Transfer pricing law in Australia is a big issue in terms of dollars and ATO focus. The first set of mega transfer pricing disputes underscores some important practical considerations.
We have been dealing with the first wave of very large-scale disputes about Australia’s new transfer pricing rules. Our experience confirms that our new rules have some important differences to the OECD Guidelines. Mega tax disputes are relatively new phenomena in other countries too, driven by post-GFC budget deficits and increasing political pressure on multinationals to pay more taxes. Mega tax disputes will continue to grow at least into the next decade, as the ATO is increasing its scrutiny is given more power to pursue multinationals.
In the past, the question was more focused on pricing the transaction and the ATO tended to accept assertions made by taxpayers. In contrast, today the ATO does not accept assertions, but rather it challenges them. Now the question would be what are we pricing ‒ the transaction that actually took place, or a notional transaction? In other words, the first question is moving towards “what is the counterfactual?”, "what would independent parties do?". Only then you price the transaction, or perhaps you would price some notional transaction if the ATO says that independent parties would enter into a transaction that is different to the actual transaction.
What is the ATO worried about?
The ATO generally reviews almost all large transactions. If the transaction is large, but simple and routine, then the level of scrutiny may be light. The more complex the transaction and the fewer comparables there are, the higher the likelihood of intense scrutiny is. Among the risk factors that one needs to be aware of are:
- the global economic value creation chain and hubs;
- profitable functions that are performed outside Australia in low tax jurisdictions, such as Singapore;
- dealings in intangibles;
- project finance in Australia;
- financial instruments, derivatives and hybrids; and
- large industries such as LNG.
Getting ready for an ATO review of your transfer pricing position
First of all - strengthen your traditional transfer pricing documentation. Focus not only on the economic analysis, but also on the factual assumptions that underpin the economic analysis , which require substantiation by way of admissible evidence. Importantly, the ATO challenges the factual assumptions in the taxpayer’s transfer pricing documentation and, crucially, the taxpayer bears the onus of proof. The economic analysis may be undermined if the taxpayer cannot prove the assumption as a matter of fact.
Another vital step in the process is considering the counterfactual from the beginning. There are two questions that the taxpayer should ask (and be able to prove, using evidence to support their assertions):
- “What other option would be available to achieve a commercial outcome?”; and
- “Why are those options less favourable to the Australian entity than the transaction that actually took place?”
What's next for transfer pricing in Australia?
Like in other countries, transfer pricing will be an area with increasing revenue office focus because the law is new and there’s large amounts of money at stake.
The ATO has significantly boosted its internal resources by recruitment in this particular area and we are certainly seeing a growth in terms of the scope, intensity and comprehensiveness of ATO reviews.
Transfer pricing in Australia is now expected to move towards restructuring and recharacterisations.
We think the ATO will be more and more willing to use its reconstruction powers and will take a stricter approach to penalties.
While there is a growing trend to increase the use of Advance Pricing Agreements (APAs) ‒ and the ATO has been encouraging their use ‒ the ATO is becoming more selective about which taxpayers may be admitted to the process, and more rigorous when reviewing APA applications. There may be scope for growing disputes between the ATO and other revenue offices when bilateral APAs are negotiated, or where disputes involving the Mutual Agreement Procedure provisions in tax treaties arise. Australia is one of 20 countries committed to mandatory binding arbitration under the Base Erosion and Profit Shifting project.
The ATO has also said it would look to run some test cases in order to test the boundaries of the law, and identifying suitable test cases forms part of its review process.
We see that transfer pricing is becoming a more important agenda item, not only within internal tax teams, but also at the level of senior management of the company.
An effective risk management system for transfer pricing may not prevent an audit by the ATO, but may make the audit process less onerous, with much higher likelihood of a positive resolution with the ATO.