In this episode, we will focus on SMEs that are not part of an SGE and we will provide some typical examples of how these SMEs can safeguard against ATO challenges without comprising the expenses of the compliance of doing so.
Having high-quality contemporaneous transfer pricing documentation in place that evidence the actual commercial and financial relations and factual circumstances is the best “insurance policy” to defend a transfer pricing position in the event of an ATO review or audit.
Good quality documentation does not mean having a transfer pricing documentation report the size of the tax legislation, rather, having a tailored approach that is fit for purpose can produce a much more efficient and robust solution.
Here are five transfer pricing examples that cover common transfer pricing issues.
Transfer Pricing Examples
For SMEs transfer pricing compliance obligations might be overwhelming or the compliance costs and burden might outweigh the underlying risk exposure. We have explored a few common transfer pricing scenarios to provide practical guidance on how the situation could be less complicated and how to ease the compliance burden.
We have selected the following five examples based on the most typical situations we have experienced for small to medium businesses in Australia.
1– Inbound distributor with an annual turnover of $40 million and a profit-before-tax of 3.5%.
This company is eligible for the “Distributor Option” of the Simplified Transfer Pricing Record Keeping (STPRK) discussed in episode two of the mini-series. Instead of preparing a full-size TP Doc (answering the 5 Questions as recommended by the ATO to get a RAP) then now only need to verify eligibility to the option and demonstrate that STPRK is applied on the IDS. Accordingly, need to keep contemporaneous documentation substantiating the eligibility for the option applied. This documentation should simply and sensibly explain how the relevant eligibility criteria are met.
2– Inbound distributors with low financial performance or losses with an annual turnover of $20 million.
The losses are due to the loss of a major customer and supply chain delays due to a fire at the manufacturing site. Recommend to prepare a memorandum that relies on the format of a normal TP Doc but does not include a benchmarking analysis. Instead, the focus should be explaining the “gap” between the actual financial performance and the ATO’s expectations of the financial performance of medium-risk inbound distributors detailing that the “gap’ is related to non-transfer pricing issues (i.e., commerciality analysis).
3– Inbound intercompany loans that meet STPRK option for low-inbound loans.
Let’s assume that the intercompany loans meet the STPRK option for low-inbound loans. In that case, you just have to document how you qualify for this STPRK option.
4– Low-value Intragroup services options (1) less than $ 2 million – De minimis rule. (2) above $2 million also in STPRK.
Are the intragroup services less than AUD 2m or more? If they are less, use the De minimis rule.
If above, then total expenses/income for low-value intragroup services received/provided can’t be greater than 15% of total expenses).
For low-value-intragroup services, there are a few additional eligibility criteria to the no-losses, no restructuring, etc for using a recommend safe-harbor mark-up which is detailed in the STPRK PCG2017/2. The safe harbor will mean that the taxpayer does not need to do what would normally be required for intra-group services – such as an in-depth benchmarking analysis and a ‘benefits test’ to justify that the services received or provided are following the arm’s length principle.
A ‘benefits test’ is a test that demonstrates that the services have actually been provided, the taxpayer benefitted from the services, and if the services were not provided by its international related parties the taxpayer would have to either source these services from a third party or do them in-house.
5– Mismatch for start-ups in the digital industry with cost-plus arrangements as might do more activities after a few years that generate income.
Let’s assume an Australian start-up company. In the beginning, the US Parent company was setting up the Australian subsidiary to explore the potential of the Australian territory, as a technical support office and to help locate Australian customers. The Australian subsidiary did not have an income but was paid on a fully cost-plus basis from its parent company. This was documented in compliant transfer pricing documentation by applying the cost-plus transfer pricing methodology to find arm’s length cost-plus benchmarks to demonstrate the Australian entity’s related party dealings were in accordance with the arm’s length principle.
Over the years the Australian subsidiary adds more and more activities including interfacing with customers and start to generate sales and it becomes more like a reseller of digital products. This will mean that the cost-plus model or its existing transfer pricing documentation is no longer fit for purpose and the remuneration model will have to be re-considered to ensure there is a match between the structure and substance.
Accordingly, the Australian entity is recommended to explore and apply other transfer pricing methodologies available including the safe harbour concessions in the STPRK as more appropriate ways of supporting its international related party dealings are following the arm’s length principle.