Before the COVID-19 pandemic, organisations were becoming more agile in a changing global market, creating more efficiencies by manufacturing in low-cost jurisdictions, “near-sourcing” to reduce carbon footprints and managing the impacts of trade tensions. Supply chains had been under scrutiny from tax authorities as audit activity accelerated globally – driven by the Organization of Co-operation and Economic Development's Base Erosion and Profit Shifting project and a global focus on MNE tax compliance.
For MNEs to survive and thrive in the current uncertain environment, they must transform and digitalise their supply chains. This is having a material impact on the tax burden of MNEs – particularly creating transfer pricing challenges. To manage this, tax executives must achieve greater integration into their businesses, streamline transfer pricing functions and embrace digital models.
On-going trends will continue to impact MNE supply chains
MNEs now need to become more agile about their supply chains – both in the short term and beyond COVID-19. To stay on top of these changes, MNEs should focus on critical areas including:
- Managing temporary changes in supply chain and inventory levels in line with the changing demand.
- Building redundancy at all phases of the supply chain to counter the shortages of raw materials, components and sub-assemblies critical in the manufacturing process.
- Accelerating digital transformation. The next-generation supply chain must be fully digital, delivering the transparency and resilience demanded by businesses and consumers.
The Australian Taxation Office (ATO) has acted quickly
The ATO has been closely monitoring changes in global supply chains and how they impact the Australian tax base. In recent years, the ATO has established a Tax Avoidance Taskforce to investigate and challenge the aggressive tax avoidance arrangements. The Taskforce has highlighted that taxpayers ‘low assurance’ or ‘red flags’ are often associated with related party dealings designed to achieve Australian tax savings.
Accordingly, the ATO has increased its focus on MNEs tax and transfer pricing compliance. Key areas of interest to the ATO include:
- Tax Governance: The ATO is focusing on establishing clear controls and processes within the corporate governance framework of the taxpayer to support tax decision-making and manage tax risks, particularly for transfer pricing and Goods & Services Tax (GST).
- Diverted Profits Tax (DPT): The DPT aims to prevent the diversion of profits offshore through contrived arrangements. Due to the ongoing changes in supply chain, DPT has emerged as one of the key focus areas for the ATO, especially in cases where lower profits are earned in Australia compared to overseas related parties in the supply chain.
- Multinational Anti-avoidance Law (MAAL): The MAAL is an extension of Australia's general anti-avoidance rules and aims to ensure MNEs pay their fair share of tax on the profits earned in Australia. The MAAL counters the erosion of the Australian tax base by MNEs where the products or services are supplied by foreign affiliates and the Australian entity is integrally involved in the contract on behalf of its foreign affiliates.
- Debt financing: The ATO has released a risk assessment framework for related party financing arrangements. The higher the risk rating, the more likely the financing arrangements will be reviewed by the ATO. This framework is very rigid and a number of MNEs have found themselves in the high risk zones for straightforward financing arrangements.
- Reportable Tax Position (RTP): The RTP requires certain taxpayers to disclose uncertain tax positions on their corporate income tax return. With the RTP Schedule, the ATO is seeking to understand the tax and transfer pricing risks associated with arrangements that the ATO has raised concerns, including financing and marketing or procurement hub arrangements.
- Intangible assets: The ATO has been focusing on all types of intangible arrangements, including:
- The transfer or migration of intangible assets between an Australian entity and offshore related parties.
- The use of intangible assets, e.g., through licensing arrangements.
- DEMPE (development, exploitation, maintenance, protection and enhancement) functions and how they are remunerated.
- Characterisation of intangible transactions, including whether payments in the nature of a royalty have been appropriately recognised.
The ATO has recently released draft practice compliance guidance on Intangibles. This guidance provides a framework for assessing risks associated with intangibles. In addition, the ATO has been amending the relevant compliance forms (RTP, Local file and International dealings schedule) to source more information on how MNE incorporate intangibles into their supply chain.
It’s important for you to keep records of activity, as the transfer pricing risks associated with intangibles will be a significant area of focus of the ATO in the coming years.
How can you minimise transfer pricing risks?
In this environment of increasing ATO scrutiny, MNEs must actively manage their tax and transfer pricing risk profiles. To achieve this, MNEs need to address the following areas:
- Intercompany agreements: MNEs should ensure intercompany agreements reflect their actual supply chain and any changes. This could require amending the existing agreements or entering into new agreements. The agreements should appropriately reflect the new financial and commercial conditions. Specifically, it is important to understand whether changes in Incoterms are required considering the new responsibilities of the buyer and the seller for paying and managing various elements of the shipping process. Furthermore, MNEs should also consider the tax implications (income tax, customs and GST) of the new terms of the agreement before finalising them.
- Re-evaluation of functional profile: The increasing focus on building redundancy into all phases of the supply chain has meant that it is essential for MNEs to continually assess their business operations and their respective contribution to the global value chain. This is particularly true where key personnel or functions are moving into and out of Australia. Similarly, it’s crucial to monitor the appropriateness of profits throughout the supply chain.
- Digital Transformation: When employing new technologies in the supply chain, MNEs must consider where each of the key DEMPE functions are undertaken by group entities and ensure the appropriate allocation of profits.
- Transfer Pricing Documentation: MNEs must establish and maintain accurate transfer pricing documentation to support the supply chain disruptions and any other COVID-19 impacts, by documenting the impact of global situations, travel restrictions, vaccination requirements, and any other issues that arise.
How can we help?
In this changing environment, it is crucial to follow a systematic process to understand the business models and accordingly set up a transfer pricing structure that balances and optimises the operational, commercial and tax risks and benefits. Grant Thornton is well equipped to help MNEs set up appropriate transfer pricing frameworks in their journey of supply chain transformations in a post-COVID world, as well as review existing frameworks to test their relevance in the current operating environment.