Transfer pricing laws and why it’s time to review your profits
With the Australian Tax Office (ATO) continuing to target multinational corporate tax avoidance, the Australian distributors of products and services from overseas companies need to be aware of the latest guidance surrounding transfer pricing laws. A review of your distribution arrangements with a qualified adviser is one of the ways you can gain more certainty that you’re not in breach of the rules.
Distribution arrangements for Australian inbound distributors
Overseas corporates usually set up an Australian subsidiary to distribute their products and services in Australia. This includes software and other digital services. The intellectual property (IP) in those products or services is owned by the overseas parent company.
The Australian inbound distributor can then market those products and services to Australian businesses by:
- selling the products/services;
- sub-licensing the overseas parent company’s IP; or
- facilitating the grant of an IP licence from the overseas parent company, to a third party purchaser.
The Australian inbound distributor receives payment for the goods and services from the Australian purchaser, and then pays the overseas parent company for the distribution rights. That amount they pay is a matter the ATO is looking at closely.
If the subsidiary pays too much to the overseas parent company, the resulting reduction in the Australian inbound distributor’s profits might be considered tax avoidance under Australia’s tax rules. This is why it’s important for Australian inbound distributors and their officers to familiarise themselves with the ATO’s approach to transfer pricing, to ensure they’re not penalised under Australia’s tax rules.
The ATO’s approach to profit
The latest guidance from the ATO outlines its approach to compliance.
In most cases, for Australian inbound distributors, the ATO will:
- Analyse the Australian inbound distributor’s ‘earnings before interest and tax’ relative to sales, in connection with the distribution arrangement with the overseas parent company;
- The ATO will use that analysis to assess the Australian inbound distributor’s ‘profit outcome’ from its distribution relationship with the overseas parent company;
- The ATO then compares the Australian inbound distributor’s profit outcome, against ‘profit markers’ that the ATO has developed for Australian entities that operate in the same industry sector. For example, specific profit markers have been developed for the life sciences, information and communication technology, and motor vehicle industries, as well as a general schedule for other distributors;
- The ATO then determines the ‘transfer pricing risk’ based on the difference between the profit outcome and profit markers.
Generally, the distribution arrangement should be ‘at arm’s length’, using what independent parties would have done in similar circumstances as a benchmark.
The levels of transfer pricing risk
The ATO has issued guidance around how it responds to the different levels of transfer pricing risk that it’s calculated.
- Low transfer pricing risk: it’s unlikely the ATO will allocate compliance resources to assess the transfer pricing outcomes (other than to confirm the Australian inbound distributor’s activities);
- Medium transfer pricing risk: the ATO will monitor the arrangements using available data and may contact the Australian inbound distributor before allocating compliance resources;
- High transfer pricing risk: the ATO may contact the Australian inbound distributor expressing its concern, actively monitor its arrangements, and commence a review or audit.
However, it’s important to note that the profit markers do not act as a ‘safe harbour’. Falling either side does not guarantee that the ATO will or will not conduct an audit or take compliance action.
What is the next step for Australian inbound distributors?
To make sure they’re not in breach of the tax rules, these are some of the steps that Australian inbound distributors should take.
- Review their distribution arrangements with their overseas parent company;
- Seek good accounting advice about transfer pricing issues;
- Document all steps that they’ve taken to assess the risk level of their distribution arrangements with the overseas parent company and ensure compliance with Australia’s transfer pricing laws.
Australian inbound distributors can also take advantage of the ATO’s ‘advance pricing arrangement’ programme. This facilitates an agreement with the ATO about the pricing of the distribution arrangements which can provide the Australian inbound distributor with some certainty about its liability under the transfer pricing laws.
If it’s time for a review of your distribution arrangements and how to ensure compliance with transfer pricing laws, contact our IP team at Mahoneys.