The Australian Taxation Office ("ATO") recently issued draft Taxation Ruling TR 2010/D2 (the "Draft Ruling") dealing with the application of the transfer pricing provisions to business restructuring by multinational enterprises ("MNEs"). The purpose of this publication is to provide practical guidance to document a business restructure from a transfer pricing standpoint.
A business restructuring can occur for various commercial reasons. It may be in response to competitive pressures, business opportunities, market conditions, cost pressures and changing operating and regulatory environments. As recognised in paragraph 64 of the Draft Ruling, the alternative to restructuring may be to operate less profitably, at a loss or going out of business.
Business restructuring may also result in the transfer of profits out of Australia. For instance, the restructure could involve the conversion of a manufacturer to an entity providing manufacturing services. In such cases, careful consideration of the arm's length principle is warranted.
Broadly, to prove compliance with the arm's length principle, the taxpayer will need to compare/ benchmark its related party dealing with a similar transaction entered into by independent parties. In practice, the business restructuring arrangements entered into by MNEs tend to be fairly unique. The corollary to this is that it is extremely difficult to find comparable information for the purpose of this comparability analysis. Accordingly, the Draft Ruling focuses on indicias of arm's length dealing and in particular, options realistically available to the taxpayer, how independent parties would interact in similar circumstances and the consideration of the risk-reward trade-off.
Practical documentation considerations
The Draft Ruling applies the first 3 steps of the four-step process for testing the arm's length nature of international prices as discussed in Taxation Ruling TR 98/11. The first step involves a functional analysis. Steps two and three involve the selection and application of the most appropriate transfer pricing methodology. It is recommended that the transfer pricing study should include the following information:
- A description of the functions, assets and risks of the relevant entities pre and post restructure. The pre and post contractual terms/arrangements and the relevant actions involved in the restructure should be discussed;
- Details of any assets transferred, benefits provided and contracts terminated;
- The underlying commercial and strategic drivers for the restructure and how they fit in the context of the strategies of the taxpayer and the MNE Group. The business case, analysis, reports and submissions relating to the restructure may be included as an appendix to the transfer pricing study;
- The expected benefits of the restructure including the additional value created and the nature of those benefits, how the parties share in the benefits and each parties contribution to achieving those benefits. The cost benefit analysis performed to support the restructure may be included as part of the appendix to the transfer pricing study;
- Whether the relevant taxpayer is disadvantaged by the restructure;
- Whether there are alternative options that would have been available to the relevant parties that are more commercially advantageous. This means that a comparability analysis (taking into account the risk-reward trade-offs and the relevant legal, commercial, economic and financial implications) will be required to be performed, which analyses and compares the options available to the taxpayer; and
- Documentation and support evidencing:
- That the restructure makes commercial/ business sense to the particular taxpayer;
- That the commercial interests of the taxpayer is protected and actions taken (including evidence of real bargaining) by the taxpayer to protect such interests;
- The consideration of alternative options. If a particular option is not realistically available, it may be helpful to document the reasons for such a conclusion.
What you can do now
Identify all past restructures (say for the past 10 years) and consider preparing a transfer pricing study to document the arm's length nature of the transaction. In this regard, it is noted that the Commissioner has no time limit to make a transfer pricing adjustment. Further, under section 136AD(4) of the Income Tax Assessment Act 1936, where for any reason (including insufficiency of information), it is not possible or practical to ascertain the arm's length consideration receivable/payable relating to the restructure, it is open to the Commissioner to determine that amount.
This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2009 Moore Stephens Australia Pty Limited. All rights reserved.