In this regard, the ATO generally allows 28 days to comply with the request for information, with limited opportunities for an extension.
International Compliance Assurance Programme
As of January 2018, the ATO is participating in the pilot of the International Compliance Assurance Programme (ICAP), launched by the OECD. This programme complements the justified trust initiative discussed above.
The ICAP involves various tax administrations undertaking cooperative multilateral risk assessments on multinational taxpayers using country-by-country (CbC) reports and other relevant information to assess TP and permanent establishment risks.
A pilot has commenced under the ICAP, involving eight OECD member tax administrations, being Australia, Canada, Italy, Japan, the Netherlands, Spain, the UK and the US. Each nation has one headquartered company subject to the programme.
ATO diverted profits tax guidance
In summary, the DPT is intended to provide the ATO with additional powers within Australia's general anti-avoidance regime framework to deal with global groups who have 'diverted' profits from Australia to offshore associates using arrangements that have a 'principal purpose' of avoiding Australian income or withholding tax. The DPT will apply to SGEs carrying on business in Australia. The DPT applies from income years commencing on or after July 1 2017.
Where the DPT applies, tax is imposed on the amount of the diverted profit at a rate of 40% (Australia's corporate income tax rate is 30%). Any DPT imposed is payable within 21 days of the DPT assessment. The taxpayer has a 12-month review period in which to provide the commissioner with further information disclosing reasons why the DPT assessment should be reduced (in part or in full). If, at the end of that period of review, the relevant taxpayer is still dissatisfied, the taxpayer will have 60 days to challenge the assessment by filing an appeal with the Federal Court. However, and importantly, the taxpayer will generally be restricted to adducing evidence that was provided to the commissioner before the end of the period of review in any Federal Court proceedings.
Certain exemptions apply to certain types of trusts, vehicles and funds, and the DPT will also not apply if sales are of a relatively low materiality (generally less than $25 million), if sufficient foreign tax is paid offshore (generally at least 80% of the Australian reduction), or if sufficient economic substance (SES) exists within the relevant members of the scheme (based on TP principles). In practice, supporting that SES exists will be a key area of focus for taxpayers to support that the DPT is not applicable.
The ATO has estimated that 1,470 taxpayers are within the scope of DPT and 130 are in the 'high risk' category. As a result, the ATO has released draft Law Companion Ruling (LCR) 2017/D7 and draft Practical Compliance Guideline (PCG) 2018/D2 to assist taxpayers that may be affected by DPT. The draft LCR clarifies various concepts and explains how the ATO will apply the DPT law to provide taxpayers with greater certainty on the application of the law.
The draft PCG sets out the ATO's client engagement framework for the DPT and outlines the ATO's approach to risk assessment and compliance activity. It also provides examples to illustrate the relative risk of adopting certain types of arrangements in the context of the DPT based on different industry sectors and functional profiles. In this regard, the examples include situations relating to lease-in lease-out arrangements, intangibles migration and run-up run-down, limited risk distributors, marketing hubs and insurance arrangements. The guidance also outlines that an agreed advance pricing arrangement (APA) with the ATO will generally result in a low-risk classification for DPT purposes.
Finalised guidance on cross-border related-party financial arrangements – PCG 2017/4
Following a seven-month consultation process, the ATO has published final guidance on cross-border related-party financial arrangements, which sets out its approach to assessing risk in respect of related-party cross-border financing arrangements. The PCG applies retroactively to financing arrangements existing or coming into operation on or after July 1 2017.
The measures imposed under the PCG enable taxpayers (and the ATO) to assess the risk profile in relation to their cross-border financing arrangements. Applying the framework outlined in the PCG, the ATO will assess cross-border related-party financing arrangements according to a colour-coded tax risk matrix.
The PCG aims to provide guidance to taxpayers as to what indicia the ATO will take account of when determining the degree of compliance resources to allocate to an intra-group loan arrangement (e.g. based on the features of the arrangements, the profile of the parties to the arrangements and the choices and behaviours of the taxpayer's global group). These considerations are bifurcated into two broad groups under 'motivational' and 'pricing' headings. Practically, this means the risk assessment approach involves point scoring under the two categories and mapping the result in a table against two axes.
The ATO has indicated that arrangements that are considered high risk or above would be subject to review as a matter of priority. Moderate risk ratings would still be subject to review, albeit the ATO has indicated a willingness to work with taxpayers and resolve areas of difference.
ATO draft guidance on non-core procurement hubs
In June 2018, the ATO released a draft of proposed Schedule 2 to PCG 2017/1, intended to be effective for income tax years commencing on or after January 1 2018, which will focus on non-core procurement hubs. Similar to the guidance in Schedule 1 of PCG 2017/1 (which relates to marketing hubs), a colour coded matrix applies which is driven by the 'tax at risk' and the degree of TP documentation prepared in accordance with ATO TP rulings.
Broadly, to determine tax at risk, taxpayers must determine the degree to which the non-core procurement hub's profit is greater than operating costs plus 25%. Other factors will impact the calculation (such as the degree of controlled foreign company income that may be attributable). Non-core procurement hubs that earn less than cost plus 25% will be considered low risk from an Australian perspective.
This new schedule being proposed will have broad coverage, and will be relevant for numerous industries (such as natural resources) as well as for multinationals looking to rationalise supply chains.
Update on country-by-country reporting
The first year of CbC reporting (CbCR) compliance in Australia has so far resulted in the lodgement of over 2,100 Australian local files (ALF), 1,463 master files, and 42 CbC reports with the ATO. As taxpayers prepare for the second year of CbC compliance in Australia, taxpayers should be aware that there are various key changes to the ATO template for the second year. These include:
- A requirement for substantially more detail to be included in the short-form local file;
- A more granular disclosure of third-party expense recharges; and
- Greater detail related to foreign exchange gains/losses and deferred foreign currency arrangements.
International dealings schedule
The ATO has also included additional questions in the international dealings schedule (IDS). Among other things, taxpayers must now disclose if their international related-party dealings are subject to 'hub' arrangements as outlined in the ATO's relevant guidance, being PCG 2017/1. Taxpayers must also disclose if the taxpayer undertakes contract research and development (R&D) services for an international related party. Clearly these additional questions focus on key risk areas and may allow the ATO to better understand where to dedicate resources for matters such as the DPT.
Senate committee report part III
The Australian senate economics references committee recently released its final report of inquiry into corporate tax avoidance in Australia. The report, titled 'Much heat, little light so far' outlines 13 recommendations. The committee's recommendations are non-binding but include the following:
- Amending the thin capitalisation rules so that the worldwide gearing ratio is the only method by which interest-related deductions should be calculated for the purpose of tax treatment in Australia;
- Exploring options to modify TP rules, or other tax laws, to ensure multinational enterprises make the appropriate contribution to Australian tax revenue; and
- Requiring publication of excerpts of CbC reports be made publicly available free of charge.
The economics committee's recommendations further demonstrate the degree of scrutiny being placed by broader stakeholders on the TP arrangements of taxpayers, as well as the expectations regarding transparency in the Australian tax environment.
Upcoming ATO guidance
We expect the ATO to release the following guidance in the near future:
- Guidance related to the interaction between the TP rules and debt/equity rules;
- Guidance related to derivatives and guarantees; and
- Further guidance in relation to the application of the arm's-length debt test.
The Australian TP landscape continues to evolve and become more complex. Significant global entities in particular face numerous challenges in ensuring that their TP affairs are in order and well supported. With the enactment of the DPT and with CbC information now available to the ATO, it is more important than ever that taxpayers ensure they are well resourced and prepared to navigate the Australian TP landscape.