Chapter 1
Introduction and conduct of the inquiry
1.1
The Tax Laws Amendment (Cross-Border Transfer Pricing) Bill (No. 1) was
introduced into the House of Representatives on 24 May 2012.[1]
The bill was passed in the House of Representatives on 19 June 2012 without
amendment. On 19 June 2012, the Senate referred the provisions of the bill to
the committee for inquiry and report by 14 August 2012.[2]
Cross-border transfer pricing
1.2
Treasury outlined that '[t]ransfer pricing refers to the prices charged
when one part of a multinational group buys or sells products or services from
another part of the same group in a different country. The prices charged will
impact their level of profits, and therefore the amount of tax they have to
pay, in the respective countries'.[3]
Transfer pricing rules are intended to require multinational firms to price
intra-group goods and services to properly reflect the economic contribution of
their Australian operations.[4]
1.3
In his second reading speech, the Hon Mr David Bradbury, MP, Assistant
Treasurer and Minister Assisting for Deregulation, outlined that transfer
pricing rules 'are critical to the integrity of the tax system':
This bill will play an important role in ensuring that an
appropriate return, for the contribution of Australian operations to a
multinational group, is taxed in Australia for the benefit of the broader
community.
This is an important issue: in 2009 cross-border trade within
multinational groups was valued at approximately $270 billion, or about 50 per
cent of Australia's total trade flows.[5]
1.4
The Assistant Treasurer outlined that the amendments 'reflect the
bargain we have struck in our treaties' and that they 'are consistent with
internationally accepted transfer pricing rules'. He noted that the measures
are intended to clarify the operation of the current law.[6]
Conduct of the inquiry
1.5
The committee advertised the inquiry on its website and wrote directly
to a range of individuals and organisations inviting written submissions. These
included government departments, industry groups, and academics. The committee
received 23 submissions, which are listed at Appendix 1.
1.6
The committee also held a public hearing in Canberra on 26 July 2012.
The names of the witnesses that appeared are at Appendix 2.
1.7
The committee thanks all who contributed to the inquiry.
1.8
The Organisation for Economic Co-operation and Development (OECD) stated
in its Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations:
The role of multinational enterprises (MNEs) in world trade
has increased dramatically over the last 20 years. This in part reflects the increased
integration of national economies and technological progress, particularly in
the area of communications. The growth of MNEs presents increasingly complex
taxation issues for both tax administrations and the MNEs themselves since
separate country rules for the taxation of MNEs cannot be viewed in isolation
but must be addressed in a broad international context.
These issues arise primarily from the practical difficulty,
for both MNEs and tax administrations, of determining the income and expenses
of a company or a permanent establishment that is part of an MNE group that should
be taken into account within a jurisdiction, particularly where the MNE group’s
operations are highly integrated.
In the case of MNEs, the need to comply with laws and administrative
requirements that may differ from country to country creates additional
problems. The differing requirements may lead to a greater burden on an MNE,
and result in higher costs of compliance, than for a similar enterprise
operating solely within a single tax jurisdiction.
In the case of tax administrations, specific problems arise
at both policy and practical levels. At the policy level, countries need to
reconcile their legitimate right to tax the profits of a taxpayer based upon
income and expenses that can reasonably be considered to arise within their
territory with the need to avoid the taxation of the same item of income by
more than one tax jurisdiction. Such double or multiple taxation can create an impediment
to cross-border transactions in goods and services and the movement of capital.
At a practical level, a country’s determination of such income and expense
allocation may be impeded by difficulties in obtaining pertinent data located
outside its own jurisdiction.[7]
1.9
The Tax Justice Network Australia (TJN-Aus) provided an overview of
global mispricing activities and trends with an emphasis on the impact of
mispricing on developing countries:
Anti-corruption non-government organisation, Global Financial
Integrity, estimated collectively developing countries lost US$418 billion from
transfer mispricing in 2009, much of this money laundered through secrecy
jurisdictions. Africa lost US$25 billion in transfer mispricing, while the
Philippines lost US$8.1 billion, Cambodia US$721 million and Indonesia US$8.5
billion. Globally overseas aid in 2009 was only US$120 billion...
Christian Aid commissioned calculations also found that
Australia lost 1.1 billion euros in tax revenue through transfer mispricing
to the EU in the period 2005–2007 and US$1.5 billion in tax revenue through
transfer mispricing to the US in the same period....
The TJN-Aus is concerned by allegations of well known
multinational companies being engaged in tax dodging, suggesting that it cannot
be taken for granted that all companies will seek to comply with the spirit of
the tax laws in the countries they operate in.[8]
International developments and the
arm's length principle
1.10
In 1995 the OECD published the OECD Transfer Pricing Guidelines for
Multinational Enterprises and Tax Administrations (the OECD guidelines);
these were updated in 2010. The guidelines have been largely followed in
domestic transfer pricing regulations in OECD Member countries. The guidelines
provide an overview of the 'arm's length principle' which is used to establish
a transfer price that is based on a price that two unrelated/independent
parties would agree to for a particular transaction in similar circumstances.
There are five different transfer pricing methods used to calculate an arm's length price which are divided into two categories:[9]
Traditional transaction methods
- comparative uncontrolled price method;
-
resale price method; and
-
cost plus method.
Transactional profit methods
- transactional net margin method; and
- transactional profit split method.[10]
1.11
The majority of discussion on methodology within this report relates to
the comparative uncontrolled price method and the transactional net margin
method. Figure 1.1 provides a simplified comparison of arm's length methodologies.
1.12
The Australian Taxation Office (ATO) guide, International Transfer
Pricing: Applying the arm’s length principle describes the arm’s length
principle as follows:
The arm’s length principle uses the behaviour of independent
parties as a guide or benchmark to determine how income and expenses are
allocated in international dealings between related parties. It involves
comparing what a business has done and what a truly independent party would
have done in the same or similar circumstances.[11]
1.13
The secretariat to the UN Tax Subcommittee on Practical Transfer Pricing
Issues outlined the rationale for the arm's length principle:
...because the market governs most of the transactions in an
economy it is appropriate to treat intra‐entity
or intra‐group transactions
as equivalent to those between independent entities. Under the arm's length principle,
the allocation of expenses and profits with respect to intra‐group transactions is tested
and adjusted, if the transfer prices are found to deviate from comparable arm’s
length transactions. The arm's length principle is argued to be acceptable to
everyone concerned as it uses the marketplace as the norm...
Overall, the underlying idea behind the arm’s length
principle is the attempt to place transactions, both uncontrolled and
controlled, on equal terms in terms of tax advantages (or disadvantages) that
they create. It has been widely accepted and has found its way into most transfer
pricing legislation across the world.[12]
Figure 1.1: Comparability issues in methodology selection
Source: Australian Taxation Office, 'International transfer pricing:
applying the arm's length principle', April 2005, p. 7.
Australian transfer pricing rules
1.14
The Explanatory Memorandum (EM) outlined that under Australia's current
regulatory framework, the arm's length principle is established in Division 13
of Part III of the Income Tax Assessment Act 1936 which provides
transfer pricing rules to both:
- capture fiscal evasion, including inappropriate profit shifting
to overseas jurisdictions with lower tax regimes; and
- relieve double taxation.[13]
1.15
Australian tax treaties also contain articles pertaining to transfer
pricing rules: the associated enterprise article (usually article 9) and the
business profits article (usually article 7).[14]
The treaties are incorporated into domestic law as part of the International
Tax Agreement Act 1953 and are generally based on the OECD Model Tax
Convention on Income and on Capital which also incorporates the arm's
length principle.
1.16
The EM placed a strong emphasis on the Commissioner of Taxation's
position that 'Division 13 and/or Australia's tax treaty provisions could be
used in making transfer pricing adjustments'.
1.17
It argued that income tax law has made specific provision for transfer
pricing amendments based on treaty rules since 1982. The EM outlined that under
the current regulatory framework it has been understood that 'a treaty power to
make a transfer pricing adjustment could apply if inconsistent with Division 13'
of the Income Tax Assessment Act 1936:
The Parliament not only assumed that the treaty transfer
pricing rules could be applied to increase a taxpayer’s liability, but intended
this outcome be both facilitated and clarified through further amendments to
the income tax laws (notably through the enactment of section 170 and former section
226 of the ITAA 1936).
The plain words of subsections 170(9B), 170(9C) and 170(14) of
the ITAA 1936, introduced in 1982 (with Division 13), assume the treaty
transfer pricing rules provide a power to amend assessments.[15]
Recent court proceedings
1.18
In June 2011, a matter relating to transfer pricing was brought before
the Federal Court. Federal Commissioner of Taxation v SNF (Australia) Pty
Ltd (SNF case) concerned the transfer pricing provisions in Division 13 and
their application to SNF (Australia) Pty Ltd's (SNF) purchase of chemical
products from overseas companies, all of whom were owned by the same parent
company as SNF. The proceedings challenged the interpretation and application
of transfer pricing adjustments.[16]
1.19
Between 1998 and 2004, SNF sold polyacrylamide products, used in the
cleansing of water, to Australian businesses. It purchased these chemicals from
a number of overseas companies owned by the same parent company as SNF. During
this period, SNF incurred trading losses, which it said were the result of
significant Australian competition, poor management and poor employee sales
performance.
1.20
The Commissioner of Taxation (Commissioner) disagreed with these
reasons, attributing the losses wholly to SNF paying its suppliers more than
arm’s length consideration. Accordingly, the Commissioner issued transfer
pricing adjustments under Division 13 of the ITAA to account for these
allegedly inflated prices and to increase SNF’s taxable income for financial
years ending on 30 June 1998 to 2000 and 2002 to 2004.
1.21
SNF appealed the Commissioner's decision to the Federal Court, where it
successfully argued that the transactions with its related companies were at
arm's length and its losses were due to other factors. SNF argued that whether
or not a transaction was at arm's length should be assessed by reference to the
prices paid for the same or comparable products by third parties, referred to
as comparable uncontrolled prices. The Federal Court found at first instance
that the prices paid by SNF to its related company suppliers were less than the
prices paid by third parties for the same or similar products. Accordingly, the
Federal Court ruled that the Commissioner should not have adjusted SNF’s
taxable income. The Commissioner appealed to the Full Court of the Federal
Court (Full Court).
Full Court’s Decision
1.22
The Commissioner argued before the Full Court that the third party
transactions upon which SNF relied were not sufficiently comparable to the
transactions between SNF and its related company suppliers to show that the
SNF's consideration was at arm's length. Because there were no comparable
transactions, the Commissioner argued, the Court could not use the comparable
uncontrolled prices method to determine whether or not SNF's consideration was
at arm's length and should use an alternative method. The Commissioner argued
that the appropriate method was the transactional net margin method, which
looked at the median operating profit margins of other businesses with similar
functions and risk profiles to determine the operating profit margin SNF should
have made and the prices it should have paid for the products.
1.23
The Full Court rejected this argument. It found that the transactions
upon which SNF relied were sufficiently comparable and that by using the
comparable uncontrolled prices method, SNF had paid less for the chemical
products than had third parties.[17]
1.24
The Commissioner also argued that the transfer pricing provisions in Division 13
of the ITAA should be interpreted consistently with the OECD Transfer Pricing
Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines).
The Commissioner stated that the OECD Guidelines required an inquiry into what
a purchaser in identical circumstances to those of the taxpayer would have
paid, but for its membership of the group.
1.25
The Full Court also rejected this argument. It found that the OECD Guidelines
did not support 'the Commissioner's submission that one was required to examine
only putative purchasers who were in the same circumstances as
the taxpayer'[18].
Further, the Full Court found that the OECD Guidelines were not a legitimate
guide to interpreting either the double taxation treaties underlying
Division 13 of the ITAA or, accordingly, Division 13 itself.[19]
This was because the OECD Guidelines could only be used to assist
interpretation of taxation treaties where they reflect the subsequent agreement
or practice of the relevant State's parties. As there was no evidence of such
agreement or practice, the Commissioner could not rely on the OECD Guidelines
to interpret either the treaties or Division 13.[20]
The Full Court did, however, note that materials relevant to the interpretation
of the double taxation treaties could be used to resolve ambiguities in
Division 13 of the ITAA. This was because the double taxation treaties and
Division 13 should be interpreted consistently.[21]
1.26
The Full Court upheld the trial judge's interpretation of the arm's
length requirement, endorsing the trial judge’s statement that:
The essential task is to determine the arm's length
consideration in respect of the acquisition. One way to do this is to find
truly comparable transactions involving the acquisition of the same or
sufficiently similar products in the same or similar circumstances, where those
transactions are undertaken at arm's length, or if not taken at arm's length,
where suitable adjustment can be made to determine the arm's length
consideration that would have taken place if the acquisition was at arm's
length.[22]
1.27
The EM outlined the Commissioner of Taxation's position in relation to
the recent court proceedings:
The Commissioner of Taxation (the Commissioner) has long held
and publicly expressed a view that the treaty transfer pricing rules, as
enacted, provide an alternate basis to Division 13 [of the Income Tax
Assessment Act 1936] for transfer pricing adjustments...
This case was argued only on the basis of Division 13; the
Court did not have to decide whether the Commissioner could apply the relevant
treaty rules as an alternate basis for transfer pricing adjustments. However,
the decision in SNF highlighted that Division 13 may not adequately reflect the
contributions of the Australian operations to multinational groups, and as such
in some cases treaty transfer pricing rules may produce a more robust outcome.[23]
Consultation on reforms
1.28
On 1 November 2011 the government announced a consultation process on
reforms to transfer pricing rules highlighting that 'recent court decisions
suggest our existing transfer pricing rules may be interpreted in a way that is
out-of-kilter with international norms'.[24]
The Hon Bill Shorten, MP, Minister for Financial Services and Superannuation
stated:
International thinking on transfer pricing has moved on since
the current transfer pricing rules were inserted in the income tax law... Last
year, for example, the OECD substantially updated its Transfer Pricing
Guidelines, which are used by governments and business alike.[25]
1.29
In line with the announcement, Treasury released a consultation paper, Income
tax: cross border profit allocation review of transfer pricing rules. Submissions
to the paper closed on 30 November 2011 and 28 submissions were received.[26]
1.30
An exposure draft and explanatory memorandum for the bill were released
on 16 March 2012. Submissions closed on 13 April 2012 and 22 submissions were
received.[27]
1.31
In addition, three consultation meetings were held on 18 November 2011,
7 February 2012 and 4 April 2012 where tax practitioners, peak body
representatives and industry representatives were invited.[28]
Structure of this report
1.32
Chapter 2 will provide a broad overview of the bill, and subsequent
chapters will discuss certain provisions of the bill in greater detail as they
relate to concerns raised by submitters to this inquiry.
1.33
Chapter 3 will discuss revenue implications in the context of the retrospective
nature of the bill as well as judicial commentary on treaty based transfer
pricing rules.
1.34
Chapter 4 will explore submitters' views on Australian Taxation Office
rulings.
1.35
Chapters 5, 6 and 7 will address the justification of 'Parliament's
intention' on tax treaty powers:
-
Chapter 5 will canvass submitters' views;
- Chapter 6 Treasury's views; and
- Chapter 7 will examine the two opposing views on the 2003
amending Act which the date for retrospectivity is based.
1.36
Chapter 8 will address the impact of the bill on taxpayers, particularly
in relation to the retrospective nature of the bill. It will also explore
arguments that the bill discriminates against tax treaty countries.
1.37
Chapter 9 will discuss submitters' concerns regarding methods of arm's
length assessments for transfer pricing with suggestions that the bill favours
profit based methods at the expense of transaction based pricing methods.
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