New transfer pricing legislation introduced into Parliament
New transfer pricing legislation introduced into Parliament
The Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 (the bill) has been introduced into the Australian Parliament, including amendments designed to modernise Australia’s transfer pricing rules. While the transfer pricing aspects of the bill replicate – for the most part – the Exposure Draft (ED) legislation released in late 2012, changes have been made which arguably ‘water down’ some of the more controversial aspects of the ED. Nevertheless, it is disappointing that more of the concerns expressed during consultation on the ED have not been addressed.
The release of the bill came a day after the Organisation for Economic Cooperation and Development (OECD) issued its report on Base Erosion and Profit Shifting (BEPS Report). The BEPS Report highlights the need for actions to be implemented to curtail base erosion and profit shifting through avenues including transfer pricing. This provides an interesting backdrop for the evolution of Australia’s transfer pricing rules, particularly given the Government’s decision to include reformed general anti-avoidance provisions and transfer pricing provisions in the same bill.
Currently, Australia's transfer pricing rules comprise three sets of provisions: Subdivision 815-A of the Income Tax Assessment Act (ITAA) 1997, the existing laws in Division 13 of the ITAA 1936, and the transfer pricing articles in Australia’s double taxation treaties. The proposed changes to the transfer pricing rules will apply to income years commencing on or after the earlier of their date of enactment or 1 July 2013. The new laws will repeal Division 13, and Subdivision 815-A will not apply to income years to which the new laws apply. It is expected that the bill could pass through Parliament before the end of March 2013. The new rules will apply both in a treaty and non-treaty context.
The main points of interest in the bill are summarised below.
Self-assessment - The proposed new operative provisions (Subdivisions 815-B and 815-C of the ITAA 1997) will be self-executing in their operation, unlike Division 13 and Subdivision 815-A, which apply through the making of a determination by the Commissioner. Practically speaking, this means taxpayers must address compliance with the new provisions in lodging their income tax returns. Despite the new rules operating on a self-assessment basis, taxpayers can only self-assess to increase taxable profits.
Time limit for amendments - Previously there has been no limitation on the period in which the Commissioner could amend an assessment to give effect to a transfer pricing adjustment. An eight-year amendment period was proposed in the ED, which has been reduced to seven years in the bill. There is no time limit on the Commissioner’s ability to ascertain additional amounts of withholding tax payable under Subdivision 815-B, or the Commissioner’s ability to make consequential adjustments.
Endorsement of OECD material - Proposed Subdivisions 815-B and 815-C must be applied “so as best to achieve consistency with” the OECD’s Transfer Pricing Guidelines and Model Tax Convention and its Commentaries. In addition, some aspects of the OECD Guidelines have been “unpacked” into the legislation itself, (i.e. the most appropriate method rule and comparability factors for selecting and applying arm’s length pricing methods). Thankfully, the wording in the ED qualifying that OECD guidance did not need to be considered “where a contrary intention appeared”, has been removed in the bill.
Reconstruction - The greatest concern expressed in consultation on the ED was the breadth of the proposed reconstruction power given the Commissioner’s ability to substitute arm’s length conditions and look to the underlying economic substance of transactions. Helpfully, the Explanatory Memorandum (EM) to the bill states that the new provisions are only intended to be applied by disregarding and/or reconstructing the actual transactions in the “exceptional circumstances” prescribed in the OECD Guidelines; however, the drafting of the provisions raises concerns as to whether the bill reflects that intention.
Documentation and penalties - In line with the ED, the bill states that failure to prepare the required transfer pricing documentation by the time the relevant tax return is lodged will mean that an entity cannot have a Reasonably Arguable Position (RAP) for penalty purposes. The content and focus of transfer pricing documentation will be required to change to address the new rules, particularly in respect of substantiating arm’s length conditions and aligning the actual conditions to arm’s length conditions.
Broadening of the ‘transfer pricing benefit’ concept to withholding tax - The bill includes an additional, specific provision enabling the transfer pricing rules to be applied where a taxpayer has received a withholding tax benefit by virtue of non-arm’s length conditions (e.g. due to reduced interest or royalty payments).
Some other key aspects of the new rules, consistent with the ED, include:
Financing - There are specific provisions regarding the interaction of the thin capitalisation and transfer pricing rules, such that a taxpayer with international related-party borrowings may be required to show that the amount of its debt is arm’s length for purposes of pricing that debt.
Definition of arm’s length conditions - The new rules allow for the substitution of arm’s length conditions where an entity receives a transfer pricing benefit by virtue of non-arm’s length conditions operating between it and its international related parties. The new rules therefore require “postulation of how independent entities in comparable circumstances would have dealt with one another had they been dealing at arm’s length.”
Profit attribution to permanent establishments (PEs) - Subdivision 815-C is intended to simply “modernise” the drafting of Division 13 as regards PE profit attribution while retaining the “relevant business activity” approach which involves an arm’s length allocation of an entity’s actual income and expenditure to its PE. The Board of Taxation is due to report to the Government by the end of April 2013 as to whether Australia should adopt the authorised OECD approach (a “functionally separate entity” approach) for PE profit attribution, and we could see further reform in this area in the near future.
The new transfer pricing rules are designed to ensure that “the amount brought to tax in Australia from cross-border conditions that operate between entities reflects the arm’s length contribution made by an entity’s Australian operations.” While the ATO contends that it is very much ‘business as usual’ in terms of administering the transfer pricing provisions and the ATO’s approach to cases, taxpayers must now do the work to apply the arm’s length principle in determining taxable income before lodging their income tax returns.
Introduction of the bill into Parliament comes at a time when the Australian tax landscape for multinationals is changing rapidly. In addition to the proposed new transfer pricing rules, there is also a specialist reference group reviewing the taxation of multinationals, members of Parliament and the media are aggressively attacking multinationals’ tax practices, and the Inspector General of Taxation is reviewing the ATO’s management of transfer pricing matters. And all of this is against a global backdrop of the OECD’s work on base erosion and profit shifting, and a G20 that is increasingly interested in ‘fixing’ an international corporate tax system that is seen as broken as a result of the world economy’s recent evolution.
This environment is giving rise to significant challenges for dealing with transfer pricing issues, and means that it is more important than ever for taxpayers to ensure they are satisfied that their taxable incomes reflect arm’s length conditions and that their cross-border arrangements are commercial.