By Leslie Prescott-Haar and Sophie Day at TP EQuilibrium AustralAsia
On 19 June, the Australian Taxation Office published high-level guidance on the impact of COVID-19 on transfer pricing.
This guidance applies to businesses economically affected by COVID-19, and relates to the preparation of transfer pricing documentation to support the arm’s length nature of intercompany arrangements, but does not address whether COVID-19 related changes to intercompany arrangements may be regarded as arm’s length.
The Australian Taxation Office’s guidance at this stage is general in nature, and does not address technical matters associated with application of the transfer pricing methods and determination of arm’s length conditions associated with the pandemic and economic downturn.
The Australian Taxation Office acknowledges that analyses of comparable company benchmarking data may not reliably support arm’s length outcomes of continuing transfer pricing arrangements where these are impacted by COVID-19, particularly in the short term.
As such, the Australian Taxation Office expects that taxpayers will, on a contemporaneous basis, assess and document the function, asset and risk profile of the Australian entity before and after COVID-19, economic circumstances, where the actual economic impacts of COVID-19 on the Australian operations and industry should be outlined, the contractual arrangements between the Australian entity and its related parties, and if any obligations or material terms and conditions have been varied, amended or terminated, evidence of the impact (if any) of COVID-19 on the specific product and service offerings of the Australian entity and how this has affected the financial results, and evidence of changes in business strategies as a result of COVID-19, including decisions made, outcomes sort and actions taken to give effect to those strategies.
To evidence the impact on the specific product and service offerings of the Australian entity, the Australian Taxation Office expects a detailed profit and loss analysis showing changes in revenue and expenses, with an explanation for variances resulting from COVID-19, details of profitability adjusted to where the businesses’ outcome would have been if COVID-19 had not occurred, the rationale and evidence for any increased allocation of costs or a reduction of sales (and subsequent changes in operating margins) to the Australian entity, taking into consideration its function, asset and risk profile, and evidence of any government assistance provided or affecting the Australian operations.
The guidance further indicates that the Australian Taxation Office does not intend to review Practical Compliance Guideline 2019/1 relating to inbound distribution (Note: this Practical Compliance Guideline is generally regarded as having ‘aspirational’ profit margins for Australian distribution), due to the effect of COVID-19.
However, the Australian Taxation Office has ‘left the door open’ to review such Practical Compliance Guideline when benchmarking data covering financial periods impacted by COVID-19 becomes available. Unfortunately, database data lags and extensions of filing requirements for financial statements will likely delay such review.
In relation to existing advance pricing agreements, the Australian Taxation Office’s guidance recognises that a breach/es of a critical assumption/s in the advance pricing agreement may occur.
In our experience, the revenue authorities are often hesitant to ‘open’ previously-agreed advance pricing agreements unless highly material changes have occurred. For advance pricing agreements under current negotiation, unfortunately, the guidance indicates that for taxpayers “significantly affected by COVID-19, it may be difficult to progress the advance pricing agreement application without objective evidence of any impact experienced or high uncertainty around potential outcomes”.
Given that an advance pricing agreement is intended to address difficult transfer pricing issues, this “wait and see” approach may be unhelpful to certain taxpayers.
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