The Australian Taxation Office (the ATO) has published a draft practical compliance guideline - PCG-2018/D8 - (the Draft Guideline) outlining its compliance approach to transfer pricing issues related to inbound distribution arrangements. The Draft Guideline provides a framework for inbound distributors to assess their potential risk of an ATO transfer pricing review against specific "profit markers" provided by the ATO.
We note that the Draft Guideline does not provide advice or guidance on the technical application of Australia's transfer pricing legislation. Accordingly, the ATO acknowledges that having a high risk rating under this Draft Guideline does not necessarily mean that a taxpayer's inbound distribution arrangements would fail to comply with Australia's transfer pricing rules. However, the higher the risk rating, the greater the risk of an ATO audit / review.
Once finalised, the Draft Guideline will have effect from the date of publication and will apply to existing and new inbound distribution arrangements.
Who is effected?
The Draft Guideline is applied to entities that are engaged in the distribution of:
- goods purchased from related foreign entities for resale
- digital products or services where the intellectual property in those products or services is owned by related foreign entities.
What are the profit markers?
The Draft Guideline defines certain profit markers for distributors in the following sectors:
- Life Sciences, split into three categories:
- Category 1: Marketing, logistics, and warehousing
- Category 2: Those activities mentioned in Category 1, plus regulatory approval, market access or government reimbursement activities
- Category 3: Those activities mentioned in categories 1 and 2, plus specialised technical services.
- Information and communication technology (ICT), split into two categories:
- Category 1: Sales and marketing, pre/post sale services
- Category 2: Those activities mentioned in Category 1, plus complex sales processes, direct selling activities; and large customer relationship management.
- Motor vehicles
- A catch-all "General distributors" segment.
A taxpayer's transfer pricing risk from its distribution arrangements will be determined based on a five year weighted average earnings before interest and taxes (EBIT) / sales (EBIT margin). The Draft Guideline provides sets of indicative EBIT margins for the defined types of distributors:
|Distributor type||High risk||EBIT margin % Medium risk||Low risk|
|General||< 2.1%||2.1% - 5.3%||5.3% >|
|Category 1||< 3.5%||3.5% - 4.1%||4.1% >|
|Category 2||< 4.1%||4.1% - 5.4%||5.4% >|
|Category 1||< 3.6%||3.6% - 5.1%||5.1% >|
|Category 2||< 5.5%||5.5% - 8.9%||8.9% >|
|Category 3||< 7.0%||7.0% - 10.0%||10.0% >|
|Motor vehicles||< 2.0%||2.0% - 4.3%||4.3% >|
According to the Draft Guideline, if the EBIT margin is above the higher amount, the arrangement will likely to be of a low risk and (generally) compliance resources will not be allocated by the ATO to assess the transfer pricing outcomes. If the margin is below the higher amount, but above the lower amount, the arrangement will fall into a medium-risk category, where the ATO will monitor it and may contact the taxpayer to seek a better understanding of the arrangement. If the margin is below the lower amount, the arrangement will be considered to be of a higher risk and the ATO is more likely to allocate compliance resources to review the transfer pricing outcomes of the arrangement.
However, this risk framework does not apply to taxpayers where any of the following cover their inbound distribution arrangements:
- an APA
- a settlement agreement between the taxpayer and the ATO
- a court or Administrative Appeals Tribunal decision that applies to the taxpayer
- the ATO has conducted a review of the taxpayer's inbound distribution arrangements and subsequently provide a low risk or high assurance rating for those arrangements.
This Draft Guideline is a useful framework that can be used by taxpayers to assess the transfer pricing risk of inbound distribution arrangements; understand the compliance approach the ATO is likely to adopt given the transfer pricing risk profile of a taxpayer's inbound distribution arrangements; and understand the type of analysis the ATO will embark upon when assessing the transfer pricing risk of inbound distribution arrangements. It follows other recent transfer pricing guidelines issued by the ATO, including on cross-border debt and regional marketing hubs. This continues the focus of the ATO on proactive engagement and regular reviews with multinational corporations.
It is noteworthy that the Draft Guideline goes into some detail about the ATO's APA program, and usage of APAs to assist taxpayers to manage transfer pricing risks and provide taxpayers the opportunity for greater tax certainty on a prospective basis.
Taxpayers should review their transfer pricing arrangements to determine where they sit within the ATO’s risk assessment framework, and consider strategies in order to mitigate any potential risks identified. This Draft Guideline is especially pertinent for multinational clients who have recently restructured, or are in the process of restructuring, their operations and transfer pricing models in Australia (e.g. from a sales/marketing model to a limited risk distributor model) in response to Australia's Multinational Anti-Avoidance Law (MAAL), and who may now have to undertake a further review of their transfer pricing arrangements in Australia.