Government releases Exposure Draft of new transfer pricing legislation
As part of its process of reforming Australia's transfer pricing rules, the Government has now released Exposure Draft legislation to replace the current transfer pricing provisions in Division 13 of the Income Tax Assessment Act 1936.
Please refer to the Exposure Draft and Explanatory Material
This legislation is the second stage of the Government's announced reform process. The first stage was completed in September with the enactment of Subdivision 815-A of the Income Tax Assessment Act 1997, prescribing "treaty-equivalent cross-border transfer pricing rules" whose primary purpose is to ensure that the transfer pricing articles in Australia's tax treaties can be applied as an assessment power independent of Division 13.
The latest Exposure Draft legislation is for new Subdivisions 815-B, 815C, 815-D and 815-E of the ITAA 1997. Division 13 will be repealed when the new provisions are enacted. Subdivision 815-A has retrospective effect (from 1 July 2004), but will have no prospective operation from the date of application of the new changes.
According to the Government, the purpose of Division 815 is to bring Australia's rules more into line with international best practice and help Australia protect its tax base. In announcing the reforms last November, the Government referred to recent court decisions (e.g. the decision in the SNF Australia case) as suggesting that Australia's existing rules may be interpreted in a way that is out-of-sync with international norms. The SNF Australia decision casts doubt on the validity, under Division 13, of transfer pricing adjustments proposed by the Commissioner that rely on profit methods. The status and relevance of the OECD Transfer Pricing Guidelines in Australia were also questioned.
Key features of the new provisions are:
- Subdivision 815-B, which modernises Division 13 as it applies to separate legal entities, is broadly drafted to ensure that the amount taxable in Australia as a result of cross-border conditions between entities reflects the arm's length contribution made by Australian operations. This is unlike section 136AD of Division 13, which is drafted in terms of arm's length pricing of (i.e. consideration for) transactions
- Unlike Division 13, which operates only through a Commissioner's determination, Subdivision 815-B requires taxpayers to self-assess their taxable profits by applying the arm's length principle
- Like section 136AD of Division 13, 815-B only provides for adjustments to increase taxable profits
- Like section 136AD of Division 13, 815-B applies whether the parties are "related" or not, allowing the ATO to attack collusive behaviour between unrelated parties that results in a reduction of profits in Australia
- Like Subdivision 815-A, 815-B explicitly requires that it be interpreted consistently with the OECD Transfer Pricing Guidelines, and incorporates the OECD-approved methodologies and comparability factors
- Subdivision 815-B contains an express requirement to have regard to the economic substance of the transactions entered into in identifying the arm's length conditions for those transactions, and allows the ATO to potentially reconstruct transactions where the arrangements are not considered "substantially similar" to that which would have occurred between independent parties, given the options realistically available to the Australian taxpayer
- Subdivision 815-C, which modernises Division 13 as it applies to permanent establishments (PE), confirms the relevant business activity approach (also known as the single entity approach), under which the arm's length principle is applied to attribute an entity's actual income and expenses to its PE, as the basis for attributing profits under Australia's domestic transfer pricing rules. The Board of Taxation is currently conducting a review to report to Government by next April on the implications of Australia's adoption of a functionally separate entity approach as now endorsed by the OECD
- Subdivision 815-D links contemporaneous documentation evidencing application of the arm's length principle to the current transfer pricing penalty regime. Without such documentation, taxpayers will not be able to establish a reasonably arguable position in relation to that pricing. It also applies some new de minimis thresholds
- The current unlimited time period for making transfer pricing adjustments is replaced with an eight-year limit.
There are a number of aspects of the Exposure Draft that are controversial, notably the explicit focus on economic substance and the apparent inconsistency with the OECD's position where reconstruction of transactions by tax authorities is only allowable in exceptional circumstances. The proposed legislation allows reconstruction by the ATO where it is considered that the taxpayer would not have entered into the transactions given the options realistically available to it and where a substantially similar arrangement would not have been entered into by independent parties. This will likely put a heavy burden on taxpayers not only to consider the price of intra-group transactions but also the associated terms of the transaction, and will undoubtedly introduce uncertainty for taxpayers and the ATO alike as to how this test would be applied in practice.
While the removal of unlimited time periods for amendments will be welcomed, it is unclear why an eight-year limit is required, leaving timing for transfer pricing adjustments significantly out of step with other time limits for income tax. This is particularly the case given all of the information readily available to the ATO in reviewing taxpayers' transfer pricing arrangements.
It is clear that the ATO can be expected to continue with renewed vigour its targeting over recent years of business restructures, intra-group financing arrangements and recurrent loss-makers.
Submissions on the Exposure Draft legislation close on 20 December 2012. Deloitte will be submitting a response and we would welcome the opportunity to receive any comments you may have or to discuss any aspect of the amendments with you.
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