3.1
As detailed in chapter one, the amendments in schedule 2 are intended to
modernise Australia's domestic transfer pricing rules so that they are better
aligned with the international best practice standard, as set out by the OECD.
3.2
Despite the apparent intent of the amendments, the committee heard from
a number of witnesses that the bill was inconsistent with the OECD Guidelines,
and in fact bestowed upon the Commissioner broader powers than is contemplated
in the OECD Guidelines.
3.3
A number of organisations also argued that the amendments would
introduce new uncertainty into the tax law, and impose a substantial compliance
burden on taxpayers with related party dealings.
3.4
As noted in chapter one, section 815-130 of the bill provides for 'exceptions'
to when the identification of arm's length conditions must be based on the form
and substance of the commercial relations in connection with which the actual
conditions operate (that is, it provides for 'exceptions' to the 'basic rule').
3.5
These exceptions provide an ability to 'reconstruct' dealings or
arrangements (including substitution of actual arrangements with no
arrangements where independent entities in comparable circumstances would not
have entered into any commercial or financial arrangements) in certain
instances, such as when:
- the economic substance of the arrangements does not match the
legal form; and
- the arrangements, viewed in their totality, differ from those
which would have been entered into by independent enterprises acting in a
commercially rational manner.
3.6
The non-recognition and substitution (commonly known as 'reconstruction')
of actual dealings or arrangements is one key way of achieving an arm's length
outcome consistent with the arm's length principle (as described in chapter
one).
3.7
Some submissions and witnesses argued that schedule 2 is inconsistent
with the OECD Guidelines, as it allows transactions to be disregarded and/or
substituted in a broad range of circumstances.
3.8
The Federal Chamber of Automotive Industries (FCAI), the Tax Institute, ICAA,
the Law Council of Australia, Chevron, Ernst & Young, CTA, the Minerals
Council of Australia (MCA), KPMG and RSM Bird Cameron all expressed concern
that the legislation does not explicitly include the limit in the OECD
Guidelines that a 'reconstruction' approach should only be used in 'exceptional
cases' (as indicated at paragraphs 1.64 and 1.65 of the OECD Guidelines). These
organisations argued that, in this respect, the bill in fact goes beyond the
OECD Guidelines in the breadth of its application of the reconstruction
approach. In doing so, it is argued, the bill bestows upon the Commissioner
unnecessarily wide powers to disregard the actual conditions connected with the
commercial or financial relations between parties, a power that has no parallel
in the OECD Guidelines.[1]
3.9
As the ICAA put it to the committee:
The OECD looks at reconstruction only in exceptional
circumstances. Through the machinery that has been introduced in the
legislation, in effect actual conditions are replaced by arms-length conditions
whenever there is any transfer pricing benefit. That, we believe, is at odds [with
the OECD Guidelines] in terms of how the mechanism actually works.[2]
3.10
The Tax Institute further added that while the OECD Guidelines provided
for a reconstruction approach in exceptional circumstances, there is no
parallel in the OECD Guidelines to subsection 815-130(4), which provides for
the non-recognition of arrangements (that is, the 'annihilation' of
arrangements, or, as Treasury puts it, the substitution of arrangements with no
arrangements) in circumstances where independent entities simply would not have
entered into any commercial or financial relations at all:
With respect to the annihilation provision, the OECD
guidelines in a number of places—and our submission includes the specific
paragraph references—acknowledge that multinational enterprises in their
related party dealings can enter into transactions which independent parties do
not. They acknowledge the difficulty in that situation in applying the
arms-length principle where you may not have independent party transactions to
use as your reference point. In that context, the annihilation provision as
proposed will simply annihilate any related party dealing where the Commissioner
is able to put forward the proposition that independent parties would have not
entered into that transaction at all.[3]
3.11
In its submission, GE made a similar point regarding section 815-130(4),
suggesting that it:
...does not seem appropriate to extend the meaning of the
OECD guidelines by including additional exceptional circumstances which are not
specified in the OECD guidelines unless there is clear policy intent to do so.[4]
3.12
Both the Tax Institute and ICAA told the committee that the annihilation
provision (that is, 815-130(4)) provided the Commissioner with powers that were
too broad.[5]
3.13
In a similar vein, KPMG wrote in its submission that the annihilation
provision:
...is likely to result in harsh and potentially inappropriate
outcomes in cases where real activities are being undertaken by the Australian
taxpayer.[6]
3.14
The Law Council of Australia also suggested that in instances where the
Commissioner asserts that independent parties dealing independently with one
another may not have entered into particular arrangements (that is, where the
reconstruction provision is applied) the burden of proof should be on the Commissioner
to show that the parties, if dealing independently of another, would have
entered into a different arrangement. This would protect taxpayers from the 'very
onerous burden' of having to prove that 'they have acted as independent parties
would have in terms of the form of a transaction.'[7]
3.15
To the extent these witnesses and submissions noted that the Explanatory
Memorandum detailed (and thereby placed constraints on) the circumstances in
which a reconstruction approach might be taken, they did not regard this as an
adequate substitute to inclusion of these constraints within the bill itself.
As Ernst & Young noted in its submission:
The omission of the OECD requirements around reconstruction
from the face of the legislation is likely to be interpreted by the courts as a
deliberate departure from the words of the OECD Guidelines notwithstanding any
comments in the Explanatory Memorandum, and therefore make the reconstruction
rules easier to apply than is intended by the OECD Guidelines.[8]
3.16
Meanwhile, in its submission Chevron pointed to the practical
difficulties of the bill's self-assessment aspect, given the broad
reconstruction provisions contained therein:
Specifically, in a self-assessment environment, the
reconstruction provisions require taxpayers to: first, hypothesise, for a given
arrangement, what conditions are purportedly not arm's length; second, then
hypothesise the possible ways in which some hypothetical taxpayer might
alternatively have structured that arrangement but for the hypothetical non-arm's
length conditions; and finally, hypothesise which of the possible ways would
align with the Commissioner's view as to what was most commercially appropriate
in order to avoid future disputes.[9]
3.17
Treasury explained to the committee how it had linked the proposed rules
relating to reconstruction in the bill directly to the OECD Guidelines,
including through the use of the heading 'Exceptions' in section 815-130. It
further noted that the operation of these rules, as well as their relationship
to the OECD Guidelines, is described in detail at paragraphs 3.92 to 3.106 of
the Explanatory Memorandum. The bill, Treasury told the committee, includes:
...an express provision that links the schedule back to the
guidelines. The exposure draft provisions of this section contained additional
detail and we had a consistent response from the business and practitioner
community that that risked moving away from the OECD material by trying to
unpack them in too much detail. So the decision following consultation was to
increase the amount of language in that provision that was common to the
guidelines. You would have heard throughout evidence today that there was an emphasis
on exceptional circumstances. We clearly made that the heading in the
reconstruction provision and we then set out the two exceptional criteria under
which reconstruction could apply. And in the [Explanatory Memorandum] we really
moved away from a new interpretation of the rule and cross-referenced specific
aspects of the OECD guidelines to ensure that the risks around a different
interpretation were minimised.[10]
3.18
Treasury also addressed criticisms around what some organisations had
termed the 'annihilation provisions' in the bill – that is, the non-recognition
of actual arrangements and substitution with no arrangements. Treasury
emphasised that while it believed this approach was entirely consistent with
the OECD Guidelines, it could only be applied where no alternative set of
arrangements or dealings could be postulated:
Basically, on the two criteria set out in the guidelines for
when reconstruction can apply—when the substance of the arrangements differ
from the legal form of the arrangements and also where the arrangements viewed
in their totality differ from those that would have been entered into by
independent parties acting in a commercially rational manner—our view is that,
when you look at the guidelines, when you look at that second criterion in
particular about what independent parties would have done, they clearly could
have done two things. They could have put in place an arrangement that differed
from that which occurred between the related parties or they could have done
nothing. So we have simply stepped out those two possibilities, but I would add
that that second possibility, that nothing would have occurred, is a very high
test indeed in that it is not sufficient that there be alternatives of another
course of action or nothing; there has to be no alternative situation that
could have occurred before you can move to the situation that you replace what
happened with nothing.[11]
3.19
The committee is comfortable that the reconstruction provisions in the
bill are consistent with the OECD Guidelines, in that the proposed rules
relating to reconstruction draw directly on the language used in the OECD
Guidelines and are clearly included in section 815-130 as 'exceptions' (under
that heading) to the 'basic rule'. The committee further notes that the
operation of these rules, as well as their relationship with the OECD
Guidelines, is detailed in paragraphs 3.92 to 3.106 of the Explanatory
Memorandum.
3.20
The committee is further satisfied that the non-recognition of
arrangements in certain limited circumstances is consistent with the OECD
Guidelines. In this respect, the committee also notes that a very high
threshold has been set on when this rule can be applied – namely, when no other
set of arrangements or dealings can be postulated.
3.21
Given the above, the committee does not believe that the bill introduces
a broad reconstruction power, but rather that it sets out reconstruction rules
in a manner that is consistent with the international best practice standard
set by the OECD.
3.22
Under current subdivision 815-A, a transfer pricing adjustment is made
at the level of taxable income/tax loss. A specific rule then requires that the
Commissioner make a secondary determination in respect of the component amounts
(that is, items of assessable income, deductions, capital gains or capital
losses) unless it is not practicable to do so.
3.23
In contrast, subdivision 815-B does not contain the additional rule
because, according to the Explanatory Memorandum, it is not required:
A rule of this kind is not necessary because under
Subdivision 815-B an entity is required to work out its taxable income,
loss of a particular sort, tax offsets or withholding tax payable on the basis
that independent conditions operated. This process is different from simply
making an overall adjustment to these amounts (as was permitted under
Subdivision 815-A) and by definition allows and requires the
identification and valuing of items that are relevant in determining the
aggregated amounts.
As such, even if a profit based method is used in applying Subdivision 815-B, taxpayers
(and the Commissioner in the case of an amended assessment) must attribute the
arm's length conditions to the value of individual components that form part of
the tax equation. The determination of an entity's tax position must therefore include
all questions (for example the identification of specific amounts of income and
expenditure) that would ordinarily be considered in calculating any elements of
the entity's tax position.[12]
3.24
FCAI argued that this information in the Explanatory Memorandum should
be included in the legislation itself. FCAI argued that without an additional
rule in the legislation requiring the Commissioner to identify component
amounts when making transfer pricing adjustments, the amendments would allow
the Commissioner to increase the overall 'taxable income' of a taxpayer without
being required to have regard to the prices of specific underlying transactions.
Because Customs Valuation rules are levied on a transaction-by-transaction
basis, it would potentially be difficult for FCAI members to obtain customs
duty refunds in instances where the Commissioner makes a 'transfer pricing
adjustment' based on an adjustment to 'taxable income.' As the FCAI explained
to the committee:
...when a transaction is considered under the customs
legislation, it is based on the price paid or payable for the goods—so it is based
on the fact of a transaction. That, therefore, is the price that we actually
pay for the goods, and the duty is assessed on that price. What may happen with
this bill, in our understanding, is that subsequent to that transaction, at
some later stage, the Commissioner may come in and say, 'We do not accept that
that price was really the reflective price,' and they will then adjust the
price downwards, which means that we have paid duty at a higher rate than we
should have. But, because that adjustment is not underpinned by a transactional
reference, we have nothing to go back to Customs with and say, 'Here, Customs;
this is why the transaction price needs correcting—because the considerations
that the Commissioner may have under this legislation are much wider.' That is
okay—that is what he might need to do—but the inconsistency causes us some
concern.[13]
3.25
FCAI also argued that the lack of any requirement for a transfer pricing
adjustment to have a 'transactional basis' increased the risk that taxpayers
would be exposed to double taxation. FCAI explained that, from its reading of
the new rules:
... if there is an adjustment made in Australia that is not
transactionally based—it is overall economic considerations based—when we go to
the overseas entity and say, 'We have to pay a different rate of tax; you have
to now go back to your taxation authorities in your country,' the taxation
authorities in that country will go, 'Where is the transactional evidence?'
There is not any.[14]
3.26
FCAI also expressed concern that the issue would not be resolvable
through mutual agreement procedures, as Treasury has previously suggested,
because mutual agreement procedures require agreement as to the facts and
material, and those facts and material would not be available:
The issue we have here is if the Commissioner has this
overriding power to look at taxable income with reference to underlying
transaction and applies an adjustment to taxable income, under mutual agreement
procedures where the two revenue officials meet the first thing the two revenue
officials need to do is agree in respect of the fact pattern and any legal
documents. They go through a range of criteria but they have to agree the facts
and the materials. I cannot see how you are going to agree the facts and the
materials if you have one revenue official with this very broad power to amend
taxable income without reference to an underlying transaction. If you have
mutual agreement procedures, the Australian revenue with officials with the
IRS, the IRS are going to say, 'Okay, you've amended one of the subsidiaries of
one of our multinationals $100 million. How are we going to come to the party
and do the compensating adjustment from our end when we don't really know what
it refers to...'[15]
3.27
Similarly, in its submission Ernst & Young argued that the
provisions in the bill:
...do not require the ATO to identify individual transaction
amounts with a sufficient level of granularity to ensure relief under the
[Mutual Agreement Procedure] articles of Australia's double tax agreements and address
the impact on other areas, such as the ability to claim Customs duty or
withholding tax refunds.[16]
3.28
Returning to the points made in the Explanatory Memorandum, Treasury
told the committee that the confusion on this point appeared to have arisen as
a consequence of the fact that the additional requirement in subdivision 815-A
– that is, the requirement that the Commissioner make a secondary adjustment in
respect of the component amounts – has not been included in subdivision 815-B.
This appeared to have created the false impression that:
...there can be an aggregate-level adjustment without the
requirement to identify the component parts of the income or deductions that
are being adjusted. And that is not actually how these provisions work. They
will require the identification of the individual amounts and income, or the
deductions, that have been adjusted.[17]
3.29
The 'working out' of particular amounts is a long-established and key
feature of the core provisions of ITAA 1997 (as set out in section 4-15), and
by definition requires the identification of component amounts. Treasury
explained to the committee that the requirement that an entity 'work out'
particular amounts ensured that subdivision 815-B could not be applied without:
...drilling down to those component amounts, because in effect
what it does is feed into the primary tax calculation in the core rules of the
income tax act which requires you to sum up the components of assessable income
and allowable deductions and arrive at a taxable income amount.[18]
3.30
Treasury assured the committee that while it was certainly the case that
customs and transfer pricing values were determined according to different
methods, the relevant government agencies were working together to achieve the
most consistent valuation approach for both income tax and customs purposes:
The point has certainly been made very well and consistently
in the consultations we have had with industry that, to the maximum extent that
is possible to achieve a sensible, pragmatic outcome through agencies of the
government working together so that a consistent valuation approach is adopted
for both income tax and customs purposes, that would be desirable and I think
that point has been persuasively put. The ATO and Customs have made a number of
public statements that they already are and that they will continue to
endeavour to work together to achieve the maximum consistency.[19]
3.31
The committee notes that, because an entity determining a transfer
pricing benefit must 'work out' particular amounts (that is, taxable income,
tax loss, capital loss or tax offsets) on the basis that arm's length
conditions had operated, this by definition requires the identification of
component amounts. The committee is therefore satisfied that it is not
necessary to include in the bill an additional rule requiring that the
Commissioner identify component amounts when making a transfer pricing
adjustment.
3.32
The committee also notes that the interaction of customs duty and
transfer pricing law is not a new issue introduced by the bill.[20]
3.33
Nonetheless, the committee believes there may be value in the government
considering further consultation with the automotive industry (and specifically
FCAI) regarding the interaction between the new proposed transfer pricing rules
and Customs Valuation rules. As such, the committee recommends that the
Treasury-Customs-ATO interagency consultation committee which it understands is
working through these issues consult further with FCAI and other interested
industry groups on how the new transfer pricing rules will interact with
Customs Valuation rules.
Recommendation 1
3.34
The committee recommends that the government consider further
consultation with the automotive industry, and specifically the Federal Chamber
of Automotive Industries, regarding the interaction between the new transfer
pricing rules and the Customs Valuation rules.
3.35
A number of organisations, including the Tax Institute, ICAA, Chevron, GE,
PricewaterhouseCoopers, CTA, MCA and KPMG, told the committee that it was
unreasonable to introduce a seven year time limit for the Commissioner to amend
assessments. These organisations argued that there was no reason not to use the
four year limit that applies to other taxpayers under section 170 of the ITAA
1936.[21]
3.36
The Tax Justice Network Australia, however, argued in its submission
that the time limit should in fact be higher, and suggested eight years would
be appropriate in this regard.[22]
3.37
Treasury has informed the committee that under the current transfer
pricing rules, the Commissioner has an unlimited period in which to make a
transfer pricing adjustment. In this sense, introducing a seven year time limit
provides greater certainty for taxpayers.[23]
3.38
Treasury also argued that a four year time limit would not provide the
Commissioner with sufficient time to conduct transfer pricing audits. As such,
the introduction of a seven year time limit strikes an appropriate balance
between maintaining the integrity of the rules and providing taxpayers with
certainty.[24]
3.39
The committee notes that currently there is no time limit on the Commissioner
making a transfer pricing adjustment. The committee is satisfied that the seven
year time limit in the bill strikes a good balance between the need to provide
taxpayers with certainty and the need to provide the Commissioner with adequate
time in which to conduct a transfer pricing audit, which it accepts are
typically highly complex in nature.
3.40
A number of submissions and witnesses, including the FCAI, Ernst &
Young, the Tax Institute, ICAA, Chevron and the Law Council of Australia,
suggested that the record keeping requirements in the bill, as provided in subdivision
284-E of schedule 1 of the TAA 1953, were onerous, lacked clarity or both. In
particular, these organisations raised concerns about how the record keeping
requirements interacted with the penalty regime.
3.41
For instance, FCAI argued that the record keeping requirements were onerous,
and the requirement to prepare transfer pricing documentation before the time
in which an entity lodges its income tax return is unrealistic. FCAI further
suggested that this could potentially lead to delays in the lodgement of annual
tax returns.[25]
3.42
Ernst & Young argued that there is insufficient clarity regarding
the transfer pricing documentation requirements. In particular, it is unclear
what is expected from taxpayers so that they can establish a 'reasonably
arguable position' (RAP) in order to avoid or minimise administrative penalties
for adjustments to taxable income made in connection with a transfer pricing
benefit.[26]
3.43
The Tax Institute expressed concern that the documentation requirements
would be especially onerous for small and medium enterprises, 'particular when
taken in conjunction with the penalty provisions that the bill proposes to
introduce.'[27]
3.44
ICAA made a similar point, and related their concerns in this respect
back to what they viewed as the overly broad powers given to the ATO to reconstruct
dealings in determining a transfer pricing adjustment:
The issue is the degree of documentation. Obviously the
smaller the enterprise the more onerous it is to have very comprehensive
documentation. Some of the concerns that we have with the bill relate to the
fact that it introduces very broad powers that are not clear and probably
require some more specific restrictions to them. An example of that is
replacement of the actual facts of a transaction with the facts that can be
hypothesised by the ATO as to what an independent party would have otherwise
done. So it actually requires taxpayers to start to second-guess what sort of
hypothesis the ATO may come up with. There are very little restrictions as to
how that hypothesising should occur. So it is in that context—the degree and
the complexity of the documentation—that we raise our concern.[28]
3.45
Similarly, Chevron and the MCA both argued the record keeping
requirements would be especially onerous in light of the number of hypothetical
arrangements that a taxpayer would have to account for in documentation given
the breadth of the reconstruction provisions.[29]
3.46
The Law Council told the committee that while tying documentation to
penalties was a good approach, the:
...natural place where it seems to us that should sit is as
to whether reasonable care has been adopted by the taxpayer in their tax
return. We do not believe it is appropriate to make documentation a
precondition to the adoption of a reasonably arguable position. The reason we
say that is that ...there is case law about what [a RAP] is; it is a term of
substance; it probably has nothing to do with whether you document the
transaction in a particular way. We feel that is diluting the real meaning of
that concept and it is out of place.[30]
3.1
In its submission, GE argued that the Explanatory Memorandum had failed
to explain why it was considered necessary to 'introduce stricter requirements
for establishing a RAP for transfer pricing than for other matters.'[31]
3.47
Several organisations, for example PricewaterhouseCoopers and the Law
Council of Australia, argued that while the Commissioner would have discretion
to remit penalties, a taxpayer should not be expected to rely on the
possibility that the Commissioner may exercise a general discretion to remit
penalties.[32]
3.48
The committee also heard concerns from a number of organisations that subdivision
284-E does not provide scope for the Commissioner to remit penalties to a rate
less than 10% of underpaid tax even if a taxpayer has a RAP, and therefore does
not encourage voluntary compliance. In its submission, KPMG contrasts this arrangement
with current ATO administrative arrangements, whereby the ATO will generally
remit penalties to nil where a taxpayer has maintained documentation that the
ATO rates as being medium-to-high quality. In short, this will mean that the
amendments will require taxpayers 'to do more in relation to record keeping but
provide them with a less favourable outcome as a result.'[33]
3.49
The ATO explained to the committee that it provides various forms of
guidance to taxpayers so that they could make an informed judgement about the
level of risk taxpayers are exposed to in terms of related party dealings, and
the level of compliance that they might therefore consider.[34]
3.50
Treasury added that, in relation to the keeping of documentation:
...obviously the more simple arrangements are, the less
onerous the documentation and transfer pricing analysis will need to be to
substantiate arm's length arrangements; and the more complex the arrangements,
the more detailed the analysis may be. One of the features of the interactions
between the penalties and the documentation provisions—again, this came out of
consultation—is that you are only prohibited from establishing a reasonably arguable
position in relation to a matter that has not been sensibly or appropriately
documented in accordance with the provisions. So, to the extent that you have a
large number of very simple transactions that you are very confident are at arm's
length, taxpayers have the ability to risk assess those and focus their efforts
on the more complex transactions that they feel may be more likely to give rise
to a transfer pricing adjustment.[35]
3.51
Treasury also informed the committee that the reporting requirements had
been relaxed somewhat following consultations on the exposure draft:
Under the exposure draft, taxpayers were required to document
'all conditions' that satisfied the cross-border requirement in order to
establish a reasonably arguable position in relation to any transfer pricing
adjustment. As a result of feedback in consultation that this approach was too onerous,
the documentation requirements has been changed so that taxpayers need only
document the application (or non-application) of the rules in respect of a
particular matter in order to establish a reasonably arguable position in
relation to that matter.
This approach provides an incentive for taxpayers to evaluate
their cross-border dealings and prepare documentation in respect of matters
that they consider to be at risk of transfer pricing adjustments. Allowing
taxpayers to determine which matters, if any, should be documented provides
appropriate flexibility for smaller taxpayers and taxpayers with low-risk
dealings to self-assess whether transfer pricing documentation is needed to
support their cross-border dealings.[36]
3.52
The committee notes that the record keeping requirements are not
mandatory, but allow taxpayers to evaluate their cross-border dealings and
prepare documentation in respect to matters that they consider to be at risk of
transfer pricing adjustments. The committee believes that this approach
appropriately balances the risk to revenue of transfer mispricing and the
compliance burden placed on entities engaged in cross-border related party
dealings.
3.53
However, noting some of the concerns raised by several witnesses, and in
particular concerns regarding the impact of the record keeping requirements on
small and medium enterprise, the committee recommends that the government
consider expanding its efforts to provide guidance to taxpayers so that they
can make an informed judgement about the level of risk they are exposed to in terms
of related party dealings.
Recommendation 2
3.54
The committee recommends the government consider expanding its efforts
to provide guidance to taxpayers so that they can make an informed judgement
about the level of risk they are exposed to in terms of related party dealings,
and the level of documentation they therefore need to maintain in relation to
these dealings.
3.55
As Treasury explained to the committee, while there is no de minimis
threshold that exempts an entity from the application of the transfer pricing
rules, there is a de minimis threshold that will apply to the application of
penalties:
[These] transfer-pricing rules will utilise the existing de
minimus thresholds in relation to penalties, which are one per cent of the
shortfall or $10,000 for companies, and two per cent of the shortfall or
$20,000 for trusts and partnerships. The way the rules are constructed is that
they just refer to those provisions as opposed to replicating them. That was a
process that we undertook as a result of recommendations coming out of
consultations, so that, in the event that those thresholds are updated or
increased over time, our rules would naturally feed into those updated
thresholds.[37]
3.56
For its part, the Tax Institute argued that the de minimis threshold was
'far too low.'[38]
3.57
ICAA made the same point, telling the committee that:
The de minimis threshold is very low and does not really
offer any significant practical advantage to small and medium businesses.
Also, the institute would point out that, in some
jurisdictions, small to medium enterprises are actually carved out from all of
the transfer pricing requirements, including documentation. That happens in the
UK. In addition, there are observations in other jurisdictions, such as Canada,
where a small to medium enterprise that makes an effort to comply will also be
given an accommodation in terms of reduced penalties. These are features that
are not currently in the current bill that we believe would be very, very
advantageous and would help small to medium enterprises.[39]
3.58
The ICAA further suggested that a 'carve out' of this sort would have a 'minimal'
impact on revenue. It pointed to the British example, where if there is concern
about 'revenue leakages, there is still an opportunity to bring that taxpayer
into the transfer pricing regime.'[40]
3.59
The MCA pointed to what it regarded as a lack of practicality in the de
minimis threshold, particularly given the cyclical nature of the mining
industry, where companies sometimes go into a low profit position or even a
loss position for extended periods:
Under the proposed legislation a threshold of only $10,000 of
income tax payable creates a potential obligation to prepare full documentation
for a related part cross border transaction just over $33,000 in order to
obtain a RAP. This threshold is far too low for all entities including small to
medium organisations and there is no rationale provided for this apparently
arbitrary threshold. The compliance costs associated with record keeping are
likely to be significant and would constitute an unreasonable administrative
burden on our member companies – and indeed on the ATO – for the limited
revenue return on dealings below this threshold.[41]
3.60
The MCA suggests that, if the link between the documentation requirement
and the establishment of a RAP is maintained (which it argues against), then 'in
the interests of maintaining a reasonable balance between compliance costs and
revenue gained, the de minimis threshold should be the greater of $10 million
or 1% of income tax payable.'[42]
3.61
In its submission, Pitcher Partners argued for a 'meaningful de minimis
threshold below which the transfer pricing rules do not apply,' in order to
protect the 'middle market' from the high compliance costs of the transfer
pricing rules.[43]
3.62
RSM Bird Cameron was also highly critical of the 'lack of an adequate de
minimus threshold' and its apparent impact on SMEs, arguing that the new
rules amount:
...to a significant burden being placed on the SME sector,
particularly given these enterprises do not engage in the supposed profit
shifting of multi-national enterprises which these legislative changes have
been sold on. It is very unfortunate, and indeed concerning, that the smaller
end of town will once again suffer from changes brought on by the actions of
larger enterprises.[44]
3.63
The Tax Justice Network Australia, by contrast, pointed to research
suggesting 'transfer mispricing is a key method of tax avoidance by Australian
companies,' and told the committee that it would 'strongly oppose' any increase
in the de minimis threshold.[45]
3.64
Treasury has informed the committee that the de minimis thresholds
provide protection to smaller taxpayers, and are directly linked to the general
thresholds under the law, ensuring that they will be automatically updated by
any changes to the general thresholds.[46]
3.65
In regard to suggestions from some witnesses that small and medium
business be 'carved out' of the transfer pricing regime, Treasury informed the
committee that during the policy design process it gave careful consideration
to 'safe harbours' for small-to-medium enterprises (which would effectively 'carve
out' those enterprises from the transfer pricing rules) but had concluded that
the nature of transfer pricing means that any test which relies on a threshold
amount could easily be circumvented. Treasury further noted that although 'some
transfer pricing rules of other jurisdictions may contain safe harbours, many
jurisdictions are currently grappling with emerging transfer pricing risks.'[47]
3.66
The committee notes concerns about the adequacy of the de minimis
threshold that will apply to the application of penalties. It recommends that
the government continue to consult with businesses, and in particular small and
medium enterprise, regarding the compliance impact of the transfer pricing
amendments.
Recommendation 3
3.67
The committee recommends that the government continue to consult with
businesses, and in particular small and medium enterprise, regarding the
compliance impact of the transfer pricing amendments.
3.68
In its submission to this inquiry, and in its appearance before this
committee, the Australian Bankers' Association (ABA) told the committee that
the requirement in subdivision 815-C for banks to indentify actual third party
income and expenses is not achievable for many financial transactions. The ABA
noted that this point:
...has been acknowledged and accepted by the Australian
Taxation Office in Taxation Ruling TR 2005/11 and by the OECD in formulating
their approach for profit attribution.[48]
3.69
Asked to clarify why banks could not undertake a simple aggregation of
transactions to get a single net aggregated transaction, the ABA outlined the
difficulties involved with regard to transactions in derivatives:
We can take 10,000 transactions, which we do across the
world—say, foreign exchange. That would be done across all of our branches
around the world. We will consolidate it and do one transaction to hedge that
risk with another counter-party—another bank or another type of institution. With
the current law as it stands you have got to look at a one for one. So actual
revenue and actual costs. You cannot allocate one transaction that covers
10,000 transactions—that you can do in a month, in a day—across the globe. It
is just a little bit too hard to say, 'This cost goes to that branch.'[49]
3.70
ABA suggests in its written submission that subdivision 815-C only
operates in one direction – to increase taxable income – and thus fails to
provide a single, clear set of rules to apply to the allocation of profits to
permanent establishments for all purposes of Australian tax laws:
Our members consider that it is not appropriate to introduce
comprehensive rules for the allocation of profits to permanent establishments
that operate in one direction only, against the taxpayer, instead of operating
as a single, comprehensive set of rules for the allocation of profits to
permanent establishments for all relevant purposes of the Australian income tax
law.[50]
3.71
ABA suggests that subdivision 815-C should contain a clear rule that
positive amounts taken into account in determining the arm's length profits of
a permanent establishment outside Australia, other than amounts that are
capital in nature, should be taken to be foreign source income. It is suggested
that a rule of this kind is needed to ensure that the permanent establishment
rules interact appropriately with section 23AH, which provides an exemption in
respect of 'foreign branch income.'[51]
3.2
The ABA reiterated these points in its appearance before the committee.[52]
3.72
In respect of the issue raised by the ABA in relation to the aggregation
of multiple transactions, Treasury has advised the committee that, provided it
is the most appropriate approach, subdivision 815-C can allocate an entity's
profits to its permanent establishment in an 'aggregated' way.
3.73
Treasury has explained that subdivision 815-C is applied on the
assumption that an entity's permanent establishment was a separate legal entity
that dealt with its head office on an independent basis. In order to work out
how much of the head office's income and expenses are attributable to its
permanent establishment, subdivision 815-B (which deals with arrangements
between entities) and the full suite of OECD methodologies are applied to the
actual entity and assumed entity (being the permanent establishment) by
analogy. Consistent with Australia's current treaty practice, the amount that
can be allocated to the permanent establishment is limited to 'actual' amounts
of income and expenditure, meaning that additional 'notional' amounts cannot be
generated. If the most appropriate method involves allocating the entity's
profits on an 'aggregate' (rather than item by item) basis, subdivision 815-C
will require the entity to attribute profits on that basis.[53]
3.74
Treasury has informed the committee that a source rule for foreign
permanent establishments is not required because subdivision 815-C only allows
for 'upwards' transfer pricing adjustments (that is, adjustments to increase a
taxpayer's Australian tax). A source rule for amounts that are attributable to
a foreign permanent establishment, according to Treasury, is therefore not
required because subdivision 815-C can only apply to reduce such amounts.[54]
3.75
The committee notes Treasury's explanation for why a source rule for
foreign permanent establishments is not required.
3.76
The committee also notes the advice from Treasury that subdivision 815-C
can allocate an entity's profits to its permanent establishment in an 'aggregated'
(rather than item by item) way, provided that is the most appropriate approach.
3.77
Nonetheless, the committee recommends that government re-examine issues raised
by the ABA, in particular the implications of its suggestion that it is simply
not possible to undertake a simple aggregation of transactions, and whether the
bill as currently drafted properly allows for this.
Recommendation 4
3.78
The committee recommends the government give further consideration to
the concerns expressed by the Australian Bankers' Association, and in
particular whether the bill as currently drafted takes account of its concerns
regarding the aggregation of multiple transactions.
Recommendation 5
3.79
The committee recommends that the government give further consideration
to suggestions made by some witnesses that, where it will provide greater
clarity and precision with regard to the intent of amendments in both schedules
as expressed in the Explanatory Memorandum, this intent should be included in
the legislation itself.
Recommendation 6
3.80
The committee recommends that, subject to the other recommendations in
this report, the Senate pass the bill.
Senator Mark
Bishop
Chair
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