Transfer pricing a key focus for ATO

Last updated 13 August 2019

Jeremy Hirschhorn,

Second Commissioner, Client Engagement

Welcome address and opening remarks at the Tax Institute National Transfer Pricing Conference

Sydney, 14 August 2019

(Check against delivery)

Welcome and opening address

Thank you Mariana (von-Lucken, CTA) and good morning everyone, it’s a pleasure to be here today to open the Tax Institute’s National Transfer Pricing Conference.

There are many familiar faces in the crowd, and I would I would like to acknowledge my ATO colleagues Sophie Lewis and Keir Cornish who will also be speaking with you throughout today’s event.

I come here not as a transfer pricing technician, but as someone who has the privilege of seeing the Australian taxation system in operation, and the responsibility to ensure that it works as intended for the benefit of all Australians.

Transfer pricing (and avoiding transfer mis-pricing) is a key focus of the ATO given its criticality to the Australian taxation system.

So this morning I will share with you some observations on the ATO’s views on transfer pricing: why it’s important to the Australian tax system, our strategy of transparency in relation to transfer pricing risk, and what we think good transfer pricing advice looks like in 2019.

Why the taxation of large corporates is important to Australia

Ultimately a tax system is about us collectively sharing our resources for the benefit of all. Australia is fortunate to have a robust tax system and an effective tax administration which supports the social benefits we all enjoy.

Importantly, the number of large corporate groups in the Australian tax system is comparatively small, yet the impact they have on revenue is significant.

Australia’s 1,500 or so large corporate groups contribute around 60% of all corporate income tax reported, about $50 billion or so per annum, give or take depending on commodity prices; and more than 10% of total ATO tax collections each year. We estimate the level of compliance of large corporate groups is over 95%, the vast bulk of which is paid voluntarily.

Beyond their tax contribution, they also play a critical role in the tax system as community perceptions of their compliance underpin willing participation in other taxpayer segments.

Why transfer pricing is particularly important to the Australian tax system

Australia is a country where transfer pricing is very important:

an open trading country, with high levels of imports and exports, much of which with related parties
a country open to foreign investment, with high levels of investment from overseas
a high reliance on corporate taxes, particularly from large businesses
a relatively high headline corporate tax rate
a world where “reality” supply chain tax rates could be significantly lower than even low headline rates due to aggressive tax structuring, particularly prior to full implementation of the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) program.
With these two last factors providing significant incentives to aggressively transfer price or simply transfer mis-price

As such, the ATO must be acutely focused on ensuring that related party transactions are transfer priced, not transfer mis-priced.

This has been recognised by successive Governments, which have kept the Australian taxation regime at “best practice”, with early and pragmatic adoption of international developments in tax law. Most recently, the current Government has implemented measures such as the Multinational Anti Avoidance Law (MAAL), Diverted Profits Tax (DPT), Country by Country (CbC) reporting, anti-hybrid and the most up-to-date transfer pricing rules.

It has also been recognised “on the ground” by the current Government, which funded the ATO almost $700 million to establish the Tax Avoidance Taskforce for four years, and has just extended and expanded the Taskforce for another three years with an additional $1 billion of funding.

Focusing on the woods not the tree

Under the “justified trust” approach enabled by the Tax Avoidance Taskforce funding, the ATO is focusing on whole-of-taxpayer profiling and risk assessment. This helps us understand the taxpayer's business model and any tax planning motivation and opportunities they may have. This profile and the risks involved tell us what we need to do to gain confidence each taxpayer is paying the right amount of tax.

As an adviser, if you also look at your client’s tax structure and performance holistically, rather than individual transactions or issues in isolation, you will be in a better position to understand the tax risk profile of your advice and anticipate the ATO’s likely reaction from the outset.

This is particularly important for transfer (mis) pricing matters. We often see a price set based on an optimistic application of one methodology. To truly judge the risk of a transfer pricing position, it is important to triangulate a range of methodologies, as well as to understand the big picture of where channel profit is being landed around the world (especially untaxed profits).

Do you understand your client’s tax profile relating to the Australian channel?

Understanding the effective tax borne (ETB) of the Australian channel is critical to the ATO understanding the tax risk profile. The ATO developed the ETB to address public commentary by large corporates who were asserting that they had an effective tax rate of about 30% in Australia, when we knew that this figure didn’t represent the amount of Australian corporate tax paid on their economic activities. The community can’t be expected to understand this level of detail and their confusion led to distrust about the amount of tax large corporates were paying.

The methodology identifies an economic group’s worldwide profit from Australian-linked business activities and the Australian and offshore tax paid on that profit. As an adviser, ETB is another tool which will provide you with an early insight into how your client may be profiled and risk assessed by the ATO, in an effort to establish justified trust. As above, it is also a useful sense check on any transfer prices and whether they are giving plausible, common sense outcomes. Further, it may flush out any upstream hybridity or non-taxation relevant to the anti-hybrid rules or the MAAL or DPT. Importantly, it will also flush out what I describe as “transfer mis-pricing arbitrage” structures, where one methodology is chosen for the “true” exporting company, another methodology is used by the “true” importing company, but a low or un-taxed entity is inserted into the middle to book the residual channel profit.

What is the ATO doing to help reduce transfer mis-pricing risk?

As an administrator we are seeking to provide greater levels of certainty in the tax system. This benefits the system as a whole, but also assists taxpayers that are trying to do the right thing, it:

provides confidence that expected tax outcomes will ultimately be achieved
helps taxpayers avoid taking inadvertently risky positions
reduces compliance costs
provides a level of comfort that there is a level playing field, and
makes Australia a more attractive place in which to invest.

From a transfer pricing perspective, we are doing this by explicitly exposing to taxpayers our risk assessment parameters on the most important types of transaction for multinationals operating in the Australian economy.

Through our Practical Compliance Guidelines materials, we set out our perspective on what we consider safe ‘green zone’ arrangements in relation to transfer pricing issues, as well as detail on what we consider risky ‘red zone’ arrangements.

While these don’t set out our view on the arm’s length conditions or pricing in any particular transaction, they do help taxpayers make decisions about the amount of tax risk to which they want to be exposed:

their compliance risk in relation to transfer pricing
the likelihood and extent of compliance activity (if any) by the ATO.

Of course, if a particular taxpayer’s situation is very different from the range of situations set out in the various Practical Compliance Guidelines (PCGs), there is the possibility that a fair transfer price may fall outside the green zone. In practice, many come to us claiming to be different, but fail to convince us that they are sufficiently different for us to accept a price outside the green zone. Of course, where we can’t resolve issues, we will continue to seek correction through assessments and litigation where necessary.

Through this approach we are seeing taxpayers looking to engage with us earlier to resolve issues and 'lock in' future arrangements in line with the guidance – this provides certainty to both the ATO and the taxpayer moving forward.

In our approach to resolving legacy disputes, we are being firm with taxpayers looking to settle with us and making it clear we will only do so where we can also lock in future compliance to achieve certainty of appropriate tax outcomes.

Focus areas

If I just touch quickly on a few of our recent focus areas, where we have been quite overt about what is acceptable compliance risk in publishing PCGs.

Related party loans continue to be used by Australian taxpayers, and we have made great inroads in addressing taxpayers who have sought to achieve artificial transfer pricing benefits through these arrangements. For example, we have brought about $80 billion in previously high risk related party loans into low risk or ‘green zone’ arrangements, and expect this to increase as we resolve existing issues.

Marketing hubs continue to be a key focus area. But again, by working actively with taxpayers to resolve these matters we are seeing a positive impact of our hubs strategy on reducing the use of these arrangements to reduce tax in Australia. It’s a matter of public record that BHP will now be paying their full Australian tax on their Singapore hub, and that their on-going arrangements are in line with our ‘green zone’ set out in our guidance materials. This was a significant development in our marketing hubs strategy; as one of Australia’s major taxpayers this sends a strong signal to taxpayers with similar arrangements in that industry, as well as to the emerging oil and gas industry.

More recently we have also signalled to the market our focus on inbound supply chains. We observed a race to the bottom in terms of the profit landed in Australia and realised we had to intervene with expected returns. Not only was this inappropriately reducing Australian tax, but also clogging up our APA processes with ambit claims, adversely affecting taxpayers with genuine prices seeking certainty.

Transfer mis-pricing traps

I thought I would briefly set out some of the transfer mis-pricing traps that we see in practice:

pricing a contractual arrangement that does not reflect what is happening in reality
entering into transactions or restructures against the best interests of the Australian entities, for example:
- entering into a worse transaction with a related party than could be obtained with a third party (or in fact was previously in place with a third party)
- contractually artificial allocations of risk and reward that would never occur in the real world
  - I describe this as the “kidney donor” approach to transfer pricing: just because you can point to someone living a full life on dialysis, this doesn’t support a proposition that someone would remove their own kidneys and go on dialysis in order to transfer the risks and rewards of their kidneys to someone else
transferring intellectual property to a related party just before it becomes commercially viable at a significant discount to what it would be worth
an optimistic use of one methodology, with no cross-checking against other methodologies
ultimately transfer pricing disputes are resolved by judges – history would show they are concerned with real world pragmatism and have little time for convoluted methodologies or expert witnesses; it has been said that the reason for having expert witnesses in transfer pricing cases is to ensure that the other sides are also disregarded
pricing a transaction which would never take place with a third party
failing to take into account the bargaining power that the group would have with a notional third party if it were to enter into that transaction (a version of the “orphan” approach) – in the real world, a Coles pays less per square metre than the florist
when the price is bad (or there is a change in transfer pricing legislation), changing the story not the price.

In relation to the last point, and at the risk of bluntness, some transfer pricing documentation and supporting information we receive reads more like a historical novel than a well-researched biography: some of the characters are real, but there is a lot which seems to come from the imagination of the author. In short, we often find that the glossier the report, the worse the price.

Being wise not clever

So if I think then about ‘what does a wise advisor do?’ well it’s really the flipside of some of these things.

A person providing wise advice:

understands the big picture of where channel profit is being landed around the world (especially untaxed profits)
looks at whether the transaction makes commercial sense and, if it does not, does not simply price a non-commercial transaction
looks at multiple methodologies to see if the price makes sense
where the price is bad, changes the price, not the story
understands the ATO’s risk assessment frameworks
seeks greater certainty – particularly where transfer pricing is part of their “tax infrastructure” (i.e. it is material to their fundamental tax profile), rather than a fringe issue.

Be a transfer pricing professional

To conclude, I just want to reiterate that what you do is really important – you are a critical part of the operation of the tax system in Australia. What you do matters, not just to your clients, but to confidence in the tax system as a whole.

We are encouraged by the increased and positive engagement from taxpayers and their advisors over the past few years to address transfer pricing issues upfront.

I encourage everyone during each of the sessions today to think about how they can be a wise transfer pricing professional.

On that note I will pass back to Mariana. Thanks again for having me this morning and I hope you enjoy the rest of the conference.

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