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End of attention
This question provides us with a reassurance that you are aware of your documentation requirements relating to determining the arm's length outcome for your international related party dealings (if applicable).
You should have written documentation to support the following for your international related party dealings:
- the characterisation of the international dealings in the context of your business, as described in step 1 of Taxation Ruling TR 98/11,
- the selection of the most appropriate arm's length pricing methods for those dealings, as described in step 2 of Taxation Ruling TR 98/11
- the application of the most appropriate arm's length pricing methods to those dealings, as described in step 3 of Taxation Ruling TR 98/11.
If you do not have contemporaneous documentation sufficient to make a reasonable assessment of whether your international related party dealings complied with the arm's length principle, answer no and print X at A.
If you have contemporaneous documentation sufficient to make a reasonable assessment of whether your international related party dealings undertaken during the income year complied with the arm's length principle, answer yes and print X at B.
If you have not undertaken any international related party dealings during the income year, answer not applicable and print X at C.
Documentation is contemporaneous if the following applies:
- it is existing or brought into existence either
- at the time you are developing or implementing any arrangement that might raise transfer pricing issues
- when you are reviewing these arrangements prior to or at the time of the preparation of tax returns
- the documentation records information relevant to transfer pricing decisions.
The documentation may be in the form of books, records, studies, budgets, plans and projections, analyses, conclusions and other material that record the information. It may be in electronic or written form.
The initial analysis of your international dealings against the arm's length principle will have been carried out and documented at the time of engaging in the dealings. To review those international dealings before you prepare your tax returns is prudent business practice.
Where you have not used arm's length consideration in the ordinary course of your international related party dealings, you should review prices before preparing the tax return, and make any adjustments for taxation purposes. Keep all your documentation in relation to this.
Adequacy of documentation
We do not expect taxpayers to prepare or obtain documents beyond the minimum needed to make a reasonable assessment of whether they have complied with the arm's length principle.
However, the documentation that is created in the ordinary course of the taxpayer's business and used by it to establish the prices for its international related party dealings - for example, invoices and orders - will not generally be regarded as contemporaneous documentation in relation to the arm's length nature of the dealings. This is because the documents do not produce any evidence or provide any basis for comparison for determining whether prices are established at arm's length.
It is not possible to provide a general checklist of documentation that would be adequate or desirable. We realise that it is necessary to strike an acceptable balance between:
- the need to keep compliance costs to a minimum
- our legitimate concern in ensuring the proper amount of Australian tax is paid.
The amount and type of documentation that should be created or obtained over and above that created in the ordinary course of business will depend on the facts and circumstances of each case.
The issue is a practical one having regard to what a prudent business person would do in the same circumstances, and taxpayers need to exercise commercial judgment in assessing their own compliance with the arm's length principle.
Arm's length pricing methods
The arm's length principle is the statutory test for pricing international related party dealings. The principle is incorporated into the associated enterprise articles in each of Australia's double tax agreements.
No particular method to establish the arm's length pricing, or order in which methods should be applied, is prescribed in the double tax agreements or related legislation, and taxpayers have the greatest scope to use methods appropriate to their circumstances.
Taxation Ruling TR 97/20 sets out:
- the methods we accept
- when these methods are considered acceptable
- our views on the concepts involved, and the issues that arise, in applying the methods.
We strongly recommend that all taxpayers with international related party dealings read this ruling.
For more information, refer to Permanent establishments.
Where the dealings between related parties are capital in nature, the most appropriate choice of method must be based on the facts and circumstances of each case. No specific methods are recommended.
Choice of method to determine arm's length pricing
Establishing arm's length transfer prices between associated enterprises involves a four step process. These four steps, briefly, are:
- understanding the cross-border dealings in the context of the taxpayer's business - that is, characterisation of the dealings
- selecting the most appropriate method or methods
- applying that method
- establishing review and adjustment processes.
The first two steps may be complex processes and you may need to refer to specific details provided in Taxation Ruling TR 98/11.
We consider that the prudent taxpayer will document the following:
- the processes of characterisation and selection
- the reasons for the final choice of method
- the reasons why other methods were considered and rejected.
As mentioned earlier, we strongly recommend you should keep adequate documentation. However, the complexity of the dealings will indicate the extent to which analysis and supporting documentation is required.
Application of pricing methods
The application of the chosen method will usually require two separate processes:
- an assessment of comparability
- the collection of supplementary data.
The first process may include:
- searching for comparable transactions or enterprises
- identifying sources of information used in the search
- adopting transactions or enterprises as being comparable
- rejecting other transactions or enterprises as not being comparable
- providing reasons and amounts where an independent transaction has been adjusted to make it comparable with the dealings under examination
- applying the pricing method, and any checking method - such as sampling - to ensure the validity of the chosen method and resultant arm's length price.
The second process may include the following:
- collecting data on profit projections
- creating or acquiring records to supplement the analysis of comparability and function
- collecting data to calculate financial performance ratios, as part of applying the chosen pricing methods.
You should prepare and retain relevant documentation about these processes.
Last modified: 09 Nov 2011QC 24292