Australia - ATO’s continued focus on MNEs and arrangements with intangible assets

The Australian Tax Office (ATO) has released an updated draft Practical Compliance Guideline (PCG) on intangible arrangements (PCG 2023/D2) for public consultation and comments. The original draft (PCG 2021/D4) was released two years ago in May 2021, and there are significant changes in the current version.

The release of the updated draft PCG coincides with other proposed tax integrity measures, focused on multinationals and treatment of intangible assets, including:

  • Deduction denial for royalties paid to low-tax jurisdictions - The proposed bill on denying deductions for payments relating to intangibles connected with low-tax jurisdictions. This measure is acknowledged in the draft PCG but is not covered therein.
  • Public disclosure of country-by-country (CbC) reporting - The proposed bill to publicly disclose CbC reporting information to the public requires providing the book value and list of intangible assets held in each jurisdiction.

While the overall position of this draft has not changed from the prior version, the draft outlines the ATO’s compliance approach regarding intangible arrangements involving international parties with respect to:

  1. Arrangements involving the migration of intangible assets; and
  2. Arrangements involving mischaracterisation of Australian activities related to the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets.

The draft PCG continues to provide comprehensive guidance and sets out the ATO’s compliance approach including its risk assessment framework under Table 1 (migration of intangibles) and Table 2 (Australian DEMPE of intangible assets) adopting a points-based assessment relating to all types of intangible arrangements and DEMPE activities performed both on and offshore. The inclusion of the ATO risk assessment framework is probably the biggest change to the guidance in comparison to the previous draft. When finalised, the PCG will have retrospective application as it would apply both to future and historic arrangements involving intellectual property migration.

Due to the inherently complex nature of the topic, the draft PCG focuses on qualitative factors as part of the assessment and, therefore, introduces a high degree of subjectivity in the application of the risk assessment framework. Although the existence of documentation is no longer driving the risk rating, a high focus is placed on the supporting documentation and evidence to be able to substantiate the assessment, including:

  • Commercial considerations and decision-making processes
  • Understanding the substance of the activities
  • Identifying and evidencing the intangible assets and connected DEMPE activities
  • The tax and profit outcomes.

In addition to the application of transfer pricing principles, the draft guidance considers other tax risk areas arising from intangible arrangements such as withholding tax, capital gains tax, general anti-avoidance provisions (GAAR), diverted profits tax (DPT) and also supplements the existing Taxpayer Alerts (TA 2018/2 and TA 2020/1) surrounding arrangements involving intangible mischaracterisation and non-arm's-length arrangements and schemes.

Unlike the tax integrity measures noted above that apply only to Significant Global Entities (SGEs)/country-by-country reporting entities, the draft PCG guidance applies to all types of taxpayers and does not include a materiality threshold. As such, the ATO expects taxpayers to maintain a high level of analysis and documentation to support their intangible arrangements in addition to documents that evidence arm’s length outcomes.

Once the PCG is finalised, for those taxpayers required to lodge a reportable tax position (RTP) schedule, additional reporting obligations will include the need to self-assess and disclose the taxpayer’s assessment of each of the risk factors identified by the ATO under part two of this guidance. 

Date of application

As noted above, once finalised the PCG will apply to both prior and future years.  In the meantime, the current draft is subject to a public consultation process and all submissions were due by 16 June 2023.

BDO comments

In addition to having a points-based assessment framework, this draft PCG is more comprehensive than the previous draft. However, the application of the risk assessment framework outlined under Table 1 and Table 2 is subjective in nature and therefore will be highly dependent on the quality of evidence collected when substantiating the assessment.

The draft PCG makes it clear that the transfer pricing provisions operate separately and independent of the risk assessment framework provided under this PCG. This creates additional compliance expectations for taxpayers to maintain a laundry list of evidence to support their intangible arrangements, including disclosures in the RTP schedule. Importantly, there is currently no materiality threshold for the application of this guideline.

The ATO’s expectations concerning contemporaneous evidence required to support transfer pricing arrangements is consistent with a global trend whereby tax authorities are increasingly expecting more analysis and evidence to be created at the time arrangements are entered into and maintained to support these arrangements at a later point in time.

The requirement to maintain the expected documentation and evidence outlined in the draft PCG at the time of seeking entry to an advance pricing arrangement (APA) program could demotivate taxpayers looking for certainty on their intangible arrangements. This is disappointing given the inherently complex nature of dealing with intangibles and the desire by taxpayers to utilise the APA program to achieve greater tax certainty.

With respect to any intangible assets migrated/transferred in earlier years, the guidance is not clear on the number of prior years the ATO expects a taxpayer to complete the risk assessment framework for. This naturally creates greater uncertainty for historic arrangements and taxpayers will need to consider the materiality and potential risk if they choose not to backfill historic arrangements with additional/robust evidence. 

The PCG states that the ATO will consider the taxpayer’s business systems and governance processes, including any appropriate materiality threshold that a taxpayer applies in their businesses, to determine a reasonably expected documentation level. While this is a welcome move, in practice a business may adopt a different measuring stick than a tax authority, leaving room for uncertainty.

We strongly recommend that taxpayers assess their intangible arrangements, given there is now a substantial body of guidance issued on the subject and it’s clear that the subject of intangibles is one of the ATO’s key focus areas. It is also critical for taxpayers to be aware of the risk rating of their intangible arrangements, and to ensure they have sufficient evidence to support those arrangements. 

The risk rating of intangible arrangements, including whether the arrangement falls within one of the examples provided by the ATO in Appendix 1 of this PCG, should be maintained on file, together with the documents and evidence outlined in Appendix 2 of the draft PCG.  

The ever-increasing administrative burden placed on taxpayers seems to be here to stay and taxpayers will need to continue to assess the group’s risk appetite and tax governance policies to decide how to deal with these ongoing demands.

How can BDO help you?

Given the PCG’s retrospective application when finalised, and the similarity of its risk assessment framework with other transfer pricing guidance, it is clear the ATO will expect all affected taxpayers to self-assess their intangible arrangements. We encourage impacted taxpayers to start considering all arrangements within scope of the PCG to ensure they have sufficient evidence to support positions adopted.

We encourage you to contact a BDO adviser if you think you may be affected by this guidance or are unsure of your risk profile under this new guidance.

Joel Phillips
Natalya Marenina
Zara Ritchie
BDO in Australia

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