Transfer Pricing – hiding your head in the sand is no longer an option!

In December 2014, the Australian Taxation Office (“ATO”) finalised its guidance in relation to transfer pricing documentation and penalties.

This guidance articulates the ATO’s views on the interpretation and practical application of the legislation regarding the key concepts in the new law relating to preparation of transfer pricing documentation and penalties as they apply to Australian and foreign multinationals with years beginning on or after 29 June 2013.

Documentation

The guidance recommends that “five key questions” are considered in preparing transfer pricing documentation, being:

1. What are the actual conditions that are relevant to the matter (or matters)?
2. What are the comparable circumstances relevant to identifying the arm’s length conditions?
3. What are the particulars of the methods used to identify the arm’s length conditions?
4. What are the arm’s length conditions and is/was the transfer pricing treatment appropriate?
5. Have any material changes and updates been identified and documented?

One area where the Australian rules extend beyond those of the OECD is the question of whether the transaction or arrangement itself is arm’s length in nature. This “reconstruction” issue is unique to Australia and would not typically be addressed in other OECD-based transfer pricing documentation.

Reasonably arguable position

The guidance strongly reinforces the requirement to satisfy the self-assessment regime and highlights that documentation that is not prepared prior to lodgment of a tax return will not be considered to be contemporaneous and therefore will not entitle the taxpayer to assert that it has a ‘reasonably arguable position’ (“RAP”).

Penalties

The ATO penalty guidance confirms that taxpayers who do not prepare contemporaneous documentation will be unable to argue that they have a RAP. Generally, the compliance penalty that applies where a taxpayer does not have a RAP is 25% of the tax shortfall. Where the taxpayer has prepared contemporaneous documentation but still suffers a transfer pricing adjustment, the compliance penalty is reduced to 10% of the tax shortfall, where the taxpayer can demonstrate that it has a RAP.

While the preparation of transfer pricing documentation is not mandatory under the transfer pricing rules, taxpayers are required to keep tax records that support their tax filing positions: this specifically includes transfer pricing records. The taxpayer can only argue that they have a RAP on a transfer pricing matter if the taxpayer has prepared contemporaneous transfer pricing documentation.

 

Simplified record-keeping

The ATO has provided certain eligibility criteria so that taxpayers can elect to apply simplified transfer pricing documentation rules in Australia. Where taxpayers meet the eligibility criteria and elect to apply the simplified transfer pricing documentation rules, the election will effectively provide a safe harbour from ATO scrutiny.

Taxpayers should confirm whether they qualify for these “safe harbours” before they commit to preparing full documentation reports. However, the safe harbours do have limited application and may not be available to many taxpayers.

Our Observations

It is clear that the compliance obligations on taxpayers have increased significantly under the new rules. Taxpayers need to be aware that transfer pricing analysis and documentation is no longer an optional extra.

The ATO is very clear that, under self-assessment, taxpayers must:

• Exercise prudence in completing their International Dealings Schedule;
• Analyse their transfer pricing position in advance of preparing and filing their return;
• Prepare Australia-specific transfer pricing documentation before filing their return to evidence compliance and obtain penalty protection; and
• Develop internal pricing policies to manage their annual transfer pricing obligations.

In the absence of proactive transfer pricing risk management processes, the ATO will consider the taxpayer to have a greater risk and this is likely to result in considerably more scrutiny of the taxpayer by the ATO.

For assistance with analysing your transfer pricing position and preparing complying documentation, please contact our Director of Taxation Services Paul Glover.