Chapter 8

Implications for taxpayers and international trading partners

8.1        Submitters highlighted issues created by the retrospective nature of the bill in relation to taxpayers and international trading partners.

8.2        The Senate Scrutiny of Bills Committee also drew attention to the retrospective provisions of the bill 'as they may be considered to trespass unduly on personal rights and liberties, in breach of principle 1(a)(i) of the Committee's terms of reference'. It did, however, state that:

In the circumstances the Committee leaves the question of whether the proposed approach is appropriate to the consideration of the Senate as a whole.[1]

8.3        This chapter will explore the issues taxpayers may encounter when applying the bill to previous years including:

• difficulties in applying 'multiple transfer pricing rules';
• the burden of proof for assessments; and
• time limits for adjustments.

8.4        The chapter will also address submitters' concerns on the impact of the bill on international trading partners including:

• Australia's trading reputation in the global market;
• discrimination against international trading partners;
• Article 1(2) of the US treaty; and
• double taxation and Mutual Agreement Procedures (MAPs).

8.5        The chapter concludes with submitters' requests for further clarity about how the Commissioner will apply the retrospective elements of the bill.

Implications for taxpayers

8.6        The Tax Institute highlighted that retrospective legislation can be disadvantageous to taxpayers on the following grounds:

• may 'disturb' bargains struck between taxpayers;
• may expose taxpayers to penalties in cases where they have adhered to the law as it was previously written;
• financial accounts may be deemed incorrect and as a result, have adverse implications for investors and capital markets;
• may materially impact on a taxpayer's financial viability for investment decisions; and
• may exacerbate concerns in the international community of the policy risk of investing in Australia.[2]

Multiple transfer pricing rules

8.7        PricewaterhouseCoopers (PwC) asserted that the proposed changes will increase the complexity of doing business in Australia. It suggested that proposed Subdivision 815-A creates 'a patchwork of different transfer pricing rules that could apply to a particular transaction depending upon whether or not a treaty applies, which treaty applies and which period the relevant transaction occurred'.[3] Moore Stephens provided further detail on the application of this 'patchwork' of rules:

If one assumes that the retrospective nature of the law has its desired effect, a critical issue all Treaty based taxpayers with international related party transactions will need to consider is what do they need to do, if anything, to attend to their "potential" taxation obligations of the past? This will involve a review of the pricing of their international related party transactions and profitability and a consideration of two versions of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines), along with other legislated/prescribed material.[4]

8.8        Ernst and Young suggested that the retrospective application could drive taxpayers to take an audit defence strategy to maintain existing positions rather than adjust their approach to transfer pricing to the proposed new rules:

...where a taxpayer makes a change in existing transfer pricing practices as a result of 815-A this change could be seen as an admission by the taxpayer that the prior position was incorrect. We would suggest that taxpayers would then be concerned that such an admission could be used by the ATO to support a position that the prior transfer pricing position should be adjusted. To avoid potentially undermining earlier transfer pricing positions, taxpayers may be motivated to maintain existing positions and to develop audit defence strategies that take into account the new rules. This will only lead to more audits and lower rates of change in taxpayer behaviour.[5]

8.9        Ernst and Young therefore suggested that a transition period for the bill could help mitigate these adverse consequences. It suggested as an example that taxpayers could be given 12 months to align with proposed Subdivision 815-A 'with the assurance that earlier transfer pricing positions would not be adjusted and penalised'.[6]

Burden of proof

8.10      The Law Council of Australia expressed concern that, under the provisions of the bill, taxpayers retain the burden of proof even though the bill increases the Commissioner's powers. It argued that this approach is inconsistent with international practice where the onus is on tax administrators to prove a taxpayer's pricing is not consistent with the arm's length principle (see paragraph 18 of the OECD Guidelines):

The amendment provided for in the Bill gives the Commissioner an independent and additional taxing power and increases the scope for application of profit based analysis using information more readily available to the Commissioner than taxpayers. As already observed, the burden of compliance with the proposed new laws, as well as the existing domestic transfer pricing regime which will continue to apply, will be significant for taxpayers. Accordingly, the Committee considers that the burden of proof in relation to the new measures should properly lie with the Commissioner. In the alternative, either the taxpayer should bear no legal or evidential onus to prove that the assessment is excessive or, upon leading evidence in support of positions taken, it should be expressly incumbent on the Commissioner to demonstrate that the taxpayer's position is manifestly wrong.[7]

Time limits

8.11      A number of submitters expressed concern that no time limit was specified for when adjustments could be made by the Commissioner. Submitters argued that, should the retrospective application pass the Senate, the time limit for amendments should be limited to four years.[8] The Law Council of Australia commented:

The Law Council's submission is that there should be a time limit. It should be the usual time limit of two years or a maximum of four years, but also with the usual provision that applies in other cases that, if the Commissioner of Taxation, while conducting an audit, forms the view that he needs more time in order to determine whether tax is properly payable, the commissioner can approach the court and seek an extension. That seems to us to be a wholly sensible approach.

Taxpayers should be given certainty in relation to previous years income so they can draw a line underneath it. There are also the issues about how long people keep records and keep all the relevant people around. If you go back further and further, it disadvantages taxpayers who have probably had a turnover of personnel and have probably moved their warehouses several times. How long do they need to keep the documentation? These are issues that crop up. It seems to us to be a very sensible reform just to insert a time limit, perhaps on the usual basis.[9]

Relationship with foreign trading partners

8.12      Submitters argued that the bill creates uncertainty for Australia's international trading partners and the retrospective application of the proposed measures 'will be seen as an example of sovereign risk and bad faith by the governments of trading partners and multinationals doing business in Australia'. For example, Moore Stephens stated:

We are exceptionally concerned at the likely adverse impact on the reputational damage to the Australian Taxation Office (ATO) (and Australia, as an investment destination) that can be expected to follow in the event that the legislation is back-dated as planned.[10]

8.13      The Australian Private Equity and Venture Capital Association commented:

...we note that retrospective legislation by its nature undermines business confidence, and as such is bad policy other than in the most exceptional cases. The retrospective nature of the proposed amendments is another example of why international investors now perceive investment in Australia to have greater sovereign risk than previously. Once investors' attitudes in this regard have been formed, it is, in our assessment, difficult to reverse. A stand by the Senate against legislative amendment with retrospective application in this instance will be a strong signal towards rectifying this worrying development.[11]

8.14      RSM Bird Cameron is particularly concerned that the bill will have a negative impact on Australia's reputation in the global market. It argued that the approach proposed by the bill to assess Australia's 'fair share of profits' is unworkable:

We are greatly concerned that the direction the Government is seeking to head with regard to its review of Australia's cross-border taxation policies represents a departure from this internationally accepted model, and an erosion of international consensus. The focus of consultation thus far appears to be on ensuring Australia taxes its "fair share of profits" (as opposed to receiving arm's length consideration). What is Australia's "fair share of profits" (based on relative economic contribution) in any given transaction or circumstance is a highly subjective question and will receive a different answer from every Revenue authority worldwide. As does the reciprocal question of any international authority's "fair share" when asked of the ATO. For this reason, the move in Australia to taxing based on a "fair share of profits based on relative economic contribution" is unworkable. What is proposed appears to be a form of 'free for all'. The impact of this will be, in our view, business uncertainty and concern over the Australian political process. It will result in increased disputes, double taxation and reduced international investment. If Australia wishes to be highly involved in the global economy, it must conform to global interpretations or risk losing investment.[12]

8.15      The American Chamber of Commerce in Australia (AmCham) represents the interests of American companies undertaking business in Australia. It noted that 'the most significant source of foreign investment in Australia is the United States'. AmCham expressed concern that the bill, and in particular the retrospective application of it, creates 'unnecessary uncertainty and business risk, which in turn will negatively affect foreign investment in Australia'.[13]

8.16      The Business and Industry Advisory Committee to the OECD (BIAC) is an independent organisation officially recognised as the representative of the OECD business community. BIAC highlighted that 'the global business community is concerned about recent developments in the tax field in Australia' and raised the retrospective application as one of its key concerns:

We are concerned that retroactivity is not only unwelcome for the future of Australia's investment climate, it will also send a signal to other countries that retroactivity is an acceptable route, including those countries with which Australia trades and in whom Australian business invests . Currently, many countries have rules that forbid such retroactivity or have through other means indicated that retroactivity is not a course that will be used by their legislator. Retroactive rules will serve to cause a downturn in global economic activities.[14]

8.17      Deloitte asserted that retrospectivity 'is not the approach to international tax law expected from a sophisticated trading nation and does considerable damage to Australia's reputation for fair dealing in international trade and taxation'.[15]

Discrimination against tax treaty countries

8.18      A number of submitters have argued that the bill discriminates against countries that hold tax treaties on the basis that they will be required to adhere to obligations in both Division 13 and the relevant tax treaty while non-treaty countries will only be subject to Division 13.[16] Chevron Australia commented:

...we note that the proposed amendments only apply to countries with which Australia has a tax treaty – it does not apply to 'tax havens'. This has the perverse outcome that companies from our treaty countries are unfairly and inappropriately discriminated against compared to companies which operate in tax havens.[17]

8.19      KPMG argued that this 'outcome is counter-intuitive as the impact of the retrospective aspects of the Bill will only affect taxpayers who transact with associated enterprises in tax treaty countries'.[18] AmCham also commented:

The proposed retrospective amendments solely relate to companies owned by residents of countries which have an agreement with Australia for the avoidance of double taxation. Accordingly, the proposed amendments would not affect any investor from a country with which Australia does not have an agreement. This includes tax havens and foreign investors who choose to divert their investment through another jurisdiction. We consider that this element of the legislation is highly discriminatory against investors from countries such as the United States, which remains by far the most significant county of investment in Australia.[19]

8.20      GE suggested that preferential treatment of tax havens is inconsistent with Australia's position of Chair of the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes.[20] At the committee's hearing GE further asserted:

On the matter of applying stricter rules to tax treaty partners, if treaties confer an additional taxing power, this means there would be two ways of making tax adjustments to increase the taxable income of entities conducting business with treaty countries. By contrast, there would only be one more restrictive basis for assessing tax haven entities. If we accept the Treasury position—which we do not—that this is not a change in the law and that treaties have always operated to confer a taxing power, then we are accepting that parliament has for over 30 years sought to apply harsher rules to dealings with treaty countries. We do not accept that this would be parliament's intention. If we do not accept that parliament intended to apply stricter rules to dealings with treaty countries than would apply to tax havens, then we should not pass this bill, as it achieves exactly that.[21]

Non-discrimination article

8.21      Some submitters suggested that the bill could breach the non-discrimination article in some of Australia's tax treaties.[22] Moore Stephens highlighted Article 24 and noted that a non-discrimination article provides, among other things, that:

Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances...are or maybe subjected.[23]

8.22      Treasury have responded to these concerns by outlining that the non-discrimination article would not apply to a transfer pricing adjustment in this context. It explained that, broadly, the article applies where a contracting State subjects resident foreign nationals to a more negative tax treatment than residents who are nationals. Treasury offered the following explanation:

In the case of enterprises, Article 24(5) may apply where a Contracting State subjects a resident enterprise that is owned or controlled by foreign residents to a more onerous tax burden than that imposed upon another resident enterprise owned or controlled by residents. Article 24(5) may also apply where an adjustment is made for both enterprises, but is more onerous for the enterprise that is owned or controlled by foreign residents as a result of its ownership or control status.

A transfer pricing adjustment that is made as a result of a tax treaty applying would not offend a non-discrimination article contained in that treaty. This is because the relevant power upon which such an adjustment would be based would not distinguish enterprises on the basis of nationality, or the residence or nationality of its owners or controllers. That is, the treaty transfer pricing rules apply to enterprises without discrimination as to nationality or ownership.

Moreover, even if such an adjustment did result in differential treatment, the non-discrimination articles contain specific carve-outs in relation to transfer pricing adjustments that would preclude the article from applying. These carve-outs apply to the relevant treaty powers given that they are conferred under the domestic law.[24]

Article 1(2) of the US treaty

8.23      Some submitters expressed concern that the bill could potentially breach Article 1(2) of the Australia-US Convention.[25] For example, GE asserted that under Article 1(2) of the US treaty, the treaty may not increase tax above the liability that would result under the domestic law. Where the domestic law provides a more favourable outcome than the treaty, the taxpayer may apply the provisions of the domestic law. It argued that the bill circumvents the spirit of this agreement.[26]

8.24      Chevron Australia provided an extract of the 2006 US Model Income Tax Convention Technical Explanation on Article 1(2):

Paragraph 2 states the generally accepted relationship both between the Convention and domestic law and between the Convention and other agreements between the Contracting States. That is, no provision in the Convention may restrict any exclusion, exemption, deduction, credit or other benefit accorded by the tax laws of the Contracting States, or by any other agreement between the Contracting States.

... Paragraph 2 also means that the Convention may not increase the tax burden on a resident of a Contracting States beyond the burden determined under domestic law. Thus, a right to tax given by the Convention cannot be exercised unless that right also exists under internal law.

It follows that, under the principle of paragraph 2, a tax-payer's U.S. tax liability need not be determined under the Convention if the Code would produce a more favourable result.[27]

8.25      PwC provided a full copy of the 'technical explanation' of the convention between the US and Australia treaty. It highlighted extracts which it argued 'confirm that the Australia-US tax treaty was never meant to and cannot apply to increase tax liability—as accepted by the Government when it signed the treaty and when it was passed into law':[28]

The technical explanation is an official guide to the Convention. It reflects policies behind particular Convention provisions, as well as understandings reached with respect to the interpretation and application of the Convention...

Paragraph 2 [of Article 1] provides that the Convention may not increase tax above the liability that would result under domestic law or under other agreements between the Contracting States. If domestic law provides a more favourable treatment than the Convention, the taxpayer may apply the provisions of domestic law. For example, if certain interest income derived by non-residents is exempt from tax by statute, but the Treaty authorizes a tax at source of not more that 10 percent, the statutory exemption will apply. A taxpayer, however, may not make inconsistent choices between the rules of the Internal Revenue Code and the Convention rules.[29]

8.26      In reference to Article 1(2) of the US treaty, AmCham expressed concern that the bill is not in accordance with signed treaty agreements:

The consequences of the proposed amendments are said to be in accordance with double taxation agreements signed. However, the double tax agreement with the United States specifically provides that the agreement cannot be used to increase taxation, only to ensure an appropriate allocation of tax between the two countries (Article 1(2)). Accordingly, the basis upon which retrospectivity has been justified by reference to interpretation of the agreement, is not sound for the purposes, at least, of the double taxation agreement with the United States.[30]

8.27      In response, Treasury outlined that Article 1(2) does not specifically apply to the transfer pricing rules. It explained that in operation, the article is required to identify a relevant and specific exclusion, exemption deduction rebate or allowance. It outlined that the proposed rules provided in the bill do not provide this type of 'specific benefit'. Treasury offered the following explanation:

Even if it were possible to construe Division 13 as providing the type of specific benefit set out under Article 1(2), Article 1(2) would still have no application as it would not be the convention of itself operating to restrict the benefit but rather the operation of another domestic law. There is no suggestion that Article 1(2) prevents the implementation of the Convention, in whole or part, in the domestic law.

Further, even in the event that all of the issues above could be overcome Article 1(2) would still not apply in transfer pricing cases as Article 1(3) must also be considered.

Broadly, Article 1(3) of the Convention authorises either Australia or the United States to tax its own residents in any manner irrespective of any other provision of the Convention, including Article 1(2). Article 1(3) very deliberately takes precedence over Article 1(2), and would apply to all cases involving the application by Australia of Article 9 of the Australia-US Convention (involving associated enterprises).[31]

Double taxation and Mutual Agreement Procedures

8.28      A number of submitters raised concerns that the rules will increase the risk of double taxation and highlighted the time and costs involved for Mutual Agreement Procedures (MAPs) in these instances. KPMG stated:

The retrospective aspect of the Bill has the potential to lead to significant unresolved double taxation for which positive resolution using the MAP in Australia's tax treaties would be unlikely. This in turn would have a negative impact on the profile of Australia as an OECD member country and raise issues of sovereign risk for prospective future investment decisions.[32]

8.29      GM Holden suggested the portrayal of MAPs in the EM was oversimplified and argued that such an outcome can be time-consuming and costly:

Holden does not agree that relief from double taxation will be as easy to obtain as Parliament has portrayed in the EM. It is a matter of public record that Holden is currently involved in a Mutual Agreement Procedure which has been on-going for some considerable time and as a result, Holden does not believe that future relief from double tax will be easy to obtain in as timely and inexpensive a fashion as Parliament predicts. This problem will be exacerbated for companies, like Holden, that deal with related parties on several transactions in multiple jurisdictions, and represents an unfair compliance burden on these taxpayers should transfer pricing adjustments be made going back to 1 July 2004.[33]

8.30      In addition, Moore Stephens highlighted that escalating a transfer pricing dispute is not in the interest of taxpayers as this can be a costly course of events which may reflect adversely on the taxpayer:

As to the question of the possible imposition of double taxation suffice it to say that I am aware of some horrendous situations where double taxation has arisen... I believe that under the proposed law this position will deteriorate further, contrary to Treasury's statement that: "...these amendments will not change the capacity of the competent authorities to reach a satisfactory solution should double taxation occur." The Senate must appreciate that many taxpayers do not have the financial capacity to fight transfer pricing disputes through the courts because of the enormous costs involved and, for some, the fear of the attendant adverse publicity. I submit that it is beholden upon our Government to protect taxpayers from the creation of laws that may be misinterpreted by an overly enthusiastic Revenue authority.[34]

8.31      The Institute of Chartered Accountants in Australia also commented:

Paragraphs 1.47 to 1.50 of the EM provide comment on Mutual Agreement Procedure (MAP). The Institute considers this to be an oversimplification of the practicalities involved.

Notwithstanding the MAP mechanism, the Institute is of the view that there is the potential for significant unresolved double tax to be brought into existence for which positive resolution would be unlikely. This in turn would have a negative impact on the profile of Australia as an OECD member country and raise issues of sovereign risk for prospective future investment decisions.[35]

MAP statutes of limitation

8.32      The Minerals Council of Australia (MCA) outlined the process of MAP. It highlighted that a number of countries have a statute of limitation on the years covered by MAP which would prevent taxpayers from having access to MAP in certain cases dating back to 2004:

The typical option would be to go to treaty partner, through their tax office, and apply for a mutual agreement procedure whereby the allocation of tax between Australia and that other country is agreed so that there is no double taxation. However, there are two problems with that. One is that in a number of countries there is a statute of limitation. An example is the United Kingdom, where there is a six-year statute of limitation. As this legislation is retrospective over eight years, there would already be two years that could not be covered under a MAP process. It is also important to remember that the MAP process is not a binding position that has to be agreed between countries. It is a best endeavour, so there is still a very significant risk that a company could be left with double taxation.[36]

8.33      In response, Treasury argued that MAPs will continue to provide relief in situations where automatic relief is not provided:

Subdivision 815-A is modelled on the transfer pricing rules in Australia's tax treaties. Multinational groups that are subject to Australian tax as a result of Subdivision 815-A will be able seek to offset that liability in the treaty partner jurisdiction through mutual agreement procedures (MAP) in cases where automatic relief is not granted. All of Australia's tax treaties contain a MAP article that is intended to resolve cases of double taxation should they arise. The ATO has been successful in reaching agreements with other jurisdictions through MAP and these amendments will not change the capacity of the competent authorities to reach a satisfactory solution should double taxation occur. This ensures that in treaty cases the internationally accepted approach to resolving transfer pricing issues is adopted, which will decrease rather than increase the likelihood of double taxation.[37]

8.34      Mr Tony McDonald, General Manager of the International Tax and Treaties Division at Treasury, and Mr Michael Jenkins, Assistant Commissioner at the ATO, told the committee:

Mr McDonald: Obviously, because this legislation is only applicable to treaty partners and the mutual agreement procedures are an element of our treaties, all relevant cases have the mutual agreement procedures available to them. The way these procedures operate is for the ATO to work through with our treaty partners. My observation is that, while these processes can be lengthy, they do in the vast majority of cases result in a resolution and the ATO has a very good record in this area. But I might ask my ATO colleagues if they would expand upon that.

Mr Jenkins:  To amplify a couple of the points made by Mr McDonald, the ATO has a good record of settling disputes at the MAP table. Over a long period of time there have been only two matters, I think, where we have not been able to reach full relief on the double tax issue, and that has not been the totality of the double tax in question; it has just been a portion of that.[38]

8.35      The ATO provided the following table which outlined the number of MAP cases that have been resolved over the last eight years including inbound and outbound matters (where the ATO is seeking relief and also where other jurisdictions are seeking relief).

Table 8.1: MAP agreements resolved over eight years and amounts involved

Source: Treasury, answer to question on notice, 26 July 2012 (received 9 August 2012).

8.36      The table above refers only to MAPs specifically related to transfer pricing and Treasury 'noted that transfer pricing MAP matters tend to be more complex [than other forms of MAPs] and frequently involve significant amounts'.[39]

8.37      Treasury also provided a table of data based on an OECD compilation of country MAP statistics 2006–2010 which include both general treaty interpretation cases and specific transfer pricing cases. Treasury outlined that:

Although Australia has generally had fewer MAP cases when compared against the average for the OECD reporting countries (see columns A and B of Table 2 below), Australia has completed and/or closed a higher percentage of cases over recent years in comparison to the OECD average (see Column C of Table 2 below).[40]

Table 8.2: OECD Country Mutual Agreement Procedure Statistics 2006–2010

Source: Treasury, answer to question on notice, 26 July 2012 (received 9 August 2012), p. 2.

Further guidance on retrospective application of the bill requested

8.38      CPA Australia, while opposed to the retrospectivity, argued that if it is agreed to by the Parliament, 'that further guidance on the underlying policy intent be provided in the form of specific examples as to when it would be appropriate for the Commissioner of Taxation to apply the law retrospectively'. It recommended that these examples be included in the EM, and also outline when it would not be appropriate for the Commissioner to apply proposed subdivision 815-A retrospectively.[41]

8.39      Although strongly opposed to the retrospective application of the bill, RSM Bird Cameron also called for further guidance on transfer pricing rules to promote stability and attract foreign investment:

Going forward, the review of the transfer pricing legislation should be focused on ensuring taxpayers have clear guidelines on how to comply with the arm's length principle. It will follow from meeting this obligation, that the correct transfer prices will be arrived at and paid. This will ensure a more stable environment to attract foreign investment, will facilitate prompt and accurate payments of tax, and maximise the potential for correct collation of supporting documentation.[42]

Committee view

8.40      The committee acknowledges the concerns raised by submitters on application of the measures proposed by the bill and its retrospective nature. As with any taxation law, it is incumbent upon the Commissioner to take measures to provide clarity to taxpayers, particularly in light of self-assessment processes.

8.41      With this in mind, the Committee notes the consistent position adopted by the ATO on treaty based transfer pricing rules, and that measures in this bill do not create a new set of rules but reiterate Parliament's position since 1982. In addition, the ATO has taken measures to provide clarity on the application of the bill. The committee notes for example statements in the EM, and from the Commissioner, that settled cases will not be reopened.

8.42      The committee also acknowledges submitters' concerns about Australia's relationship with its trading partners. The committee emphasises that Mutual Agreement Procedures (MAPs) give strength to these relationships. Although, submitters have suggested that MAPs may be costly and time consuming, the committee asserts that MAPs nevertheless provide an avenue for resolution between contracting States. The committee highlights comments from Treasury officials that 'the ATO has a good record of settling disputes at the MAP table'.[43]

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