What are transfer pricing rules and what do they seek to achieve?

Australia is a country with relatively higher rates of income tax. Hence, there is a powerful incentive for international businesses to minimise income here and shift profits to offshore related entities through arrangements/dealings whose terms do not reflect what would normally be expected between non-related party dealings at arm’s length. Transfer pricing rules are designed to counter such arrangements and protect a country’s tax revenues. 

Who do these rules apply to?

If your business is involved in multinational transactions to related entities you will need to make sure you comply with the transfer pricing rules.  There is a significant level of ATO review activity in respect to transfer pricing. 

Azure Group’s international tax team can work with you to ensure your dealings with international related parties are effectively managed and documented, such that you are aware of your obligations and will ready when the Tax Office comes knocking.

History on the reform of the transfer pricing regime

The reform of Australia’s transfer pricing rules was initiated in 2011 following the Commissioner’s loss in the Federal Court to SNF (Australia) Pty Ltd and also in the earlier case Roche Products Pty Limited. The Government was concerned that Australia’s transfer pricing rules were inadequate because the Full Federal Court decision in SNF created a cloud of doubt over the Commissioner’s ability to apply profit based transfer pricing methods, and on whether the OECD Transfer Pricing Guidelines (TPG) were relevant for interpreting Australia’s transfer pricing rules.

The resulting reform came into effect from 1 July 2013 and replaces both Division 13 and the recently enacted Subdivision 815-A. The amendments are intended to modernise the Australian transfer pricing rules and to ensure that application of the arm’s length principle in Australia’s domestic rules are aligned with international transfer pricing standards set out in the OECD Transfer Pricing Guidelines.

Arm’s length principle

The legislation focuses on the conditions that exist between entities and whether these are consistent with the “arm’s length principles”. The arm’s length conditions are to be determined using the most appropriate and reliable method. The method should be selected having regard to comparable data available, and a comparability analysis should be performed. Five comparability factors (based on the OECD comparability factors) must be considered in this analysis.

1. The characteristics of the property or services transferred.
2. The functions performed by the parties (taking into account assets used and risks assumed), in relation to the controlled transaction. An examination thereof is often referred to as a “functional analysis”.
3. The contractual terms of the controlled transaction.
4. The economic circumstances of the parties.
5. The business strategies pursued by the parties in relation to the controlled transaction

An arrangement could be considered to be non-arm’s length if it does not contain a condition that third parties would have included in a comparable arrangement. Similarly, if a related party arrangement contains a condition that third parties would not normally agree to, this may also constitute a non-arm’s length arrangement.

Restructuring of transactions

The reforms require actual transactions to be disregarded in certain circumstances. This provision may apply where the economic substance of a transaction is not consistent with its legal form. Taxpayers are not required to provide evidence of third parties entering into exactly the same type of arrangements, but they must be able to demonstrate that independent parties acting in a commercially rational manner would have dealt with one another in a similar way.

OECD guidance

The OECD Transfer Pricing Guidelines are prescribed as relevant for interpreting new rules, “except where the contrary intention appears”. The new rules also go a step further and incorporates comparability factors. Regulations may be made in the future to prescribe additional documents as relevant interpretative materials.

Thin capitalisation

Specific provisions govern the interaction of the transfer pricing rules and thin capitalisation rules (see our earlier article on Thin Capitalisation here) The intention of these provisions is to preserve the position set out by the Commissioner in Taxation Ruling (TR) 2010/7.

Self assessment

Unlike the old rules, which each required the ATO to make a determination for the rules to operate, the new transfer pricing rules will operate on a self assessment basis. Taxpayers will therefore need to assess their own transfer pricing arrangements to determine whether they comply with the rules. If a taxpayer identifies that it has a non arm’s length arrangement which has created an Australian tax benefit, it should self-assess a transfer pricing adjustment to increase Australian taxable income to reflect an arm’s length outcome. 

If you have a query about your personal situation regarding the transfer pricing reform please do not hesitate to contact us at ourteam@azuregroup.com.au