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Introduction to Australian transfer pricing
Transfer pricing rules
- Australia’s transfer pricing legislation is contained in subdivisions 815-B, 815-C and 815-D of the Income Tax Assessment Act 1997 (ITAA 1997) and subdivision 284-E of the Taxation Administration Act 1953 (TAA 1953). The legislation is intended to be interpreted to achieve consistency with the Organisation for Economic Co-Operation and Development (OECD) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017.
- The transfer pricing rules apply to Australian taxpayers, including Australian branches of overseas companies.
- Preparation of contemporaneous transfer pricing documentation is recommended but not mandatory. However, transfer pricing documentation may provide taxpayers with access to penalty relief in the event of a transfer pricing adjustment.
- Taxpayers who are considered a Significant Global Entity (SGE), are also subject to Country-by-Country (CbC) reporting. A taxpayer will be an SGE if the taxpayer is a member of a group of entities consolidated (for accounting purposes) where the global parent entity has an annual global income of A$1 billion or more.
- Effective from income years commencing on or after 1 July 2019, a taxpayer is also considered an SGE if it is a member of a national listed company group, and one of the other group members is a global parent entity with an annual global income of A$1 billion or more. (A notional listed company group is a group of entities that would be required to be consolidated as a single group for accounting purposes if a member of that group was a listed company. Any exceptions in accounting principles that may permit an entity not to consolidate with other entities are disregarded. An entity is also an SGE if it, or any other member of the actual or notional accounting consolidated group of which the entity is a member, has been given a notice by the Commissioner determining that its global parent entity would have an annual global income of A$1 billion or more for any period during the income year).
- The OECD Guidelines have been legislated as part of Australia’s current transfer pricing rules and have been effective since the first income year commencing on or after 29 June 2013.
- Since 2013, Australia’s transfer pricing legislation has been revised to specify that it is to be interpreted to achieve consistency with the OECD Guidelines updated in 2017.
Transfer pricing methods
- Australia applies the ‘most appropriate method approach’ for the selection of transfer pricing method(s). The Australian Tax Office (ATO) prefers selection to be performed on a transaction by transaction basis.
- Acceptable transfer pricing methods include comparable uncontrolled price, resale price, cost plus, transactional net margin, and profit split. Other methods can also be used if justifiable and appropriate.
- The preparation of transfer pricing documentation is recommended but not mandatory.
- Taxpayers with aggregate amounts of international related party dealings greater than A$2 million need to disclose the details of their related party transactions in the Local File and Section A of the International Dealings Schedule attached with their annual income tax return.
- In the Local File and the International Dealings Schedule, taxpayers disclose the following details about their international related party dealings: type of transaction, the magnitude of the transaction, and level of transfer pricing documentation to support the arm’s length nature of the transactions.
- The more significant and the broader the scope of a taxpayer’s international related dealings, the more likely the ATO is to review those dealings. Taxpayers with a significant level of dealings whose tax performance is low compared to industry standards are at the greatest risk of review.
- The ATO has recently published several transfer pricing Practical Compliance Guidelines which allows taxpayers to perform a self-assessment to understand the ATO’s perception of the risks associated with specific transfer pricing positions adopted.
Transfer pricing documentation
Preparation of transfer pricing documentation
- The preparation of Australian transfer pricing documentation is recommended to reduce the risk of an ATO audit and to assist taxpayers to explain their position and to minimise penalties in the event of an audit adjustment.
- Australian transfer pricing documentation should be prepared according to Taxation Ruling 2014/8 Income Tax: transfer pricing documentation and Subdivision 284-E of the Income Tax Assessment Act 1997 which requires an entity to identify the arm’s length conditions so as best to achieve consistency with the OECD Guidelines.
- Australian transfer pricing documentation should include a background to the company, a functional analysis of the company which describes the key functions, assets and risks of the company, an outline of the key intercompany transactions under analysis, an industry analysis, and economic analysis which assesses the arm’s length nature of intercompany dealings.
- Australian transfer pricing documentation should be prepared by the due date for filing the annual income tax return and needs to be in English.
Master and Australian local file
- Australia’s CbC reporting requirements are legislated under Subdivision 815-E of the Income Tax Assessment Act 1997.
- The CbC reporting implements Action 13 of the OECD’s Base Erosion and Profit Shifting (‘BEPS’) action plan.
- For income years commencing on or after 1 January 2016, taxpayers who are subject to CbC reporting are required to lodge the following statements with the ATO: CbC report, master file, and Australian local file.
- Australia’s CbC report and master file reporting requirements are consistent with Annex I and Annex III of Chapter V of the 2017 OECD Guidelines.
- The ATO has implemented its own Australian Local File reporting requirements which is inconsistent with Annex II of Chapter V of the 2017 OECD Guidelines.
Some risk factors for challenge
- Risk factors include international related party dealings with entities located in jurisdictions classified as ‘specified countries.’ These jurisdictions typically are low tax jurisdictions or tax havens.
- The Australian Government implemented the Multinational Anti-Avoidance Law (MAAL) provisions which came into effect from 1 January 2016. MAAL applies to SGEs where if under a scheme or in connection with a scheme:
- a foreign entity supplies goods or services to an Australian customer
- an Australian entity, that is an associate of or is commercially dependent on the foreign entity, undertakes activities directly in connection with the supply
- some or all of the income derived by the foreign entity is not attributable to an Australian permanent establishment, and
- the principal purpose, or one of the principal purposes of the scheme, is to obtain an Australian tax benefit or to obtain both an Australian and foreign tax benefit.
- The Australian Government also introduced the Diverted Profits Tax which only applies to SGEs. Divert Profits Tax applies where taxpayers who, under a scheme or in connection with a scheme:
- a taxpayer (the relevant taxpayer) has obtained a tax benefit
- the principal purpose, or one of the principal purposes, of a person who entered into or carried out the scheme, was to enable the relevant taxpayer to obtain an Australian tax benefit or to obtain both an Australian and foreign tax benefit
- a foreign associate of the relevant taxpayer is involved in entering into or carrying out the scheme or is otherwise connected with the scheme, and
- none of the Diverted Profits Tax exceptions apply.
- Taxpayers are subject to a failure to lodge on time penalty. As of 1 July 2017, SGEs are subject to an increased failure to lodge on time penalty which is the base penalty amount multiplied by five hundred. The SGE penalty rates from 1 July 2020 are as follows:
- $111,000 for 28 days or less late
- $222,000 for 29 days to 56 days late
- $333,000 for 57 days to 84 days late
- $444,000 for 85 to 112 days late
- $555,000 for more than 112 days late
- For any transfer pricing adjustment made by the ATO, a penalty rate of up to 50% of any tax avoided may apply.
- The ATO may apply impose administrative statement penalties for certain conduct. As of 1 July 2017, SGEs are subject to twice the penalty amount that applies to all other taxpayers. These penalties for SGEs include:
- 50%, 100% or 150% of shortfall amount for making a false or misleading statement
- 50% of shortfall amount for making a statement which treats a law as applying in a way that is not reasonably arguable
- 150% of tax-related liability for failing to provide a document as required.
Economic analysis and how to demonstrate an arm’s length result
- The ATO’s preference is that local comparable companies are selected. However, the ATO may accept non-Australian based comparable companies where the taxpayer can demonstrate that they have searched for, but could not identify, sufficient Australian based companies.
- The ATO will move a taxpayer’s transfer pricing position to the median of the arm’s length range constructed by comparable companies based on their guidance on quantifying uncertain transfer pricing positions adopted by taxpayers.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- APAs allows taxpayers to reach an agreement with the ATO on the future application of the arm’s length principles to intercompany dealings with international related parties.
- APAs provides a mechanism for managing and mitigating transfer pricing risk by providing greater certainty on a prospective basis.
- Where taxpayers obtain an APA and continue to meet its requirements, the ATO will not impose any additional income tax to the agreed payable based on the pricing worked out under the APA on the covered cross border dealings.
- APA generally covers a period of five years and may be reviewed if trading circumstances materially change. APAs are also subject to an annual reporting requirement.
- Australia has an extensive treaty network and the Mutual Agreement Procedure (‘MAP’) will often be available when double taxation occurs.
- The ATO has provided a list of ‘fast track exemptions’ for CbC reporting requirements. Taxpayers eligible for such exemptions, will be exempt from lodging one or more CbC reporting statements.
- Taxpayers who elect to lodge Part A of the Australian Local File at the same time as their income tax return will not need to complete Questions 2 to 17 of the IDS under the ATO’s administrative solution.
- Taxpayer’s who are eligible to apply the ATO’s Practical Compliance Guideline 2017/2 Simplified transfer pricing record-keep options (PCG 2017/2), do not need to prepare contemporaneous transfer pricing documentation for certain transactions. ATO will generally not allocate compliance resources to review transactions that meet the criteria under PCG 2017/2, beyond reviewing the taxpayer’s eligibility to apply PCG 2017/2.
Top 1,000 (income) tax performance program
- The ATO’s top 1,000 tax performance program was established in July 2016.
- The program reviewed public and multinational groups with annual turnover above $250 million to obtain greater assurance that large public and multinational economic groups are reporting the right amount of income tax, or identify areas of tax risk for further action. At the end of the ATO’s review, the ATO considers whether there is enough evidence to conclude that the taxpayer has paid the right amount of tax or whether further comprehensive reviews are required.
- This program has shown that transfer pricing is one of the main areas of contention. The common transfer pricing issues arising from the ATO’s top 1,000 tax performance program include:
- Limited information (documentation) on the global value chain and/or functional analysis of the entities involved in the arrangements.
- Over-reliance on the whole-of-entity Transactional Net Margin Method. There are circumstances where other methods, including transactional approaches, may be more appropriate.
- Lack of comparability analysis in applying the transfer pricing methodology. Where a comparability analysis has been included, there are often significant differences between the tested transaction/entity and the benchmarks provided.
- Changes in transfer pricing policy or methodologies without an underlying change to taxpayer functional analysis, and inappropriate methodologies being selected given the taxpayer functional profile.
Practical Compliance Guidelines
- The ATO has released several transfer pricing related Practical Compliance Guidelines. These guidelines provide a self-assessment framework for taxpayers to assess their risk rating to understand the ATO’s initial perspective on particular transfer pricing issues. The higher the risk rating, the more likely the ATO will review the taxpayer’s arrangement.
- The Practical Compliance Guidelines allows taxpayers to make relevant changes to their transfer pricing arrangements to improve their risk rating if necessary.
- The self-assessment is voluntary, however, the ATO may ask taxpayers whether they have assessed their risking rating and what the rating is.
- Relevant transfer pricing Practical Compliance Guidelines include:
- Practical Compliance Guidelines PCG 2017/1 – ATO compliance approach to transfer pricing issues related to centralised operating models involving procurement, marketing, sales, and distribution functions
- Practical Compliance Guideline 2017/2 – Simplified transfer pricing record-keep options
- Practical Compliance Guideline 2017/4 – ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions
- Practical Compliance Guideline 2019/1 – Transfer pricing issues related to inbound distribution agreements.
Transfer pricing governance
- The ATO expects that tax risk management should be a part of good corporate governance, particularly for large and complex corporations. The presence and testing of a tax internal control framework are an integral part of the risk-assessment protocols used by the ATO.
- When appropriate, the ATO may assess the tax governance process of taxpayers.
- The ATO’s Top 1,000 Tax Performance Program included conducting a review of the taxpayer’s tax risk management and governance frameworks.
- When assessing transfer pricing arrangements, the ATO will seek to understand the facts and individual circumstances affecting the taxpayer as a result of COVID-19. The ATO will look at: the functions, assets, and risk of the taxpayer, before and after COVID-19, the impact of COVID-19 on the economic circumstances, changes in transfer pricing arrangements, and changes in business strategy.
- As the analysis of comparable company benchmarking may not reliably support arm’s length outcomes where taxpayers are impacted by COVID-19, the ATO will seek to understand the taxpayers' financial outcomes that would have been achieved ‘but for’ the impact of COVID-19. This may involve an analysis showing the changes in revenue and expenses with an explanation for variances resulting from COVID-19, details of profitability adjusted to outcomes that would have occurred had COVID-19 not occurred, and the rationale and evidence for a reduction in sales.
- The ATO is not seeking to review its current risk rating benchmark for inbound distributors as described in Practical Compliance Guideline 2019/1 Transfer pricing issues related to inbound distribution agreements as a result of COVID-19. As such, inbound distributors are still to rely on the existing framework and profit markers to self-assess their risking rating.