|[Insert DD month YYYY]
[Insert client name]
[Insert client position]
[Insert company name]
[Insert client address]
[Suburb state postcode]
Dear [insert client name],
Re: Transfer Pricing
Transfer Pricing Regime Reform
We are writing to you to give you a summary of the key issues arising out of the recent reforms to Australia’s transfer pricing rules.
It is becoming increasingly apparent that the Australian Taxation Office (“ATO”) is focusing its challenge of international related party dealings on the ‘profit’ outcomes achieved by taxpayers and, in particular, whether those outcomes are inconsistent with those expected by the ATO. The ATO’s focus on profitability has been enhanced by the Federal Government’s ongoing “reform” of Australia’s transfer pricing regime effective from 1 July 2013.
In this letter, we outline the following:
Small Taxpayer Simplified Rules
International Dealings Schedule
The legislation requires taxpayers to evaluate the relevant arm’s length conditions, i.e. those that might be expected to operate under comparative dealings between independent entities, as against those conditions that “actually” applied to the dealings.
Where the actual commercial or financial conditions differ to the arm’s length conditions having regard to both the form and the substance of those dealings, arm’s length conditions are substituted in circumstances where a taxpayer would otherwise derive a transfer pricing advantage or “benefit”. The potential substitution of the actual conditions and power of the ATO to “hypothesise” what independent parties would have done in the alternative to the actual transactions(s) entered into is a major concern for taxpayers.
The ATO approach to transfer pricing is summarised in the following suite of documents:
Taxation Ruling 2014/6 (TR 2014/6: Income tax: transfer pricing – the application of section 815-130 of the Income Tax Assessment Act 1997
Taxation Ruling 2014/8 (TR 2014/8): Income tax: transfer pricing: documentation requirements
PSLA 2014/2: Administering transfer pricing penalties for income years commencing on or after 29 June 2013
PSLA 2014/3: Guidance for transfer pricing documentation.
The rulings and practice statements introduce a proposed new five-step documentation process in lieu of the former four-step process. Whilst not mandatory, absent documentation that couples with the legislation significantly greater penalties may be imposed (in addition, a taxpayer would be unable to establish a “reasonably arguable position” pursuant to Sub-division 284-E of the Taxation Administration Act).
If you meet the following criteria you are eligible to apply the small taxpayers' simplified record-keeping option to your international related party dealings. The criteria are:
have not derived sustained losses
do not have related-party dealings with entities in the specified countries
have not undergone a restructure within the year
do not have related-party dealings involving royalties, licence fees, or research and development arrangements
do not have specified service related-party dealings (either as expenses or as income) greater than 15% of your turnover
are not a distributor (if you are, refer to the distributors section to determine if you are eligible)
have assessed your compliance with the transfer pricing rules.
This option does not apply to:
international related-party financial transactions (for example, loans and guarantees) and associated charges
international related-party dealings of a capital nature.
International Dealings Schedule
Where taxpayers undertake transactions or dealings with international related parties over the specified A$2 million threshold (including average loan balances) of total transactions, the taxpayer must disclose such transactions at Section A of the International Dealings Schedule (“IDS”).
“International related party dealings” refers to transactions, agreements or arrangements between related parties, be that companies, trusts, partnerships or between a foreign branch and its Australian head office or between an Australian branch and its overseas head office. The term includes all transactions between an Australian resident and international related parties. A relationship with an international party broadly exists where either entity participates in the management, control or capital of the other entity, or simply conducts transactions that are not at arm’s length.
International related party transactions includes any type of transaction be it on revenue or capital account (including the provision of loans, the provision of services and license of intellectual property).
The ATO introduced the IDS in 2012, which replaced the outgoing Schedule 25A. The IDS allows the ATO greater insight into the international related party dealings entered into by an Australian taxpayer. The volume of information required in the IDS greatly assists the ATO, armed with its new powers, in targeting a variety of taxpayers for a transfer pricing record review or audit.
Section A of the IDS is 7 pages in length, with a comprehensive instruction guide over 70 pages in length. By way of comparison, the now superseded Schedule 25A was 2 pages in length.
For each distinct transaction type, taxpayers are required to disclose the transfer pricing methodology applied and percentage of contemporaneous Australian transfer pricing documentation that is kept for each ‘type’ of international related party dealing.
It is important to note that, in the event of a business restructure (including transfers of functions, assets and risks), a narrative is also required and taxpayers will need to describe the restructure and specify whether a professional valuation study or transfer pricing analysis of the event has been performed.
If you are eligible to apply a simplified record-keeping option because you are an eligible small taxpayer, then at the relevant labels on the IDS you would include code 7 at the percentage of documentation label code. This confirms that you have assessed your situation as complying with the transfer pricing rules and advised the ATO that a simplification option has been applied to your record keeping.
It is strongly recommended that significant attention is given to the accuracy and nature of the disclosures made by the taxpayer in the preparation of the IDS.
On a more positive note, the new transfer pricing regime imposes a statute of limitations as to how far back in time the ATO may go in making a transfer pricing adjustment. A seven-year time limit will be welcomed by many given that historically many audits have embraced time periods far exceeding seven years.
In closing, we note that the new processes operate on a self-assessment basis; accordingly, public officers really must turn their minds to the veracity of the pricing of their international relate party dealings before signing and lodging returns of affected taxpayers.
If you have further queries on any details contained within this letter or on any other matter, please do not hesitate to contact me on [insert telephone number].
[Insert partner name]