Australia’s transfer pricing legislation has now imported the most recent updates to the OECD's Transfer Pricing Guidelines as published on 10 July 2017. This follows Treasury Laws Amendment (2019 Measures No.3) Act 2020 which received Royal Assent on 22 June 2020.
The Act makes the following important changes to Australia’s transfer pricing legislation contained in Division 815.
- Specific reference has been included to the revised OECD Transfer Pricing Guidelines in subsection 815-2(a) of the Income Tax Assessment Act 1997 – these are the most recent transfer pricing guidelines approved by the OECD’s Committee on Fiscal Affairs on 19 May 2017.
- The OECD’s Transfer Pricing Guidance in respect of Financial Transactions as published in February 2020 is also likely to be imported as guidance into the Australian Transfer Pricing regime down the track. However, for practical purposes, it would be prudent to consider potential transfer pricing outcomes from application of the new guidance to financial transactions.
- The reference to the Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 – 2015 Final Reports of the OECD published 5 October 2015 in 815-135(2)(aa) and in subsection 815-135(3) of the Income Tax Assessment Act 1997 have been removed as it is now redundant - as the most recent version of the OECD’s guidelines incorporates revisions made as a result of this report.
The amendments have retrospective application from tax periods starting on or after 1 July 2017.
What change did the OECD 2015 Report and 2017 Transfer Pricing Guidelines have?
BEPS Actions 8-10 aims at reducing the risk of BEPS through intangibles by ensuring that transfer pricing outcomes are in line with value creation.
Specifically, Chapters I, II and VI of the 2010 Guidelines were amended for the following:
- Ownership of intangibles in Sections B.1 and B.2 of Chapter VI including a revised definition of the term ‘intangible property’ to address issues exclusively, therefore independent of any legal or accounting definitions
- The distinction between marketing and commercial intangibles found in the 2010 OECD Guidelines was abandoned on the basis that determining arm’s length pricing does not turn on these categorisations;
- Intangibles whose valuation is uncertain at the time of the transaction in Section D.3 of Chapter VI;
- The use of “other methods” under paragraph 2.9
- The application of the profit split method under paragraphs 6.145 to 6.149
The importation of the OECD’s Transfer Pricing Guidance on Financial Transactions supports the following key points:
- Loans may be recharacterised as equity: e.g., in the case of a longer-term loan if there isn't sufficient evidence the borrower could service the loan, or raise funds on its own in the first place. The ATO has expressed similar views in TD 2019/10;
- Only a risk-free rate of return may be required for low-substance lenders: e.g. where a lender lacks the capability or decision-making functions to control the risk associated with lending. Proxies for risk-free returns include highly-rated Government-issued securities and interbank rates.
- Cash-pooling is typically only a co-ordination service so should only attract a small return;
- Guarantee fees: no fee is payable to the extent of an implicit guarantee arising from "passive association" group benefits but an explicit guarantee going beyond this implicit support may justify a fee if it enhances the borrower's conditions (e.g. a higher credit rating or reduced borrowing costs).
Importing the guidance on Financial Transactions will help ensure Australia is on a similar page to other OECD members, though consistent practice in this area is still emerging.
The alignment of Australia’s transfer pricing legislation to the most recent version of the OECD Transfer Pricing Guidelines is a welcome reminder of the changes made with respect to intangibles which undermine the importance of ownership for determining the right to retain profits arising from the exploitation of intangibles. That is, emphasis was placed on the functional analysis or DEMPE functions (defined below) performed by the relevant entity.
The amendments are timely given the ATO’s recent release of TA 2020/1 which raises the ATO’s concerns about arrangements related to the development, enhancement, maintenance, protection and exploitation (DEMPE functions) of intangible assets that have not properly remunerated an Australian entity on an arm’s length basis.
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