The ATO has released a draft update to PCG 2019/1, proposing several important refinements to the transfer pricing risk assessment framework for inbound distribution arrangements.
The guidance is relevant for businesses operating as inbound distributors, including those that:
- distribute goods purchased from foreign related parties
- distribute digital products or services where the intellectual property is owned by related parties offshore.
The proposed updates to PCG 2019/1 will affect how inbound distributors are risk rated, categorised and where applicable, reviewed by the ATO. These changes may increase compliance obligations and risk exposure for taxpayers with distribution arrangements.
What you need to know
Companies with inbound distribution operations should review the updated guidance and consider how this impacts the ATO’s assessment of their transfer pricing risks. This includes:
- understanding how the proposed profit markers have shifted across several industries (these markers have been updated for the first time since 2019 and will influence taxpayers’ risk ratings)
- identifying distribution activities noted by the ATO as generating greater value (and higher expected profits) and assessing the impact this will have on the company’s risk profile
- reviewing the updated definition of inbound distributors. Businesses that perform certain value creation activities fall outside of this guidance, with the ATO likely to expect these taxpayers to achieve profits higher than the predefined profit markers.
What the draft guideline is about
PCG 2019/1 outlines the ATO’s compliance approach to assessing the transfer pricing risk of inbound distribution arrangements. The ATO has developed a set of profit markers that are applied to assess the taxpayer’s risk (low, medium or high) based on their profit outcomes and the industry sector in which they operate.
Taxpayers should expect the ATO to monitor, test or verify the transfer pricing outcomes for inbound distribution arrangements that fall outside the low-risk category. For taxpayers that fall in the high-risk category, it is more likely the ATO will review their arrangements as a matter of priority.
Expanded definition of ‘inbound-distributor’
The ATO has historically defined businesses to be an inbound distributor where they are predominantly involved in the distribution of goods purchased from related foreign entities for resale, or the distribution of digital products or services where the intellectual property in those products or services is owned by related foreign entities.
In the updated draft guidance, the ATO has removed the word ‘predominantly’ from the definition of ‘inbound distributor’. The scope has been broadened to include any business whose activity comprises of distribution, even if it is not their main activity.
The ATO has also revised the definition for what counts as a ‘digital product distributor’, which excludes certain distribution arrangements from the risk assessment framework.
For example, entities that contribute significantly to the delivery of digital products such as owning or operating significant equipment in Australia to host or provide the products they are selling will not be considered distributors under this new definition. The ATO’s likely view is that these activities contribute substantial value, and higher profits should be earned by these entities compared to the guideline’s profit markers.
How are different industries affected?
The ATO provided a set of profit markers when PCG 2019/1 was first released in 2019. The profit markers consider activities undertaken by the inbound distributor and factors in activities they consider to incrementally generate value in the industry sector. The industry sectors include Life Science, Information and Communication Technology, Motor Vehicles and General Distributors.
- Life sciences
- Reduced EBIT margin profit markers for some distributors as follows:
- Information and communication technology
- Reduced EBIT margin profit markers for some distributors as follows
- General & Motor vehicle distributors
- Benchmarks remain unchanged
- Broader definition of ‘inbound distributor’ may capture more taxpayers
Next steps
As the ATO refines its expectations on the profitability of inbound distribution arrangements, now is an opportune time for businesses to reassess their transfer pricing position. Proactively evaluating how the revised definitions, updated profit markers and value‑creation indicators apply to your operations and their alignment with existing transfer pricing policies is important to mitigate ATO scrutiny.
Engaging early by identifying potential risk ratings, managing gaps in documentation, and considering whether alternative pricing models may be appropriate can help manage transfer pricing risks.
Our team of specialist advisers can help determine what the revised guidance means for you and your business. Reach out to our team of specialists today if you would like to have a conversation.
Learn more about how our Transfer pricing services can help you
