Transfer pricing is increasingly influencing significant changes in tax legislation around the world. This 18th issue of BDO’s Transfer Pricing Newsletter focuses on recent developments in the field of transfer pricing in Australia, Israel, the Netherlands, and India. Transfer pricing is becoming increasingly important for both tax authorities and tax payers around the world, with various countries introducing new legislation and guidance with respect to transfer pricing. As you will read, various countries are also showing initiatives following the finalization of OECD’s BEPS project, which are expected to expand over the coming months.
We are very pleased to bring you this issue of BDO’s Transfer Pricing News, which we were able to produce in close co-operation with our colleagues from the above-mentioned countries. We trust that you will find it useful and informative. If you would like more information on any of the items featured, or would like to discuss their implications for your business, please contact the person named under the item(s). The material discussed in this newsletter is intended to provide general information only, and should not be acted upon without first obtaining professional advice tailored to your particular needs.
The Australian transfer pricing landscape is constantly evolving, with new transfer pricing rules, regulations and the release of the decision in the Chevron case on 23 October 2015. Given the extent of these developments, we provide an overview of some of the key changes and the impact this may have on businesses that operate or seek to operate in Australia.
1. Revisions to the Australian transfer pricing legislative framework
Australia updated its transfer pricing legislation during 2013, resulting in some key changes and consequences for how Australian taxpayers manage their transfer pricing. The new rules apply to income years commencing on or after 29 June 2013.
In brief, the requirements under the new rules include:
- A requirement for the Public Officer of a taxpayer to self-assess its transfer pricing arrangements upon lodging the tax return. Where adjustments are made in the tax return (and not in the accounts) it can lead to double taxation, so it is highly recommended that taxpayers ensure that any transfer pricing adjustments are made before the year end.
- A focus on the ‘arm’s length conditions’, which are the conditions that might be expected to operate between entities dealing wholly independently with one another in comparable circumstances. This may require an arm’s length allocation of profits between relevant entities. This focus is consistent with the OECD revised guidance on risk, intangibles and cost contribution arrangements.
- Reconstruction provisions which allow the actual transactions to be substituted for a hypothetical arm’s length transactions in certain circumstances, for example, looking at substance over form arrangements.
- Penalty provisions that are linked to whether a taxpayer’s transfer pricing documentation is prepared prior to the lodgment of the tax return and satisfies the ‘reasonably arguable position’ test. All taxpayers wanting to mitigate penalties must prepare transfer pricing documentation prior to lodgment and maintain the report in English in Australia.
- A shift from an unlimited amendment period to a seven year statute of limitations.
2. ATO releases guidance on preparation of documentation under new rules
The law sets out what transfer pricing analysis is required in order to achieve penalty protection. To assist taxpayers understand these requirements, the ATO has released guidance in the form of Taxation Ruling 2014/8 which details the suggested framework for the preparation of transfer pricing. The transfer pricing documentation should consider and address the ‘5 key questions’ outlined below:
- Question 1: What are the actual conditions that are relevant to the matter (or matters)?
- Question 2: What are the comparable circumstances relevant to identifying the arm’s length conditions?
- Question 3: What are the particulars of the methods used to identify the arm’s length conditions?
- Question 4: What are the arm’s length conditions and is/was the transfer pricing treatment appropriate?
- Question 5: Have any material changes and updates been identified and documented?
The ATO recommends that taxpayers consider all 5 key questions in light of their own facts and circumstances, including the relative complexity and materiality of their relevant dealings and their self-assessment risk. A minimum level of supporting evidence and documentation will be required at the time of lodging the tax return to be able to form a reasonable view of whether the transfer pricing arrangements were arm’s length during the year under review. Typically, the level of analysis required to arrive at such a view is likely to depend on the risk and complexity of the transfer pricing arrangements.
3. ATO releases revised APA policies and procedures
The ATO has released Practice Statement Law Administration (PSLA) 2015/4 which details the ATO’s revised advance pricing agreement (APA) program. Key changes include the introduction of a formal APA Program Management Unit, referred to as an ATO Triage function, and more transparent insights into the factors impacting taxpayer’s chances in entering into the APA program. The Practice Statement also emphasises that the ATO APA teams will be moving towards applying a ‘whole of tax code’ approach in reviewing APA applications as opposed to focusing solely on direct transfer pricing issues. For example, matters dealing with withholding tax and carry forward losses would be considered as part of the APA application.
Key implications from the revised APA program
In most cases, the work required before being accepted into the APA Program has increased. The PSLA indicates that the ATO continues to encourage and support taxpayers into entering into APAs where possible. However, simultaneously, the ATO emphasises that going forward, a greater level of due diligence will be applied which will be more apparent at the early engagement stage. With the new PSLA, there is an expectation that there will be more upfront work required before being accepted into the APA program. Therefore, companies who have previously concluded an APA under the old regime may find that additional work needs to be undertaken before they apply for a renewal of their APA.
Are APAs still a valuable tool to manage risk?
Minimising transfer pricing risk in Australia through an APA is still a viable alternative for multinational companies to get ahead of the curve ball and ensure there are no surprises. Multinational companies in Australia will need to determine whether entering into an APA is the right avenue, and this will require greater consultation and collaboration with advisors. The Australian BDO transfer pricing team has extensive experience in successfully negotiating APAs, resolving disputes and maintaining good working relationships with the ATO.
4. Country-by-Country reporting – Enshrining OECD transparency measures into Australian law
The Australian Treasury has released exposure draft legislation which will insert into Australian law Subdivision 815-E to implement Action 13 of the BEPS project, i.e. the introduction of new standards for transfer pricing documentation and Country by-Country (CbC) reporting to enable tax authorities to better identify and tackle transfer pricing risks. The new rules apply to Australian residents or foreign residents with an Australian Permanent Establishment with annual global revenues of AUD 1 billion. Therefore these rules apply even if the local Australian subsidiaries are small.
What do businesses exceeding the AUD 1 billion threshold need to do now?
The new regulations apply for accounting periods commencing after 1 January 2016. This means that Australian headed groups with a June year end will only need to apply the rules for the year ending 30 June 2017, whilst December balancers (typically inbound investors) will have an earlier start date of the year ending 31 December 2016, i.e. this coming financial year. Under the new draft legislation, a statement by the taxpayer is required to be lodged with the
ATO covering one or more of:
- A CbC report – requires reporting of highlevel information relating to the global allocation of a multinational group’s income and taxes paid, as well as information about the location and main business of each constituent entity within the group.
- The master file – provides an overview of the multinational group’s business operations that will enable tax authorities to place the group’s transfer pricing practices in their global economic, financial, legal and tax contexts. It requires the group’s organizational structure, its intangibles and intercompany financial activities, financial and tax positions and a description of the group’s businesses.
- The local file – focuses on specific transactions between the reporting entity and their associated enterprises in other countries. It requires identification of relevant related party transactions, the value of those transactions, and the entity’s analysis of the transfer pricing outcomes and positions.
The three reports together will provide an overview of global and local financial and operational activities of a global group, as well as the local activities, that is, full transparency for the ATO to assess transfer pricing risks. This statement will be due within one year of the year end. Therefore, the statement can be prepared at a later date than the Australian documentation which is due at the time of lodging the income tax return – usually 6 months and 15 days after the year end.
The ATO has the power to specify which of the above three documents it requires. To the extent that the Commissioner can obtain the CbC report through the (automatic) exchange of information with other Tax Authorities, it may only be necessary to supply a master and local file to the ATO.
What are the penalties for large groups for non-compliance with the new regulations?
Failure to provide a statement on time or in the approved form will not deny a company penalty protection under the existing reasonably arguable position (RAP) requirements provided they meet the existing Australian documentation requirements. However, the maximum penalty for tax avoidance and profit shifting arrangements will be doubled up to a maximum of 120% of the tax avoided for groups with an AUD 1 billion global turnover. This is perhaps the most severe penalty regime in the OECD and seems to be arbitrarily linked with a MNC’s global size.
What impact will this have on my group if it falls within the new regime?
Groups have never had to file transfer pricing documentation upfront with the ATO. On a self-assessment basis, the ATO has had to rely on the tax return including the International Dealings Schedule and accounts to assess transfer pricing risks. The ATO will now be able to more easily identify mismatches between profits arising in a low tax jurisdiction with people functions and assets/risks in the CbC reporting. When a perceived risk is identified, the ATO can investigate further into the wider group and Australian transfer pricing documentation to analyse the support for the current allocation of profits and, if appropriate, pursue a risk review and/or audit.
Given the experience that the ATO is gathering through International Structuring and Profit Shifting program/BEPS audits, there is a much higher risk of the ATO identifying exposures and commencing an audit than ever before.
5. Multinational Anti-Avoidance Law
On 16 September 2015, the Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 (the ‘Bill’) was introduced into the Australian Parliament. In addition to new CbC reporting rules and stronger penalties to combat tax avoidance and profit shifting, the Bill extends Australia’s current anti-avoidance rules to prevent multinational entities from using certain tax avoidance schemes to artificially avoid the attribution of profits to a permanent establishment (PE) in Australia. To reduce compliance costs, the new ‘Multinational Anti-Avoidance Law’ (MAAL) will only apply to foreign entities that are either parent entities (or members) of a multinational group with global revenues of AUD 1 billion or more (defined as ‘significant global entities’).
The Bill has broadened the scope of the original draft MAAL which was released in May 2015 by removing a condition for the rules to apply only where multinationals operated in a low or no tax jurisdiction. The MAAL will now apply where:
- A foreign entity derives income from making supplies (i.e. of goods and services, including electronic downloads, IP rights, rights to priority in search functions etc.) to Australian ‘arm’s length’ customers;
- There is an entity in Australia that is an associate of, or commercially dependent on, the foreign entity, which supports the making of those supplies;
- The foreign entity avoids the income derived from the supply being attributable to a PE of that foreign entity in Australia; and
- It is concluded that the scheme was entered into or carried out for the principal purpose (or for more than one principal purpose) of obtaining an Australian tax benefit, or obtaining both an Australian tax benefit and a reduction (including a deferral) of foreign tax.
In essence, the provisions seek to target schemes where income from sales between a foreign entity and Australian third party customers is booked overseas, while an affiliated (or commercially dependent) Australian entity performs activities viewed as integral in securing the Australian sales (e.g. marketing, sales support, warehousing activities), but with no income being attributed to Australia in respect of the Australian sales. Where the rules are found to apply, the foreign entity will likely be deemed to have a notional PE in Australia, with Australian sales revenue and allowable deductions being attributed to the notional Australian PE (based on Australian PE transfer pricing principles). The new rules will apply on or after 1 January 2016 whether or not the scheme was entered into, or was commenced to be carried out, before that day.
With the Bill expected to be enacted unobstructed, foreign entities with global revenues of AUD 1 billion or more entering into sales contracts directly with Australian third party customers, and having affiliated or dependent Australian entities undertaking activities in direct support of the Australian sales, should review their current arrangements now to ascertain the potential impact of these changes.
While the Explanatory Memorandum to the MAAL states that the new measures are specifically targeted at 30 large multinational companies and may impact up to 100 companies, the Treasurer’s second reading speech in relation to the Bill identified up to 1,000 multinationals which potentially could be impacted by the new measures.
6. ATO wins first landmark transfer pricing case against Chevron Australia
In a landmark transfer pricing case1 the Australian Federal Court has held that Chevron Australia did not provide sufficient evidence to prove that the consideration on an intra-group financing arrangement was the arm’s length consideration or less than the arm’s length consideration, nor proved that the ATO’s amended assessments were excessive. This was very much based on the Judge not accepting the extensive arguments provided by a number of witnesses for Chevron Australia.
The Judge found in favour of the Commissioner under both the old transfer pricing rules in Division 13 of Income Tax Assessment Act 1936 and the revised transfer pricing rules in Subdivision 815-A of Income Tax Assessment Act 19972. In relation to Subdivision 815-A which is retrospectively applied, the judge decided that it was constitutionally valid. The key implications arising from the case include the following:
- The case highlights that to the extent taxpayers cannot discharge the onus of proof through proper analysis and documentation evidence it will be difficult to defend their transfer pricing arrangements from ATO scrutiny.
- Taxpayers should review their intra-group financing arrangements to consider whether any economic analysis performed, in relation to determining the appropriate interest rate applied to their intra-group financing arrangements, takes into consideration all appropriate factors, including the financial resources available to the borrower that an arm’s length lender would regard as relevant to the pricing of the loan.
- In addition to tax and interest, penalties of approximately AUD 45 million (i.e. 25% of the scheme shortfall amount) were imposed, as the judge found the dominant purpose of the refinancing arrangement was to enter into a scheme, for which the sole or dominant purpose was to derive a benefit from the scheme. In the Chevron case, another entity in the US borrowed funds at a low interest rate (due to a guarantee from Chevron Corp) and on-lent funds to Chevron Australia at a higher interest rate which generated a large profit for the lender.
- This decision is reported just two weeks after the OECD announced its final Base Erosion Profit Shifting (BEPS) package, in which many countries around the world have endorsed a number of actions explicitly designed to tackle perceived tax avoidance by multinational groups.
- More broadly the case is likely to empower the ATO to continue its pursuit in reviewing the transfer pricing positions of multinationals, and taxpayers will need to be prepared to support their case. Chevron Australia is considering an appeal against the Federal Court judgement. Given the constantly evolving Australian transfer pricing landscape, with new measures introduced to administer the Australian transfer pricing rules, it is important that taxpayers in Australia review their transfer pricing arrangements and prepare adequate transfer pricing documentation to support the arm’s length nature of the arrangements.
Your BDO contact in Australia:
1 Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (No 4)  FCA 1092.
2 Subdivision 815-A applies to income years commencing on or after 1 July 2004 and ceases to apply to income years to which Subdivision 815-B applies, which generally starts for income years commencing 1 July 2013.