The new transfer pricing world Are you ready? Introduction

Transcription

1 Are you ready? Introduction Over the past months there have been significant developments in the transfer pricing arena, both at a global and Australian level. The implementation of various Organisation for Economic Co operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Actions including Country by Country reporting (CbCR), the enactment of the Multinational Anti Avoidance Law (MAAL), the introduction of a Diverted Profits Tax (DPT) and the landmark Federal Court decisions in the Chevron 1 case are just some of the important changes that have already had an impact on how multinational enterprises (MNEs) operating in Australia manage their transfer pricing arrangements. In addition, Australia has adopted the OECD s revisions to the Transfer Pricing Guidelines (TPG) from 1 July 2016 and has legislated a one hundred fold increase in penalties for the late lodgement of certain documents by MNEs. 2 Against this backdrop, the Australian Taxation Office (ATO) has skilled up in transfer pricing and continues to grow its anti avoidance taskforce and economist practice, to assess transfer pricing risks and tackle disputes with taxpayers. A large part of the ATO s strategy is to foster a change in taxpayer behaviour in its words, prevention before correction. Many of the ATO s publications, including Practical Compliance Guidelines (PCGs) issued in January 2017 in relation to offshore hubs 3 and more recently related party financing transactions 4, suggest taxpayers self assess their transfer pricing risk profiles and take appropriate measures where needed to ensure they avoid future scrutiny has already proven to be a busy tax year for MNEs in light of the aforementioned developments, particularly in relation to the preparation of transfer pricing documentation. Given the scale of the task, and the consequences of poor execution, many companies are having to devote more resources to transfer pricing. Given the resources involved in defending historic arrangements and preparing documentation, this begs an important question Is your organisation ready? 1

2 The minimum standard Historically, the transfer pricing provisions were enforced by the Commissioner (i.e. upon review of a taxpayer s affairs, the Commissioner could seek to make a transfer pricing adjustment and issue an amended assessment to reflect the revised tax position). However, an important feature of Australia s new transfer pricing legislative provisions is that the onus is placed on taxpayers themselves to self assess their compliance with the arm s length principle, and to ensure they have maintained contemporaneous transfer pricing documentation evidencing their application of the tax law. Any transfer pricing documentation report must therefore address the concepts of transfer pricing benefit and reconstruction to support the taxpayer s self assessment of its transfer pricing position, as explained below. A transfer pricing benefit arises where there is an understatement of taxable income, overstatement of a tax loss, over claiming of tax offsets or underpayment of interest or royalty withholding tax as a result of the conditions in related party transactions not aligning with arm s length conditions. 5 Arm s length conditions refer to conditions that might be expected to operate between independent entities in the same (or similar) circumstances. However, should one of three exceptions apply 6, the Commissioner has broad powers to reconstruct the actual transactions undertaken and the basis for identifying the arm s length conditions. 7 To self assess whether a reconstruction of the actual conditions is required, taxpayers must compare and equate the substance and form of the transaction, and must also consider what independent parties would have done in comparable circumstances. The importance of demonstrating commercial and economic substance in this context cannot be overstated. Subdivision 284 E of Schedule 1 of the Taxation Administration Act 1953 sets out what documentation taxpayers require to demonstrate the arm s length nature of their related party dealings, and the consequences of not having this contemporaneous documentation are significant. In the event of an ATO adjustment, a taxpayer cannot have a Reasonably Arguable Position (RAP) without having the relevant documentation in place at the time of lodging the relevant tax return, and could therefore be liable for additional penalties and/or interest on any additional tax payable. Similarly, the recent revision to Australia s penalty regime makes getting it wrong potentially a very costly mistake. Increased administrative penalties for significant global entities 8 (SGEs) will apply from 1 July 2017 and extend to the failure to lodge any tax document required to be lodged with the ATO on time or in an approved form. Penalties range from A$105,000 for lodging a tax return or other required tax document just one day late, to a maximum penalty of A$525,000 where just one document is lodged more than 112 days late. MNEs also need to be meticulous in their approach given that penalties relating to incorrect statements made in documents submitted to the ATO by SGEs are set to double. Penalties for entering into any tax avoidance or profit shifting scheme will also be doubled for SGEs without a RAP. Significant developments in the transfer pricing arena have already had an impact on how MNEs manage their transfer pricing arrangements. 2

3 CbCR, master file and local file obligations For the first time, certain Australian taxpayers will need to lodge transfer pricing documentation with the ATO as an ongoing compliance requirement. While many other countries have deferred the implementation of CbCR and Master/ Local File reporting to 2017, Australian taxpayers are already subject to CbCR. Applicable from 1 January 2016, Australian taxpayers who are part of SGEs (i.e. an entity that is part of a multinational group with an annual global income of A$1 billion or more) must file a Country by Country report, a Master File and a Local File. Companies with a 31 December 2016 year end must therefore submit their documentation to the ATO by 31 December Whether or not the Australian taxpayer is the head company of the global group or a member, it is the Australian taxpayer that is obliged to file the necessary documentation locally with the ATO, not the ultimate parent of the MNE. In a tax consolidated context, that would be the Australian head company of the tax consolidated group. Australian subsidiaries of MNEs may be eligible for exemptions for some of the filing requirements in certain circumstances, however based on discussions with the ATO and recently released CbCR exemption guidance 9, there are no blanket exemptions for submission of the documents. Each request will be assessed on a case by case basis. Whilst the ATO has adopted the OECD s BEPS Action 13 Master File template, the ATO s approved form for the Local File has diverged from the OECD requirements. The Australian Local File is akin to the International Dealings Schedule (IDS) which already forms part of the company income tax return, however requires more granularity at a transactional level. It also requires the digital provision of information which is generally largely included in an entity s transfer pricing documentation, including agreements (not required by Subdivision 284 E but typically annexed to documentation reports), names and jurisdictions of counterparties, transfer pricing methods applied etc. Similar to the IDS, the Local File information will be used by the ATO to risk assess taxpayers. The provision of agreements to the ATO means that it is timely to review those agreements and ensure that the legal form matches the substance of the arrangement, as well as the consistency of agreements (and pricing approaches) for similar transactions occurring within the MNE around the world. Unfortunately the preparation and lodgement of CbCR, Master and Local File documentation is separate and distinct to the preparation of Subdivision 815 B documentation for Subdivision 284 E purposes. That is, the new rules simply add an extra layer of reporting, and an additional reporting date (12 months following year end). If you are a member of a global group, now is the time to reach out to your parent company to confirm what you need to be collating at a local level, for CbCR purposes. Action 13 is a clear reminder that the local reporting requirements are merely one piece of the puzzle. Changes are happening at the global level as well, so solutions need to be consistent and coordinated. In this evolving tax environment, one which demands increased transparency by the taxpayer and is characterised by greater sharing of information between tax authorities, technological solutions are more important than ever. Planning, centralisation, consistency, efficiency and risk assessment will be the foundation of effective transfer pricing management by MNEs. A clear reminder that local reporting requirements are merely one piece of the puzzle. 3

4 The MAAL Enacted late in 2015, the MAAL is broadly intended to ensure that MNEs do not use complex, contrived and artificial schemes to avoid a taxable presence in Australia. From a transfer pricing perspective, the philosophy underlying the MAAL is to prevent the risk and rewards of selling from being artificially alienated from the selling functions/activities (consistent with the OECD s desire to ensure transfer pricing outcomes align with where value is created). For example, the MAAL targets scenarios where a foreign entity supplies goods or services to Australian customers but an Australian related party performs activities (e.g. sales and marketing support) that go some way to securing the sales. Central to the ATO s application of the MAAL is a review of the nature of activities performed in Australia, their principal purpose, and the global structure and value chain as it is relevant to the Australian entity s operations. Prior to 31 March 2016, taxpayers were given transitional concessions including relief from penalties, and a less adversarial approach was taken by the ATO including guidance on provisions, and the potential to seek binding rulings and Advance Pricing Arrangements (APAs). Any application of the MAAL provisions now goes through the standard ATO compliance processes and thus faces a greater risk of increased penalties. The ATO has also identified certain potential anti MAAL planning structures, and has released Taxpayer Alert TA 2016/11 Restructures in response to the Multinational Anti Avoidance Law (MAAL) involving foreign partnerships. In the Federal Budget, the Government announced retrospective changes to the MAAL to address the concerns raised in this Taxpayer Alert. What is abundantly clear from this is that any anti MAAL type structuring will not be tolerated by the ATO. Taxpayers should ensure they review their arrangements and consider an ATO engagement strategy if necessary. The DPT Over and above the MAAL, the DPT was proposed in the 2016 Budget as a secondary anti avoidance measure targeting the unsupported shifting of Australian profits to offshore entities in lower tax jurisdictions (i.e. where the effective tax rate is less than 24%). Australia s version of the DPT is modelled on the UK equivalent, and the HMRC are currently in the process of risk assessing taxpayers to which the DPT could potentially apply. However the Australian DPT is significantly wider in scope than the UK version and, unlike the UK rules, is designed to capture financing arrangements within its ambit. The application of the DPT will be based on the satisfaction of several gateway tests which capture Australian taxpayers that are part of a SGE, who engage in dealings with a foreign related party. The DPT has been included as part of Australia s general anti avoidance provisions (Part IVA Income Tax Assessment Act 1936), and consistent with those provisions, requires the ATO to form a view as to whether there was a principal purpose of obtaining a tax benefit. Central to a taxpayer s ability to show that the DPT should not apply to them will be their ability to demonstrate sufficient economic substance associated with their transactions. Having received Royal Assent in early April, the DPT will apply from 1 July 2017 regardless of when the transaction was entered into. The DPT allows an assessment to be issued based on a tax benefit identified by the ATO. The tax benefit (based on existing Part IVA principles) is effectively the ATO s view of the diverted profits under the arrangement entered into, as compared to the Australian tax position under a reasonable alternative counterfactual asserted by the ATO. The diverted profit is taxed at 40% to be paid upfront. This reflects the ATO s general strategy to change taxpayers behaviour around aggressive structuring and transfer pricing, as well as their approach towards disputes with the ATO. Taxpayers should consider the potential application of the DPT to their existing and new transactions, and should be able to support/evidence the substance of entities in lower tax jurisdictions with which they are transacting. It is expected that every ATO risk review of MNEs will include a DPT focus. The messaging from the ATO is that although DPT is not a provision of last resort, it is expected that the DPT will be applied only in very limited circumstances, after giving consideration to the operation of the ordinary provisions in the income tax law. However, as the DPT is enacted as part of Part IVA, in the event that the ATO applies the DPT to a taxpayer, there is likely to be double tax arising because Part IVA is expressly excluded from Australia s Double Tax Agreements and therefore taxpayers cannot invoke the Mutual Agreement Procedures in the treaties to relieve the double tax. The DPT was proposed as a secondary anti avoidance measure targeting the unsupported shifting of Australian profits to offshore entities in lower tax jurisdictions. 4

5 ATO encouraging taxpayers to self assess their risk The final allocated rating will depend upon other factors including the amount of tax at risk, the transfer pricing analysis and documentation, and behavioural indicators (e.g. voluntary engagement with the ATO, whether there is full disclosure and provision of primary supporting evidence). Should it fall within the higher risk zones (i.e. amber and red zone), reviews will be commenced by the ATO. Taxpayers falling in the red zone will also attract unwanted attention from the ATO as such cases are much more likely to proceed directly to audit and any resolution of the matter through non adversarial channels (i.e. settlement or alternative dispute resolution) may be limited. 11 The ATO issued PCG 2017/1 in January this year setting out the ATO s compliance approach to transfer pricing issues related to the location and relocation of certain business activities (e.g. procurement, marketing, sales and distribution functions), and associated operating risks into centralised operating models (referred to by the ATO as hubs ). This is a significant development on an issue that has been a hot topic for the ATO for many years and will need to be considered by many taxpayers in the mining and oil & gas sectors. The guidance primarily focuses on existing and newly created offshore marketing arrangements, however it is expected that this will be expanded to include procurement and shipping arrangements. The guidance outlines a white zone and five risk zones from green (low risk) to red (very high risk) and explains how the ATO will approach taxpayers in each zone differently in terms of resourcing, and the type/extent of any compliance review. The white zone provides a concession from self assessment of risk by the taxpayer on the basis that there has already been ATO engagement in the form of an APA, settlement agreement or review resulting in a low risk rating being allocated. Broadly, the risk rating turns on the hub s profit compared to its costs (effectively operating expenses). If its profit is less than a 100% mark up on its total costs, and it also passes a secondary test (the commercial realism indicator which is still being developed by the ATO), then the arrangement will be classified as low risk (green zone) and ATO resources will generally not be applied. 10 Where the hub s profit is greater than a 100% mark up of hub costs, the arrangement will fall into one of four higher risk zones (blue, yellow, amber or red). Ultimately, the ATO can risk assess as it likes, so while the PCG provides a valuable insight into its overall approach to risk assessment, taxpayers could use the guide as a self assessment tool. This is particularly relevant in light of the ATO s proposal to amend the IDS to include a hub risk rating disclosure. Taxpayers should see the PCG as an indication of what to expect from the ATO, i.e. a clear emphasis on internal risk processes, how taxpayers should be working with the ATO going forward, and the disclosures expected of them. However, despite public consultation on PCG 2017/1, there appears to remain some ambiguity regarding its application and it provides limited technical guidance with respect to the ATO s transfer pricing analysis of hubs. What is clear is that it is imperative that the hub has commercial and economic substance and the taxpayer can evidence risks borne in practice (and the ability to bear these risks), by the hub. 12 It is imperative that the hub has commercial and economic substance and the taxpayer can evidence risks borne in practice. 5

6 Financing arrangements The case on everyone s lips at the moment is Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation (2017) FCAFC 62. This decision is a landmark decision in the transfer pricing arena given the fundamental concepts drawn out in the judgement, not just in respect of intra group financing transactions. Broadly the case concerned the pricing of interest on an inter company loan between Chevron Australia (the borrower) and a United States (US) subsidiary (the lender) over the period No explicit parental guarantee was provided and the lender did not have security over the borrower s assets. In summary, the Commissioner made a determination that the interest rate of 1 month Australian LIBOR plus 4.14% (which represented a mark up on the external funding costs of the US subsidiary) charged by the lender on the loan was excessive. The Federal Court in the first instance agreed with the Commissioner, and this position was affirmed by the Full Federal Court on 21 April The Court found that in considering the application of the arm s length principle, the borrower was not an orphan (i.e. a stand alone entity) but a subsidiary of a major MNE. In other words, if a lender providing finance to a subsidiary takes into account the fact that the entity is part of the wider global group, then that is the appropriate reflection of the arm s length principle. The case also highlighted that the application of the arm s length principle requires commerciality of the arrangements. In the context of this case, the Courts were of the view that an unsecured loan arrangement, as described in the legal agreement between the parties, would not have taken place in the market. Rather security, operational/financial covenants, and/or a parental guarantee would have been provided. MNEs, regardless of the industry in which they operate and the type of international related party dealings they have, must take note of the decision as many of the issues are not confined to financing or the oil and gas industry. Themes throughout the case such as contractual form versus substance, whether conduct was truly arm s length, the commerciality of arrangements and agreements, and true comparability are some key concepts the ATO expects to see addressed in any transfer pricing analysis. Financing issues have long been considered a material risk, so increased ATO activity in this area is expected following the Chevron decision. Most recently the ATO has made it clear that inbound financing transactions are a top priority. 13 Buoyed by the Chevron appeal outcome, on 16 May 2017 the ATO released the long anticipated draft PCG 2017/D4 outlining its risk assessment framework for related party financing arrangements. Similar to PCG 2017/1, PCG 2017/D4 sets out a risk assessment methodology for taxpayers to apply to determine which risk zone their inbound and outbound financing arrangements fall within, based on a cumulative scoring system. The qualitative and quantitative indicators, and their relative weightings have been developed based on the ATO s expectation that, in most cases, the cost of related party financing should align with the financing costs that could be achieved by the ultimate parent company (on an arm s length basis). Importantly, the framework is to be applied against each related party financing arrangement. While PCG 2017/D4 is still subject to consultation and feedback, it signals the significant uplift of the ATO s focus and activity in the area of cross border financing. MNEs, regardless of the industry in which they operate and the type of international related party dealings they have, must take note of the Chevron decision as many of the issues are not confined to financing or the oil and gas industry. 6

7 Measures to ease the compliance burden The ATO: skilling up to fight the transfer pricing battle Adoption of the OECD s revised TPG For taxpayers with low level international related party dealings, the ATO released Simplified transfer pricing record keeping options 14 ( simplification measures ) to mitigate the documentation burden for eligible taxpayers. In order to qualify, certain general and specific eligibility criteria must be met. Though being able to apply the simplification measures does not waive the operation of Subdivision 815 B, taxpayers which can apply the simplification measures can make positive documentation disclosures in their IDS and/or Local File, and the ATO has stated that it will not allocate resources or take compliance action to examine transfer pricing records for eligible entities. Importantly, the simplification measures are not a safe harbour or administrative concession as noted above, taxpayers must evidence that each eligibility criterion for the relevant measure(s) has been correctly applied, and that Subdivision 815 B has been applied. Nonetheless, the measures have certainly eased the transfer pricing compliance burden for eligible taxpayers, particularly SMEs. The ATO recently announced that it is also proposing to issue formal letters of comfort to taxpayers they consider to be swimming between the flags. The letters will constitute an administrative indication of the ATO s position. While the letters cannot be relied upon as binding against the ATO, this is still a welcome proposed addition to the ATO s suite of compliance products, and should provide additional assurance to taxpayers with low level/low risk international related party dealings. The ATO has signalled its intention to focus on tax avoidance issues with the creation of a Tax Avoidance Taskforce from 1 July 2016, and an additional 390 people to be recruited to the Taskforce. Further, the Government s International Structuring and Profit Shifting (ISAPS) funding was also extended through to We have seen a focus on greater transparency and pro active enforcement by the ATO through its release of Tax Alerts and guidance on various topics. In these publications the ATO is emphasising the importance of open communication and early engagement. The requirement for groups to prepare general purpose financial statements for their Australian operations, and implementation of the tax transparency code for large Australian corporates, are further examples of the ATO s drive for open dialogue with taxpayers and the general public. Its significant audit activity (i.e. 7 major MNE audits to be finalised by June 2017) is a reflection of the ATO s renewed strategy and expanded capacity. The ATO s Corporate Plan suggests we should expect more of the same in the coming year. In light of the ATO s evolving capabilities and drive for transparency, the demands being placed on tax departments at the domestic level have increased significantly. The revisions to the TPG are designed to align transfer pricing outcomes with value creation. The OECD revised the TPG in accordance with Actions 8 10 of the OECD s BEPS Project in May 2016 and the revised TPG will apply to Australian taxpayers from 1 July The revisions to the TPG are designed to align transfer pricing outcomes with value creation, focusing on the following key areas: Contractual arrangements, including the contractual allocation of risks and corresponding profits, and the importance of substance in the allocation of risk Multinational group synergies, including passive association Transfer pricing issues relating to transactions involving intangibles Low value - adding intra group services Cost contribution arrangements. In the context of intangibles, MNEs must perform a detailed analysis of the economic ownership and DEMPE functions (i.e. Development, Enhancement, Maintenance, Protection and Exploitation) required in respect of any identified group IP. The Revised TPG are reflective of the concept that reward is driven by risk/substance rather than legal form or ownership. MNEs must ensure that group companies performing important functions, controlling economically significant risks and contributing assets, receive returns commensurate with the value of their contributions. The revised TPG also emphasise the importance of ensuring that any risks allocated to an entity are consistent with that entity s functions and financial ability to bear the risk. MNEs must ensure that only those risks which can be, and are in substance managed and controlled by an entity, are allocated to them. 7

8 Where to now? Assess, Reset, Communicate We have seen companies devoting significant resources and spending years battling transfer pricing audits with the ATO. Now is the right time to assess, reset and communicate. Transfer pricing has been at the forefront of the ATO s recent compliance activity and this will continue to be the case in the face of public sentiment that MNEs are not paying their fair share of tax. 15 Taxpayers should be prepared for earlier ATO intervention and engagement. The onus is now squarely on taxpayers to ensure they have a clear understanding of their reporting obligations, can support the economic and commercial substance of their dealings/international related parties, and have adequately self assessed and managed their transfer pricing risk. This is especially relevant in light of the increased penalties that could apply. The continued release of guidance from the ATO should be taken into account by taxpayers, as these publications are usually roadmaps as to what information the ATO would request in the event of review, and what consequences may arise should the cases be elevated to audit. In the meantime, large corporates should start planning (if they have not done so already) how they will tackle their transfer pricing obligations and risks for the year ahead. Transparency, risk assessment and proactive engagement with the ATO by the taxpayer should be a priority for boards. Tax, and more specifically transfer pricing, has become a major strategic business issue requiring consultation across the business. Substance should set the agenda for every tax conversation - what are the functions, who bears the risk, where is the value created? Assess - analyse your existing value chain with a view to ensuring profits are commensurate with functions, assets and risks. If you apply the law and document your position, you should have a strong line of defence. Rather than seeing it as a burden, use the documentation process as a way of putting your best foot forward rather than just dotting the i s and crossing the t s. Fail to do so and be prepared for the consequences. Reset - consider the implications of the OECD s Actions 8 10 guidance, which now form the reference to Australia s transfer pricing law. If necessary, revisit pricing arrangements to ensure the pricing aligns with value creation and substance, can be considered commercial, and negotiate with your related parties to reset such pricing or profit allocations if required. Revisit your intercompany agreements to ensure they align with substance. Communicate - with your international related parties and within your organisation. Discuss potential transfer pricing risks at a board level, and proactively communicate with the ATO (or other revenue authorities) if you are keen to obtain certainty. Consider APAs as a tool to manage global transfer pricing risk. The onus is now squarely on taxpayers to ensure they can support the substance of their dealings and have self assessed and managed their transfer pricing risk. 8

9 References 1. Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation No.4 [2015] FCA 1092; Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act (No 27) ATO, Practical Compliance Guideline (PCG) 2017/1: ATO compliance approach to transfer pricing issues related to centralised operating models involving procurement, marketing, sales and distribution functions, < COG/PCG20171/NAT/ATO/00001>. A further Discussion Paper (potentially to be converted into a PCG) is also nearing finalisation on Lease In Lease Out arrangements 4. ATO, Practical Compliance Guideline (PCG) 2017/D4: ATO compliance approach to taxation issues associated with cross border related party financing arrangements and related transactions, < %22COG%2FPCG20174%2FNAT%2FATO%2F00001%22>. 5. Section , Subdivision 815 B of the Income Tax Assessment Act The three exceptions to the basic rule, i.e. where actual and arm s length conditions may not align hence the reconstruction provisions could apply, include: i) where substance and form do not align, ii) where independent parties would have entered into alternative transactions, or iii) where independent parties would not have entered into the transaction at all 7. Section , Subdivision 815 B of the Income Tax Assessment Act Broadly, members of groups with global revenues exceeding AU$1billion. 9. ATO, Country by Country reporting: Exemption Guidance, < International tax for business/in detail/transfer pricing/country by country reporting Exemption guidance/?page=1>. 10. ATO, PCG 2017/1: ATO compliance approach to transfer pricing issues related to centralised operating models involving procurement, marketing, sales and distribution functions, para 6, 25 and 77 78, < NAT/ATO/00001>. It is noted that the OECD s Revised Transfer Pricing Guidelines also address commodity pricing and the attribution of value to marketing hubs. 11. Ibid, para Ibid, para ABC news, ATO chief issues enough is enough ultimatum to corporate tax dodgers, < au/news/ /tax commissioner chris jordan attacks multinational companies/ > tax for business/in detail/transfer pricing/simplifying transfer pricing record keeping/ 15. ABC News, Corporate tax minimisation costs governments $US1 trillion says accounting insider, < /corporate tax minimisation costs governments 1 trillion/ >. Contacts (Transfer pricing, Deloitte Tax Services Pty Ltd) Geoff Gill Tel: gegill@deloitte.com.au Ockie Olivier Tel: oolivier@deloitte.com.au Soulla McFall Tel: smcfall@deloitte.com.au Jacques Van Rhyn Tel: jvanrhyn@deloitte.com.au Fiona Craig Tel: ficraig@deloitte.com.au Paul Riley Tel: pbriley@deloitte.com.au Janelle Sadri Director Tel: jsadri@deloitte.com.au Nicole Chiam Senior Analyst Tel: nchiam@deloitte.com.au 9

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