The ATO has released the revised Draft Practical Compliance Guideline PCG 2023/D2 (“draft PCG”), outlining the compliance approach to intangibles arrangements involving international related parties, addressing the tax issues associated with restructures (“migration”) or mischaracterisation of Australian activities in connection with intangible assets.
This draft PCG reflects comments received during initial consultation on PCG 2021/D4, with the ATO again opening this draft PCG to consultation.
Importantly it should be noted that this draft PCG does not address the proposed multinational enterprise integrity measure, denying deductions for payments relating to intangible assets connected with low corporate tax jurisdictions, announced as part of the 2022–23 Budget.
This draft PCG has an updated structure compared to its predecessor and details the ATO’s Compliance Approach, Risk Assessment Framework, and Evidence Expectations separately. While there is no stated date of effect, it is noted that the guideline will apply retrospectively once issued.
Part 1: The ATO’s Compliance Approach
The ATO will assess compliance risks associated with different arrangements based on their Risk Assessment Framework and will review Intangibles Arrangements to ensure compliance with other tax obligations such as capital gains tax and capital allowance provisions. They may also apply the General Anti-Avoidance Rules, including diverted profits tax, if an arrangement is found to be lacking substance.
The ATO's engagement and review activities will be influenced by the risk rating assigned to the arrangements, with those arrangements demonstrating a high-risk more likely to be subject to further review, while low-risk arrangements are less likely to be examined unless there is evidence of incorrect pricing. When reviewing an arrangement, the ATO may consider additional factors beyond those set out in the draft PCG.
Part 2: The ATO’s Risk Assessment Framework
The ATO’s risk assessment framework to evaluate compliance risks associated with intangibles arrangements consists of two tables:
- Risk Assessment Framework Table 1 which assesses compliance risks related to the migration of intangible assets, with questions concerning the restructures or changes involving intangible assets, the substance of the Relevant Entity, and the tax outcomes of the arrangement.
- Risk Assessment Framework Table 2 which assesses the risks associated with the Development, Enhancement, Maintenance, Protection, and Exploitation (“DEMPE”) activities performed in Australia. Table 2 applies to intangibles arrangements that do not involve the migration of intangible assets in the current year.
Taxpayers are required to self-assess their compliance risk by applying the risk assessment framework to each intangible arrangement, with the assessment involving consideration of various risk factors outlined in one of the two tables to determine whether the arrangement is categorised as high, medium, or low risk.
For existing intangible arrangements, the assessment should be done before lodging a tax return, and for new intangible arrangements, it should be done at the time of entering into the arrangement. Where multiple arrangements relate to the same intangible asset, or multiple intangible assets are naturally grouped together, then these can be considered as one Intangibles Arrangement for the purposes of self-assessment.
Examples of high, medium, and low-risk arrangements are detailed in Appendix 1 of the draft PCG, which also demonstrates the level of compliance risk associated with the different types of arrangements. The overall risk rating will be based on the total points allocated in either Risk Assessment Framework Table 1 or Table 2, and in the event of different risk ratings under both tables, the higher risk rating is considered the overall risk rating.
Part 3: The ATO’s Evidence Expectations
The ATO outlines their expectations for substantiating Intangibles Arrangements, with a non-exhaustive list detailed in Appendix 2 of the draft PCG. The complexity of the business and the contribution of Intangibles Arrangements to the business will dictate the type and level of evidence expected by the ATO to substantiate the Intangibles Arrangement, with the ATO considering the taxpayer's business systems, governance processes, and materiality thresholds. It should be further noted that these expectations do not replace the requirements for transfer pricing documentation but can assist in supporting and verifying such documentation.
The requirements set out in this draft PCG highlight the importance of reviewing existing Intangibles Arrangements and maintaining appropriate contemporaneous transfer pricing documentation, with insufficient documentation potentially resulting in a higher-than-expected risk rating. Once finalised, taxpayers preparing a Reportable Tax Position (“RTP”) schedule would be required to disclose their risk rating under this PCG.
Given the retrospective application and anticipated increased compliance burden associated with this draft PCG, it is advised to contact one of our Transfer Pricing specialists at Grant Thornton to discuss the impact of this further.
This draft PCG is open for consultation until 16 June 2023 with submissions to be made to IntangiblesArrangements@ato.gov.au.