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The Act contains measures to counter arrangements designed to move profits from one entity to another. These arrangements are commonly called transfer pricing or profit shifting. Broadly, the transfer pricing rules allow the Tax Office to increase a taxpayer's assessable income or decrease allowable deductions to negate the effect of the arrangement - see Division 13 of Part III.
The rules apply only where there is an international agreement. For the purpose of applying the definition of an international agreement, the CFC is treated as a resident of a foreign country. The result is that the transfer pricing rules apply to most non-arm's length arrangements involving the CFC.
CFC in an unlisted country
Unlist Co1, which you wholly own, is a CFC resident of an unlisted country. In turn, Unlist Co1 wholly owns another CFC in an unlisted country - Unlist Co2. Unlist Co1 lends Unlist Co2 $1 million and there is no interest payable on the loan. The market interest rate is 10%.
Unlist Co1 will be taken to have received $100,000 on the loan. This amount will be tainted interest income and will be included in the tainted income of the company. If the company fails the active income test, the notional assessable income of Unlist Co1 will include $100,000.
Application of the transfer pricing rules to non-arm's length arrangements involving CFCs resident in the same listed country
The transfer pricing rules do not apply to arrangements involving CFCs resident in the same listed country at any time when an international agreement is in force.
Impact on the active income test
The Tax Office can make adjustments reflecting arm's length values to amounts used in determining whether a CFC has passed the active income test. An adjustment can be made if, in working out the attributable income of a CFC, the Tax Office would make a transfer pricing adjustment in relation to the acquisition or supply of property by the CFC.
Last modified: 05 Dec 2006QC 18000