Understanding the R&D tax incentive

The Australian Government has introduced the Tax Laws Amendment (Countering Tax Avoidance and The Australian Government has introduced the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 amending the transfer pricing rules.

These reforms will have a substantial impact on all businesses operating internationally.

The new rules will apply to income years commencing on or after the earlier of 1 July 2013 and the day the Bill receives Royal Assent.

Broadly, the new rules may automatically deem the amounts taken to be paid or received for goods, services to be different to the actual amount paid where the parties are not considered to be dealing on “arm’s length terms” and a transfer pricing benefit is obtained.

By altering the transfer price amount, tax liabilities may be manipulated.

It should be noted that the rules apply to any “commercial or financial relation” between cross border parties, including interest charges on loans.

Addionally taxpayers often forget to include in their transfer pricing policies internally generated services such as HR, accounting and finance, marketing and sourcing which is often done in a central office on behalf of the cross border group.  This is often overlooked and the ATO will require the pricing of these to the overseas entity to be based upon a third party rate.

Key reforms

Arm’s length conditions

The new rules focus on arm’s length conditions and require that dealings between international related parties be priced on the basis that the actual conditions between entities in their business dealings are ignored and prices must be determined on “internationally accepted arm’s length principles”.

For the transfer pricing provisions to apply, it must be determined that independent entities would not have done what was actually done given the options available to them.

The identification of the relevant arm’s length conditions must be done in a way that best achieves consistency with prescribed guidance material, particularly the Organisation for Economic Co-operation and Development (OECD) guidelines. There may be some difficulties in applying the new rules where the Australian “conditions” and OECD Guidelines do not directly correlate.

Thin capitalisation and transfer pricing

Broadly, the thin capitalisation provisions operate to limit the deductibility of interest in respect of certain cross-border financing arrangements. The transfer pricing provisions might either reduce or increase the deemed interest charge.

The transfer pricing provisions only require the interest rate (not the quantum of debt) to be set as if arm’s length conditions had operated. However, the ATO may determine the level of acceptable interest charged based on an arm’s length level of debt.  This figure may be lower than the actual loan amount. It will be necessary to perform a transfer pricing analysis of all cross-border financing arrangements.

Documentation

Where the ATO has concluded that there existed a sole or dominant purpose to obtain a transfer pricing benefit, any transfer pricing adjustments may attract a minimum penalty of 50% of the tax shortfall.  Where documentation supporting a reasonable arguable position is provided, then the minimum penalty may be reduced to 25%.

There will be no penalties for transfer pricing adjustments where the amount of additional income tax or withholding tax payable as a result of an adjustment falls below:

  • for trusts and partnerships, the greater of $20,000 or 2% of the entity’s net (taxable) income per the tax return; and
  • for all other entities, $10,000 or 1% of the income tax payable per the tax return.

In many cases, taxpayers will be required to undertake a full transfer pricing analysis just to determine if they fall within such low levels.

Amendment periods

The new rules will require transfer pricing adjustments to be made within seven years of the date on which an entity receives an assessment. This is considerably longer than the ordinary four-year amendment period the ATO has for most other tax adjustments.

Self-assessment

Transfer pricing is now in the self-assessment regime. This means that there is a much higher burden on taxpayers. Taxpayers will have to consider transfer pricing to ensure that taxable income is consistent with arm’s-length conditions.

What does this mean for you?

These reforms will have a substantial impact on all businesses operating internationally. Taxpayers will need to revisit their approach to transfer pricing. In particular, they will need to ensure that:

1. adequate documentation is in place before lodgement of relevant tax returns; and

2. their transfer pricing approach is fully and accurately reflected in the International Dealings Schedule lodged with their Australian tax returns.

The new rules will mean that more transactions will require transfer pricing rules analysis. The onus is placed on taxpayers to ensure that they have correctly calculated their taxable income. Therefore, if the transfer pricing rules are not considered, taxpayers could incur increased tax assessments and penalties.