A Bill has been introduced to amend the current transfer pricing rules. The expressed object of the legislation is to ensure that the amount brought to tax in Australia from cross-border conditions between entities is not less than it would be if those conditions reflected the arm’s length contribution made by Australian operations through functions performed, assets used and risks assumed and the conditions that might be expected to operate between entities dealing at arm’s length. Importantly the rules do not rely on or assume a tax avoidance motive.

The legislation gives statutory effect to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations as approved by the Council of the OECD which are no incorporated into domestic law. These Guidelines provide guidance in determining whether or not there is arm’s length consideration. The incorporation of these Guidelines into domestic tax rules was probably the result of the decision of the Full Federal Court in Federal Commissioner of Taxation v SNF (Australia) Pty Ltd [2011] FCAFC 74 which held that those Guidelines were what they said namely just guidelines for determining the arm’s length principle and not binding. They are now more than guidelines and are incorporated into the provisions. Nevertheless, despite that, the decision of the Full Federal Court would probably be the same under the new rules as under the old rules.

The rules will operate on a self-assessment basis. However there are severe consequences for the taxpayer if they get it wrong particularly if there is no documentary support for the pricing which has been adopted by the taxpayer. Although there is no obligation to keep administrative records to justify your pricing mechanism, the failure to do so can increase the penalty amount which is assessed.

The base amount penalty where it is reasonable to conclude that the entity entered into the scheme with the sole or dominant purpose of obtaining a transfer pricing benefit (for themselves or another entity) will be 50% of the shortfall amount or 25% if it is reasonably arguable that the adjustment provision does not apply. In other cases it will be 25% of the shortfall amount or 10% if it is reasonably arguable that the adjustment provision does not apply. Therefore there are severe penalties if your international pricing methodology is incorrect.

The shortfall amount is the amount of the additional income tax or withholding tax payable as the result of the Commissioner taking action against the taxpayer.

You will not have a reasonably arguable position if you do not have records that:

  • are prepared before the time by which you lodge your income tax return for the income year relevant to the matter (or matters)
  •  are in English, or readily accessible and convertible into English
  •  explain the particular way in which the transfer pricing provisions applies (or does not apply) to the matter (or matters)
  • explain why the application of the transfer pricing provisions to the matter (or matters) in that way best achieves the consistency with the specified OECD guidelines for arm’s length pricing.

In addition:

  • the records must also contain information in respect of the relevant arm’s length conditions, as well as particulars about the method selected and the comparable circumstances relevant in identifying the arm’s length conditions i.e. transfer pricing documentation should also contain an explanation of all the steps that are undertaken in identifying which method should be selected, and the comparable conditions used in that process
  • in cases where the records explain the application of the transfer pricing rules to a matter (as opposed to the non-application of the rules), the records must also explain the result of the application of the relevant provisions and contrast this result with the outcome that would have been achieved in the absence of the provisions being applied (for example, the entity’s tax result under arm’s length conditions relative to actual conditions)
  • in cases where the records relate to the application of the provisions that relate to the arm’s length principles as between cross border entities (as distinct from those that apply between an entity and its permanent establishment), then the records must also explain the actual conditions that are relevant to the matter in question 
  • in cases where the records relate to the application of the provisions that relate to the arm’s length principles as between an entity and its permanent establishment, the records must also explain the actual profits and arm’s length profits attributed to the permanent establishment that are relevant to the matter, as well as the particulars of the activities and circumstances of the permanent establishment that were assumed as the result of the entity being deemed to be a separate and distinct entity. Taxpayers will need to make themselves familiar with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as approved by the Council of the OECD and last amended on 22 July 2010. These are no longer merely guidelines but are incorporated into domestic tax legislation in relation to the determination of whether or not the arm’s length test applies to the international pricing as between cross border entities and an entity and its permanent establishment.