The Australian Taxation Office (ATO) has issued several transfer pricing-related taxpayer alerts (TAs) and practical compliance guidelines (PCGs) that set out how the ATO assesses tax compliance risk across a range of activities or arrangements. These include:
- TA 2015/5 – Arrangements involving offshore procurement hubs;
- TA 2016/4 – Cross-border leasing arrangements involving mobile assets;
- TA 2016/10 - Cross-border round robin financing arrangements;
- PCG 2017/1 – The ATO compliance approach to transfer pricing issues related to centralised operating models involving procurement, marketing, sales and distribution functions;
- PCG 2017/2 – Simplified transfer pricing record keeping options; and
- PCG 2017/4 – ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions.
The PCGs help the ATO to deploy compliance resources more effectively to higher-risk activities/arrangements.
For taxpayers, the PCGs provide practical compliance guidance when the application of tax laws might be uncertain, or when those laws create a heavy administrative or compliance burden. In recent years, the international dealings schedule (IDS), reportable tax position (RTP) schedule, and country-by-country reporting are just some of the measures that have significantly increased taxpayers’ transfer pricing compliance burdens.
While the PCGs are risk assessment tools, they do not address technical positions in connection with the application of the transfer pricing legislation.
Because PCGs are becoming increasingly relevant and important, this article explores how they are intended to be used by both the ATO and taxpayers.
Self-assessing risk under PCGs
Transfer pricing continues to be the number one tax risk area challenging multinationals.
Taxpayers can use the principles in the PCGs to better understand, and take steps to manage, their transfer pricing compliance risk, in line with the law, by:
- Self-assessing the tax risk associated with certain related-party arrangements;
- Understanding the compliance approach the ATO is likely to adopt given the risk profile of the related-party arrangements in question;
- Mitigating the transfer pricing risk associated with certain arrangements, thereby reducing compliance risk exposure; and
- Understanding the type of analysis and evidence the ATO would require when assessing the risk outcomes of related-party arrangements.
To the extent that taxpayers follow the PCGs in good faith, the Commissioner of Taxation will administer the law in accordance with the approaches set out therein.
Risk ratings in the PCGs
The ATO’s compliance approach will vary depending on the risk rating of the related-party arrangement in question (see Figure 1).The risk framework generally comprises six risk zones consistent with the risk zones identified in PCG 2017/4 (refer to Figure 1). The yellow zone in the hub risk framework is classified as “moderate to high” risk, as opposed to purely moderate risk (refer to paragraph of 28 PCG 2017/1).
|Risk zone||Risk level|
|White||Arrangements already reviewed and concluded|
|Blue||Low to moderate risk|
|Red||Very high risk|
The risk ratings are based on a number of qualitative and quantitative factors, including pricing and motivational indicators, possible tax at risk, and transfer pricing documentation held. The ATO will generally monitor, test, and/or verify the taxation outcomes of related-party arrangements that fall outside the white zone or green zone (low-risk category), with arrangements in the red zone likely to be subject to immediate ATO review or audit.
Concerns have been raised by several taxpayers about the reasonableness of their self-assessed positions. For example, numerous taxpayers with related-party debt on similar terms to third-party financing may still fall outside the green zone under PCG 2017/4 for commercial reasons. Similarly, many centralised hubs’ financial outcomes, particularly in the energy and resources sector, will far exceed the cost-plus threshold stipulated in PCG 2017/1, based on their functional, asset, and (in particular) risk profiles. The lack of commercial focus in the PCGs highlights the need for taxpayers to self-assess to support their transfer pricing outcomes.
Self-assessing risk vs self-assessing under Subdivision 815-B
It is important to distinguish between self-assessing risk under the PCGs and self-assessing compliance with the law under subdivision 815-B of the ITAA 1997. This is because subdivision 815-B is self-executing, which means it does not require the Commissioner to make a determination. Rather, the onus is on taxpayers to establish that there is no transfer pricing benefit obtained based on the entity’s transfer pricing positions and treatment.
Even if a taxpayer’s arrangement(s) fall in the green zone (the low-risk category), this does not alleviate the need to apply the law to demonstrate that the taxpayer obtained no transfer pricing benefit. Conversely, taxpayers with a high PCG risk rating will not automatically be obtaining a transfer pricing benefit. However, “high risk” taxpayers may be prompted to adjust their pricing or otherwise review their documentation and technical positions to strengthen their defence as to why their transfer pricing treatment is in fact commercial and at arm’s length.
In order to have penalty protection, taxpayers must maintain compliant documentation and have a reasonably arguable position (RAP) that the transfer pricing rules do not apply to require an increase in the Australian tax liability.
To have a RAP, an entity needs to have a documented transfer pricing treatment, i.e. records explaining the way in which the transfer pricing provisions do/do not apply to a matter, which complies with the requirements of section 284-255 of the Taxation Administration Act 1953. The documentation must also satisfy the general RAP test – that is, what is argued must be about as likely to be correct as incorrect, at a minimum.
How the ATO is using PCGs
The tax authorities’ sharpened focus on tax governance and transparency is increasingly apparent. The ATO is making progress in its top 100 and top 1,000 “justified trust” reviews (or “streamlined assurance reviews”). As part of these reviews, the ATO is asking specific questions pertaining to PCGs, for example:
- Whether any taxpayer alerts or PCGs apply to arrangements entered into by the taxpayer;
- What the taxpayer’s self-assessed risk ratings are, and whether their arrangements fall into the amber or red risk zones of any relevant PCGs; and
- In the case of centralised procurement, marketing, or sales and distribution hubs, for taxpayers to provide global value chain summaries and detailed information on the centralised operations.
Additional IDS questions and local file disclosures have also arisen based on the PCGs. For example, question 28b of the IDS directly asks whether any of the schedules within PCG 2017/1 apply to an entity’s offshore dealings. Taxpayers that are required to complete a RTP schedule must also disclose their self-assessed risk zone in accordance with Schedule 1 of PCG 2017/4.
The ATO will undoubtedly release more PCGs covering specific categories of taxpayers and types of business restructures or arrangements. For example, PCGs are set to be released setting out industry benchmarks pursuant to the ATO’s inbound supply chain project for import distributors in various sectors.
The ATO has long advocated a ‘prevention is better than cure’ approach, encouraging taxpayers to engage proactively with the ATO to obtain certainty.
Through the publication of PCGs on various transactions and arrangements perceived to be more ‘high risk’, the ATO is encouraging taxpayers to self-assess and disclose their risk ratings so there is proverbially “nowhere to hide”.
Taxpayers must be acutely aware of the PCGs and should self-assess their transfer pricing compliance risk as part of their ongoing and effective tax governance processes.
|Janelle Sadri, director at Deloitte Australia, firstname.lastname@example.org|
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