MARCH 2015 AUSTRALIAN TAX ALERT RECENT DEVELOPMENTS - AUSTRALIAN TRANSFER PRICING (TP) RULES: TIME TO STEP UP INTRODUCTION With the Australian Taxation Office's (ATO) escalating focus on international profit shifting, it is essential for multinational taxpayers (MNEs) to properly understand the new Australian Transer Pricing (TP) rules, assess the implications of these rules on their operations/transactions, what documentation they need to prepare and when, and what penalties may apply if the ATO disagrees with their approach. The ATO has in recent months issued several Practice Statements and Taxation Rulings (summarised in Appendix A) to provide guidance to MNEs in respect of the application of the new TP rules. Most recently, the ATO issued Practice Statement PS LA 2015/3 on 26 February 2015. This Practice Statement outlines the internal ATO approval processes to amend the actual commercial or financial relations of the parties in identifying arm's length conditions in relation to cross-border TP. A particularly challenging aspect of the TP rules is the application of the reconstruction provisions which potentially allow actual transactions to be disregarded, and hypothetical arm's length transactions to be substituted in certain circumstances. This analysis requires reference to the form and substance of the commercial or financial relations between the parties. The reconstruction provisions are discussed further below. The ATO focus is far wider than e-commerce multinationals and extends, amongst others, to financial services, energy, resources, pharmaceutical and other technology MNEs. RECAP OF THE NEW TP RULES Australia's new TP rules have been introduced to modernise TP rules and bring them in line with more recent Organisation for Economic Co- Operation and Development (OECD) TP guidance. They are contained in Division 815 (particularly Subdivision 815-B) of the Income Tax Assessment Act 1997 and apply from income tax years starting on or after 29 June 2013. The purpose of these rules is essentially one of anti-avoidance, aimed at countering international profit-shifting techniques.
In particular, the TP rules apply where a MNE would otherwise obtain a tax advantage in Australia from cross-border conditions that are inconsistent with the internationally accepted arm s length principle. In this situation, the rules provide that the MNE's Australian tax position should instead be determined as if the arm s length conditions in fact existed. SELF-ASSESSMENT The new TP rules are "self-executing", requiring MNEs to determine their overall tax position arising from transactions with offshore parties on a self-assessment basis. Essentially, the MNEs are required to conduct an analysis to self-assess the extent to which the actual conditions of their international related party transactions differ from the arm's length conditions for those transactions. If they differ and the difference results in a tax advantage (referred to as a "TP benefit" and discussed further in Appendix B attached), the arm's length conditions will be taken to operate. RECONSTRUCTION POWERS The reconstruction provisions provide the ATO with significant power to reconstruct or disregard actual transactions, where these are not considered to be arm's length and replace them with arm's length conditions where: the form of the actual commercial or financial relations is inconsistent with the substance of those relations independent MNEs would not have entered into the actual commercial or financial relations and would have instead entered into alternate commercial or financial relations independent entities would not have entered into commercial or financial relations at all. The ATO is particularly concerned about the significant increase in intra-group trade in services and intangible property and related financial arrangements (eg hybrid instruments). In Taxation Ruling TR 2014/6 issued by the ATO, the following areas are identified in outlining the ATO's views on the application of these reconstruction provisions: intra-group debt; distribution and marketing arrangements; and assignment of intellectual property rights. DOCUMENTATION TP rules do not mandate the preparation or keeping of TP documentation, however, failing to do so prevents a MNE from having a "reasonably arguable position" (RAP). Establishing a RAP may lower administrative penalties for the MNE in the event of a TP adjustment. In this regard, the ATO released Taxation Ruling TR 2014/8 (TP documentation and Subdivision 284-E) and Practice Statement PS LA 2014/3 (Simplifying TP record keeping). The key record-keeping requirements are summarised as follows - that is, the records must: be contemporaneous, the records are to be prepared each income year before the MNE lodges its income tax return for that year. So, if a MNE's year end is 30 June 2014, it would ordinarily need to have its documentation completed by 15 January 2015. MNEs with a 31 December year end will need to apply the new rules for the year ending 31 December 2014, with the first tax return under the new rules due on 15 July 2015. Any subsequently created documentation will not assist to reduce the applicable penalties if the ATO makes a TP adjustment. Further, the records must exist even where the MNEs participate in joint ventures, partnerships and other business structures or otherwise deal with third parties. Accordingly, where information is required from third parties to complete TP documentation, the contractual arrangements need to ensure appropriate access to that information. be kept in English or readily accessible and convertible into English. Accordingly, where TP documentation is prepared in line with the OECD guidelines, the Australian entity will need to ensure that the documentation addresses all the requirements of the new TP laws to be eligible for a RAP, including that the MNE has full and free access to TP documentation. explain the particular way in which the TP rules apply (or does not apply) An MNE's documentation must provide sufficient information to evidence and support its TP treatment and/or result. The particulars DLA Piper 2
of the TP method used and comparable circumstances relevant to identifying those arm's length conditions should also be documented. The MNE's documentation will need to identify the arm's length conditions and explain how the arm's length conditions are based on the commercial or financial relations in connection with which the actual conditions operate. Further, the documentation should outline how the MNE has had regard to the form and substance of those commercial and financial relations. explain why the application of the TP rules in that particular way best achieves the consistency with the prescribed guidance material The MNE should refer to the prescribed guidance material (eg OECD TP Guidelines) that is relevant to the matters being documented. Further, the documentation should explain how the prescribed guidance material has been taken into account by the MNE in applying the TP rules. Further, the ATO has outlined the following four key categories under which certain MNEs can obtain TP documentation relief: small taxpayers (turnover less than A$25M and specified services that make a significant contribution to the group account for less than 15% of turnover); certain distributors; intra-group services and low level loans. time of lodgement of their tax return under the new rules. In particular, MNEs: should ensure that their TP affairs are documented and supported contemporaneously before 2014 tax returns are filed/lodged who qualify for simplified documentation should continue to monitor their TP arrangements and their ongoing eligibility for the documentation concession each year relying on global documentation prepared in line with OECD Guidelines will need to ensure that the specific and detailed Australian TP documentation requirements have been satisfied. A more detailed summary of the fundamental concepts underlying the TP rules is provided in Appendix B. PENALTIES In the event of a TP adjustment, penalties may be imposed by the ATO. The penalty percentage is assessed as a percentage of the tax shortfall and could range from 10% (may apply even if MNE has RAP) and 50% depending on whether the TP arrangements were entered into with the sole or dominant purpose of avoiding tax in Australia and whether the MNE has a RAP. FUTURE ACTION All MNEs with Australian or offshore operations will be affected to some extent by the new TP rules. It will be important for MNEs to review their existing arrangements and documentation by the DLA Piper 3
MORE INFORMATION For more information, please contact: Jock McCormack Partner - Head of Tax T +61 2 9286 8253 jock.mccormack@dlapiper.com Anshu Maharaj Senior Associate T +61 2 9286 8002 anshu.maharaj@dlapiper.com Eddie Ahn Senior Associate T +61 2 9286 8268 eddie.ahn@dlapiper.com Contact your nearest DLA Piper office: BRISBANE Level 28, Waterfront Place 1 Eagle Street Brisbane QLD 4000 T +61 7 3246 4000 F +61 7 3229 4077 brisbane@dlapiper.com CANBERRA Level 3, 55 Wentworth Avenue Kingston ACT 2604 T +61 2 6201 8787 F +61 2 6230 7848 canberra@dlapiper.com MELBOURNE Level 21, 140 William Street Melbourne VIC 3000 T +61 3 9274 5000 F +61 3 9274 5111 melbourne@dlapiper.com PERTH Level 31, Central Park 152 158 St Georges Terrace Perth WA 6000 T +61 8 6467 6000 F +61 8 6467 6001 perth@dlapiper.com SYDNEY Level 22, No.1 Martin Place Sydney NSW 2000 T +61 2 9286 8000 F +61 2 9286 4144 sydney@dlapiper.com www.dlapiper.com DLA Piper is a global law firm operating through various separate and distinct legal entities. For further information, please refer to www.dlapiper.com Copyright 2015 DLA Piper. All rights reserved. 1202416428 [DO NOT DELETE AS TABLE BELOW IS ATTACHED TO THIS PARAGRAPH MARK] This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication. DLA Piper 4
APPENDIX A - ATO TP GUIDANCE Document issued by the ATO Name of Document Date issued 2015/3 Taxation Ruling TR 2014/8 2014/4 2014/3 2014/2 Taxation Ruling TR 2014/6 Miscellaneous Taxation Ruling MT 2008/2 Approval process for the application of subsections 815-130(2) to 815-130(4) of the Income Tax Assessment Act 1997 26 February 2015 TP documentation and Subdivision 284-E 17 December 2014 Administration of the penalty imposed under subsection 284-75(3) of Schedule 1 of the Taxation Administration Act 1953 To provide ATO personnel with guidance on the application of the options under Simplifying TP Record Keeping Administration of the TP penalties for income years commencing on or after 29 June 2013 TP - the application of section 815-130 of the Income Tax Assessment Act 1997 Shortfall penalties: Administrative penalty for taking a position that is not reasonably arguable 17 December 2014 17 December 2014 17 December 2014 12 November 2014 12 November 2008
APPENDIX B - TP BENEFIT AND RELATED ISSUES: FUNDAMENTAL CONCEPTS TP BENEFIT An entity obtains a TP benefit where: the MNE and another entity have "commercial or financial relations"; the actual conditions (not limited to contractual terms) between the MNE and another entity differ from the "arm s length" conditions (discussed below) and satisfy the "cross-border" test (discussed below); and if the arm s length conditions had operated: the MNE's taxable income or its interest or royalty withholding tax payable would have been greater; or its losses or tax offsets would have been less. ARM'S LENGTH CONDITIONS The "arm s length" conditions are those that might notionally be expected to operate between independent entities dealing wholly independently with one another in comparable circumstances. In identifying the arm s length conditions, the method(s) used should be those that are the most appropriate and reliable in the circumstances. Relevant factors to take into account in choosing the method(s) include: the relative strengths and weaknesses of the methods available in the particular circumstances; the functions performed, assets used and risks borne by the entities; the availability of reliable information available to support the method; and the degree of comparability between the actual circumstances and the comparable circumstances, i.e. the notional circumstances postulated by the method used in determining arm s length conditions. Circumstances are comparable if any differences between them do not materially affect any relevant condition, or if a reasonable accurate adjustment can be made to eliminate the difference. In identifying comparable circumstances, regard should be had to factors such as: the functions performed, assets used and risks borne by the entities; the characteristics of any property or services transferred, e.g., physical features, quality, reliability, availability and volume; the contractual terms; economic circumstances, e.g., location, market size, level of competition, availability of substitutes, level of supply and demand, consumer purchasing power, degree of governmental regulation, costs of production and transport, market level and the timing of transactions; and the entities business strategies, e.g., a business pursuing a market penetration scheme may have temporarily depressed its price below that charged for comparable products. Where reliable comparability adjustments cannot be made, this may indicate that another method based on different points of comparison should be used. The basic rule is that the identification of the arm s length conditions must normally be based on the actual commercial or financial relations in which the parties operate. It must also have regard to both the form and substance of these relations, though in cases of inconsistency, the substance prevails. However, if independent entities in comparable circumstances would not have entered into those particular commercial or financial relations, and instead would have entered into substantially different relations, the identification should instead be based on those relations. If independent entities in comparable circumstances would not have entered into commercial or financial relations at all, the identification is based on that absence of relations. The ATO has released a Taxation Ruling, TR 2014/6, which outlines its views on the relevance of the actual commercial or financial relations to the identification of the arm's length conditions for transfer pricing purposes, including the circumstances in which the basic rule would not apply.
The application of the transfer pricing provisions, including the identification of the arm s length conditions, must also be done so as best to achieve consistency with the OECD Guidelines, as amended or supplemented by regulations. ACTUAL CONDITIONS DIFFER FROM THE ARM'S LENGTH CONDITIONS The arm's length conditions are those that would normally be expected to operate in dealings between independent and unrelated parties in circumstances comparable to the actual transaction between the parties. Based principally on the Explanatory Memorandum to the Bill (Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013) that introduced the current TP rules, the arm's length conditions should be determined in accordance with the following principles: The arm's length conditions are identified by hypothesising what independent entities would have done in place of the actual entities in comparable circumstances. Generally, the basic rule is to identify the arm's length conditions based on the form and substance of the commercial and financial relations that actually exist between the parties (i.e. the actual transaction). In certain circumstances, the actual commercial or financial relations of the entities can be disregarded and substituted with more appropriate relations in determining the arm's length conditions; e.g. where the form differs materially to the substance of the arrangements or where independent parties would not have entered into the actual arrangements. The arm's length condition may not necessarily be a single value or price but could be within a range of values, where any points within that range are equally appropriate and reliable. In determining whether parties have dealt with another independently, a key question asked is whether the outcome of the dealings is a matter of real bargaining. The relationship between the parties is relevant but not determinative. It is not essential for the parties to be related for the transfer pricing rules to apply. Parties that are unrelated might not deal independently with one another, where for example: one party submits to the direction of the other party; one party is indifferent to an outcome sought by the other party; or both parties collude to achieve an ulterior motive. CROSS-BORDER TEST The cross-border test ensures that purely domestic arrangements are excluded from the transfer pricing rules. The conditions satisfy the cross-border test if they operate in connection with a business that the entity carries on in an area covered by an international tax sharing treaty that Australia has with another country. Alternatively, the conditions satisfy the test if: the conditions operate at or through an overseas permanent establishment of either or both of the entities concerned, and either or both the entities concerned are: an Australian resident; a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936 (Cth); a partnership in which all of the partners are, directly or indirectly through one or more interposed partnerships, Australian residents or resident trust estates; or the conditions do not operate solely at or through an Australian permanent establishment, and neither entity is a type of entity listed above. We note that it is not a requirement for entities to be associated or related for the cross-border test to be satisfied.