The reformation process of Australia's transfer pricing regime that commenced in November 2011 has continued apace in 2014. 2015 is also likely to be a year of significant change. As at the date of preparing this publication, the latest development occurred on December 17, 2014, when the Australian Taxation Office (ATO) released a new tranche of Rulings and Practice Statements. It included critically, Taxation Ruling TR 2014/8 which outlines the Commissioner's views on Transfer Pricing Documentation. The Ruling also came out with a complimentary compendium 2014/8 EC that forms a summary of 21 key issues raised from by external parties and the ATO's response or action.
TR 2014/8 sets out the Commissioner's views on the transfer pricing documentation that an entity should keep in order to meet the requirements of Subdivision 284-E of the Taxation Administration Act 1953. This ruling is of particular importance to taxpayers as an undocumented transfer pricing position, if found to be incorrect, is taken to be not reasonably arguable and significant penalties could apply.
Also issued on the December 17, 2014 were Practice Statement PS LA 2014/2: Administration of transfer pricing penalties' and ‘Practice Statement PS LA 2014/3: Simplifying transfer pricing record keeping’.
Earlier in the year, the ATO released TR 2014/6 to deal with their powers to reconstruct transactions. These provisions will have a significant impact on taxpayers as they enable the Commissioner to reconstruct a transaction where they consider that it has not been conducted on an arm's length basis. TR 2014/6 suggests that the Commissioner will take a broad approach to this power when considering whether or not to apply the reconstruction provisions to an entity's cross-border dealings. Please refer below for further discussion.
These new publications are all part of the ATO's ongoing programme of modernising interpretive material to compliment new legislation that was brought into effect for accounting periods commencing on or after June 29, 2013.
The broad framework of the legislative materials is as follows:
- reconstruction (no prior ruling), TR 2014/6
- penalties (Taxation Ruling TR 98/16), PS 2014/2
- documentation (Taxation Ruling TR 98/11), TR 2014/8 and PSLA 2014/3
- transfer pricing methods (Taxation Ruling TR 97/20), updated public ruling to be issued by September 2015
- relief from double taxation (Taxation Ruling TR 2000/16), updated public ruling to be issued by September 2015
- transfer pricing determinations (Taxation Ruling TR 2007/1), updated public ruling to be issued by September 2015
- transfer pricing review work (Practice Statement PSLA 2005/14), revised practice statement to be issued by September 2014 Delayed
- Transfer Pricing Review Panel (Practice Statement PSLA 2004/13), revised practice statement to be issued by September 2014 Delayed
- advance pricing arrangements (Practice Statement PSLA 2011/1), revised practice statement to be issued by September 2014 Delayed
- referral of work to the International unit (Practice Statement PSLA 2006/9), revised practice statement to be issued by September 2014 Delayed
Evolution of Australia's New Transfer Pricing Regime
As mentioned above, Australia's new transfer pricing rules are in place for accounting periods commencing on or after June 29, 2013.
They require taxpayers to take OECD transfer pricing guidelines into account when identifying the ‘arm's length’ conditions applicable to the taxpayer. This has been confirmed by TR 2014/8, as discussed below.
Whilst reinforcing OECD Guidance throughout the rulings, there appears to be a deafening silence on the proverbial elephant in the room, namely the wider BEPS Action Plan and OECD efforts to address the burden of transfer pricing documentation and the Masterfile approach and country-by-country reporting.
Taxation Ruling TR 2014/8 sets out the commissioner's view on the preparation and maintenance of transfer pricing documentation. The ruling confirms legislative guidance that a taxpayer cannot maintain a ‘Reasonably Arguable Position’ (RAP) where ‘contemporaneous' transfer pricing documentation is not maintained.
The requirements for taxpayers to satisfy the self-assessment regime and documentation to be deemed contemporaneous are strongly reinforced throughout this ruling. It states that documentation that does not fully satisfy the requirements of Subdivision 284-E of the Taxation Administration Act (TAA) 1953 and is not prepared before or at the time of lodgement of the company's tax return, will not be considered a RAP. Documentation prepared after the lodgement of the company tax return ‘cannot be taken into account’.
Across all manner of tax issues, the ability for a taxpayer to obtain a RAP is becoming increasingly more difficult. The hurdle appears to have been set far higher than before, with the ATO taking a more adversarial approach to RAP papers. The implication of this for transfer pricing documentation is worrisome, given the seemingly neverending issues to be addressed to satisfy the legislative requirements.
Documentation should seek to demonstrate that the ‘actual’ conditions that operated were in accordance with ‘arm's length conditions' (TR 2014/8); that is, that the commercial or financial conditions that actually existed are aligned to that which might be expected to operate between independent entities dealing wholly independently with one another, in comparable circumstances, and no transfer pricing benefit is derived.
Records should contain all necessary factual information that allows ATO personnel to readily ascertain and identify (read quickly and easily understand) the arm's length conditions and any variance to the actual conditions.
In considering the level of documentation to be prepared, an entity should prepare and maintain documentation in respect of the commercial and financial conditions that are material and relevant.
Entities will need to undertake a risk assessment of its relevant dealings and prepare and maintain documentation that best evidences those matters which could be the subject of dispute with the Commissioner.
OECD Guidance is frequently cited to support this ruling. Entities are not expected to prepare documentation that goes beyond evidencing that actual conditions were consistent with arm's length conditions and properly establishes the arm's length contribution made by Australian operations. This concept in itself however, appears to be an onerous task.
Records must be kept in an entity's possession or should be readily and fully accessible by the entity, therefore the existence of global documentation does not necessarily meet this test.
Penalty relief is only available where a RAP is maintained.
Practice Statements Release
In addition to the transfer pricing ruling outlined above, two practice statements were issued:
- PS LA 2014/2 – administration of transfer pricing penalties
- PS LA 2014/3 - simplifying transfer pricing record keeping
The practice statements are welcome as they attempt to fill a void left by a lack of guidance as to the interpretation and application of the new transfer pricing legislation.
The material however is extensive and interpretively broad. It is clearly drafted in an all-encompassing manner with the intention to capture as many potential transfer pricing issues as possible. This approach is consistent with the measures believed to be necessary by the Australian government and ATO to combat perceived profit-shifting by multinational entities in Australia through transfer pricing mechanisms.
PS LA 2014/3 ‘Simplifying transfer pricing record keeping’ refers to an ATO online guidance publication ‘Simplifying transfer pricing record keeping’ that was not yet published at the time of writing this analysis. The practice statement stipulates that the ATO is not to review the records beyond conducting a check to confirm an entity's eligibility.
Subdivisions 815-B-D of the Income Tax Assessment Act 1997 (‘ITAA 1997’) apply to treat the taxpayer as if the transactions they conducted with related parties were conducted at an arm's length basis with independent entities. This new regime requires taxpayers to analyse the extent to which transactions they conduct with international related parties differ from how the transaction would be undertaken if at arm's length (see www.rsm.com.au for archived articles).
If the difference between these transactions results in a transfer pricing tax benefit, the new transfer pricing rules will apply to deem that the arm's length transaction applies rather than actual transaction that occurred.
Put simply, the arm's length principle effectively requires an assessment of whether the commercial or financial relations and ensuing conditions, transactions and the allocation of profits, make commercial sense for all of the parties to the transaction or arrangement, judged from the perspective of independent parties dealing wholly independently with each other.
The substance of these rules is contained in Section 815-130 which provides the Commissioner with significant powers to disregard the form of transactions conducted by taxpayers and replace them with ‘arm's length’ conditions where:
- the form of the actual commercial or financial relations is inconsistent with the substance of their relations
- independent entities dealing wholly independently with one another in comparable circumstances would not have entered into the actual commercial or financial relations
- independent entities dealing wholly independently with one another in comparable circumstances would have entered into other commercial or financial relations and those other commercial or financial relations differ in substance from the actual commercial or financial relations
This provision requires the commissioner to consider how the transaction may have occurred between independent entities based on the substance of the actual transactions conducted by the taxpayer.
ATO Interpretation of Reconstruction Provisions
The other major development in 2014 was the release of TR 2014/6 which provides an outline of the commissioner's views on the application of the reconstruction provisions contained in section 815-130. Broadly, TR 2014/6 confirmed that the commissioner intends to take a wide-ranging approach when applying the reconstruction provision to an entity's cross-border dealings.
This ruling is of particular significance to taxpayers as it suggests that the commissioner will seek to apply the reconstruction provisions on a more regular basis.
It appears that the commissioner's interpretation may conflict with the approach suggested by the OECD in Chapter 1 of the OECD Transfer Pricing Guidelines. Specifically, the OECD takes a moderate view of reconstructing transactions, suggesting that the tax administration should not disregard the actual transaction or substitute other transactions for the actual transaction in other than exceptional cases.
Furthermore, the ruling seems to lack guidance to taxpayers on the types of situations where the ATO may seek to apply these broad provisions.
The new rulings do nothing to reduce the ever-increasing burden on taxpayers to comply with disclosure and record keeping requirements, in fact quite the opposite. They make no reference to the likely changes that will be adopted at an international level in the very near future, nor seek to provide any guidance on transitioning from the old to new regimes.
Ongoing compliance will now necessitate a thorough review by taxpayers of existing and future transfer pricing documentation both in terms of structure, depth and content.
How the actual administration and enforcement of this regime operates in practice remains to be seen, yet is of significant concern given the breadth and depth of the powers available.
Further, in the wider BEPS project environment, one wonders how relevant this guidance will remain in the near future.
More considered comments will be made by us in the near future.
The authors strongly recommend that existing and future transfer pricing documentation requirements be discussed with transfer pricing experts to determine compliance with the new transfer pricing rules and the associated ATO materials.
This is particularly urgent for taxpayers with a June 30, 2014 year end, as the ATO will be keen to implement the new legislation and guidance.