ATO’s long awaited compliance guidelines in relation to intangible arrangements with international related parties.
On 19 May 2021, the Australian Taxation Office (ATO) released the long awaited draft Practical Compliance Guidance (PCG 2021/D4) for public consultation and comment. The guideline sets out the ATO’s compliance approach to international arrangements connected with the development, enhancement, maintenance, protection, and exploitation (DEMPE) of intangible assets and/or migration of intangibles. This guidance supplements the existing Taxpayer Alerts (TA 2020/1 and TA 2018/2) surrounding arrangements involving intangible mischaracterisation and non-arm's length arrangements and schemes.
The draft PCG is far reaching and sets out the ATO’s compliance approach and risk assessment framework relating to all types of intangible arrangements including migration of intangible assets and DEMPE activities performed both on and offshore. While mainly focussed on transfer pricing concepts, the draft guidance considers other tax risk areas arising from intangible arrangements such as withholding tax, capital gains tax, general anti-avoidance provisions (GAAR) and diverted profits tax.
The draft PCG outlines the ATO’s expectations for taxpayers to maintain a high level of analysis and documentation to support their intangible arrangements, as well as the type of documents the ATO expects to be kept to evidence arm’s length outcomes.
Once finalised, the PCG is intended to have retrospective effect and, for those companies required to lodge a Reportable Tax Position (RTP) schedule, additional reporting obligations will include the need to disclose assessment of each of the risk factors identified by the ATO and how the arrangements compare to the examples contained in Appendix 2.
If finalised in its current form, this PCG will increase the burden for taxpayers in supporting their existing and future intangible arrangements.
In further detail
The PCG is divided into two parts:
- Part one - provides an outline of the ATO’s compliance approach; and
- Part two - provides an outline of the ATO’s risk assessment framework and how the ATO will assess risk, including 12 examples of intangible arrangements and their risk assessment under the new framework (using the ATO’s well known High, Medium and Low risk assessment).
ATO’s compliance approach
The ATO seeks to review intangible arrangements focusing on aspects such as mischaracterisation of DEMPE activities, non-arm’s length outcomes and structures or restructures that avoid or reduce Australian tax obligations. The PCG’s compliance approach aims at consistency with Australian legislation, such as the GAAR, DPT and CGT provisions, as well as the transfer pricing guidelines published by the OECD, in particular, Chapters I, VI and IX.
Consistent with previous PCG’s, the level of engagement from the ATO will be dependent on high-risk factors applicable to the intangible arrangement. Where one or more of the risk factors are determined as high, as per the PCG, the ATO will likely conduct further engagement including review or audit.
As with all transfer pricing arrangements, taxpayers may request access to the ATO’s advance pricing arrangement program (APA Program) to obtain certainty with respect to their intangible arrangements, however, the ATO has indicated that documentation and analysis in accordance with the PCG will be required for access to the program and taxpayers with low risk factors will be more likely accepted.
ATO’s risk assessment framework
The risk assessment framework is divided into two parts:
- Risk factors - setting out features and examples of arrangements used to inform an assessment of risk; and
- Documentation and evidence expectations - outlining the (high) level of evidence the ATO will expect when assessing intangible arrangements against the risk factors.
The risk factors focus on:
- Commercial considerations and decision making
- Understanding the form of the intangibles arrangements
- Identifying and evidencing the intangible assets and connected DEMPE activities
- Analysing the tax and profit outcomes.
These risk factors are classified as high, medium or low risk depending on a qualitative assessment of the level of supporting documentation and evidence. Potentially, lack of sufficient documentation may result in a high risk rating.
Notably, the PCG includes a non- exhaustive list of documents which may be considered as evidence to determine the risk profile of a particular arrangement. Some examples of expected evidence are:
- Transfer pricing documentation, supplementary analysis, valuation reports, etc, including details (digital or physical records) in relation to DEMPE functions, decision making and approval processes, organisational charts and correspondence
- R&D tax incentive claims
- Minutes of board and other meetings as well as correspondences with tax advisers or tax personnel in relation to preparing or revising the minutes
- Guidelines, manuals, policies, procedures, specifications, governance and like documents relevant to the intangibles arrangements
- Legal agreements
- Specific documents and evidence to identify and clarify the intangible assets and DEMPE activities
- Correspondence of persons identified as involved in DEMPE activities
- Documents detailing the assets (e.g. intangible asset registers) and capabilities of relevant entities and employees involved
- Any financial modelling or projections, including models of anticipated tax impacts of options or arrangements prepared by tax personnel or tax advisers.
The list of evidence the ATO has identified may be beyond the level of information readily available by taxpayers and may not be considered commercially realistic.
The draft guidance also includes 12 examples reflecting the ATO’s view of what constitutes high risk, medium risk or low risk depending on the level of documentation or evidence available.
The examples provided cover various intangible arrangements including:
- Centralisation of intangible assets
- Mischaracterisation of intangible assets and DEMPE activities
- Migration offshore of pre-commercialised intangible assets or rights to use intangible assets
- Contract R&D arrangements and cost contribution arrangements.
Date of application
Once finalised, this guidance is proposed to apply to arrangements both before and after its date of issue.
Who does this apply to?
As currently drafted, the guidance does not include materiality limits and, as such, is intended to apply irrespective of the size of the taxpayer or nature of intangible arrangements.
Once finalised, taxpayers preparing the Reportable Tax Position (RTP) schedule would be required to disclose their risk rating under the PCG.
- This guidance is an indication of the ATO’s continued focus on transfer pricing issues relating to intangibles and provides useful examples to taxpayers in relation to the ATO’s concerns. The examples are helpful to understand the ATO’s risk assessment framework, however, do not consider practical challenges such as identification, valuation and pricing of Intangibles. This is a controversial topic and taxpayers are often forced to revert to Mutual Agreement Procedures (MAP) to avoid double taxation.
- There is no materiality threshold for application of this guideline which indicates the ATO’s expectations for all taxpayers regardless of their size or tax impact of the arrangement. Whilst the ATO does recognise the level of documentation will be influenced by the complexity of the taxpayer’s arrangements, it remains to be seen how this plays out in practice.
- The draft PCG creates increased uncertainty and compliance obligations on taxpayers by requiring a subjective analysis of the risk factors. Further, the ATO states that “exhibiting Medium or Low Risk Factors may not exclude your Intangibles Arrangements from further review.”
- The risk assessment focuses heavily on the level of documentation taxpayers may need in relation to intangible arrangements. The expectations of the ATO in this regard have increased beyond the traditional approach to documentation and may be considered extensively onerous.
- It is not yet clear how other tax considerations such as GAAR or DPT are intended to apply, although it is understood these anti-avoidance provisions will be applied only in rare circumstances where there is a clear motive to avoid tax.
- To obtain an APA, taxpayers will need to retain the expected documentation and evidence outlined in the draft PCG, which is considered to be a very high benchmark.
How can BDO help you?
With no materiality threshold, retrospective application and no guidance on how to identify, value and price intangible arrangements, the PCG will create a significantly increased compliance burden and uncertainty for many taxpayers with intangible arrangements.
We encourage you to contact a BDO adviser if you think you may be affected by this guidance or if you are unsure of the risk profile of your arrangements.
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