May 21, 2021
Australian Taxation Office issues compliance guidelines on Intangibles Arrangements
On 19 May 2021, the Australian Taxation Office (ATO) released guidance on Intangibles Arrangements with international related parties in draft Practical Compliance Guideline (PCG) 2021/D4. This represents the latest of the ATO’s transfer pricing-focused PCGs.
The PCG outlines the ATO’s compliance approach and risk factors connected with ”Intangibles Arrangements,” encompassing arrangements connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets or where intangible assets are migrated offshore. The definition of intangible assets and the DEMPE framework are sourced from the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines.
Similar to the other transfer pricing focused PCGs, the ATO’s risk assessment framework identifies three risk categories (i.e., low, medium and high risk) for Intangibles Arrangements based on various risk factors and the level of supporting evidence prepared. These factors include:
A key requirement of the PCG is the increased analysis and supporting evidence required by the ATO when analyzing Intangibles Arrangements. In this regard, the PCG outlines exhaustive supplementary documents that may be requested during a review to identify the benefits of any Intangibles Arrangements, the nature of intangible assets utilized, the commercial considerations associated with the arrangement, the DEMPE activities and the profit outcomes between the parties.
Notwithstanding the guidance provided in relation to documentation, the PCG does not go further and address issues in relation to how Intangibles Arrangements should be remunerated, priced or benchmarked. Given this exclusion, the PCG notes that “exhibiting Medium or Low Risk Factors may not exclude your Intangibles Arrangements from further review.”
It is expected that once the PCG is finalized, taxpayers that are required to file a Reportable Tax Position (RTP) Schedule will be required to disclose the risk rating for their Intangibles Arrangements.
The PCG confirms that the ATO will review Intangibles Arrangements with a focus on identifying arrangements that mischaracterize Australian DEMPE activities. In particular, the ATO is concerned with whether the functions performed by Australian entities (in connection with the DEMPE of intangible assets) are properly recognized and remunerated in accordance with the arm’s-length principle embodied in Australia’s transfer pricing rules.
The PCG is aimed at achieving compliance with each step of the Australian legislation as well as consistency with the relevant transfer pricing guidelines (i.e., Chapter I, VI and IX of the 2017 OECD Guidelines). On this basis, consistent with the obligations of Subdivision 815-B, the PCG guides taxpayers to first assess whether the ”actual conditions” of the Intangibles Arrangements are consistent with the ”arm’s-length conditions.” In the event they are different, there may be a requirement to substitute the arm’s-length conditions.
Consistent with other transfer pricing PCGs, the level of engagement (or likely ATO review) will be dependent on the risk assessment of the Intangible Arrangements. In this regard, if an intangible arrangement exhibits one or more of the High-Risk Factors (as described below), the ATO will likely commence further engagement which may include a review or audit.
The PCG does highlight that the advance pricing arrangement (APA) program can provide taxpayers with certainty on their Intangibles Arrangements. However, to be accepted into the APA program, the ATO will expect that the documentation and evidence prepared is consistent with the requirements of this PCG. Further it is indicated that a taxpayer will be more likely to be invited to make a formal APA application where the Intangibles Arrangements exhibit the Low Risk Factors.
The PCG outlines 4 risk factors and 12 examples that form the basis of the ATO’s risk assessment. The four risk factors are summarized below.
Evidence of the commercial considerations and decision making
In circumstances where a taxpayer has restructured or had a change of arrangement, there is an expectation that the taxpayer analyzes and documents the circumstances in which the restructure was entered into or occurred.
Evidence to support this position should be contemporaneous and verify the market value of any intangibles acquired (or sold), identify the tax and commercial objectives considered and any other considerations. The evidence and documents potentially required by the ATO is exhaustive and includes:
Understanding the form of the Intangible Arrangement
The form of the arrangement should be substantiated by documents, such as legal agreements, internal guidelines, manuals, policies, procedures and governance documents. These documents could include:
Identifying intangible assets and connected DEMPE activities
The documentation should accurately identify the nature of the intangible assets, the DEMPE activities and evidence the entities that manage, perform and control DEMPE activities. The supporting evidence may include:
Analyzing the tax and profit outcomes of the Intangibles Arrangements
Documentation should substantiate the economic outcomes and benefits obtained by relevant entities which align with the DEMPE activities and the functions performed. In considering whether the tax and profit outcomes are consistent with the commercial and economic substance, the evidence assessed may include:
Intangibles Arrangements examples
Appendix 2 provides 12 examples of Intangibles Arrangements and their risk assessment under the PCG framework (i.e., High, Medium or Low risk). The PCG is therefore ”example heavy,” but the focus of the examples provides some insights into the ATO’s areas of concern. While the inclusion of examples is welcomed, the risk assessment for these examples is heavily impacted by a ”statement of fact” on whether the documentation prepared was either not maintained (i.e., High Risk), incomplete (i.e., Medium Risk) or substantiates the arm’s-length nature of the arrangement (i.e., Low Risk). As such, it raises the question as to the extent to which these examples provide practical guidance on the nature, quantum or type of analysis required to differentiate between a Low and Medium Risk assessment.
Reportable Tax Position (RTP) Schedule
As noted, the PCG anticipates companies required to file an RTP Schedule with their corporate income tax return may be required to disclose:
As highlighted above, if the RTP discloses one or more of these High-Risk Factors, the ATO will be likely to undertake further engagement with taxpayers, which may include a review or audit.
The key implications from the release of the PCG are:
EY has been, and continues to be, involved in ongoing consultation with the ATO regarding the scope and details of the PCG.
In this regard, the ATO continues to encourage taxpayers to proactively engage with them to address specific issues.
EY will work closely with taxpayers in these discussions in order to raise issues and help to achieve an increase in clarity of the ATO’s expectations. We welcome your input as part of this process.
For additional information with respect to this Alert, please contact the following:
Ernst & Young (Australia), Sydney
Ernst & Young (Australia), Perth
Ernst & Young (Australia), Melbourne
Ernst & Young (Australia), Brisbane
Ernst & Young (Australia), Adelaide
Ernst & Young LLP (United States), Australia Tax Desk, New York
Ernst & Young LLP (United Kingdom), Australia Tax Desk, London