The Tax Laws Amendment (Cross-Border Transfer Pricing) Act (No. 1) 2012, which contains new domestic transfer pricing laws, has received Royal Assent.
The new law represents stage one of transfer pricing law amendments and is highly controversial in that it introduces retrospective tax legislation. This is a consequence of recent Court decisions that have negatively impacted some of the Government's long-held views on domestic transfer pricing law.
The Commissioner of Taxation's public position is that the new law merely clarifies longstanding practice which will not change. Despite this, taxpayer positions established based on previous law may need to be revisited having regard to the potential impact of new Sub-division 815-A. Areas of particular attention going back to 2004, and going forward, include intra-group debt arrangements, historical loss positions, business restructures and previous and future tax and financial disclosures.
The new law was introduced as there was a perceived threat to the Australian tax revenue base. Recent Court decisions, especially Commissioner of Taxation v SNF (Australia) Pty Ltd, had not affirmed long-held views of the Commissioner of Taxation about how domestic transfer pricing rules should be applied. Also, there continued to be great uncertainty and intense debate about:
- the extent to which Australia's tax treaties are a separate source of taxing power to domestic transfer pricing laws;
- the status of the so-called indirect profit-based transfer pricing methodologies such as transactional net margin method (TNMM); and
- the power of the Commissioner to reconstruct transactions based on hypothetical arrangements and ignore actual transactions, for instance where an enterprise's debt/equity position is within domestic thin capitalisation safe harbor rules.
New Sub-division 815-A has been introduced into the Income Tax Assessment Act 1997 (ITAA 1997). Broadly, where a tax treaty applies, the treaty will apply and operate independently of the existing Australian domestic law, by incorporating the relevant treaty articles into domestic law.
The subdivision authorises the Commissioner of Taxation to make a determination negating a transfer pricing benefit. This can be done if:
- an Australian tax treaty applies to the facts;
- that treaty includes an associated enterprises article or a business profits article (as relevant); and
- an entity obtains a transfer pricing benefit.
A transfer pricing benefit arises if the amount of profits that might have been expected to accrue to the entity has not so accrued because of non-arm’s length features of the commercial or financial relations between the entity and its associates, and taxable income would have been larger or tax losses smaller.
The rules also provide for consequential adjustments as a result of a transfer pricing benefit being negated.
An equivalent regime applies in the context of permanent establishments (PEs) although it applies based on the absolute profits of the entity. This is consistent with existing domestic law, which does not recognise relevant dealings between the PE and the enterprise's other operations (with some exceptions for instance for certain financial institutions).
In this context, the Government has also announced on 24 May 2012 that it has commissioned the Board of Taxation to investigate the impact of Australia adopting the Authorised OECD Approach (also known as the functionally separate entity approach) in respect of the attribution of profits to PEs.
The focus of new Sub-division 815-A on the treaty articles and the emphasis on profits, is intended to broaden the scope of the Commissioner's inquiry as to whether a taxpayer should be the subject of a transfer pricing adjustment. It is also intended to better cater for the application of profit-based transfer pricing methods such as TNMM.
Cast in language that at times is very similar to Australia's domestic general anti-avoidance rules, new Sub-division 815-A also raises the spectre of the Commissioner seeking to reconstruct transactions based on a commercial sense standard. This capacity is made clear in regard to how the law is to be applied to the interaction with Australia's thin capitalisation rules. It is unclear to what extent this position will be consistent with the OECD Transfer Pricing Guidelines, where such powers are viewed as a matter of last resort.
The new law is to be applied as consistently as possible with OECD principles. To counter the Court's decision in SNF that the OECD Transfer Pricing Guidelines had no legal standing under domestic law, a new rule is included that allows reliance to be placed on the most recent versions of the OECD Model Tax Convention and the OECD Transfer Pricing Guidelines, as well as any other documents prescribed by regulation. For years prior to 2012-13, but after 1 July 2004, the relevant OECD guidance is the version of these documents last published before the start of the relevant year.
Date of effect
Controversially, the new rules have been backdated to 1 July 2004. This raises great uncertainty for taxpayers. The Government has justified this on the basis that the intended operation of the rules was consistently made clear in public statements over many years. This is despite the Courts having found the previous domestic law to have been deficient in adequately capturing that intention.
Although transitional relief for interest and penalties has been provided, it is questionable how much protection it will offer affected taxpayers in practice.