8 June 2016
Global Tax Alert
News from Transfer Pricing
Australia’s new
transfer pricing
guidance impacts
profit attribution in
global value chains
starting 1 July 2016
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Executive summary
The 2016 Australian Federal Budget announcement to implement the changed
Organisation for Economic Co-operation and Development (OECD) transfer
pricing guidelines (CTPG) with application from 1 July 2016 requires immediate
attention. The CTPG implement Base Erosion and Profit Shifting (BEPS)
Actions 8-10 aligning transfer pricing outcomes with the value chain and
provide guidance on what are considered to be high risk related party dealings.
Taxpayers with the following intragroup arrangements may be significantly
impacted by the CTPG:
•Assumption of risks and attribution of associated profits by a group member
on a contractual basis including the use of “limited risk entities” in the global
value chain without the activity of managing those risks
•Commodity transactions not currently priced by applying the Comparable
Uncontrolled Price (CUP) method or where there are significant discounts to
the CUP in connection with marketing hubs
•Transfers of intellectual property (IP) where, when using up to five years look
back, the transfer value of the IP is inconsistent with actual profits attributed
to such IP
•Attribution of profits associated with the use of intangibles that is inconsistent
with the Development Enhancement Maintenance Protection Exploitation
(DEMPE) activities
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Global Tax Alert Transfer Pricing
The CTPG, together with the following major changes now
falling into place change the landscape for many multinational
enterprises (MNEs):
•Country by Country Reporting (CbCR) information collected
from 1 January 2016
•Multinational Anti-Avoidance Law (MAAL) effective from
1 January 2016
•Voluntary tax transparency code encouraged for adoption
from FY2016
•Diverted profits tax (DPT), for income tax years beginning
on or after 1 July 2017
•Multilateral instrument for changes to double tax treaties
(treaties) from late 2016
•Australian Taxation Office (ATO) Taskforce and increased
funding combined with a target to raise an additional
AU$3.7 billion over a four year period
•Increased penalties
Together these are a major catalyst for MNEs to review their
global value chain and operating structures.
Detailed discussion
Big picture impact of the CTPG
The CTPG further empower the ATO to challenge transfer
pricing arrangements. Taxpayers will need to ensure they
are prepared for possible ATO challenges. The CTPG are not
focused on pricing but rather what constitutes economic
substance in the global value chain (apart from championing
the CUP for commodities and the additional guidance on low
value added services). While keeping documentation up to
date remains important, the CTPG require a more holistic
approach including consideration of other developments in
the BEPS action plans. From a broader perspective, MNEs do
not have the luxury to wait for all pieces of the puzzle being
fully shaped with the start date of the CTPG less than one
month away.
The ATO is already framing its transfer pricing queries along
the lines of the CTPG, e.g., focus on the extent to which
DEMPE functions are performed in Australia. Recent ATO
focus has been on the MNEs in the pharma and high-tech
industries and whether there has been inadequate profit
attributed to such activities in Australia. This ATO focus has
now widened to all industries and forms part of the standard
ATO queries for transfer pricing reviews.
Transparency and information sharing initiatives form
strategic pieces of the BEPS puzzle that MNEs are struggling
to come to grips with. These initiatives are set to transform
the international tax environment and will require a globally
coordinated, consistent and well executed response from
MNEs involving decision makers at the highest levels within
the organization.
Detailed analysis of CTPG
OECD BEPS Actions 8-10 are focused on aligning transfer
pricing with value creation. Incorporation of the CTPG
requires immediate attention of affected companies.
1. Risk allocation (Chapter I)
From 1 July 2016 onwards, it will be even clearer that
a mere contractual allocation of risk is not sufficient to
conclude that the risk is appropriately borne by an entity.
The risk allocation will need to align with the functions
performed and financial ability to bear the risk. The risk will
be allocated to the entity that has the ability to control or
manage the risk and has the financial ability to bear it as
well.
Action – As part of an overall assessment of transfer pricing
policies and underlying operational and financial structures,
MNEs will have to evaluate whether the current allocation
of risk is likely to be respected from a transfer pricing
perspective. Where this is not the case, remedial action
may need to be undertaken to ensure that the contractual
allocation is respected. This could be by transferring the
right people to the entity assuming the risk or increasing
the financial capacity to assume the risk or alternatively,
realigning the contractual risk allocation and associated
profits with the substance. This may be particularly relevant
for low substance marketing and procurement hubs as well
as low substance IP holding entities.
2. Changes to entitlement to IP profits (Chapter VI)
From 1 July 2016 onwards, the ability for Australian
companies and their overseas related parties to be entitled to
IP related profits will depend on activities actually performed
having particular regard to what DEMPE functions are
undertaken. In essence, this focus broadens from financial
risk and decision making to functions that relate to the
development, enhancement, maintenance, protection and
exploitation of the IP.
Global Tax Alert Transfer Pricing
Action – Companies need to assess their profit profile and
determine whether any remedial action is required where
the DEMPE functions are not performed or appropriately
managed by an IP owner and the IP owner does not control
the risk in relation to the intangible. In these circumstances
the IP owner may only be entitled to a risk free return for tax
purposes on its investment. Conversely, where the Australian
company performs DEMPE functions, it may be entitled to
IP profits for tax purposes even where it does not legally
assume financial and operating risks and has historically
been compensated as a “limited risk” service provider.
3. Treatment of hard to value IP (Chapter VI) especially
early-stage transfers of IP
Many MNEs maintain some form of central IP ownership with
at least one of the IP owners typically located in a low tax
jurisdiction. This IP owner often acquires its interest in the IP
at an early stage of the development of the IP at a relatively
low value due to uncertainties on future commercialization
of the IP. Both the form of the transfer and the quantification
of the value of the IP are likely to come under close scrutiny,
especially if the actual value when viewed looking back up
to five years, differs significantly. Potential issues associated
with these transfers may be exacerbated where the IP owner
does not undertake significant DEMPE functions.
Action – These IP transfers will require more than an
independent valuation exercise. More specifically, a much
more detailed analysis of underlying assumptions will be
required. Mechanisms to adjust the transfer price based on
actual future performance may also be useful in mitigating
any potential challenges based on hindsight. It will also
be helpful to ensure that adequate DEMPE functions are
undertaken by the IP owner to support the bona fides of
the IP transfer itself.
4. Commodities pricing (Chapter II)
The impact of the commodities pricing guidance primarily
affects companies in the mining, resources and agribusiness
industries, with potentially some application in the chemical
industry. The CTPG enshrine the CUP as the most appropriate
method and allow publicly quoted prices to be used. There
are a few nuances as to how the CUP should be applied. In
particular the timing of the comparable transactions that
need to be carefully navigated. Further, the guidelines appear
to raise concerns where significant value is attributed to
central marketing and/or procurement hubs.
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Action – Companies in the affected industries should reassess
their transfer pricing policies for commodities to ensure
compliance with the CTPG and identify arrangements where
remedial actions may be required. Further, where marketing
hubs form part of the global value chain the profit attributed
to these activities should be carefully reviewed. It may be
necessary to look again at the evidence available to support
the attributed profit.
5. Low value services (chapter VII)
A major simplification from a transfer pricing perspective is
the blanket application of cost plus methods with a 5% markup on low value added services.
Action – Where low value added services are currently
provided at a higher rate or using a different method,
transfer pricing policies need to be reviewed and potentially
amended.
6. Other
Other changes, of limited impact in most situations, might
have significant impact in certain situations:
•Location savings
•Dealing with local market features
•Assembled workforce
•Group synergies including Halo effect versus guarantee
•Cost contribution arrangements (CCAs) - distinction
between service CCA and development CCA and valuation
of contributions in principle at market value
The CTPG should not impact the application of Australia’s
transfer pricing reconstruction power modifying commercial
and financial relations in the legislation. The CTPG are applied
after the reconstruction power and are relevant for the
determination of the arm’s length conditions.
Changes to profit split guidance are still to be finalized
(discussion draft at the moment). They are likely to increase
scope for profit splits where non-routine functions are
performed, e.g., pharmaceutical distributors and situations
where there are no reliable comparables.
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Global Tax Alert Transfer Pricing
Implications
Proactive responses may include:
At minimum, defensive actions may include:
•Update documentation to account for the changes ensuring
a globally consistent approach
•Test structures using data analytics and business process
analysis
•Analyze DEMPE functions to support current profit
attribution in connection with IP
•Undertake an overall health-check
•Prepare evidence to support the global value chain
•Realigning profit attribution in connection with IP to better
align with DEMPE functions
•Restructure of global value chain, asset ownership and risk
to better reflect functions being undertaken
•Review tax governance, reporting and public relations (PR)
strategy against possible negative challenges from external
commentators and internal stakeholders including potential
“whistleblowers”
For additional information with respect to this Alert, please contact the following:
Ernst & Young (Australia), Sydney
• Paul Balkus
• Daryn Moore
• Jesper Solgaard
+61 2 9248 4952
+61 2 9248 5538
+61 2 8295 6440
Ernst & Young LLP, Australian Tax Desk, New York
• Andrew Nelson
+1 212 773 5280
[email protected]
[email protected]
[email protected]
[email protected]
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purposes only and is not intended to be relied upon as
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