Australia: Reconstruction of transactions the key concern in the transfer pricing taxation reforms

Last Updated: 28 May 2013
Article by Mark Friezer

Most Read Contributor in Australia, November 2017

Key Points:

The transfer pricing reforms would give the Tax Commissioner very wide powers, with little guidance to constrain their exercise.

The Taxation Commissioner's reconstruction power in the transfer pricing reforms to the Income Taxation Assessment Act 1936 (Cth) needs further consideration, according to the Law Council of Australia.

Clayton Utz tax partner Mark Friezer appeared before the Senate Economics Legislation Committee on Tuesday, 30 April 2013 in his capacity as Chair of the Taxation Committee, Business Law Section, Law Council of Australia.

The Law Council is not a lobby group for any particular business interest; its response is based on an interest in the rule of law, the integrity of the tax provisions themselves and the efficacy of policy implementation.

This is an edited version of Mark's submissions on its behalf.

The Law Council's views on the transfer pricing reforms

In transfer pricing, we agree with the premise of the arm's-length pricing rules.

The thing that has been exciting everybody, of course, is the reconstruction provision and the very broad powers in the bill. There is some discussion in the explanatory memorandum which holds back those powers or provides an indication that they will only be used in exceptional circumstances. Our view is that these are really powerful tools and, to the extent that there is an intent to constrain their usage, that should be made clear in the legislation itself.

We have one other suggestion: in the case of reconstruction we believe that a reversal of the onus of proof is warranted. Under the rules as proposed, it is open to the Commissioner to assert that, in particular, parties may not have entered into a particular transaction had they acted as independent parties dealing at arm's length with each other. We suggest that, provided that there is adequate documentation, the Tax Commissioner should be required to discharge an evidentiary burden to show that the parties, if dealing with each other independently, would have entered into a different transaction.

We say that because there is a lot more evidence open to the Commissioner to make that assertion. He has the whole taxpayer pool to observe the behaviour of taxpayers at large in this area and it seems to us that, in a self-assessment regime, it is a very onerous burden on the taxpayer to have to prove that they have acted as independent parties would have in terms of the form of a transaction.

So as I said, our recommendation there is that there should be a discharge of an evidentiary burden by the Commissioner as distinct from a mere assertion.

Reliance on OECD guidelines

The rules talk about interpretation consistently with OECD guidelines. We would like to see a little more detail about what that means. Are they simply to be used as an interpretive guide; are they somehow incorporated into our legislation?

If it is the latter, I think there is some concern that we are ceding legislative power to a group within the OECD and we should not be abrogating our legislative power in that way.

What we are after there is perhaps some greater clarity around how in a practical sense the OECD guidelines would be used.

Documentation and transfer pricing

We believe that tying documentation to penalties is fine as an approach, but the natural place where it seems to us that should sit is as to whether reasonable care has been adopted by the taxpayer in their tax return.

We do not believe it is appropriate to make documentation a precondition to the adoption of a reasonably arguable position. The reason we say that is that a reasonable arguable position – there is case law about what that is; it is a term of substance; it probably has nothing to do with whether you document the transaction in a particular way. We feel that is diluting the real meaning of that concept and it is out of place.

The second point on documentation is that we believe the de minimis threshold – the $10,000 rule – is too low.

The final point I would like to make about transfer pricing is the issue of waiver of privilege. The documentation requirements have in the past been recognised as possibly implicitly requiring that the documentation be provided to the ATO. In that event, there is an issue as to whether there is waiver of client privilege. In fact, in one of the Commissioner 's tax rulings, TR98/11, it states that properly documenting transfer pricing positions will not result in a waiver of privilege.

All we would like to see there is that the same clarity around waiver be introduced possibly in the EM or bill for these transfer pricing rules.

The Law Council's views on the Part IVA reforms

The Law Council supports a robust general anti-avoidance rule. We believe that, notwithstanding the recent decisions, part IVA only has, generally speaking, been a successful safeguard the integrity of the tax system.

We recognise that there is a balance to be struck with part IVA between unnecessarily restricting taxpayers from entering into transactions and safeguarding the revenue. Clearly, to the extent that there is a view that there are significant revenue losses – and that comes down to a policy issue, at the end of the day, as to what is unacceptable tax practice – we recognise that there is a balance needed. However, we believe that the current proposals are an overreach. I will go into a little bit of detail as to why we believe that.

Stepping back from the provisions, one can say the cases where the Commissioner has had difficulty are not the kind of paper scheme tax avoidance cases that a scheme promoter comes up with a view to providing to a potential purchaser a tax deduction. That type of artificial scheme is generally concerned with deductions. In the past, tax avoidance cases have generally impugned such schemes quite successfully. Where you have a deduction that is claimed by a client, the do nothing scenario means that if you do not do anything you do not get a deduction. It does not operate in that area.

As we said in our written submission, what is problematic it is this movement of part IVA into areas where perhaps it was not intended to venture – that is, into what we regard as genuine business transactions. This is where the balance becomes importance. Quite frankly, it is a difficult area. The situation of a business taxpayer availing itself of rollovers and consolidation rules – very complex rules within the tax law that in fact do have embedded integrity rules – is often a complex one. But those situations are driven by the background of a genuine transaction.

If we look at the cases that have been entered into by the Commissioner, on a number of occasions the observation has been made in the cases that indeed there was an underlying commercial transaction taking place. Part IVA does not fit well in those circumstances. In other words, the focus of this discussion is on tax benefit when in fact in many of those cases I would submit that the Commissioner might well have failed on dominant purpose if he had not already failed on tax benefit.

What we are really saying is that the current provisions are changing more than they need to be changed in part IVA to address the concerns that the Commissioner may have. As a result, we believe that there will be some collateral damage. What specifically do I mean by that? There are a number of points.

First of all, the comparison is no longer with the alternative that the taxpayer can prove would have happened but with any number of a range of a possible alternatives. The annihilation versus reconstruction distinction that is now made is being made on a funny basis. It is being asserted that it was always there in the law, although none of the courts seem to have recognised that it was ever there. It seems to us that that distinction is not necessary.

The change would suggest that a holistic view should be taken of tax benefit together with dominant purpose. Again, there is a bit of an assertion that that has always been there, but it has not really been the way that the courts have looked at the issue. And, logically, it is difficult to see how one can sequence consideration of dominant purpose having regard to tax benefit before determining what the tax benefit actually is. We do not believe that there is actually any damage done by the traditional way of determining what the tax benefit is and determining if there is indeed a tax benefit – which, on any view, is a thing that has to be cancelled at the end of the day – and then making an inquiry about dominant purpose. It seems to us illogical and counterintuitive to reverse that inquiry to really no good end.

Therefore, the concern we have is that a lot of these changes are unnecessary. the scope of the abuse is not large. They are an unnecessary disruption to the precedents which have been established over 30 years now with part IVA with a consequent lack of certainty for taxpayers.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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