Australia outlined how it plans to treat transfer pricing issues related to the location and relocation of certain business activities and operating risks into centralized operating models, commonly referred to as “hubs.”
The outline comes in a discussion paper the Australian Taxation Office (ATO) released as a draft practical compliance guideline. The types of activities that are commonly centralized include marketing, sales and distribution functions. The draft, open for comment until September 30, is aimed at helping taxpayers:
- Assess whether their hub arrangements pose a transfer pricing risk and how they can work with the tax office to mitigate that risk,
- Understand when the ATO may take a closer look at their hub arrangements and the documentation and evidence it will expect them to have readily available, and
- Understand their disclosure obligations.
The draft lays out ATO risk classification for offshore marketing hubs. For offshore marketing hubs, a green zone of low risk applies where the hub profit is less than a 100% markup of hub costs. For hub profits exceeding the 100% mark, the risk zones are:
- Blue — low to moderate risk where net tax impact is less than AUD$5 million a year,
- Yellow — moderate to high risk, with a net tax impact falling between AUD$5 million and AUD$50 million a year,
- Amber — high risk, with net tax impact exceeding AUD$50 million a year, and
- Red — very high risk for those not able or choose not to apply risk methodology or calculate tax impact.
The different zones reflect a number of variables including pricing indicators, possible tax at risk, taxpayer engagement and behavior and the quality of transfer pricing analysis and evidence. Typically a “hub” would have significant substance; however, it is likely the ATO may consider any entity performing any activity having a “markup on cost above 100%” out of the low-risk green zone.
Being out of that zone means you can expect the tax commissioner to monitor, test and/or verify the transfer pricing outcomes of the hub. High-risk-rated hubs will be reviewed as a matter of priority, the ATO said.
The documents identify and describe the features and attributes (scenarios) of hubs that are considered at low risk of not complying with the transfer pricing rules. The ATO says that following the hub protocols doesn’t limit or waive the law but acknowledges that, if you choose to follow it, or your hub already aligns with it, the tax office generally won’t allocate compliance resources to examine the transfer pricing outcomes of the hub.
The ATO stresses that the protocol doesn’t constitute a “safe harbor” and that the information doesn’t replace, alter or affect in any way the interpretation of tax law.
If you determine that a hub’s potential risk is outside the green zone, the ATO says there is no presumption that the hub arrangement is priced incorrectly. What it means is that the ATO considers the hub is at risk and it generally will conduct some form of compliance activity to further test the pricing outcomes.
The ATO says an offshore marketing hub will be assessed as being in the green zone if it satisfies both of these tests:
- The “cost plus” indicator. Based on the cost plus methodology, this is the primary test. The cost plus indicator is: Hub profit is less than or equal to a 100% markup of hub costs.
- The “commercial realism” indicator. This secondary test is applied to offshore marketing hubs that satisfy the primary test to cross-check that the profit outcomes of the hub are commercially realistic.
In recognition that this is the first time the Commissioner has publicly released guidance in relation to hubs and to encourage willing and cooperative compliance going forward, the Commissioner, for a limited time, is willing to remit penalties and interest if certain conditions are met. Specifically, if you make a voluntary disclosure in relation to back years and adjust its pricing to come within the green zone, the Commissioner will exercise his discretion to remit certain penalties and interest charges.
Down the road
In recognition of the complexity of these arrangements, the Commissioner’s undertaking will remain in place for 12 months from the date of publication.
Date of effect. Once completed, the new protocol will be effective from its date of issue and will apply to existing and newly created hubs. The ATO says the use and application of the rules will be continuously reviewed over the next three years. Any revisions to improve its efficacy will be made at the end of the review period or on an “as necessary” basis. The ATO says it will consult with taxpayers over proposed material changes.