The Australian Government has released an Exposure Draft of proposed retrospective amendments that will implement the first stage of reforms to transfer pricing.
The Exposure Draft was released by the Government on 16 March 2012 and follows the announcement and release by the Government of a Consultation Paper on 1 November 2011.
Australia's transfer pricing rules were introduced in 1982 and are currently contained in Division 13 of the Income Tax Assessment Act 1936 and in various Articles in Australia's Tax Treaties. Broadly, they ensure that Australia receives an appropriate share of tax revenue from cross-border transactions entered into by taxpayers. Principally, these transactions are undertaken between members of multinational groups.
The transfer pricing rules have not been materially amended since their introduction some 30 years ago. Legislative reform to the rules provides increased certainty with respect to their application and increased harmonisation with international practice.
However, the proposal to amend the legislation retrospectively has been controversial. The Commissioner contends that he has always had the power to use Tax Treaties in transfer pricing disputes. Many have argued that Tax Treaties are entered into to avoid double taxation and do not empower the Commissioner to impose taxation where no taxing right exists under domestic law.
These proposed amendments put that debate to rest for income years commencing on or after 1 July 2004. In the Explanatory Memorandum to the Exposure Draft, the Government notes that it has always held the views confirmed in the proposed rules (ie. since the introduction of the transfer pricing rules in 1982), however, the amendments will apply from 2004 on the basis that the 2004 income year commenced immediately after the Parliament last demonstrated its intention that the law should operate in this way.
Submissions on the current Exposure Draft close on 13 April 2012.
Interaction between Australia's Treaty network and Australia's domestic transfer pricing rules
The Exposure Draft proposes to introduce new subdivision 815-A into the Income Tax Assessment Act 1997 and is intended to implement the first stage of the proposed amendments to Australia's transfer pricing rules.
The Exposure Draft is focused on the interaction between Australia's Treaty network and its domestic unilateral transfer pricing rules contained within Division 13. The Exposure Draft confirms that where a Tax Treaty applies, the Treaty will apply and operate independently of the domestic legislation.
The purpose of proposed subdivision 815-A is to make certain:
- that the transfer pricing Articles in Australia's Treaties (broadly being the "Associated Enterprises Article" and the "Business Profits Article") can be applied and operate to provide assessment authority independently of Division 13, through explicit incorporation into the 1997 Act; and
- to require the arm's length principle to be interpreted as consistently as possible with relevant OECD guidance.
Transfer pricing benefit
The new rules introduce the concept of a "transfer pricing benefit", which can arise in two situations:
- firstly, when an Australian resident taxpayer enters into a transaction with an "Associated Enterprise" (eg. a foreign related party) and the amount of profit that might have been expected to accrue to the entity has not so accrued; and
- secondly, when the amount of profit attributed to the Australian PE of a foreign resident under the Business Profits Article is less that the amount of profit that might have been expected to have been attributed in the relevant circumstances.
The amount of the "transfer pricing benefit" is the difference between the profits accrued (or attributed, as the case may be) and the profits that might have been expected to have accrued (or have been attributed) had the parties been operating independently of each other. In the case of the Australian PE of a foreign resident, the profits that might have been expected to have been attributed to the entity are determined by treating the Australian PE as a "distinct" and "separate" enterprise.
If the thin capitalisation rules contained within division 820 of the 1997 Act also apply to an entity in relation to an income year, there are additional proposed rules that will apply in determining an entity's "transfer pricing benefit" for the income year. The additional rules are intended to ensure that any adjustment made to a taxpayer's tax position under proposed subdivision 815-A is used to establish the arm's length cost of debt capital under the thin capitalisation rules. This is consistent with the current administrative approach set out in Taxation Ruling TR 2010/7.
Determinations by the Commissioner
In circumstances where a "transfer pricing benefit" has been identified, the proposed rules empower the Commissioner to make determinations to ensure the taxpayer's liability to tax appropriately reflects the transfer pricing benefit received. For example, a taxpayer's taxable income may be increased, or a tax loss or capital loss may be decreased, relative to what the taxpayer has returned.
Relevance of OECD Guidelines
In its Consultation Paper released in November 2011, the Government notes that practitioners, the ATO and Treaty partner administrators have "extensively" relied on the OECD Guidelines in applying and interpreting transfer pricing profit allocation rules in Australia. The Consultation Paper also notes that courts in Australia have not endorsed the use of the OECD Guidelines in this manner. In fact, the relevant standing these rules have had has never been certain in practice. The Consultation Paper itself notes that "a clear legal pathway for use of the Guidelines might also reduce the need for legal argument on this point in litigation".
Relevantly, the Exposure Draft includes a proposed rule that explicitly refers to the guidance that can be relied on and referred to in determining whether a "transfer pricing benefit" exists. For the 2012-13 income year and later income years, the guidance that can be relied on is:
- the Model Tax Convention on Income and on Capital, published by the OECD on 22 July 2010;
- the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration, published by the OECD on 18 August 2010; and
- any other documents prescribed in the Regulations.
For income years prior to 2012-13 (but beginning on or after 1 July 2004), the relevant OECD guidance is the version of the abovementioned documents that were last published before the start of the relevant income year.
Other issues for possible reform
The Consultation Paper released in November noted a number of other issues for consultation within the overall transfer pricing review that were focused on harmonising Australia's domestic legislation with international transfer pricing developments. Some proposals are to amend the legislation to:
- specifically refer to the various transfer pricing methodologies that may be relied on to demonstrate adherence to the arm's length principle and introduce a "most appropriate method" (this would be consistent with recent OECD guidance and practice). At present, a number of other jurisdictions have legislative rules that govern the use and application of the transfer pricing methodologies that may be relied on. In Australia, these are referred to in ATO Taxation Rulings;
- introduce a legislative requirement for transfer pricing documentation. Again, this requirement is set out in ATO Taxation Rulings and other administrative guidance;
- broaden the arm's length principle;
- introduce time limits for the amendment of assessments due to a transfer pricing adjustment.
The Government has yet to announce whether further Exposure Draft legislation dealing with these issues will be released following the period of stakeholder consultation.
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