Further ATO guidance and proposed risk-rating framework for intangible arrangements

The Australian Taxation Office (ATO) has released a draft Practical Compliance Guideline on Intangible Arrangements (PCG 2021/D4) in which it details its compliance approach and the risk assessment framework it plans to employ when considering the risk profile of intangible arrangements (IAs) operating between international related parties.

PCG 2021/D4 builds upon earlier guidance material the ATO released on the same subject matter – Taxation Alert (TA) 2018/2 and TA 2020/1, with the latter TA discussed in this article.

The focus of this PCG is on providing a framework for identifying risks related to IAs such as the whereabouts of development, enhancement, maintenance, protection, and exploitation (DEMPE) activities, the transfer of intangible assets and business restructurings and other risks such as withholding tax, capital gains tax, the general anti-avoidance rule and the diverted profits tax.

There are two parts to the draft PCG: the ATO’s compliance approach and the risk assessment framework.

Compliance approach

The PCG re-states the starting point that taxpayers must self-assess their tax filings and that the ATO uses a range of engagement and assurance tools, including the risk guidance set out in the PCG. The PCG is identified as an important tool for taxpayers to self-assess their compliance risk, by reference to these.

Furthermore, it is also foreshadowed that for taxpayers required to complete a reportable tax position schedule, they will need to disclose the outcome of the risk rating process (or alternatively disclose a 'high risk').

A higher risk rating means it is more likely the ATO would commence compliance activity. On the other hand, a low-risk rating intimates a lower likelihood of such activity, but does not provide a 'safe harbour' or blanket assurance that no ATO risk review will be conducted. The ATO again highlighted the fact that the simplified transfer pricing record-keeping options are not available to international related party transactions involving royalties, licence fees, or R&D arrangements (which again illustrates the inherent risks involving IAs).

Risk-assessment framework

At the heart of PCG 2021/D4 lies what the ATO requires taxpayers to consider in the course of self-assessing the risks associated with their IAs. Put simply, taxpayers would be required to compare their IAs to each of the following Risk Factors, when providing evidence to support the arm’s length nature of their IAs.

The Risk Factors are:

• Commercial considerations and the decision-making process – the ATO is looking for analysis that groups would have conducted when considering changes to their existing operating model. The application of the arm’s length conditions would mean that businesses are more likely than not to undertake a cost-benefit analysis when considering material changes to their existing operating model. On such premises, the ATO expects taxpayers to have considered both qualitative and quantitative aspects of changes to their operation including financial modelling, assessment of other realistically available options to them. Such analysis may have been prepared by way of presentation to the board of directors or internal or independent reviews and the like.
• Alignment of the form and substance of the IA – the ATO expects to see documents that support the extent to which the legal arrangement in relation to the IA aligns with the economic substance of the arrangement. The types of documentation expected is not limited to legal agreements between the parties to the IA, but also a range of other documents such as policy documents, manuals and procedures that may have been prepared.
• DEMPE activities connected with the intangible asset – the delineation of the intangible asset with specificity, and how the DEMPE activities generate value, needs to be articulated in transfer pricing documentation. As part of documenting the DEMPE activities, the ATO would be looking for evidence to support the assertion that the parties to the IA do indeed have the required capabilities (both technical and financial) to manage, perform and control each of the DEMPE components. While the ATO recognises the complex nature of MNEs' value chain and the difficulty associated with identifying and tracking intangible assets through the various stages of the DEMPE journey, the type of evidence it is expecting to be provided is quite extensive. It ranges from correspondence and meeting minutes to valuations, studies, and analyses that may have been provided by advisers.
• Substantiating the tax and profit outcomes of the IAs – The ATO expects documentation to confirm whether the operating model is driven primarily by profit-related outcomes instead of tax considerations. The types of evidence the ATO expects to see include financial modelling (including tax impacts), as well as standard information such as general purpose financial statements.
• The nature of the IA – in determining the compliance risk associated with the nature of a particular IA, the ATO provides 12 examples of arrangements with various stated risk levels as illustrated below.

RSM insights

•  IAs have been a key area of the ATO’s focus over the last few years, evidenced by the volume of guidance material that has been released – e.g., TA2016/1, TA2018/2, and TA2020/1 and dating back earlier to TR 2011/1 (regarding business restructurings).
•  While the draft PCG provides useful guidance in terms of the type of documentation expected, the level of information and evidentiary material taxpayers are expected to put in place may be overwhelming for some groups – for whom a pragmatic approach may nonetheless be appropriate.
• Given Australia's income tax law places an onus on taxpayers to self-assess their compliance with relevant tax laws including the transfer pricing rules, this PCG should be seen as a useful framework for groups to understand where they sit on the risk spectrum.
• For those taxpayers whose IAs fall in the high-risk category, they should consider whether their positions are supportable.

If you have IAs that have not been documented, it is time to assess your level of exposure to an ATO compliance risk review.

HOW CAN RSM HELP?

Should you have any questions about IAs we highly recommend you reach out to your RSM tax adviser to discuss your situation and what we can do to help.