Australia’s transfer pricing rules seek to avoid the underpayment of tax in Australia by having businesses price related party international dealings according to 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), and the risks assumed in carrying out these activities.
Pricing not in accordance with Australia’s transfer pricing rules is often referred to as ‘international profit shifting’.
Australia’s double tax agreements and domestic law require pricing of goods and services and allocation of income and expenses between related parties to accord with the arm’s length principle.
The arm’s length principle and comparability
The arm’s length principle uses the behavior of independent parties as a guide or benchmark to determine the pricing of goods and services and how income and expenses are allocated in international dealings between related parties. 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 OECD countries.
As many factors may influence prices or margins, you need to closely examine the dealings you are 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 examining the facts and circumstances of each case and recognizing there is 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 should not be expected to prepare or obtain documents beyond the minimum needed to reasonably assess whether their dealings with related parties comply with the arm’s length principle.
Businesses should consider the level of certainty they wish to achieve, having regard to 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 a transfer pricing audit if they do not have proper processes to determine arm’s length prices and cannot demonstrate to us the methods they have 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.
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, and dispute with, us
- to help explain your position to us
- to minimize penalties in the event of an audit adjustment, as any penalties will have regard to the extent and quality of the documentation kept.
See also: TR 2014/8 Income tax: transfer pricing documentation – Subdivision 284-E
Simplified transfer pricing record keeping options practical compliance guideline (PCG)
Simplified transfer pricing record keeping options have been developed to minimise the record-keeping for eligible taxpayers. The administrative safe harbour rules therein also allows taxpayers to better manage risks associated with international related party dealings by directing resources to transactions.
The ATO has issued a Practical Compliance Guide PCG 2017/2 https://www.ato.gov.au/law/view/document?DocID=COG/PCG20172/NAT/ATO/00001&PiT=99991231235958to assist certain concessional taxpayer groups. The options contained in this Guideline reflect the types of transactions or activities that are deemed low risk in the context of international related party dealings. The Guideline specifies the criteria for this group to self-assess their eligibility to use one or more of the eight simplification options.
There are eight simplified transfer pricing record keeping options available:
- small taxpayers
- intra-group services
- low-level inbound loans
- management and administration services
- technical services
- low-level outbound loans
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