introduction to Transfer pricing

1. introduction to Transfer pricing • 22 January 2019 • David Bond, Director +61 9211 7426 David.Bond@greenwoods.com.au • Kristy-Lee Malkki, Associate +61 9211 7428 Kristy-Lee.Malkki@greenwoods.com.au

2. Agenda • What is transfer pricing? • Transfer pricing legislation • APAs • Transfer pricing compliance

3. What is transfer pricing?

4. What is transfer pricing? • International trade • About 60% of international trade occurs between subsidiaries of multinationals. • The pricing of these transactions impacts the tax liabilities of these multinationals in the countries they operate. For example making a lower profit in the country with the higher tax rate. • Tax Authorities’ response • Transfer pricing represents a significant threat to tax revenues, particularly in higher tax countries • Tax authorities around the world are devoting resources to informing their transfer pricing rules • The BEPS project is part of this response. • “

5. What is transfer pricing? • “

6. transfer pricing legislation • The transfer pricing rules are contained in Division 815 of ITAA 97: • Subdivision 815-A: treaty-equivalent cross-border transfer pricing rules • Subdivision 815-B: arm’s length principle for cross-border conditions between entities • Subdivision 815-C: arm’s length principle for permanent establishments • Subdivision 815-D: special rules for trusts and partnerships • Subdivision 815-E: reporting obligations for significant global entities

7. subdivision 815-B – Transfer pricing benefit Transfer pricing benefit • “Actual conditions” - different to “arm’s length conditions” • “Cross border test” is satisfied • Replacing “arm’s length conditions” would result in: • higher taxable income; • lower losses; or • lower tax offsets • “Arm’s length conditions” are substituted in calculating taxable income • (self assessment provision)

8. ACTUAL conditions • Commercial or financial relations • Broad enquiry about all the relevant or comparable circumstances • Comparable circumstances • Functions performed, assets used, and risks borne by the entities • Characteristics of any property or services transferred • Terms of any relevant contractsbetween the entities • Economic circumstances • Business strategies of the entities.

9. Reconstruction provisions Basic Rule Arm’s length conditions must be based on the commercial or financial relations in connection with which the actual conditions operate, having regard to both the form and substance of the relations Exceptions • where the substance is inconsistent with form • where independent parties dealing wholly independently with one another: • would not have entered into the commercial or financial relations • but instead would have entered into other commercial of financial relations • where independent entities would not have entered into the commercial or financial relations

10. Reconstruction – substance v form Case study Foreign IP Owner 100% R&D services contract • Australian R&D activities

11. Reconstruction – Would have entered into different arrangements (1) Case study Foreign Manufacturer 100% Sale of products • Australian distributor Assumes warranty risk, and receives warranty fee = 1% sales Market evidence that independent distributors don’t assume warranty risk

12. Reconstruction – Would have entered into different arrangements (2) Case study Parent 100% $100m loan • Australian gas subsidiary - AUD loan - 10 years

13. Reconstruction – Would not have entered into the arrangements Case study Parent 100% Transfer of distribution business • Australian subsidiary

14. OECD guidelines • Arm’s length conditions: • Identify arm’s length conditions so as to best achieve consistency with: • OECD Transfer Pricing Guidelines last amended on 22 July 2010. • OECD Report - Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 - 2015 Final Reports(BEPS)

15. arm’s length conditions • Arm’s length conditions: • Conditions you would expect to operate between independent entities • Dealing with each other wholly independently • In comparable circumstances. • TP rules: • Can apply to transactions between third parties • Use traditional transfer pricing methods to identify “arm’s length conditions.

16. transfer pricing Methods • Arm’s length methodologies • Traditional transaction methods: • Comparable uncontrolled price (“CUP”) method • Resale price method • Cost plus method • Transactional profit methods: • Profit split method • Transactional net margin method

17. transfer pricing methods • CUP example

18. transfer pricing methods • TNMM example AusCo is a distributor of krill oil, which it purchases from SwedenCo, a related party. Revenue: 6,500,000 Cost of Goods: 6,100,000 Profit 400,000 EBIT: 6.15%

19. RECAP of subdivision 815-B

20. advance pricing agreement A taxpayer can apply to the ATO to join the APA program. It provides the taxpayer with an opportunity to reach an agreement with the ATO on the future application of the arm's length principle to the taxpayer’s international related party dealings.

21. advance pricing agreement

22. advance pricing agreements

23. compliance requirements • Transfer Pricing Documentation • Country-by-Country Reporting • International Dealings Schedule • Reportable Tax Position Schedule

24. Transfer pricing documentation • Subdivision 284-E Tax Administration Act: • Transfer Pricing Documentation (explains how Subdivision 815-B applies to the transaction and meets certain requirements) • In English • Prepared before lodgement of income tax return • Otherwise deemed not to have a RAP and so subject to higher level of penalties • Assist public officer reach view that no transfer pricing benefit and therefore does not need to self assess transfer pricing adjustment

25. Country-by-country reporting (SGE only) • Country by country reports: • Country-by-Country Report • (Spreadsheet with data for each group entity) • Master File • (Word document describing global business) • Australian Local File (IDS on steroids) • Part A • Part B • Short Form Local File • Due 12 months after year end

26. international dealing schedule • Lodged with the ATO as a schedule to the income tax return • Applies to all Australian entities with related party transactions in excess of $2 million or with branch operations • Informs the ATO of: • the aggregated income and expense amount of each type of related party transaction; • total value of the related party loans held and issued; • amounts recorded as claimed and returned for branch operations; and • the aggregated value of transactions with entities in specified countries.

27. Reportable tax position schedule • Lodged with the ATO as a schedule to the income tax return • Applies only to companies in public or international economic groups with a turnover greater than $250 million, which the ATO have notified in writing • The RTP schedule requires taxpayers to disclose their most contestable and material tax positions: • Category A: a position that is about as likely to be correct as incorrect, or less likely to be correct than incorrect • Category B: a position in respect of something disclosed in the taxpayer's financial statements or a related party's financial statements which is uncertain • Category C: a reportable arrangement

28. What IS the ATO worried ABOUT? • Large and complex transactions with few comparables available • The global economic value creation chain and hubs • Profitable functions that are performed outside Australia in low tax jurisdictions, such as Singapore • Dealings in intangibles • Business restructures • Project finance in Australia • Financial instruments, derivatives and hybrids • Debt pricing and guarantee fees • Large industries such as LNG

29. Contact us • David Bond • Director, Perth • T +61 8 9211 7426 David.Bond@greenwoods.com.au • Kristy-Lee Malkki • Associate, Perth • T +61 8 9211 7428 • Kristy-Lee.Malkki@greenwoods.com.au