First tranche of transfer pricing reforms introduced into Parliament
30 May 2012
Last November, the Government announced reforms to Australia’s transfer pricing rules.
The Tax Laws Amendment (Cross-Border Transfer Pricing) Bill (No. 1) 2012 introduced into Parliament last week is the first phase of those reforms. In accordance with the Government’s announcement, the bill is intended to “clarify” that the transfer pricing rules contained in Australia’s tax treaties operate independently of, and provide a separate taxing power to, Division 13 of our domestic income tax law.
On the basis that this is merely a “clarification” of the law, the Government has seen fit to make these changes retrospective, applying to income years commencing on or after 1 July 2004. The bill and the explanatory memorandum are provided at the 'Parliament of Australia' website.
The bill largely follows the exposure draft (ED) legislation released earlier this year (see Transfer Pricing Law Reforms, March 2012). The legislation amends the Income Tax Assessment Act 1997 to insert a new Subdivision 815-A – Treaty-equivalent cross-border transfer pricing rules. This provision authorises the Commissioner to make an adjustment negating a “transfer pricing benefit”, which is defined by reference to the amount of profit that would be allocated to the taxpayer under the transfer pricing rules in an applicable tax treaty. In this way, the treaty outcome is subjected to tax under the new domestic law provision.
The Government invited submissions on the ED and consulted with various bodies, advisers and the broader business community. It is pleasing to see that some of the concerns raised during this process have been addressed in the bill. However, the retrospective application of the new legislation has been maintained despite the groundswell of opinion that this is bad policy and is potentially damaging to Australia’s reputation as a jurisdiction in which foreign investors can invest and trade with certainty and confidence.
Key differences between the ED and the bill are:
Linking adjustments to transactions
The ED legislation was framed in such a way that an adjustment could be made to profits/taxable income under Subdivision 815-A without requiring the Commissioner to attribute that adjustment to a particular item of assessable income, deduction or capital gain/loss. Apart from the potential problems this can cause for the taxpayer at a domestic level, it is also problematic for the purposes of requesting correlative relief or the use of a Mutual Agreement Procedure under a relevant treaty. The bill now provides that the Commissioner must attribute the adjustment unless “it is not possible or practicable” to do so
The ED and the explanatory material accompanying it remained silent on the issue of penalties, with the concern being that the retrospective application of Subdivision 815-A would unfairly give rise to penalties. The legislation now contains a transitional rule limiting the amount of penalties where Subdivision 815-A applies to the amount applicable had the bill never been enacted and the current law instead applied. This is hardly a concession as, given the ATO’s view that the treaties have always provided a separate basis for making transfer pricing adjustments, its interpretation of the current law will result in penalties being applicable where a Subdivision 815-A adjustment is made on the basis that the adjustment would have been made under the treaties in the absence of Subdivision 815-A
- Interaction between transfer pricing and thin capitalisation rules
Previously, this interaction was dealt with in a taxation ruling – TR 2010/7. The ED sought to preserve the ATO’s views on this issue by legislating them into Subdivision 815-A. It went so far as to legislate the contentious ATO view that it could, where necessary in applying the transfer pricing rules, substitute an arm’s length debt amount for a taxpayer’s actual debt amount in determining an arm’s length interest cost. The legislation now omits any reference to an arm’s length value of the debt interest, although the explanatory memorandum makes it clear that the legislation allows for such an amount to be taken into account for the purposes of determining an arm’s length interest rate, which is then applied to the actual amount of the debt.
This is the first phase of the reforms. The other phases announced in November 2011 deal with prospective changes to the transfer pricing rules, including those dealing with the attribution of profits to permanent establishments. These prospective reforms have so far been the subject of only limited consultation with Treasury; however, Treasury has indicated that the drafting of the new provision replacing the current Division 13 will largely follow that used in Subdivision 815-A.
On the permanent establishment reforms, the Assistant Treasurer also announced last week that he has commissioned the Board of Taxation to investigate the impacts of having Australia change its current profit attribution rules to adopt the OECD’s “functionally separate entity” approach. The terms of reference include reporting on the advantages and disadvantages of adopting the functionally separate entity approach and what principles should be followed in amending the income tax legislation should that approach be adopted. The Board of Taxation is required to report on these and other issues by 30 April 2013.