Transfer pricing is very specialized area, not every business will have international transactions. We wrote this article is for you to get some ideas about Australian transfer pricing concepts and risks. We strongly suggest you find transfer pricing specialist to get suggestions before you arrange or perform any cross-border international transactions. 

Australia and International transfer pricing – concepts and risk assessment

Australia's transfer pricing rules seek to avoid the underpayment of tax in Australia. The rules aim to make sure that businesses price their related-party international dealings in line with what is expected from independent parties in the same situation.

Pricing for international dealings between related parties should reflect the right return for:

·       the activities carried out in Australia;

·       the Australian assets used (whether sold, lent or licensed);

·       the risks assumed in carrying out these activities.

Pricing that does not comply with Australia's transfer pricing rules is often referred to as 'international profit shifting'.

You should carefully consider the terms and conditions of any international dealings you enter into with related parties to ensure that your business outcomes properly reflect economic activity in Australia.

Australia's double-tax agreements and domestic law require that pricing of goods and services and allocation of income and expenses between related parties comply with the arm's length principle.

What’s situation has Transfer Pricing 

If you have international transactions with a related party – such as a loan from your foreign subsidiary – your Australian tax can be affected if the amounts for the transaction don't comply with the arm's length principle under the transfer pricing rules.

Some multinational businesses attempt to shift their profits to low-tax jurisdictions by setting unrealistic prices for their actual commercial or financial dealings with their related parties.

Businesses with related party international dealings may have their transfer pricing reviewed or audited by Australian Tax Office (“ATO”), with the possibility of pricing adjustments and penalties.

The more significant and broader the scope of a business's international dealings with related parties, the more likely ATO is to review those dealings. Businesses with significant levels of dealings whose tax performance is low compared to industry standards are at the greatest risk of review.

The arm's length principle and comparability

The arm's length principle uses the behaviour of independent parties as a guide or benchmark to determine in international dealings between related parties:

·       the pricing of goods and services, and

·       how income and expenses are allocated.

It involves comparing what a business has done and what an independent party would have done in the same or similar circumstances. This principle is supported by all Organisation for Economic Co-operation and Development (OECD) countries.

 

Many factors may influence prices or margins, so you need to closely examine the dealings you're comparing and the circumstances of the parties involved. This comparison with arm's length activity means it is difficult to achieve absolute precision and certainty.

 

For dealings to be comparable:

·       none of the differences between the situations should be material, or

·       reasonably accurate adjustments can be made to eliminate the effect of any such differences.

The materiality of any differences depends on the facts and circumstances of each case and recognising that there's likely to be some uncertainty in the judgments that have to be made.

Applying the arm's length principle

In assessing compliance with the arm’s length principle, you should exercise commercial judgment about the nature and extent of documentation appropriate to your particular circumstances. Both the ATO and the OECD state that businesses only need to reasonably assess whether their dealings with related parties comply with the arm’s length principle. They should not be expected to prepare or obtain documents beyond the minimum needed to do this.

Businesses should consider the level of certainty they wish to achieve, taking into account the impact of international dealings with related parties on their overall business. This assessment will determine the level of risk to which a business is exposed.

Businesses risk having a transfer pricing audit if they do not have proper processes to determine arm's length prices and cannot demonstrate to ATO the methods they've used to determine their prices. They also risk a transfer pricing adjustment and penalties as a consequence of any audit.

Arm's length methodologies

There are several internationally accepted methodologies that your business can use to comply with the arm's length principle. Australia's transfer pricing rules do not prescribe any particular methodology or preference to arrive at an arm's length outcome. You should seek to adopt the method that is best suited to the circumstances of each case.

Whatever method you use should give a commercially realistic outcome. It is generally expected that a reasonable business person would seek to:

• maximise the price received for supplying property or services, taking into account their business strategy, economic and market circumstances, and minimise the costs associated with acquiring property or services.
• be adequately rewarded for any activities carried out. 

Documentation requirements

You must keep documentation that can substantiate compliance with the arm's length principle.

Transfer pricing documentation and Subdivision 284-E provides further details on how to demonstrate that you have complied with the principle.

There are sound practical reasons why you should adequately document compliance with the arm's length principle, namely:

• to reduce the risk of audit by ATO, and dispute with ATO
• to help explain your position to ATO
• to minimise penalties in the event of an audit adjustment, as any penalties will take into account the extent and quality of the documentation kept.

International dealings schedule

If your business is engaged in international dealings with related parties, and has more than $2 million of related-party dealings, you are required to complete an international dealings schedule (IDS) and lodge it with your income tax return for that year.

The IDS imposes obligations to disclose information about related-party international dealings, including:

·       the nature and amount of certain categories of transactions

·       details of dealings of a financial nature

·       receipts or payments of non-monetary consideration

·       details of restructuring events

·       details of arm's length methodologies used

·       the level of documentation held to support the selection and application of the most appropriate arm's length methodologies

·       details of disposals or acquisitions of any interest in a capital asset.

The IDS allows you to notify ATO if you are eligible and choosing to adopt any of the simplified transfer pricing record-keeping options. ATO developed some simplified transfer pricing record-keeping options (simplification options) so eligible businesses can opt to minimise record-keeping and compliance costs.

The IDS may change from year to year, so make sure you check the schedule and accompanying instructions for the income year you are addressing. You will need to refer to Schedule 25A for relevant income years prior to 2011–12.

ATO will publish instructions each year to help businesses complete their IDS.

Take care when completing your IDS. ATO uses the information provided to help identify businesses that may pose a transfer pricing risk. If you fail to complete an IDS where required, you may incur penalties or be prosecuted.

We suggest you to engage a transfer pricing specialist to help you to prepare the IDS and related documents. 

Transfer pricing risk assessment

Businesses with related-party international dealings may face:

·       a client risk review

·       a subsequent audit, with possible pricing adjustments and penalties.

ATO generally allocates resources to transfer pricing cases based on the perceived risk to revenue of businesses not complying with the arm's length principle.

The broader and more significant the scope of a business's international dealings with related parties, the more likely we are to do a client risk review.

Your business is at the greatest risk of a client risk review if it:

·       has significant levels of international dealings with related parties

·       pays less tax compared to industry standards

·       has recently undertaken business restructures that materially affect its related-party international dealings.

Transfer pricing is very specialized area, not every business will have international transactions. We wrote this article is for you to get some ideas about Australian transfer pricing concepts and risks. We strongly suggest you find transfer pricing specialist to get suggestions before you arrange or perform any cross-border international transactions. 

Claire was working in big four accounting firms specialized in transfer pricing, Claire and her international colleagues/partners in CTAC group from China, US, Korea, HK, Germany, etc to support our clients to deal with international transactions issues. 

Chang Accounting Advisory Pty Ltd, we are CPA practice and tax agent. If you or your families or friends need our services, please feel free to contact our team for any assistance. 

This article is for informational purposes only and does not form part of our advice. This article is based on Australian Taxation Office (ATO). Please contact our team if you need any assistance.

Claire Chang, 0497 131 419, claire.chang@changadvisory.com.au, WeChat: clairechang26

Michelle Cui, 0433 539 870, michelle.cui@changadvisory.com.au, WeChat: michellejc