Australia may exercise transfer pricing reconstruction power, will change approach to allocation of risk, official says

by Julie Martin,  Editor, MNE Tax

The Australian Taxation Office (ATO) has not yet used its sweeping power to reconstruct transactions for transfer pricing purposes; however, that may soon change, Australian Deputy Commissioner Mark Konza said at the Tax Institute’s 2018 National Transfer Pricing in Conference held August 8.

Speaking in Sydney, Konza said that the ATO is currently considering the using its transfer pricing reconstruction power to address cross-border related party arrangements that do not appear to make commercial sense and that result in moving value created in Australia out of Australia.

“For example, we may need to consider the substitution of arm’s length arrangements where an Australian entity seeks to transfer significant assets from Australia or allows the relative value of its Australian assets to erode in ways that independent entities acting commercially would not,” Konza told the conference.

The ATO’s transfer pricing reconstruction power, added in 2013 in Section 815-130 of Subdivision 815-B of the Income Tax Assessment Act, allows the Commissioner to recast cross-border related party transactions in accordance with how independent parties would have hypothetically dealt with one another and impose transfer pricing adjustments on that basis. In a 2015 practice statement, the ATO said it would only exercise these powers after fulfilling several levels of ATO review.

Konza said that the ATO’s view of how to apply Section 815-B has evolved as the Australian courts have weighed-in on transfer pricing matters and the OECD has amended its transfer pricing guidelines.

He said the Full Federal Court’s April 2017 decision in Chevron supports the view that modification of a non-arm’s length arrangement can sometimes be necessary.

OECD guidelines on risk

Konza also said that OECD’s updated transfer pricing guidelines addressing the allocation of risk will affect transfer pricing cases in Australia. The OECD guidelines are incorporated into Australian law.

“We have seen cases in the past where companies have argued that the profits from risk control functions undertaken in Australia should be recognized offshore due to a foreign role in setting a policy environment or formalizing a decision through a board meeting. Under the new commentary, it will be clearer that the outcomes of that entrepreneurial function are properly allocated to Australia.

“We have also seen cases where it is asserted that the manner in which the Australian entity is contractually compensated by a related entity, such as with a fixed target margin, means that relevant entrepreneurial risks and functions cannot be allocated to Australia. Again, the new commentary makes it clear that the form of contractual compensation is no barrier to properly identifying the dealings, and assigning correct economic prices,” he said.

Country-by-country reporting, MLI

Konza said the ATO received its first batch of country-by-country reports electronically in September 2017 and had thus far received 2,116 local files, 1,463 master files, and 42 country-by-country reports.

Australia is one of 69 jurisdictions that have agreed to automatically exchange country-by-country reports, he said.

Australia signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) in June 2017, he noted. The MLI is expected to modify 31 Australian bilateral tax treaties and introduce mandatory binding arbitration into 13 treaties, Konza said.

If countries’ MLI elections don’t change, mandatory binding arbitration will be available for cross-border disputes involving Belgium, Canada, Fiji, Finland, France, Ireland, Italy, Malta, Netherlands, New Zealand, Singapore, Spain, and the UK, he said.

He said arbitration may be available for 10 tax treaty mutual agreement procedure (MAP) cases if not resolved by the date mandatory arbitration comes into effect.

MAAL

Konza called Australia’s Multinational Anti-Avoidance Law (MAAL) a success, noting that, so far, 44 MNEs have restructured in response to the 2015 law and now book sales revenue in Australia.

The law was enacted to thwart arrangements that avoid the attribution of sales revenue to an Australian taxable presence to avoid Australian or foreign taxes, he said.

Konza said that a majority of the restructures also involved moving from a net cost plus return to a sales based return transfer pricing method.

Pharmaceutical, energy, resources sectors

Konza said the ATO is now focusing its efforts on transfer pricing in the pharmaceutical industry, with nine audits underway and nine advanced pricing arrangement applications in process.

“We will also be continuing to look at the energy and resources sector – specifically exploration expenditure, hubs (particularly marketing hubs) and related party financing such as debt funding, the use of derivatives to avoid interest withholding tax and cross-currency interest rate swaps,” he said.

The oil and gas industry is a particular focus, he said.