Governments and Tax Authorities all around the world are calling for and applying greater scrutiny on multinationals. The Australian Taxation Office win against Chevron Australia on the pricing of cross-border intragroup funding in 2017, is the most significant transfer pricing decision in Australian history. It will further encourage the pursuit of other multinational organisations which fund their operations in Australia with significant levels of related party debt.
Zara Ritchie, BDO Global Leader Transfer Pricing and Natalya Marenina, Principal, Transfer Pricing, BDO Sydney, take a look at the most significant Australian cross-border tax developments of 2017 and consider what 2018 is likely to bring. Article published by MNE Tax.
Significant global entities
The term ‘significant global entities,’ or SGEs, became well known in 2017 to a much wider audience than international tax and transfer pricing professionals.
SGEs are companies which are part of a group with global accounting consolidated revenue in excess of AUD 1 billion (≈ USD 786.5 million), even if Australian operations are insignificant.
The host of measures directed at SGEs in Australia is unparalleled and often misunderstood by the global head office due to the unilateral nature of some of the measures.
Australian local file
While the implementation of country-by-country (CBC) reporting has been gradual worldwide, Australia has been an early adopter and the Australian landscape is characterised by divergence from the OECD Action 13 local file design and the magnitude of penalties for non-compliance with lodgement requirements.
In Australia, SGEs are required to lodge with the ATO three compliance documents: the CbC report, master file, and the ‘ATO design’ Australian focal file. The ATO design Australian local file, a document unique to Australia, continues to cause significant confusion among MNEs, mainly due to the fact that it shares its name with the local file under the OECD’s Action 13 framework but the two documents have little in common.
The ATO design Australian local file is primarily a quantitative information disclosure form which needs to be prepared only for Australian taxpayers and thus adds to the compliance burden for MNEs with operations in Australia.
The first wave of lodgements for the year ended 31 December 2016 were originally due by 31 December 2017; however, the ATO granted an automatic extension to 15 February 2018. The ATO places the responsibility for lodgement of the documents on a local taxpayer, with some (limited) concessions depending on overseas obligations.
The substantial penalties up to AUD 525,000 (≈ USD 413,000) per tax document in extreme cases was legislated to encourage compliance by SGEs, not only in relation to CbC reporting requirements, but also in relation to all other tax documents.
Further, the administrative penalties as a percentage of a shortfall of tax in the case of a transfer pricing adjustment also doubled for SGEs in 2017, leading to a potential situation where the penalty can exceed the tax shortfall.
The ATO clearly signaled to MNEs that it is ready to use its new penalty powers. As such, it is crucial for SGEs to be aware that failure to lodge tax documents on time, especially if there is a history of late lodgments, can lead to very significant penalties.
Lodgment of this suite of documents will arm the ATO with substantially more insight and information about global and local operations and ensure more targeted risk and audit activity. This activity is likely to increase by mid-2018, following the first automatic exchange of CbC reports.
Financial statement disclosure
In keeping with the desire for increased transparency, the Australian government introduced a new requirement for SGEs to prepare and lodge what it refers to as ‘general purpose financial statements’ for tax years commencing from 1 July 2016.
These detailed financial statements will need to be lodged together with a company’s income tax return and penalties will apply for late lodgment, in line with penalties for other tax documents noted above.
Once lodged, the financial statements will become publicly available, thus, ensuring increased transparency and disclosures about commercial and financial activities of SGEs. Some concessions apply for the first year, however in future years, groups will need to consider how this increased level of disclosure (unique to Australia) should be managed.
Diverted profits tax
For tax years starting 1 July 2017, a new unilateral diverted profits tax, with a special penal tax rate of 40%, will apply to certain transactions made by SGEs, on a ‘pay now argue later’ basis.
The diverted profits tax is designed to apply to transactions that are deemed to lack sufficient economic substance and, in the ATO’s view, divert local Australian profits to low tax jurisdictions (i.e., where the effective corporate tax rate is below 24%).
The ATO issued guidance on application of the new tax just days before Christmas 2017. The Draft Law Companion Guideline clarifies various aspects of the new legislation, including the effective tax rate (clarifying that it is not simply a headline tax rate in a certain country) and economic substance (with some clear indicators of cases where it is questionable).
A separate guidance to ATO tax officers covers a complex multi-step process to be followed in issuing a diverted profits tax assessment, reflecting the atypical and serious nature of the process. The ATO also noted that it will issue further guidance which will include examples of what it considers to be particular arrangements and structures with various levels of diverted profits tax risks.
Whilst not all MNEs will be happy with the contents of the guidance, the ATO’s transparent approach to what activities are considered high risk and how the law will be applied is arguably somewhat helpful.
The new tax is expected to apply in only a limited number of cases. However, as it is an anti-avoidance measure, taxpayers will not be able to utilise mutual agreement procedures in established tax treaties.
Consequently, the application of the diverted profits tax is likely to result in double taxation, and, as such, MNEs should assess the likelihood of the tax being triggered in their specific circumstances and respond/modify business operations accordingly where commercially practicable.
Cross-border financing transactions
In April 2017, the Full Federal Court ruled against Chevron Australia in favour of the ATO on appeal, in what arguably has been the biggest transfer pricing court case ever in Australia.
Chevron ultimately settled its position with the ATO and therefore decided not to appeal the case further, making the ATO victory even more definitive.
The ATO, clearly boosted by the win, published its risk assessment framework for cross-border related party financing arrangements, which provides MNEs indications of how the ATO will perceive the risk of their financing dealings.
The risk assessment framework does not replace the application of the Australian transfer pricing legislation and is a separate exercise from transfer pricing compliance.
The framework does not provide a safe harbour, but is an assessment tool which highlights to taxpayers how the ATO is likely to approach the review of their specific arrangement and thus helps MNEs to plan and prepare.
The guidance outlines the assessment framework that will be used by the ATO to risk rate a company’s cross border financing transactions and allows an 18-month period (from December 2017) for MNEs to restructure their arrangements.
It is fair to say that not only does the ATO feel confident following its Chevron win, but it also now has the requisite tools and framework to challenge cross-border financing arrangements. In 2018, all MNEs, including those operating in the small and medium size enterprise (SME) bracket, will feel the heat from the ATO’s activity targeting cross-border financing.
Other ATO risk assessment programs/initiatives
The ATO’s Tax Avoidance Task Force and review programs are not just focussed on SGEs.
A ‘justified trust’ initiative has been under way for some time focussing on the top 100 and top 1,000 taxpayers and joint audits are being conducted with other countries’ tax authorities. The ATO’s Top 1,000 Tax Performance Program is one of a number of programs led by the ATO and involves streamlined assurance reviews of the largest 1,000 MNEs focusing on those with turnover above AUD 250 million (≈ USD 187 million)
While some of these programs don’t focus solely on transfer pricing, the ‘whole of tax’ reviews include transfer pricing aspects and reflect the ATO’s continual focus on MNEs and perceived tax risks.
Way forward for MNEs – what would 2018 bring?
The ATO has clearly indicated its intention in 2018 to target multinationals who they believe may have structured their operations to avoid paying their ‘fair share’ of Australian tax.
MNEs should evaluate how their current and proposed tax and transfer pricing arrangements are affected by a raft of new measures and plan their compliance and mitigation strategies in counterbalance to the ATO and OECD measures outlined above.
It is unlikely 2018 will bring further legislation affecting the transfer pricing affairs of MNEs, but one can expect the ATO to concentrate on risk and compliance activity as well as development of additional risk assessment frameworks.
It is expected that 2018 will be a year of strong ATO activity in Australia, with multiple programs targeted at SGEs, especially following submission of CbC statements by affected MNEs, digital tools to analyse and compare data, and a focus on cross-border financing.
It is also clear that these audit activities will no longer focus on the largest MNEs, as technological advancements affecting case selection and various focus programs will allow the ATO to efficiently target smaller taxpayers.
In retrospect, the multiple compliance measures implemented for the first time in 2017 and volume of legislative changes have been unprecedented and the real effect on MNEs will only be understood in the years to come.
One thing is clear: the ATO significantly lifted the compliance game for MNEs and one can only wonder if (and when) tax authorities across the world will (have to) follow.
BDO Australia’s Transfer Pricing Practice helps groups navigate this fast changing transfer pricing environment. Aided by dedicated transfer pricing practitioners around the BDO network, we provide a range of planning, compliance, audit defence and benchmarking services. We can work with you to develop transfer pricing policies that are defensible, flexible and in line with your overall tax planning strategies.
For further information please see Transfer Pricing.