A strict new Australian approach to transfer pricing will impact New Zealand businesses with Australian operations.
New Zealand might be a small fish in the global pond but it features prominently on the Australian Tax Office’s (the “ATO’s”) radar for cross-border related party transactions. ATO’s statistics show New Zealand is the 6th most significant country by value of related party revenues and expenses for Australian businesses. It can therefore be expected that the ATO will be looking very closely at transactions between Australian and New Zealand entities.
Australia amended its transfer pricing rules in 2013. The ATO have released two draft rulings which apply these new rules. They outline a hard-line approach to transfer pricing:
• The new rules allow the ATO to disregard, or reconstruct, related party transactions where the economic substance does not match the legal form. In a nutshell, the test is no longer whether the transfer price is “arm’s-length”, but also whether the transaction itself is. For example, it is not only whether the interest rate on a related party loan is arms-length but also whether the company could have borrowed, and how much. This means that the ATO can effectively re-characterise a debt instrument as equity. The ATO’s threshold is whether the transaction would have taken place between independent parties.
• The ATO has also prescribed enhanced transfer pricing documentation requirements. Documentation will now need to comply with a “reasonably arguable position” standard, to mitigate the risk of penalties. This includes documentation being in place by the time Australian tax returns are filed and regularly updated.
According to KPMG the draft rulings will significantly increase the compliance burden for New Zealand businesses with Australian operations (i.e. subsidiaries or branches).
For such businesses, checking whether the ATO has grounds to disregard the form of related party transactions – be they funding structures, royalty arrangements, payments for services, or other support payments – will be critical. Any mismatch between the economic substance of the transaction and the legal form may be considered a significant weakness in the Australian transfer pricing position and open to challenge by the ATO. Accordingly, inter-company agreements should be regularly revisited to address any deficiencies, with documentation prepared and updated annually.
The potential for the ATO to reconstruct debt as equity, under transfer pricing rules, conflicts with the Australian thin capitalisation rules. The draft ruling suggests the thin capitalisation rules may be overridden. This will create uncertainty for businesses on how “safe” the Australian thin capitalisation safe harbour really is.
The ATO considers its new approach to be consistent with the OECD’s guidelines. However, the outcomes are potentially beyond those envisaged under current international practice. It also highlights that transfer pricing approaches which have been accepted by tax authorities elsewhere may not withstand a challenge by the ATO. This raises potential for double taxation.
The enhanced documentation requirements (including a specific link to Australian legislation), while conceptually similar to the ATO’s previous approach, will force transfer pricing analyses to be more extensive. At a minimum, it confirms the need for Australian transfer pricing documentation if New Zealand businesses have significant related party transactions with their Australian operations. More generally, it is no longer sufficient to treat the preparation of transfer pricing documentation as a one-off or irregular exercise; the ATO now expects annual updates. The loss of Australian penalties protection will be a significant incentive to keep up to date.
"We consider it best practice to consider the Australian transfer pricing position in tandem with the New Zealand position, to ensure both are consistent, well supported and documented," says Kim Jarrett, partner–Transfer Pricing, at KPMG.
Source: KPMG taxmail Issue 1 – May 2014
