The Australian Taxation Office (ATO) has announced that it plans to closely examine the tax profiles of companies in the pharmaceutical industry in Australia. In this context, it is likely the ATO is throwing the net relatively widely to target multinationals involved in the healthcare industry generally.

In its announcement the ATO noted the strategic importance of the industry to the Australian economy, the significant volume of annual sales (approximately AU$42 billion), and the diverse nature and structure of companies operating in industry.

Attention on the tax profiles of the pharmaceutical industry has been increasing since the Senate Economics Reference Committee's 2015 interim report on corporate tax avoidance referred to the pharmaceutical industry setting "drug prices in Australia based on maintaining a small but astonishingly consistent profit margin of 3 - 4 per cent while paying much larger revenues to parent companies overseas."

What is the ATO doing?

The ATO has dedicated a team of senior tax officials across a range of tax functions to reviewing the tax profiles and transfer pricing practices of the pharmaceutical industry.

The announcement specifically noted the ATO is conducting the reviews to gain a detailed understanding of the pharmaceuticals industry and ensure the industry "pays the right amount of tax."

The ATO will likely be assessing a range of international and domestic tax risks (including transfer pricing, tax performance, transfer pricing and income tax) particularly relevant to the pharmaceutical industry including:

  • related party financing;
  • thin capitalisation;
  • intellectual property migration;
  • consolidation and business restructures;
  • research and development; and
  • cross-border supplies.

A primary focus of the ATO on companies in the pharmaceutical industry is likely to be non-arm's length conditions operating between entities in connection with their cross-border commercial and financial relations. In the ATO's view, such arrangements can potentially result in the amount of tax attributable in Australia to not reflect the contribution made by the Australian operations to the broader pharmaceutical group through functions performed, assets used and risks assumed.

In announcing the new focus, the ATO has identified that it will investigate the above tax risks through a new series of reviews and audits, as well as cooperative compliance approaches through advanced pricing arrangement where relevant.

This new general international and domestic tax focus will likely operate in conjunction with the ATO's administration of the newly introduced Diverted Profits Tax (DPT). You can read our previous alert on the DPT and the Healthcare Industry here.

Next steps for impacted taxpayers

The ATO suggested that in order to reduce exposure to future compliance activity, taxpayers should review existing structures, transfer pricing practices and consider their position on potential Advance Pricing Arrangements. In this context it is important to have the commercial rationale of your intercompany arrangements appropriately supported and documented.