Australian Tax Office releases guide for offshore hubs involving procurement, marketing, sales and distribution functions

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1 24 January 2017 Global Tax Alert News from Transfer Pricing Australian Tax Office releases guide for offshore hubs involving procurement, marketing, sales and distribution functions EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary The Australian Taxation Office (ATO) released, on 16 January 2017, a 29 page Practical Compliance Guide (PCG) PCG 2017/1, that sets out the ATO compliance approach to transfer pricing issues related to centralized operating models (hubs) involving procurement, marketing, sales and distribution functions. In PCG 2017/1, the ATO outlines a framework of risk self-assessment that is linked to taxpayer reporting obligations and advises you may be asked to tell us if you have self-assessed your rating and if so, what your risk rating is. This will allow the ATO to tailor our engagement with you according to your hub risk profile. The PCG has effect from 1 January 2017 and will apply to existing and newly created hubs. It follows a 2016 draft paper (draft) and consultation in which EY participated. The draft and PCG arose from ATO concern about offshore entities operating as hubs in supply chains, particularly foreign hubs used by Australian businesses in marketing exports from Australia (marketing hubs). However, the PCG and principles are not necessarily limited to marketing hubs. The PCG is designed to allow Schedules on specific types of hubs and the first schedule on marketing hubs was published with the PCG. However, the ATO

2 2 Global Tax Alert Transfer Pricing intends to release additional schedules to the PCG bringing in other types of hubs. We understand a schedule applying to procurement hubs is planned this year. The PCG (Link to ATO website) is intended to: Explain the ATO compliance approach and evidence required, which will be driven by the perceived risk of businesses particular hubs and risk profiles Assist taxpayers to assess the ATO perceived compliance risk of the transfer pricing outcomes of hubs and to work with the ATO to reduce the transfer pricing risk exposure in relation to hubs The PCG requires action by international businesses using hubs, as part of tax governance and risk management processes. In particular, businesses will need to understand where their hubs figure on the ATO risk spectrum, the implications including ATO compliance activities and potential actions to reduce the ATO perceived risk. Detailed discussion Hub Risk Assessment Framework The PCG has changed since the draft. It is now a much clearer risk assessment guide rather than potentially being a proxy for determining a transfer pricing benefit. The PCG retains the draft s risk framework, 1 adding a new white zone with circumstances where a taxpayer need not self-assess the risk. Accordingly there are six risk classifications: White zone self-assessment of risk rating unnecessary Green zone low risk Blue zone low to moderate risk Yellow zone moderate to high risk Amber zone high risk Red zone very high risk The ATO s compliance enforcement depends on the hub s risk rating with a low engagement for a low risk zone consequently followed by a detailed and comprehensive review for higher risk hubs. The ATO states the higher your risk rating the more detailed and comprehensive we would expect your transfer pricing documentation and supporting evidence to be. Importantly, if a business takes no action it will be classified as in the red zone with more comprehensive ATO compliance activity and transfer pricing expectations. What are hubs for purposes of the PCG The ATO uses the term hubs to refer to commonly centralized activities including marketing, sales and distribution functions. The ATO has a specific interest in so called offshore marketing hubs. An offshore marketing hub is defined by meeting the following characteristics: The entity is a related offshore entity or a permanent establishment of a related Australian entity or related foreign entity The entity act(s) as agent or principal in relation to the marketing or sale of goods or commodities sourced from Australia The entity on-sells the goods or commodities without substantial alteration, although the entity may also facilitate refining, casting or similar processes However, the PCG also states a marketing hub covers a range of models from service providers through to full risk marketers and traders, and the definition is intended to be read broadly. Finding the zone The white zone Exclusions from the need to further risk-assess apply for taxpayers where there is one of the following: a) An Advance Pricing Arrangement (APA) that applies to the current year b) A settlement agreement with the ATO that applies to the current year c) A court decision within the last two years on transfer pricing outcomes of a hub d) A low risk rating from an ATO review of the hub in the last two years In addition, there must not be a material change in the function, assets and risks or pricing of the hub since the time of the agreement/decision/review. For marketing hubs not covered by the above exceptions Schedule 1 outlines the further process.

3 Global Tax Alert Transfer Pricing 3 The green low-risk zone Taxpayers will need to test their hub using the methodology set out in the relevant schedule to determine if they fall into the green low-risk zone. The low risk benchmark for offshore marketing hub arrangements is a hub profit of less than or equal to 100% mark-up of hub costs or a full controlled foreign corporation (CFC) attribution of the hub profit. The non-green risk zones For hubs outside the green zone, the zone will depend on: a) The tax impact of hub arrangements for the relevant year, and b) Whether taxpayers have transfer pricing documents that meet the requirements needed to have a reasonably arguable position (RAP). The starting point will be: Blue zone for hubs with a tax impact below AU$5m annually Yellow zone for hubs with a tax impact between AU$5m and AU$50m annually Amber zone for hubs with a tax impact of above AU$50m However, not having transfer pricing documentation that meets the RAP requirements will lift taxpayers from their starting point into the yellow or red zones. Taxpayers that do nothing, or are unable to apply the risk methodology, will be in the red zone. The guide provides a detailed overview of the Risk Assessment Framework in the diagram in Attachment A of the PCG. 2 Going green, to decrease risk ratings The ATO highlights that If you are outside the green zone and would like to decrease your risk rating, you are able to do so by engaging cooperatively and constructively with the ATO by applying for an APA or having an internal team, working to achieve a low risk rating. One notable change from the draft is that taxpayers with a high risk rating will be no longer be prevented from seeking an APA, and time limits will not apply. Taxpayers who wish to transition back years to the green zone and make a voluntary disclosure within 12 months will have penalties remitted and interest kept to the base rate. PCG 2017/1 stresses that the green zone is not a safeharbor. There is still an obligation for taxpayers to meet the arm s length pricing requirements, and the ATO will monitor for signs that taxpayers are increasing profits up to the low risk thresholds. Outcomes of the risk rating Green zone hubs will be treated as being at lower risk. The ATO will generally not apply compliance resources to the arrangement and businesses will be eligible to access the simplified record-keeping option. Taxpayers outside the green zone will be required to make additional disclosures in the International dealings schedule (IDS). The nature of these disclosures is not currently known, although they may overlap with the Country-by-Country reporting requirements. Guidance for supporting analysis Part B of the PCG provides guidance in relation to preparing a transfer pricing analysis to support a hub outside the green zone. Part B provides a list of questions that the ATO will consider when reviewing the hub. The ATO list goes beyond material that many multinationals would expect to provide in relation to their centralized hub activities. The ATO also notes that pricing based on third party commission rates will be robustly examined in terms of the Australian commercial rationale. Start date PCG 2017/1 applies to income years starting from 1 January The first reporting under the framework is therefore expected to be in an IDS lodged in July 2018, or provided to the ATO as part of a Reportable Tax Position or other compliance process for the year end 31 December Action Required Global businesses using foreign hubs should consider the ATO guidelines and in particular identify their risk rating on the ATO spectrum. Responses to the risk rating include take actions to reduce the risk classification or create additional supporting material. The evidence the ATO will expect to justify risky hubs is quite high, and will go beyond what many groups will currently hold the PCG is a good trigger for a review of current support for the position taken.

4 4 Global Tax Alert Transfer Pricing Endnotes 1. See PCG 2017/1, Attachment A. 2. Ibid. For additional information with respect to this Alert, please contact the following: Ernst & Young (Australia), Sydney Jesper Solgaard jesper.solgaard@au.ey.com Paul Balkus paul.balkus@au.ey.com Danielle Donovan danielle.donovan@au.ey.com David Tracey david.tracey@au.ey.com Jason Vella jason.vella@au.ey.com Ernst & Young (Australia), Melbourne Keir Cornish keir.cornish@au.ey.com Julian Hine julian.hine@au.ey.com Ernst & Young (Australia), Brisbane Kevin Griffiths kevin.griffiths@au.ey.com Ernst & Young (Australia), Perth Joe Lawson joe.lawson@au.ey.com Ernst & Young (Australia), Adelaide Michelle Fardone michelle.fardone@au.ey.com Ernst & Young LLP, Australian Tax Desk, New York Andrew Nelson andrew.nelson@ey.com

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