The Tax Laws Amendment (Cross-Border Transfer Pricing) Bill (No 1) 2012 (Stage 1) has passed through Parliament and now awaits Royal Assent.

This new legislation applies to transactions with related parties in countries that have Double Taxation Agreements (DTAs) with Australia.

The key impacts of Stage 1 reforms are significant and wide-ranging:

  • the new legislation will apply retrospectively from 1 July 2004
  • Stage 1 allows the Australian Tax Office (ATO), where a taxpayer is deemed to not be dealing at arm’s length, to reconstruct the related party transactions based on how they believe independent parties would have structured the arrangement
  • the new legislation will allow the ATO to challenge deductions for intercompany interest, notwithstanding the thin capitalisation safe harbor limit, where the ATO considers the level of debt to be not commercially realistic This Bill forms part of the ATO’s intensified focus on the enforcement of Australia’s transfer pricing rules. This is supported by the dramatic increase in transfer pricing disclosure requirements with the recently introduced International Dealings Schedule, which forms part of the company income tax return and replaces the aging Schedule 25A and the thin capitalisation schedules.  

With the enactment of this new legislation, taxpayers should expect:

  • renewed focus on companies that have related party transactions and are recording low profit margins or operating losses
  • significant impact on cross border funding of transactions.  Taxpayers should review all current and historical cross border funding arrangements and ensure appropriate supporting documentation is maintained
  • continuing interest by the ATO on businesses that have or plan to restructure their operations by shifting  functions, (tangible and intangible) assets or risks overseas
  • focus on transfer pricing documentation and related party decisions dating back to 1 July 2004.  Taxpayers should ensure they have appropriate support for their related party transactions during this period

More changes to come – Stage 2

Stage 2 of the transfer pricing reforms will be equally significant. The Australian Treasury is currently finalising the draft legislation for Stage 2 and aims to release an exposure draft for consultation and comment in mid-September.  We expect that Stage 2 will include:

  • treatment of transactions with non-treaty countries
  • transfer pricing documentation requirements
  • transfer pricing penalty provisions

Taxpayers will have only 30 days to respond to these dramatic reforms. It is the Government’s intention to introduce Stage 2 of the legislation to Parliament at the end of their Spring sitting, around late November.

What does this all mean?

The message is clear – the ATO is looking closely at a taxpayer’s international related party dealings. Greater disclosure requirements, more sophisticated scrutiny tools and the adoption of the new transfer pricing regulatory framework supports the ATO’s commercial, outcomes-based approach to transfer pricing.

Although greater consistency with trading partners in the “international dealings” arena will be viewed as a positive development for Australia, taxpayers are advised to be prepared for the “new transfer pricing environment” and should review their transfer pricing policies and practices, as well as ensure that the appropriate documentation and support are in place.

Grant Thornton advises many multinational groups on Australia’s transfer pricing regime.