The following is the Australian section of the Fall 2023 Transfer Pricing Forum, reproduced with permission from Transfer Pricing Forum. 13 TPTPFU 1, 10/19/23. Copyright © 2023 by Bloomberg Industry Group, Inc. (800-372-1033) http://www.bloombergindustry.com
Perspectives from Australia
1. How does the ATO select taxpayers for audits for transfer pricing cases and what are their focus areas that could lead to transfer pricing audits? And what measures and technology do the tax authorities have available to capture the essential information?
The Australian Tax Office (ATO) principally gains its information from annually filed international dealings
schedules (IDS), the Country-by-Country Reporting (CbCR) forms, and income tax returns (ITRs). In Australia, the preparation of TP documentation is recommended on a self-assessment basis but not mandatory.
However, not having compliant contemporaneous TP documentation in place can result in high penalties
and TP adjustments if challenged by the ATO.
MNEs with aggregated amounts of international related party dealings (IRPDs) greater than 2 million
Australian dollars (AUD) are required to disclose the details of their IRPDs including the level of compliant
transfer pricing documentation in the International Dealings Schedule (IDS) which is required to be
completed and lodged with their annual income tax return (ITR).
The ATO has for many years compiled data from the CbC report, IDS and ITRs into its comprehensive
databases, which are then screened using algorithms from which the ATO assesses risks of non-compliance, tax avoidance and profit shifting. The ATO uses the extracted data to plan and strategize for its risk review assessment programs and campaigns of Australian inbound and outbound MNEs. For example, the 2023 Company Tax Return form contains a number of questions designed to elicit information that will help the ATO target its compliance activities:
- Company reconciliation items – section 46FA deductions for flow-on dividends (Label C Q 7), offshore banking unit adjustments (Label P Q 7);
- Overseas transactions – interest expenses overseas (Label J Q 6), royalty expenses overseas
(Label W Q 6); - International related party dealings – was the aggregate amount of the transactions or dealings with international related parties (including the value of property transferred or the balance
outstanding on any loans) greater than 2 million AUD? (Label X Q 26); and - Overseas interests – did the taxpayer have overseas branch operations or a direct or indirect
interest in a foreign trust, foreign company, controlled foreign entity or a transferor trust? (Label Z
Q 28)
The ATO’s activities through these programs involving audits, risk reviews and Practical Compliance
Guidelines (PCGs) have over the years provided practitioners with profound insights into the ATO’s
expectations and thinking regarding TP documentation and what is perceived as low-risk TP frameworks.
Further, this has solidified the ATO’s approach to documentation away from a pure pricing/benchmarking exercise, demonstrating that the IRPDs are following the arm’s length principle (ALP) towards an approach of providing supporting contemporaneous evidence of the behaviour and motivation of the IRPDs or global TP structure being in harmony with the ALP.
Since 2019, the ATO have also been developing an Artificial Intelligence system which utilizes a similar
algorithm to those used on platforms such as Google and LinkedIn. The system known as ‘ANGIE’
(Automated Network & Grouping Identification Engine) facilitates the identification of suspicious activity
within the complicated affairs of MNEs and large private groups.
The system produces a network of maps connecting corporate entities and their related transactions across time. This information enables the ATO to identify “patterns of interest” based on common linkages. ANGIE has been used by ATO staff to scrutinize the integrity of corporate structures and transactions.
2. Which approaches are followed by the ATO during transfer pricing audits and what are the key elements considered by courts when deciding on transfer pricing related disputes? Please describe a few recent cases or rulings as examples to help illustrate your explanation.
The enactment of fundamental changes to the transfer pricing provisions in Tax Laws Amendment
(Countering Tax Avoidance and Multinational Profit Shifting) Act 2013 significantly expanded the ability of the Commissioner of Taxation to amend assessments on transfer pricing grounds.
In Roche Products Limited v Federal Commissioner of Taxation (2008) 70 ATR 703 and Federal Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149, the Commissioner was unsuccessful in applying profit-based methods for the purpose of determining arm’s length consideration for intra-group transactions. Both the Administrative Appeals Tribunal (AAT) and the Federal Court of Australia preferred transaction-based methods. In addition, the Federal Court of Australia in SNF Australia cast doubt on the ability of the Commissioner and taxpayers to rely upon the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines).
Subdivision 815-B replaced Division 13 of Part III of the 1936 Act and Subdivision 815-A from 1 July 2013.
Unlike the provisions in Division 13 and Subdivision 815-A, Subdivision 815-B is self-executing. The other
critical provision is s 815-115, which provides that if an entity gets a transfer pricing benefit from conditions that operate between the entity and another entity in connection with their commercial and financial relations, those conditions are replaced with the arm’s length conditions. The conditions that operate include, but are not limited to, such things as price, gross margin, net profit, and the division of profits between the entities.
The regime shift is also apparent in the numerous Practical Compliance Guidelines (PCGs) the ATO have released since The PCGs are indeed helpful as they showcase ATO’s thinking and expectations and outline the ATO’s consideration of what is viewed as low risk (unlikely to require scrutiny) and high risk (likely to attract scrutiny). The higher the risk rating, the more likely the ATO will review the MNE’s arrangement. Most of the PCGs also provide examples of arrangements ranked according to the ATO’s risk assessments. These examples are very useful and provide almost recipe-like instructions for a successful entry into the Australian market with minimized risks of scrutiny by the ATO.
Some of the most useful PCGs include:
- PCG 2017/1 – ATO compliance approach to TP issues related to centralized operating models
involving procurement, marketing, sales, and distribution functions; - PCG 2017/2 – Simplified transfer pricing record-keeping options;
- PCG 2017/4 – ATO compliance approach to taxation issues associated with cross-border related
party financing arrangements and related transactions; - PCG 2019/1 – Transfer pricing issues related to inbound distribution agreements;
- PCG 2020/7 – ATO compliance approach to the arm’s length debt test;
- PCG 2021/5 – Imported hybrid mismatch rule – ATO’s compliance approach (mismatches on
account of arrangements between deductions and/or non-inclusions of payment between
jurisdictions); and - PCG 2023/D2: Intangible arrangements.
The ATO’s Practical Compliance Guideline program also serves to highlight its areas of focus. The ATO is
strategically focused on closing the net tax gap of 7% (being the overall tax gap – the difference between
revenue actually collected and revenue expected to be collected) of $33.4 billion (AUD) as a proportion of
the expected revenue collected of approximately $480 billion (AUD)), with a specific focus on MNEs and
private groups. This initiative entails an expansion of the ATO’s task force and the introduction of targeted
compliance programs. For example, the release of PCG 2017/4 highlights that the ATO will be focussed on
intra-financing arrangements of multinational companies. Similarly, PCG 2023/D2 serves notice that the ATO will be targeting arrangements involving intellectual property migration and embedded royalties.
While the legislature has provided the ATO with broad powers in relation to transfer pricing matters, by
contrast, the Courts have been more circumspect. The Full Federal Court decision in Commissioner of
Taxation v Glencore Investment Pty Ltd [2020] FCAFC 187 is evidence of the practical and sensible approach undertaken by the Courts. This judgment was significant because it provided further clarity to Australia’s transfer pricing rules and, in particular, further elucidated key aspects of previous Full Federal Court decisions.
The Glencore Case provided novel insights into the application of Australia’s transfer pricing rules to an
integrated global business, particularly with respect to how the rules take into account the commercial and market risks impacting such a business. Specifically, the key lesson learned from this case is that related party transactions should be conducted in the following manner:
- The form of an arrangement should be consistent with its substance;
- All arrangements, agreements, and contracts between related parties should be thoroughly
documented; and - Contracts made between related parties should be commercially realistic and consistent with
dealings undertaken by unrelated third parties.
The ATO, however, have been successful in a decision which confirms and follows the landmark Chevron
decision – Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation [2021] FCA 1597
(SingTel). This decision represents a further key development in the Australian transfer pricing landscape.
In SingTel, the TP provisions operated to partially deny interest deductions on intra-group debt issued in
2002 in connection with the acquisition of Optus by the SingTel group. While the decision reflects an
application of the principles emanating from Chevron rather than any significant development in the law, it does demonstrate that the Commissioner was once again successful in establishing that parental support should be hypothesised thereby significantly reducing the interest rate for Australian deductibility.
As with the Glencore FFCT decision, the Singtel Case was concerned with the application of Division 13 and Subdivision 815-A of the Income Tax Assessment Act. Accordingly, the question which many taxpayers with arrangements outside the ambit of those provisions will be asking is whether the implications may be quarantined to those matters heard under Division 13 or Subdivision 815-A and how the approach of the Courts in the Chevron and SingTel cases may apply to matters heard where Subdivision 815-B applies.
Notwithstanding amendments to the transfer pricing rules, the arm’s length principle continues to underpin all of the provisions. Accordingly, it is arguable that the provisions have the same overriding objective even though the text of the legislation and therefore the statutory tests are markedly different. While there will be technical differences between the cases determined under the current and previous provisions, it is considered that both Chevron and SingTel nevertheless provide valuable guidance on economically relevant conditions and practical considerations in assessing transfer pricing risk associated with cross border financing arrangements under Subdivision 815-B of the ITAA 1997. Similar arguments could be made with respect to the precedential value of the FFC judgment in the Glencore Case.
With the ATO becoming increasingly concerned with cross border financing, the necessity of
comprehensively documenting related party financing arrangements is paramount. PCG 2017/4 provides a guide to taxpayers to undertake a risk assessment against the Commissioner’s compliance approach and outlines what evidence may be gathered in the event of a review.
3. How can MNEs best prepare for potential disputes in light of the factors described in Questions 1 and 2, and what can they do to mitigate the risks of future disputes?
As evidenced by the preceding discussion and the numerous PCGs, risk reviews and court cases, the ATO is clearly signalling that supporting contemporaneous evidence on the behavioural/motivational aspect is
much stronger than retrospective benchmarking. The authors also find that there are other issues with
applying the retrospective benchmarking approach to fulfill TP documentation compliance and obligations, such as:
- Australia is running out of comparable local independent benchmarks for MNEs;
- It is a backdated approach in a proactive forward-looking and moving business environment; and
- Revisiting and updating TP documentation on an annual basis will most likely be more costly over
time and will not provide MNEs with optimal protection if challenged by the ATO.
The authors have for some time now been using the concept of compiling contemporaneous evidence of
the commercial reasoning to the IRPDs when preparing TP documentation. The authors believe this
approach also gets ahead of the current and upcoming challenges facing MNEs and will further ensure
bulletproof TP positions in the future.
This change in approach to TP documentation can be used on any scale for both inbound and outbound
MNEs. The authors emphasize customizing the approach to the individual situation and circumstances and ensuring a balance between risk exposure and compliance burden and costs for the MNE.
The authors’ approach includes the following benefits:
- Holistic and will change as businesses move and expand;
- Examines the entire value chain;
- Can be included in the business decision model;
- Can easily be converted into a global TP policy and intercompany agreements;
- Annual compliance burden becomes a trivial and immaterial exercise;
- Can assist in complying with PCGs’ and new requirements from BEPS like Pillar One & Pillar Two;
and - Assist with APA application and risk review/audit defense through supporting evidence and a
documentation trail.
Regardless of the size of the MNE, with TP risks exposure and new compliance challenges coming from the ATO and the OECD, the authors highly recommend a shift in mindset to a holistic forward-looking approach.
Irrespective of new rules, guidelines, or whether consensus is met for Pillar One or Pillar Two or other
ambitious OECD recommendations, a proactive approach to the TP position will make it much easier to
tackle the new challenges. A TP position should be based on actual commercial decisions and business
plans and therefore should be documenting that the behavioral and motivational aspects of the IRPDs are at arm’s length and follow the relevant PCGs. This will make the TP position more likely to be assessed as low risk if challenged by the ATO.
Benedicte Olrik is a Managing Director of Transfer Pricing, and Meng Lee is a Director at Andersen Australia.
They may be contacted at:
Benedicte.Olrik@au.Andersen.com
meng.lee@au.Andersen.com
