On 18 December 2017, the Australian Taxation Office (ATO) published the following documents providing guidance on the application of Diverted Profits Tax (DPT):
- Draft Law Companion Guideline (LCG 2017/D7) issued on 18 December 2017 - provides guidance on some of the concepts of the new DPT law
- Law Administration Practice Statement (PSLA 2017/2) issued on 18 December 2017 - provides guidance on the administrative process for making a DPT assessment and the processes that follow such assessment.
As explained in our previous Transfer Pricing Alert from December 2017 DPT applies to significant global entities where the Australian profits are found to be diverted to lower tax jurisdictions for tax years commencing on or after 1 July 2017. When DPT is found to apply, a penalty tax rate of 40% plus interest will be imposed with no access to Australia’s double tax treaties.
LCG 2017/D7: DPT application (issued December 2017)
The draft LCG 2017/D7 provides additional but limited guidance on the principal purpose test, sufficient foreign tax test and sufficient economic substance test. Among others, the main insights are:
- Principal purpose test - The ATO clarifies that not all the eleven matters should be considered in applying the test but only those that are relevant to the case. In addition, the ATO clarifies that quantifiable non-tax financial benefits deriving from the scheme could provide a ‘strong indication’ that the scheme was NOT entered into with the principal purpose to obtain a tax benefit. However, reliance on this ‘strong indication’ is arguably softened in the following paragraph where the ATO points out that this factor must be considered and given appropriate weight alongside other factors
- Sufficient foreign tax test – The ATO provides guidance on the determination of the amount of the foreign tax liability, the situation where a group of foreign entities are involved, the interaction with the Australian thin capitalisation rules, the meaning of foreign income tax and the recognition of losses and foreign credits overseas
- Sufficient economic substance test – The ATO clarifies the concept of economic substance and the requirement to examine all of the relevant facts and circumstances, such as the conduct of the parties, the economic and commercial context of the relevant activities, and the object and the effect of those activities from a practical and business point of view. The ATO also stresses the relevance of the OECD Transfer Pricing Guidelines to assess economic substance and, in particular, the key role of a comprehensive and well thought out functional analysis. Of particular note is the emphasis that the functional analysis must be undertaken in relation to all parties involved (i.e., the Australian taxpayer as well as the overseas parties). Finally, the ATO clarifies that passive holding of an asset is not expected to indicate lack of economic substance: again, the wider relevant facts and circumstances must be assessed in reaching a conclusion on whether the economic substance is sufficient.
PSLA 2017/2 – DPT assessment (issued December 2017)
The PSLA 2017/2 provides guidance to ATO staff on the administrative process when making a DPT assessment. This multi-step process has been summarised by the ATO in a flow chart attached in the Appendix at the end of this Transfer Pricing Alert.
In their guidance, the ATO proposes that DPT analysis made by ATO officers should be presented and approved by a DPT specialist team. It also recommends that the Tax Counsel Network (TCN) be engaged in the process by the ATO officers. The involvement of these specialist teams is a strong indication regarding the sensitivity and complexity of the DPT assessment and hopefully, the expectation that applying the DPT law won’t be the norm, but rather the exception.
Where the ATO officers, DPT specialist team and TCN conclude that the DPT is applicable in the case under review, the following three steps must be taken before making the DPT assessment:
- Obtain endorsement from the DPT Review Committee
- Seek advice from the GAAR Panel at an initial hearing
- Obtain Deputy Commissioner endorsement on the decision to issue a DPT assessment.
Once the DPT assessment is issued, tax is due and payable within 21 days from the assessment notice given to the taxpayer. The period of review is 12 months from the DPT assessment notice, unless shortened or extended. During this period, further hearings by the GAAR Panel may be required where the taxpayer will have the opportunity to present its case. A taxpayer cannot object to the DPT assessment. However, an appeal can be lodged to the Federal Court within 60 days after the end of the period of review. The DPT assessment and period of review is a long and cumbersome process where tax is paid up front and a taxpayer presents its case to reverse the position over the ensuing months.
The main findings are as follows:
ATO compliance approach – The ATO will identify DPT risk in the normal course of their compliance activity, however they will prioritise and dedicate resources to arrangements they consider to be of high risk. If a DPT risk is identified the ATO’s may either pursue continued monitoring of the DPT risk or conduct a review. The ATO will communicate the actions they will take based on the findings at the end of the review, either pursuing no further actions, an audit or suggestions to request an Advanced Pricing Arrangement (APA) or private ruling.
DPT Client engagement framework – The ATO expects engagement from taxpayers who have considered potential DPT risk in their arrangements. To help taxpayers identify whether not DPT risks exist, the ATO has provided a client engagement framework (Appendix 2). If engagement is required, the avenues include either contacting the DPT specialist team, seeking entry to the APA program or applying for a private ruling
APA arrangement – Once an APA applies, the covered transactions will be considered by the ATO to be low risk provided that the critical assumptions of the APA are not breached. This means that the ATO will not dedicate resources to review the potential application of DPT to the APA covered transactions. However this assurance only applies to APA that come in to effect after 4 April 2017.
Private rulings – Can be obtained if greater certainty is required on the application of the DPT to a particular arrangement. Only applies if the arrangement being ruled upon is the actual arrangement being carried out.
Framing question for risk assessment – The framing questions aid in a taxpayer’s own initial risk assessment based on the following categories: preliminary, transaction specific, SES test and principal purpose test.
– The DPT law does not have specific record keeping requirements, however, ATO requires documentation that appropriate records of arrangements and transactions in the normal way. The types of documentation that the ATO will consider are given in paragraph 55 – 65 of the draft PCG2018/D2, however, these are not an exhaustive list and should only be taken as a guide.