Transfer Pricing Law Reforms
Government releases Exposure Draft of retrospective transfer pricing legislation
Following on from the announcement last November of its intention to reform Australia’s transfer pricing rules, the Government has now released Exposure Draft legislation to retrospectively incorporate the transfer pricing articles in Australia’s double tax treaties into our domestic law.
Please refer to the first link below for background, and to the second link for the Exposure Draft and Explanatory Material:
According to the Government, the purpose of the legislation is to give clarity and certainty in respect of two aspects of Australia’s transfer pricing rules:
- To ensure that the transfer pricing articles (the Associated Enterprises and Business Profits Articles) in Australia’s tax treaties can be applied as an assessment power independent of Division 13 of the Income Tax Assessment Act 1936 and
- To require the arm’s length principle to be interpreted as consistently as possible with relevant Organisation for Economic Cooperation and Development (OECD) guidance.
To achieve these aims, the legislation amends the Income Tax Assessment Act 1997 to include a new Division 815, with Subdivision 815-A prescribing “treaty-equivalent cross-border transfer pricing rules”. Subdivision 815-A applies to a “transfer pricing benefit”. This is essentially the amount of profit which, but for non-arm’s length conditions, might have been expected to either accrue to an Australian entity in accordance with the Associated Enterprises Article of an applicable tax treaty or be attributed to the Australian permanent establishment of a foreign entity in accordance with the Business Profits Article of such a treaty. Subdivision 815-A empowers the Commissioner to make a written determination to ensure that the transfer pricing benefit is subject to tax, by either increasing taxable income, decreasing tax losses or decreasing capital losses, as appropriate.
In working out whether there is a transfer pricing benefit, Subdivision 815-A explicitly requires that both it and the relevant treaty article be interpreted so as to best achieve consistency with the OECD Model Tax Convention and the OECD Transfer Pricing Guidelines, as relevant. For permanent establishment cases, this makes the Commentary on Article 7 of the OECD Model Tax Convention directly applicable, including the OECD report on attribution of profits to permanent establishments as from 2008.
An important issue is how the new Subdivision 815-A will interact with the existing law. According to the Government, a transfer pricing adjustment can be made under Subdivision 815-A, the transfer pricing articles of Australia’s tax treaties, or Division 13 in certain cases. There should be no inconsistency between the treaty provisions and Subdivision 815-A, and both are given precedence over Division 13 in the event of inconsistency with it.
Another important interaction is that between Subdivision 815-A and Division 820 (the thin capitalisation provisions). The new provision explicitly deals with this by essentially adopting the ATO position in Taxation Ruling TR 2010/7. In short, if Division 820 applies, then under Subdivision 815-A the rate of return for the relevant debt is to be worked out applying the arm’s length principle, which may be by reference to a reduced (e.g. arm’s length) amount of debt, and that rate of return is to be applied to the actual amount of the debt. The amendments provide that Subdivision 815-A applies before Division 820, which can apply to further reduce debt deductions.
The amendments introducing Subdivision 815-A will apply to income years commencing on or after 1 July 2004. These amendments are the first stage of the Government’s announced reforms. Further amendments are proposed to include a new provision prospectively replacing the current Division 13 for separate entities, and are also under consideration to bring Australia’s permanent establishment profit attribution rules fully into line with the current OECD-endorsed approach.
Subdivision 815-A is a response to ATO concerns about its powers under Division 13. The decision in the SNF Australia case cast doubt on the validity under Division 13 of ATO transfer pricing adjustments using profit methods, and on the status and relevance of the OECD Transfer Pricing Guidelines in Australia.
Taxpayers most affected by these amendments are those with ongoing transfer pricing audits and disputes, particularly those involving financing arrangements, where some contentious ATO views are being retrospectively given an inarguable legislative support. Previous submissions on these reforms from industry and the professions have universally argued the unfairness of this, but have so far fallen on deaf ears.
Submissions on the Exposure Draft legislation close on 13 April 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.
Fiona Craig | National leader, Transfer Pricing
Paul Riley | Asia Pacific Leader, Transfer Pricing