The ATO has been concerned with the Australian tax implications of non-residents operating or undertaking drilling operations in Australian waters. The ATO flagged a number of its concerns in Tax Alert TA 2016/4 based on the following common drilling rig/ship structure:

The ATO has now released Draft Practical Compliance Guideline PCG 2019/D5 (the Draft PCG) which addresses the transfer pricing issues arising from the bareboat leasing of drilling rigs/ships to Australian operator entities or permanent establishments (PE) of foreign entities (the Operator).

The Operator receives income under a drilling contract from a third party customer, and performs that contract with both local labour and the support of offshore related parties.

A key outgoing for the Operator is bareboat lease payments for the drilling rigs/ships paid to an offshore related party. The size of these lease payments can have a material impact on the taxable profits of the Australian Operator and hence are of interest to the ATO.

Risk assessment framework

The Draft PCG’s risk assessment process allocates taxpayers to four risk zones largely based on the Australian Operator’s earnings before tax (EBIT) / third party contract revenue margin as follows:

  • The risk assessment applies to the profitability of all the Australian operation of a multinational group. This may require the combination of the financial results of multiple Australian operating entities and PEs.
  • The Draft PCG does not apply to arrangement where the form of the arrangements does not accord with its substance or where any of the exceptions in the Australian “reconstruction provisions” apply. In this regard the ATO stated in Tax Alert TA 2016/4 that it was concerned about arrangements where the Sub-Lessor has limited commercial activities or there are limited sound commercial reasons for its position in the leasing arrangement.
  • The Draft PCG does not provide any technical guidance on the ATO’s approach to transfer pricing for these arrangements, but it does outline some of the documents it will request in the event of an ATO review.

Life in the green zone

Taxpayers which qualify for the green zone have the following benefits:

  • The ATO will generally not apply compliance resources to the arrangement
  • The taxpayer is eligible to access the simplified record-keeping option in relation to transfer pricing documentation.


  • The PCG assesses the profitability of the Australian Operator based on the return on third party revenue, rather than return on costs - which has been a more common industry approach;
  • The risk framework does not consider the impact of economic conditions affecting the offshore drilling industry. Since 2014 subdued demand for drilling rigs/ships has resulted in lower consolidated profits or losses for offshore drilling companies, making an EBIT/Sales margin of 10.5% for the Australian operations look high;
  • In addition to the transfer pricing risks, these leasing structures raise an number of income tax issues, including withholding tax risks; and.
  • It should be remembered that the Draft PCG is not the ATO’s interpretation of Australia’s tax law, and that taxpayers can take positions which is contrary to the Draft PCG provided it is supported by robust transfer pricing analysis.