ATO 2009-2010 Compliance Program: Transfer Pricing issues are back in focus

The Commissioner of Taxation has now issued the Compliance Program 2009-10. As in prior years, it sets out for the coming year the ATO’s focus issues for risk reviews and audits. As in past years, Transfer Pricing is a key focus area in the micro business, SME and large business segments of the ATO. 

Key points to note across the three key business segments separately administered in the ATO are as follows:

Micro businesses

For the 2.7 million micro businesses (annual turnover up to $2 million) the ATO lists international dealings as a specific compliance issue based on the fact that “funds can be transferred and invested in offshore jurisdictions, making it easier for Australians to conceal assets and income offshore.”  To combat this, the ATO will:

• use information supplied by overseas revenue agencies and AUSTRAC, and data supplied by payment service providers to identify Australian residents involved in foreign transactions
• work with financial institutions to identify residents involved in abusive tax-haven related arrangements.  The ATO has increased its automated data-matching analysis tools and maintained Project Wikenby to review tax-haven arrangements 
• continue to work with with trade and industry associations to develop and publish industry benchmarks so that businesses trading below the benchmark may be selected for review.  Funding has been received to expand this benchmarking approach to produce data that allows businesses to compare their business ratios to the financial norms of similar businesses in a similar turnover range.  The ATO states that it will “use benchmarks for audit case selection purposes”

Small to Medium Enterprises

The Small to Medium Enterprises segment contains 140,000 enterprises with annual turnovers in the range of $2 million to $250 million with current specific focus on businesses in the $100 million to $250 million range.  The ATO is seeking a level playing field for businesses and is conducting risk assessments and other compliance activities, looking not just at a business entity, but on the economic group comprising related companies, trusts, super funds, partnerships and controlling individuals.  The risk reviews are also taking into account the different stages of the business’ life cycle.  The ATO’s international transactions review is monitoring the effects of the economic downturn on the performance of entities with international transactions and is making specific use of AUSTRAC data.  The overall focus is on:

• Australian residents receiving foreign source income or claiming deductions and exemptions in respect of cross-border transactions
• financial and structural arrangements that rely on a lack of transparency in other tax jurisdictions
• foreign residents deriving Australian income
• payments subject to non-resident withholding tax (interest, dividends and royalties)
• Transfer Pricing arrangements where there is a significant risk of profit shifting to other jurisdictions, in particular companies with a history of profitability falling consistently below industry averages
• thin capitalisation and the correct application of the safe harbour rules

Large businesses

Large businesses (1,100 business with annual turnover greater than $250 million) are also to receive an increasing number of Transfer Pricing reviews.  The ATO mentions profit shifting through the use of Transfer Pricing, thin capitalisation, and other tax driven structures such as marketing hubs, as areas of concern.  Reviews will focus on significant transactions and business results that show inconsistencies between tax outcomes and the economic and financial outcomes.  Specific focus is on companies that exhibit low tax performance and the ATO expects to profile all such taxpayers over the coming 12 months.  The ATO is encouraging businesses to use advanced pricing arrangements (APA) to provide assurance on the risk of Transfer Pricing review or audit.  Specific emphasis is placed on loss generation and loss usage following the removal of foreign loss quarantining – specifically arrangements that inappropriately attribute foreign losses to Australia.  The focus on Transfer Pricing is based on monitoring low or falling tax performance as a result of transfer pricing practices – in particular the ATO have highlighted the following:

• restructuring of Australian based operations to shift functions, assets and risks offshore on a non-arm’s length basis, such as the sale of intellectual property at a nominal price
• paying excessive interest, guarantees and other fees to related and non related parties
• provision of Australian headquartered companies to overseas subsidiaries at no or non arm’s-length charge
• allocating income and expenses to Australian businesses which are inconsistent with the economic activities conducted in Australia
• high risk cases that appear to generate debt deductions – a “benefits” test will be applied as well as an arm’s-length test

The ATO has received funding to allocate more resources to reviewing risks and undertaking compliance activities and has reviewed the APA program to make it more attractive and relevant to industry.  A specific mention is made in the report that the ATO is working with JITSIC (Joint International Tax Shelter Information Centre) partner countries to improve Transfer Pricing processes.  Sharing of information and risk trends between tax authorities is emerging as a new tool for the ATO in these troubled economic times.

How can Grant Thornton assist?

Transfer Pricing is seen a significant risk in troubled economic times where businesses show profit drops and transactions that could be viewed as profit shifting to low tax jurisdictions or to allow profits to be offset against losses in the same jurisdiction.  The ATO is increasing its interest in financing arrangements and business restructuring and the use of industry profit benchmarks to highlight risky taxpayers for audit reviews.

If your business has any of the indicators noted above then we can help you by:

• undertaking a risk review to ascertain if your profit performance is following industry trends and match your performance to any industry life cycle or market factors
• documenting your transfer pricing process. By using the ATO’s recommended four step approach to documenting how you do business via:
• a review and analysis of functions assets and risks (performing a functional analysis)
• reviewing the selection of arm’s length pricing policies for related party dealings
• benchmarking the outcome of applying these pricing methods to determine compliance with the arm’s length principle
• assisting you have annual compaliance review processes to ensure transfer pricing documentation is maintained and updated
• benchmarking your interest costs to related offshore lenders using an ATO accepted benchmarking tool that covers most currencies and risk profiles
• reviewing license arrangements to determine if they represent service fee payments or royalties and if royalties, what withholding tax is due and what the effects of this may be on tax offsets in Australia
• considering if you need an APA or another certainty tool offered by the ATO to give you greater certainty that cross-border transactions will not result in costly ATO audit

Should you have any questions regarding Transfer Pricing or how Grant Thornton can help you to prepare for the scrutiny of the ATO, please contact your usual Grant Thornton advisor.

For more information contact:

Jason Casas
National Leader - Transfer Pricing
T +61 3 8663 6433
M +61 430 023 326
E jason.casas@au.gt.com