As rules are evolving to align value creation with taxable profits, companies need to take a fresh look at how they are legally structured globally, their transfer pricing policies and even the way they control, manage and finance their global operations.
This is becoming a key priority for multinational enterprises that have their global or regional headquarters in Singapore due to the aggressive actions being taken by other tax administrations. In this article, we briefly look at the recent developments in Australia, the related risks to Singapore headquartered companies and the recommendations to manage such risks.
Key developments in Australia
The transfer pricing landscape in Australia has changed rapidly in the last few years. Key developments include:
- Introduction of new reconstructive transfer pricing rules in 2013;
- Requirement for the Australian Taxation Office (ATO) to release income tax information of corporations with income of 100 AUD million and more in 2014;
- Introduction of multinational anti-avoidance laws and Country-by-Country Reporting in line with the Base Erosion and Profit Shifting ("BEPS") Action Plan;
- Intended introduction of the Diverted Profit Tax (Included in the 2016 – 2017 Budget announcement).
Corresponding with these developments, the ATO in the past 2 years has focused on transactions entered into by Australian taxpayers with entities located in countries with a lower tax regime. The ATO's scrutiny on transactions with these lower tax rate jurisdictions has culminated in the following two actions.
First, the ATO has amended the list of specified countries in the release of its Instructions to the International Dealings Schedule (IDS) 2016. The list traditionally included tax havens such as Cayman Islands, British Virgin Islands, Bermuda and Panama. This list has now been amended to include Singapore, Switzerland, Hong Kong, Luxembourg, Netherlands and Ireland. This means that when Australian companies are required to disclose their related party transactions with entities in Singapore, such disclosure will be grouped together with tax havens. Hence, it can be expected that there will be greater scrutiny by the ATO on related party transactions with entities in Singapore.
Second, the ATO has recently issued its draft practical compliance guideline outlining its compliance approach to transfer pricing issues related to centralised operating models involving hubs. The focus of this compliance guideline has been on centralised marketing hubs and we understand that further guidance on procurement hubs and other such structures will soon be released. Although comments are being sought from the tax and business communities, this discussion paper provides guidance to taxpayers in determining if a transfer pricing risk currently exists in their tax / business model, and provides a view as to how the ATO will tackle this. Given the number of Australian taxpayers that transact via a regional headquarter / hub structure that is typically located in Singapore, we believe that these entities are particularly at risk. This is despite the fact that the reason for locating the regional headquarters / hub in Singapore was driven by commercial, operational and business considerations.
In addition to marketing hub structures, the ATO is actively reviewing arrangements involving the use of offshore procurement hubs, which again can have a substantial impact on transactions with Singapore.
While Singapore offers tax incentives for the establishment of regional headquarters and procurement hubs, these incentives are awarded with the commitment of significant headcount and activities. Hence, there is a basis for the view that profits should "rightfully" be taxed in Singapore as that is where the real economic activities generating the profits are performed and where value is created.
However, based on the ATO's draft practical compliance guideline, it is clear that the ATO's view is one where the centralised marketing hubs should be compensated on a cost plus basis – due to their potentially limited function, asset, risk profile. In contrast, the transfer pricing model that is adopted by most MNCs is one where the regional headquarters / marketing hubs / procurement hubs are compensated by way of a residual profit, with the Australian entity labelled as the entity with limited functions, assets and risks.
The ATO's draft practical compliance guidance raises a range of questions in paragraph 105 "Testing and Evidencing the outcomes of your hub" that taxpayers need to answer to ensure that the centralised marketing hubs undertake additional activities and risks to be rewarded with additional profit so that these entities in popular hub locations are not treated as mere cost plus entities. It should be noted that although the draft practical compliance guideline assumes in all cases that transfer pricing documentation has been maintained in support of the arm's length nature of the related party transactions, the range of questions raised by paragraph 105 would require the maintenance of additional information over and above the transfer pricing documentation. The ATO may also request for other information such as contracts of employment for key personnel to understand where the functions and risks are being performed.
In light of these changes, it is recommended that multinational companies with their headquarters or hubs in Singapore review their transactions with their Australian related entities to ensure that these related party transactions are compliant with the revised Australian and Singapore transfer pricing provisions. In addition, we also recommend that a proper review of the operational / commercial substance of the Singapore entity be undertaken.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.