Show download pdf controls
  • The ratings for some of the common areas arising in reviews completed up to the end of January 2019 and June 2020 are shown below:

    Assurance Ratings for common review areas as at January 2019 and June 2020

    Bar graph compares the overall assurance rating for common review areas as at January 2019 and June 2020. These areas include R&D, consolidation and MEC structuring, transfer pricing, thin capitalisation and related party financing.

    The most significant shifts in assurance ratings we have observed relate to R&D, transfer pricing and related party financing. Our insights about what is driving these shifts and links to additional guidance on how to obtain high assurance are contained below.

    Observations

    In our reviews we consider all relevant taxpayer alerts and practical compliance guidelines to assess whether they apply to the taxpayer’s circumstances. We also review all reportable tax position (RTP) schedule disclosures.

    The issues identified may have substantial tax consequences. Typically, this is where most of our time during the review is spent to obtain higher levels of assurance.

    Structured arrangements designed to reduce Australian tax

    Low assurance or red flag ratings are sometimes associated with related party transactions (including third party back-to-back transactions) promoted or designed to achieve Australian tax savings including:

    • related party financing transactions with special terms designed to
      • defer or eliminate withholding tax while preserving annual Australian income tax deductions
      • achieve cross-border hybrid mismatch outcomes (e.g. double deductions or deductions with no corresponding income), and/or
      • circumvent specific anti-avoidance rules such as thin capitalisation and debt/equity classification rules
       
    • changes in membership of Australian tax groups through internal transactions or decisions designed to
      • increase or accelerate deductible losses or depreciation
      • generate Australian tax deductions for anticipated asset write offs
      • avoid tax on anticipated terminations or disposals, and/or
      • generate foreign tax credits
       
    • migration of Australian generated intangible assets to overseas related parties in order to reduce Australian taxable income
    • interposing partnerships or other entities designed to do any of the following
      • shift recognition of income
      • change the nature of income
      • reduce or eliminate withholding tax
      • avoid the application of targeted anti-avoidance measures.
       

    Transfer mis-pricing

    Transfer pricing is the most common area with nearly 80% of Top 1,000 taxpayers disclosing related party dealings. Multiple issues arise including:

    • inbound and outbound supplies of goods and services
    • international related party financing
      • cross border dealings in general
      • interest free loans outbound and inbound
      • cash pooling arrangements
      • related party derivatives
      • guarantee fees
       
    • management and administrative services, and other back office services
    • payment of licence fees and royalties
    • technical services
    • research and development (R&D) performed on behalf of overseas related parties
    • migration, sale or use of Australian intangible property overseas
    • offshore hubs or service centres
    • attribution of profits to a permanent establishment.

    Transfer pricing is not reviewed where the years under review are covered by an advance pricing Arrangement or settlement.

    Common issues arising in relation to transfer pricing analyses include:

    • Limited information (documentation) on the global value chain and/or functional analysis of the entities to the arrangement.
    • Over-reliance on the whole-of-entity Transactional Net Margin Method. There are circumstances where other methods, including transactional approaches, may be more appropriate.
    • Lack of comparability analysis in applying the transfer pricing methodology. Where a comparability analysis has been included, there are often significant differences between the tested transaction/entity and the benchmarks provided.
    • Changes in transfer pricing policy or methodologies without an underlying change to taxpayer functional analysis, and inappropriate methodologies being selected given the taxpayer functional profile.
    • The application of the Simplified Transfer Pricing Record Keeping rules, as per Practical Compliance Guidance PCG 2017/2 Simplified transfer pricing record-keeping options, without evidence of how the taxpayer has met the eligibility criteria.

    In respect of specific transactions, we are often seeing:

    • In relation to financing transactions – the commercial purpose or arm’s length nature of terms and conditions is not well documented or evidenced (for example, subordination, security) and other options realistically available may not be clearly considered.
    • In relation to services transactions – the beneficial nature of services and appropriateness of allocation keys may not be well documented/evidenced. Further, the cost base of the services is rarely explained or evidenced.
    • In relation to royalty, licensing or intellectual property arrangements – the beneficial nature and development, enhancement, maintenance, protection and exploitation activities may not be not well documented or evidenced.

    Other areas where we often do not obtain high assurance

    Other areas that we often do not obtain high assurance include:

    • inbound and outbound holding structures
    • consolidation
      • asset recognition (including treatment of rights to future income and intangibles)
      • valuation to support tax cost setting calculations (including evidence to support allocation of value to certain assets vis-à-vis goodwill)
      • formation or structuring of tax consolidated groups and MEC groups (including contrived changes to tax residency)
       
    • R&D
      • nexus of expenditure to R&D activities
      • methods of allocation of expenditure
       
    • thin capitalisation
      • insufficient evidence or analysis to support the use of the arm’s length debt test or worldwide gearing method
      • revaluation of assets
      • valuation of debt capital
      • insufficient documentation to support safe harbour calculations where the financial accounts for the accounting group differs or do not apply to the relevant tax group/ taxpayer
       
    • tax losses
      • generation, carry forward, transfer and utilisation
       
    • capital allowances
      • we may see the governance and processes surrounding capital allowances undertaken by personnel with limited understanding of the differences between accounting standards and the applicable tax laws. Commonly we identify errors
        • in determining the effective lives of assets,
        • general reconciliation errors, and
        • failure to differentiate between different rules applicable to capital works deductions available under Division 43.
         
       

    Broadly, these areas have remained consistent over the program. We continue to provide public advice and guidance in respect of many of these areas.

    Medium ratings – more evidence or analysis required

    For some of these issues or transactions, we will require more evidence and analysis to obtain high assurance.

    Transfer pricing, valuations or historic tax loss generation are some more common examples. We find the provision of well-constructed position papers and relevant documentation assists us in obtaining high assurance within the time constraints of the review. We encourage taxpayers to provide us with high quality information as soon as possible to assist us to obtain higher levels of assurance during the review.

    Guide to help prepare for engagements with us

    In June 2020 we published a guide to help large public and multinational companies covered by this program understand:

    • what attracts our attention
    • prepare for engagements with us, and
    • improve their (and our) confidence in their tax outcomes.

    The guide sets out the standard of information and documentation we typically look for to obtain assurance. We will update this guide to cover other issues that attract our attention in program engagements. The guide currently covers:

      Last modified: 02 Oct 2020QC 63840