• Tax Alert: New tax rulings regarding transfer pricing

TR 2014/D4 and TR 2014/D3

The Australian Taxation Office (ATO) released two tax rulings (TR 2014/D4 and TR 2014/D3) on 16 April 2014 to clarify the Commissioner of Taxation’s view on certain sections of the new transfer pricing legislation introduced on 29 June 2013. The new transfer pricing rules apply to the transactions of all multinational companies operating in Australia.

Some aspects of the new transfer pricing rules have been controversial. In particular, under the new transfer pricing legislation, significant penalties may apply where the ATO makes transfer pricing adjustments and taxpayers are unable to establish a reasonably arguable position (RAP), due to specific transfer pricing documentation not being maintained.

Further, the new transfer pricing rules, allow for the Commissioner of Taxation to reconstruct intercompany transactions and arrangements. This means that, in some cases, the ATO would have the power to disregard the actual conditions applied to intercompany dealings, and substitute these for arm’s length conditions.

Taxation Ruling TR 2014/D4 details the transfer pricing documentation requirements taxpayers must follow to establish a RAP and receive penalty protection, in the event of transfer pricing adjustments by the ATO.
On the other hand, Taxation Ruling TR 2014/D3 has been released to clarify how the Commissioner of Taxation intends to use reconstruction powers when undertaking transfer pricing reviews and audits.

The key outcomes of Taxation Ruling TR 2014/D4 are:

  • the process to prepare transfer pricing documentation has changed following the release of TR 2014/D4
  • taxpayers that prepare transfer pricing documentation before the lodgement of the income tax return for the relevant income year will be considered to have established a RAP
  • significant penalties may apply where taxpayers have not established a RAP for their transfer prices; and
  • the final Ruling will apply to income years commencing on or after 29 June 2013

The key outcomes of Taxation Ruling TR 2014/D3 are:

  • continued focus by the ATO on profit margins or division of profits, as one of the factors considered when assessing whether taxpayer’s dealings are consistent with arm’s length conditions
  • the ATO may disregard the ‘form’ of the dealings where they are inconsistent with the substance of the transactions (for example, the ATO can reconstruct financial transactions to decrease the interest rate paid if the conditions of the dealings are not considered arm’s length; and
  • the final Ruling will apply to income years commencing on or after 29 June 2013

What does this mean for taxpayers?

  • taxpayers are burdened with additional tax compliance requirements, as the process to prepare transfer pricing documentation has evolved
  • the new transfer pricing legislation provides the ATO with substantial powers to reconstruct related party dealings
  • Public Officers need to ensure that their transfer pricing policies have been implemented correctly and demonstrate the dealings take place under arm’s length conditions; and
  •  taxpayers may face significant penalties where contemporaneous transfer pricing documentation is not prepared

The release of TR 2014/D4 and TR 2014/D3 has clarified the Commissioner of Taxation’s view on the practical application of some contentious sections of the new transfer pricing legislation.

On the other hand, the release of these rulings highlights the concerning reconstructing powers that the Commissioner may have to determine additional profits to be taxed.

Taxpayers need to ensure that their transfer pricing policies demonstrate arm’s length conditions, or bear the risk of potential reconstruction of their related party dealings by the Commissioner of Taxation.