On 7 February 2018, the Australian Taxation Office (ATO) released draft Practical Compliance Guideline PCG 2018/D2 (PCG), outlining its compliance approach to the diverted profits tax introduced by Schedule 1 of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act 2017 (Cth) (the DPT). The PCG completes the suite of highly anticipated draft guidance on DPT, which already includes draft Practice Statement Law Administration PS LA 2017/2 and draft Law Companion Guideline (LCG 2017/D7) as released in December 2017.


Our observations on the issues raised by the PCG for multinational taxpayers are as follows:

  • The framing questions set out in the PCG to assist taxpayers in assessing their DPT exposure are generally helpful insofar as they provide a framework to be followed. However, taxpayers should not confine their analysis to the framework, but think more broadly and laterally in ascertaining the level of DPT risk. It is important to undertake this analysis with advice as early as possible, in order to mitigate any risk.

  • Taxpayers remain required to self-assess their exposure to DPT and to create and keep extensive records to substantiate their filing position in order to meet the broad range of information requests that may be made by the ATO in the event of a DPT review or audit.

  • The ATO notes that its compliance approach once a DPT risk is identified may include “ongoing monitoring of the risk or active consideration as part of a review”. It could also result in a formal audit commencing. Where the outcome results in “ongoing monitoring” only, taxpayers seeking further certainty may consider applying for a private ruling in the manner described in the PCG. This may be particularly so if the ATO clarifies that the application of the sufficient economic substance test (SES test) is a DPT matter appropriate for a private ruling. The PCG lists a number of documents that may be required to evidence why DPT does not apply to a specific arrangement. In our experience, large corporate taxpayers have often found it difficult to gather historical information to support assessments going back a number of years.

  • Whilst the DPT applies only to DPT benefits obtained from 1 July 2017, those benefits can arise from schemes that were implemented many years ago. Taxpayers that are concerned about a DPT exposure must begin to recover all relevant documentation from paper and electronic archives. In our experience, the documents most useful to taxpayers are those pertaining to the satisfaction of the SES test and in particular, documents evidencing a taxpayer’s ability to competently manage the contractually assumed risks.

  • The ATO has now clarified that transactions covered by APAs entered into after 4 April 2017 will be considered low risk, and that taxpayers may request a standard “DPT clause” be included to confirm this in writing. However, the ATO allows room for uncertainty by not including this clause automatically under all APAs entered into after 4 April 2017.

  • The ATO has also clarified that it will provide private rulings on certain aspects of the application of the DPT, in particular whether:

    • the relevant taxpayer has obtained a DPT tax benefit;

    • it would be concluded that a scheme was entered into or carried out for a principal purpose of obtaining a tax benefit; and

    • the sufficient foreign tax test applies in relation to the relevant taxpayer in relation to a DPT tax benefit.

    • Given that the SES test is likely to be the key issue in dispute between taxpayers and the ATO, it would be preferable if the final PCG could be expanded to either: (i) clarify that rulings on whether a DPT tax benefit has been obtained includes consideration of the SES test, or (ii) include consideration of the SES test as a separate matter on which a private ruling may be available.

  • The ATO has made clear that the DPT will be considered as part of all settlements going forward, and that DPT clauses may be included. Taxpayers with existing disputes that are on track for settlement, especially following the Chevron decision, should ensure that settlement deeds specifically cover DPT issues. The ATO has confirmed that all information in its possession may be used by it to consider the application of DPT. This could include information obtained through Country-by-Country reporting, via information sharing arrangements with other Commonwealth and State agencies, through other global information gathering processes and in the current environment, unexpected leaks.

Overview of draft PCG

The PCG outlines the ATO’s client engagement framework for the DPT. It also outlines its approach to risk assessment and compliance activity, with particular focus on its approach to the SES test. The PCG will have effect before and after its date of issue.

Importantly, the PCG does not constitute a “safe harbour” and does not relieve taxpayers from being required to self-assess their exposure to the DPT. Rather, the framing questions in the PCG are designed to provide taxpayers with a general guide of matters the ATO may consider relevant in assessing risk and undertaking compliance activity in relation to DPT.

The ATO’s compliance approach

The ATO expects to identify a DPT risk in the course of its ordinary compliance activity and, generally, expects to prioritise resources to address arrangements it considers to pose the highest risk.

The ATO may choose ongoing monitoring or active consideration after a DPT risk is identified, and may use information already available to it, as well as request additional information from the taxpayer. Ongoing monitoring may still be chosen by the ATO even if the DPT risk is low. Taxpayers can expect to hear from the ATO at the end of the review, but will not be provided with a risk rating, merely an outline of the proposed compliance approach going forward.

Matters can be escalated for audit at the end of a review, during which more detailed information will be sought from the taxpayer. It is also possible that other “treatment strategies” may be identified if audit is not considered to be appropriate, e.g. recommending an advance pricing arrangement (APA) or a private ruling be sought (see further below).

DPT client engagement framework

A DPT client engagement framework is set out in Appendix 1 to the PCG. Taxpayers are expected to use the framework to self assess whether they have a potential DPT risk. If a potential risk exists, there is a strongly worded expectation that a taxpayer is to engage with the ATO. Although the PCG does not then address what the ATO’s views would be if a taxpayer did not engage with the ATO, one outcome could be a change in the taxpayer’s risk category.

If applied correctly, the framework should direct taxpayers to one of three main avenues of engagement with the ATO:

  1. Seeking entry into the APA program. Where possible, the ATO will seek to deal with the potential application of DPT concurrently with transfer pricing issues as part of the development of an APA. Covered transactions in APAs entered into after 4 April 2017 will be considered by the ATO to be low risk, and taxpayers may request that the ATO considers including a standard DPT clause in the APA. Such clause provides written assurance that, in relation to the covered transactions under the APA, the Commissioner will not seek to apply the DPT for the income years covered by the APA. APAs entered into prior to 4 April 2017 will generally not provide assurance to taxpayers in respect of DPT.

  2. Applying for a private ruling. The ATO specifies five questions of law which may be dealt with by a private ruling on the application of the DPT:

    1. Whether the relevant taxpayer is a significant global entity.

    2. Whether the relevant taxpayer has obtained a DPT tax benefit.

    3. Whether it would be concluded that a scheme was entered into or carried out for a principal purpose of obtaining a tax benefit.

    4. Whether the $25 million income test applies in relation to the relevant taxpayer, in relation to a DPT tax benefit.

    5. Whether the sufficient foreign tax test applies in relation to the relevant taxpayer, in relation to a DPT tax benefit.

  3. Contacting the DPT specialist team. The ATO has a dedicated team responsible for the DPT, who can be contacted with general enquiries on strategy matters at

Where there is a risk that DPT may apply to an arrangement covered by a proposed settlement (including a multinational anti-avoidance law (MAAL) settlement), the ATO will generally seek to resolve the matter before proceeding with the settlement. They may consider including a clause on DPT in the settlement deed.

How taxpayers should assess DPT risk

Framing questions

The PCG includes a non-exhaustive list of framing questions across a number of categories, intended to assist taxpayers in assessing the DPT risk of their arrangements:

  1. Preliminary framing questions. These questions relate to the threshold matters for DPT to apply i.e. whether the taxpayer is a significant global entity, it exceeds the $25 million income threshold, and it has international related-party dealings.

  2. Transaction-specific framing questions. These questions relate to the nature of the arrangements, for example whether the arrangements involve:

    1. the transfer or effective transfer of valuable intangible assets offshore;

    2. the use of hybrid entities and/or instruments; or

    3. any other features that are unusual having regard to the nature of the relevant business operations.

  3. Framing questions relevant to the SES test. These questions relate to the economic substance of the arrangement, for example:

    1. Is there a genuine commercial rationale for the arrangement? Are form and substance consistent?

    2. Are there any changes that could be expected from the arrangement in the relevant business operations that have not so resulted?

    3. Is there evidence of market conduct that resembles the arrangement?

    4. Do the relevant entities have the financial capacity to assume the risks and are they exposed to the upside or downside of risk outcomes?

  4. Framing questions relevant to the principal purpose test. The PCG confirms that the questions in relation to the SES test may also apply to the principal purpose test, but some additional questions are posed, for example:

    1. Is there a more straightforward way that the commercial objectives of the arrangement could be achieved?

    2. Were any alternatives to the arrangement considered, and if so, why were they rejected?

    3. What are the commercial reasons and rationale for setting up in each jurisdiction involved?

Other guidance products

The PCG also expressly states that the ATO considers two other guidance products to be relevant to assessing DPT risk:

  1. Practical Compliance Guideline PCG 2017/1 ATO compliance approach to transfer pricing issues related to centralised operating models involving procurement, marketing, sales and distribution functions; and

  2. Practical Compliance Guideline PCG 2017/4 ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions. See our earlier alert on this guidance.

If a taxpayer’s arrangement is within the green or white zones under PCG 2017/1 or PCG 2017/4, the ATO does not expect taxpayers to separately engage with the ATO in respect of the DPT. The ATO’s approach to assessing risk in such cases will be limited to the types of arrangements outlined in the specific guidelines.


The DPT does not have specific record-keeping requirements, however the PCG confirms that the ATO will have regard to all information in their possession, including a non-exhaustive list of sources:

  1. lodged income tax returns;

  2. international dealings schedules;

  3. assessment notices;

  4. Country-by-Country reporting data exchanged automatically or by exchange of information request;

  5. information obtained from foreign jurisdictions through exchange of information processes;

  6. other information provided previously under another compliance product; and

  7. other relevant information from third party sources.

Taxpayers are also invited to provide additional information including a general submission outlining their views about the application of DPT, such as the basis for any exemptions, contemporaneous transfer pricing documentation and intercompany agreements and company policies. If taxpayers have chosen to use simplified transfer pricing record keeping, the ATO will have regard to the obligations in Practical Compliance Guideline PCG 2017/2 Simplified Transfer Pricing Record Keeping Options.

The PCG sets out the kind of documentation the ATO will consider when applying each of the principal purpose test, the sufficient foreign tax test and the SES test. Examples include:

  1. Principal purpose test. Presentations and other papers prepared in relation to the arrangement and circulated to the taxpayer’s management team and board of directors, minutes of board or other meetings at which the arrangement was considered, and internal cost-benefit analyses associated with the arrangement.

  2. Sufficient foreign tax test. Foreign income tax returns, notices of assessment, tax receipts or notices of refunds, advice or valuations obtained in relation to the potential tax consequences of proposed structures or transactions, and correspondence from foreign revenue agencies.

  3. SES test. Global value chain information including details of each entity and the activities it performs, commercial, regulatory and tax advice in connection with the arrangement, and details of staff numbers, key personnel, including their job titles, descriptions and responsibilities.

The PCG refers taxpayers to PCG 2017/4 for examples of documentation relevant to considering the application of DPT to related party financing arrangements, and to PCG 2017/1 for examples relevant to procurement, marketing, sales and distribution hubs.

For intellectual property arrangements, the ATO will pay close attention to relevant intercompany agreements and company policies, and may also consider source documents demonstrating that the relevant entities are undertaking functions, using assets and assuming risks in accordance with the representations of the taxpayer, full details of the intangible assets associated with the scheme, and intangible assets.

High and low risk scenarios for the SES test

The PCG includes scenarios selected by the ATO as demonstrating the matters they will consider when assessing risk in relation to the SES test, which cover lease in lease out arrangements, intangibles migration (pharmaceutical), limited risk distributors, intangibles migration (run up run down), marketing hubs and insurance arrangements.

High risk scenarios highlight the circumstances in which the ATO considers it is likely the SES test will not be met. Low risk scenarios highlight the circumstances in which the ATO considers the SES test will be met, and therefore the DPT will not apply. It is made clear, however, that a low risk assessment for the SES test will not preclude the application of other tax provisions, such as the transfer pricing or anti-avoidance rules.

Set out below are summaries of two of the high risk examples: intangibles migration (pharmaceutical) and marketing hubs.


High risk analysis

Intangibles Migration (pharmaceutical)

A global group’s business is the development and commercialisation of pharmaceutical products.

In July 2017, the group restructured.

Prior to the restructuring, Australia Co was the legal and beneficial owner of the IP associated with drug #16 (MD16), including registered trademarks, patents, know-how and processes. It performed all functions associated with developing, enhancing, maintaining, protecting and exploiting MD16. This involved funding and managing the development of the drug over a 10 year period.

At the final stage of clinical trials and prior to commercialisation of MD16, Australia Co and Foreign Co entered into an agreement legally transferring the ownership of all existing IP relating to MD16 to Foreign Co, including exclusive rights to utilise the registered IP for the manufacturing, distribution, marketing and commercialisation process. The trademarks were also permanently assigned to Foreign Co.

At that time, Foreign Co employed a small number of staff with very little experience in the development and commercialisation of pharmaceutical products.

Foreign Co enters a manufacturing contract with a third party manufacturer to produce MD16 for the purpose of global sales. Evidence shows Australia Co still undertakes functions related to the manufacture and commercialisation of MD16 for the global market, including oversight of testing and quality assurance, and managing legal protection. Australia Co is remunerated by Foreign Co on a cost plus basis for these services. Foreign Co is responsible for paying third parties and receives all income from global sales.


An independent entity in circumstances comparable to Australia Co would not have entered into the arrangement as Australia Co has disposed of valuable IP while continuing to undertake the main functions in connection with the commercialisation of the IP. If transfer of the IP had not taken place, Australia Co would have derived the income from global sales of the drug.

Australia Co continues to bear relevant risks associated with the exploitation of the IP as it performs the exploitation functions.

The profit made by Foreign Co and Australia Co as a result of the scheme does not reasonable reflect the economic substance of their activities in connection with the scheme.

Marketing hub

A global group generating income through selling commodities in APAC and Atlantic markets includes Australia Co and Hub Co. Australia Co carries out mining, processing, inland port activities for commodities in Australia, and also undertakes exploration activity.

All production entities in the group exclusively sell their production to Hub Co, which then on-sells to third party customers. Hub Co collects sale-side market intelligence, which is used by the other entities. Hub Co is highly dependent on the production entities for technical marketing assistance to allow it to secure the sale of commodities to third parties.

Physically, Hub Co does not alter the commodities or take physical possession.

The production companies sell commodities to Hub Co at a discount relative to their respective regional index price which allows Hub Co to generate profits on the sale to third parties.

Each of Australia Co and Hub Co employs staff to carry out activities outlined above.

The taxpayer provided documentation stipulating that Hub Co assumes the accounts receivable late payment risk and market risk.

The profits made by Australia Co and Hub Co do not reasonably reflect the economic substance of their activities in connection with the scheme.

Hub Co’s limited activities do not reasonably reflect the profits it is receiving given that the production entities provide key functions to Hub Co to allow it to secure its third party contracts.

Based on a functional analysis, Australia Co’s staff are responsible for planning, production and technical marketing of the commodities as well as collating local market intelligence. Australia Co undertakes significant activities in relation to the production, scheduling and specifications of the commodities. Key value chain decisions and management functions are undertaken by Australia Co and Hub Co does not undertake the activities required to obtain third party contracts or to satisfy its contractual obligations, and relies on the functions and decision-making activities of its related parties.

Most of the market risk is still held by Australia Co because inventory is mined and transported to local stockpiles and held there until requested by customers. Hub Co does not have control over the sales either, as these are all dependent on Australia Co’s functions.

Although Hub Co legally assumes accounts receivable late payment risk, it does not have the ability to manage and control any of its exposure to this risk, nor the financial capacity to bear the risks apart from the ability to call on the financial resources of its parent.