The Australian Tax Office (ATO) has issued a taxpayer alert to signal its impending scrutiny and concern in relation to the arrangements where the Australian taxpayer:
- Migrates intangible assets overseas on non-arm’s length terms or in a manner intended to avoid tax in Australia;
- Mischaracterises and under remunerates the Australian activities connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets; and/or
- Has a structure in place with both of the above characteristics.
The ATO is also concerned that parties to these arrangements may fail to comply with the capital gains tax (CGT) and capital allowances provisions, particularly where intangible assets and/or associated rights are migrated to international related parties.
In circumstances where these arrangements lack evidence of commercial rationale and/or substance, the ATO’s concerns will extend to the application of the exceptions in the transfer pricing provisions and an array of anti-avoidance rules.
As with other transfer pricing matters where the ATO recently expressed strong concern, BDO expects the ATO to issue a Practical Compliance Guideline (PCG) that would shed some light on how the ATO expects the arrangements to be priced and the arrangements are likely to be seen as high risk by the tax office.
BDO therefore recommends that the taxpayers who have entered into any arrangements involving intangible assets over the last 3 to 5 years, revisit those arrangements. Any new arrangements involving intangible assets should be structured with the ATO scrutiny in mind.
Specific examples of arrangements identified as high risk and of concern to the ATO within the alert are described below.
- Example Arrangement 1.1 - Bifurcation of IP
An Australian company owns, manages, performs and controls activities and risks associated with the DEMPE of valuable intangible assets. The Australian company provides services to an international related party associated with the DEMPE of new intangible assets that are intrinsically linked to the old intangibles. Over time, the return attributable to the Australian company falls as the returns attributable to the new intangible assets increase.
- Example Arrangement 2.1 - Cost Contribution Arrangement
An Australian company is a party to a cost contribution arrangement (the “CCA”) with a number of international related parties in which the participants will contribute resources and perform activities associated with the DEMPE of intangible assets for mutual benefit. The Australian company’s share of the overall contribution and relative level of substance is materially greater than that of the other CCA participants.
- Example Arrangement 2.2 - Royalty Arrangement
An Australian company pays royalties to a foreign related company for the use of a database and perform research and development activities connected to the database in return for a fee. The Australian company is obliged to disclose valuable information it may discover in the course of performing its activities in the database owned by the foreign related company.
What is the ATO’s concern?
The ATO’s key concern is whether the functions performed, assets used and risks assumed by Australian entities related to the DEMPE of intangible assets are appropriately recognised and remunerated at arm's length. The key risk is that the activities of the Australian entity have been mischaracterised and inadequately remunerated and/ or lacking the commercial rationale and Australian company’s best interests.
The arrangement may be inconsistent with that expected to be agreed between independent parties dealing at arm's length. Moreover, in such circumstances the arrangement may have been entered into for the purpose of obtaining a tax benefit.
What is the ATO doing?
The ATO are currently reviewing these arrangements and engaging with taxpayers who have entered into, or are considering entering into, these arrangements and inviting the taxpayers to engage with them directly.
Taxpayers and advisers who enter into intangible arrangements will be subject to increased scrutiny and penalties may apply to participants in and promoters of described arrangements.
It is also highly likely that the ATO is drafting the practical compliance guidelines, to encourage the taxpayers to ‘swim between the flags’.
How can BDO assist?
Our experts have in-depth experience in dealing with intangibles and can provide input on whether this Taxpayer Alert is relevant to your circumstances and, if so, what next steps you should consider. We are experienced in supporting our clients through similar reviews and can provide you with a clear road map to be ‘ATO ready’ as well as guide you through an ATO review.
Please contact a member of BDO’s Transfer Pricing team if you require assistance.