The Australian Taxation Office (ATO) has released its first Taxpayer Alert of the decade in TA 2020/1, which identifies two principal concerns regarding intangibles:
- arrangements related to the development, enhancement, maintenance, protection and exploitation of intangible assets (known as the DEMPE functions) that have not properly remunerated an Australian entity on an arm’s length basis; and
- arrangements where intangible assets and/or associated rights are migrated from an Australian entity to an international related party, as part of non-arm's length arrangements (for example where there is a lack of commercial rationale for the transfer from the perspective of the Australian entity).
This is a salient reminder of the need to appropriately characterise and remunerate an Australian entity by reference to its actual contribution to the value chain, following an enquiry as to whether the Australian entity would enter the same arrangements if it was independent of the international related parties with which it is dealing.
High-level summary of TA
The ATO’s concerns are that the types of the arrangements considered in the Alert are not conducted at arm’s length for the purpose of determining if an entity has obtained a transfer pricing benefit under Australia’s transfer pricing laws. This requires having regard to the functions performed, risks used and assets assumed by Australian entities, and also an enquiry if the arrangements even make sense from the perspective of the Australian entity.
With the litigation of high-profile transfer pricing cases in recent years (in particular Chevron and Glencore) TA 2020/1 illustrates the importance of robust transfer pricing documentation in assessing arm’s length transactions and the greater power that may be wielded by the Commissioner in reconstructing existing arrangements that do not make sense for the Australian entity to enter into, particularly when it comes to intangibles.
TA 2020/1 focuses on two types of arrangements in relation to intangibles:
- Arrangements involving the bifurcation of intangible assets and the mischaracterisation of Australian DEMPE activities (e.g. “run down/run-up” models):
- Where the ownership of intangibles assets is artificially or arbitrarily split and/or transferred to an international related party; and
- subsequently, the internal remuneration structure does not align to the value of the DEMPE activities conducted by the Australian entity;
- Arrangements involving insufficient recognition of Australian DEMPE activities:
- Where the internal remuneration structures do not align to the value of the DEMPE activities conducted by the Australian entities, including certain cost contribution and licencing arrangements.
The examples bring out two key concerns:
- the Australian entity may be making a significant contribution to the value chain but be deriving an insufficient remuneration; and
- there may be a lack of commercial rationale and/or the arrangements are not consistent with the Australian entity’s best interest or options realistically available for the Australian entity.
The transfer “mispricing” can be corrected by reference to the transfer pricing rules (including the “reconstruction” rule and the other “exceptions” to the basic rule of following the actual arrangements), the general anti-avoidance rule or – for significant global entities – the diverted profits tax.
- TA 2020/1 is consistent with RSM’s understanding of the operation of Australia’s transfer pricing laws. The ATO is quite reasonably foreshadowing greater scrutiny of arrangements where the actual arrangements differ from the substance of the activities and the commercial reality, or what independent parties would have done.
- Intangibles continue to be considered a high-risk area from the perspective of the ATO (consider TA 2016/1 and TA 2018/2 on similar issues) and taxpayers should take additional care when pricing R&D activities, and/or when structuring or re-structuring arrangements that involve intangible assets.
- By way of example, setting a cost-plus remuneration for R&D activities conducted by an Australian entity may not be sufficient in some cases. Further investigation may be required.
- Groups seeking to migrate intangible assets from Australia must consider the business rationale for entering into the arrangement – not just from a group perspective but also from the perspective of the Australian entity or entity. For example, what options were “realistically available” to the Australian entity (as set out in Taxation Ruling TR 2011/1). Business restructures are complex and widely misunderstood area transfer pricing tax law and additional consideration and care should be taken with the respect to intangible assets.
- Generally, taxpayers should review existing arrangements to consider whether the appropriate transfer pricing policy and documentation are in place, supporting the substance of the arrangements, particularly with respect to the OECD report in relation to BEPS Actions 8, 9 and 10 (Aligning Transfer Pricing Outcomes with Value Creation). Click here to read more on the OECD report.