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TP Minds Australia 2018: ATO Keynote Address: The Anti-Avoidance Agenda

As the ATO continues to mark its position among the most influential tax administrations globally, Deputy Commissioner, Mark Konza takes to the TP Minds stage to deliver an insightful keynote speech focusing on the work Australia has been doing in international taxation, with particular focus on the implementation of new laws such as the Multinational Anti-Avoidance Legislation (MAAL) and the Diverted Profits Tax (DPT). Read his full speech below and leave your comments:

Keynote Address Mark Konza, Deputy Commissioner International, ATO

[...] I would like to talk about the future of transfer pricing and the trends that are shaping that future, from an Australian perspective.

Tax compliance by multinational enterprises has been and remains an issue of acute community concern. Australia’s strategy has been to actively work with the international community to improve international tax law and administrative practice, to maintain and extend the domestic laws needed to deliver the improved international rules and to support the Commissioner of Taxation with resources to ensure that these laws are followed.

Globally and locally we are seeing changes to the transfer pricing landscape that inhibit the ability of those MNE’s who want to ‘game the system’. These changes are occurring on a number of fronts, with important elaborations of the meaning of the arm’s length standard being published by the OECD, new transparency requirements, global co-operation amongst regulators, and the enhancement of the broader framework of international tax rules. Collectively, the measures are making it harder for those MNE’s who seek to contrive outcomes under the transfer pricing rules that misalign outcomes with value creation. These efforts are critical to restore and maintain community confidence in a fair international tax system.

When the base erosion and profit shifting issue erupted globally, Australia had already begun working to address these concerns. New transfer pricing laws which ensured the totality of the relations between the parties was considered and which explicitly embraced the OECD guidance on transfer pricing had been passed in 2012.

The new law continues to be founded on the arm’s length standard, which remains the critical international consensus, and imposes on taxpayers the obligation to self-assess their transfer prices in accordance with the arm’s length standard

Consistent with the internationally agreed position, the updated law also expressly provides for the non-recognition of the actual arrangement and the substitution of arm’s length arrangements where the arrangements were not actually carried out in the described manner or were such that a party acting in an arm’s length manner would not have entered into them. It was envisaged this so-called ‘reconstruction power’ would only be used infrequently and indeed no cases have yet been completed on this basis. However, we do have current cases where we are faced with arrangements that do no not appear to make commercial sense, and the result has been to move value out of Australia that is fairly seen as created here. In these cases we are currently considering the use of this power as part of a firm response to the taxpayer’s behaviour.

As the international reaction to BEPS has taken shape, Australia actively engaged in the OECD inclusive framework discussions on responses to the BEPS action plan and has been actively involved in working to address this global issue. Australia has been in the vanguard of countries implementing responsive measures.

Having directly linked our law to the OECD guidance, we were naturally keen that the guidance be brought up to date and better align transfer pricing outcomes with value creation. The revised guidance on how you assess or demonstrate compliance with the arm’s length standard was brought into Australian law from July 2016. As the new transfer pricing rules are part of the company tax self-assessment regime, companies and their advisors have an obligation to ensure they meet the new guidelines.

The sleeping giant underneath all these new laws are the changes to the expression of the arm’s length standard. The updated OECD guidance gives us a new framework for determining the arm’s length allocation of risk within an MNE, an obligation I worry might be underappreciated by some sections of the tax pricing profession.

Risk permeates all aspects of business and is associated with the opportunities for profits, as well as the downside losses. Under the OECD guidance, risk must be allocated based on careful analysis: not only of how the enterprise is said to operate, but also of how it actually operates.

The contractual assignment of risk chosen by the MNE does not incontrovertibly determine which entity should bear the losses, or benefit from the profits, that actually flow from that risk.

The updated guidance makes it clear that the key is which entity controls the identified risk and has the financial capacity to assume the risk. Control requires the actual performance of the decision making function. For example, simply formalising the outcome of risk control functions undertaken in Australia through foreign meetings or Board Minutes does not entitle a foreign entity to the profits, or losses, that flow from the Australian control function. Similarly, merely setting a policy environment relevant for risk does not qualify as the decision making control over a risk.

It also needs to be understood that the contractual manner of compensating an entity does not dictate what risks it should be allocated under an analysis of its commercial and financial relations. For example, the decision by an MNE to compensate its Australian operation based on a particular net margin does not determine that operation’s risk profile. It is how the parties actually operate that determines the allocation of risk, and the consequent selection and application of the most appropriate transfer pricing method to determine arm’s length outcomes.

The updated guidance also provides us with new approaches to the recognition of value from intangibles that look beyond legal ownership and any mere formality of responsibility. It also enables us to have regard to actual outcomes where hard-to-value intangibles are transferred.

These changes go to the heart of many of the most challenging transfer pricing cases we face, where it may appear that an MNE is seeking to game the system. Proper application of these principles has the potential to elevate transfer pricing out of its current community reputation as being the practice of transfer mispricing, to its important role of assisting corporations to assign correct economic prices for internal transactions.

Our ability to detect and deal with the misalignment of value and tax outcomes has been significantly bolstered by the OECD country by country reporting requirements, with which you would be familiar. These were introduced with effect from 1 January 2016 for Significant Global Entities. We received the first electronic lodgement of a CbC report in September 2017 and since then we have received [2,116 Local Files], [1,463] Master Files and [42] CbC reports. Australia is one of [69] jurisdictions that have agreed to automatically exchange CbC reports. The first wave of exchange of CbC reports is due by the end of June this year, at which point we will have achieved a step change in the global transparency of how MNEs choose to operate.

Australia is an active player in the growing international co-operation amongst tax regulators. Commissioner Jordan is Vice Chair of the OECD’s Forum of Tax Administration, and Sponsoring Commissioner of the Joint International Taskforce on Shared Intelligence & Collaboration, or JITSIC as it is better known. JITSIC has 38 member countries, with a focus on sharing intelligence, and working together on areas of common concern, including collaborative casework on MNE’s who may be seeking to misalign outcomes with value creation. We believe that by working together, we can produce the best outcomes for Australia and the international tax system.

We also use our International tax networks to work with other administrations on key projects. One topical project at the moment is the design and implementation of new multilateral cooperative initiatives to assess and mitigate risk.

Launched in January 2018, we, alongside seven tax administrations, are participating in the pilot of the OECD’s International Compliance Assurance Programme, or ICAP.

ICAP involves tax administrations undertaking cooperative multilateral risk assessments on MNE groups using their Country-by-Country Reports and other relevant information. This will allow the ATO to engage in real-time with MNE’s and other tax administrations to reach an early decision about the level of transfer pricing and permanent establishment risk.

We are committed to supporting this initiative with some of the key potential benefits including:

  • Targeted and consistent interpretation and use of Country-by-Country Reports
  • Better use of resources for tax administrations and MNEs
  • Co-ordinated and transparent approach to engagement
  • Faster multilateral tax certainty
  • Few disputes entering into Mutual Agreement Procedures.

The ATO is currently working collaboratively with the MNEs and tax administrations participating in ICAP to conduct the ICAP risk assessments and establish best practice with regards to multilateral risk assessment and the use of Country-by-Country reports.

We have commenced reviewing the documentation packages for ICAP cases and have attended risk assessment workshops where the MNE walked through their documentation in order to enhance tax administrations understanding of the MNE’s business, global value chain and related party transactions.

ICAP complements our Justified Trust program as well as other initiatives, such as our Advance Pricing Arrangement and advice and guidance programs to provide tax certainty to MNEs.

We are collating feedback in terms of what is working well and what could be enhanced for an upcoming meeting to be attended by the participating ICAP tax administrations in July.

The integrity of the transfer pricing landscape is also being supported by the enhancement of the broader framework of international tax rules.

Part of that improved international tax law were the changes to the definition and interpretation of the permanent establishment rule. However, the Australian Government wanted to see a quick resolution of this issue because, quite frankly, transacting with apparently Australian companies and then seeing the invoicing coming from offshore annoyed Australian taxpayers. They smelt a rat. With good reason.

In 2015 the Government passed the Multinational Anti-Avoidance Legislation or the MAAL, as we refer to it, at the same time as CbC reporting, again with application to Significant Global Entities. The MAAL was introduced to counter ‘operate here – bill overseas’ arrangements that avoid the attribution of sales revenue to an Australian taxable presence to avoid Australian or foreign taxes.

The implementation of the MAAL saw us take a new approach and put together a roadmap which outlined to taxpayers what we believed MAAL-compliant structures would look like. This brought taxpayers to the table and allowed us not only to help them move to more economically responsible structures, but helped us to settle old disputes. The implementation was so successful that we have seen a base restoration of nearly $7Bn assessable income and there has been no need for MAAL assessments to issue so far. The MAAL has been a major victory for the Commissioner and industry members who have argued for cooperative approaches.

The broader framework of Australia’s international tax rules has also benefited from the introduction of the Diverted Profits Tax, or DPT. The DPT came into effect on 1 July 2017 and was implemented by the Australian Government in response to constant delays in the completion of audits and arguments that our existing General Anti-Avoidance Regime could not be applied where a scheme was part of a global arrangement. Also, the prospect of the DPT was intended to encourage MNEs to properly comply with their transfer pricing obligations. The DPT, restricted to SGEs earning more than $25m revenue in Australia, will apply when:

  • there is a principal purpose of obtaining an Australian tax benefit, or both an Australian and foreign tax benefit; and
  • the taxpayer obtains a tax benefit in connection with a scheme involving a foreign associate.

If we assess a taxpayer to be in breach of the DPT, we will apply a 40% tax on the DPT tax benefit which must be paid within 21 days. 12 months is allowed after the DPT assessment for information to be provided to show that the diverted profit amount is excessive.

If appealed to Court, the appeal can only consider the information provided to the Commissioner before or during that 12 month period. The review of DPT assessments will lift the onus on both the Commissioner and the taxpayer to identify, supply and consider the necessary information as quickly as possible.

As we must wait until taxpayers have lodged their 2017 tax returns, we will not be in a position to issue a DPT assessment until at least the beginning of 2019. Whilst it is only expected to apply in a small, limited, number of cases, we are looking very closely at some arrangements. Particularly arrangements which involve any of the following:

  • the transfer or effective transfer of valuable intangible assets offshore
  • the transfer or effective transfer and/or centralisation of functions and/or risks offshore
  • a significant transfer of value relative to overall profitability
  • the mischaracterisation of payments (for example, service fees rather than royalties)

A small number of taxpayers have also been alerted to the possibility of DPT being considered in the future.

Australia also pays very close attention to the integrity of its thin capitalisation regime. Recently announced budget measures will remove the ability to revalue some assets for thin capitalisation purposes only. Entities will now have to rely on their financial statements for values in the safe harbour calculation. The measure may result in some taxpayers shifting to the Arm’s Length Debt Test, which requires rigorous analysis and is an area where we are reviewing the guidance regarding our expectations. The ALDT has been an increasingly popular election for thin cap purposes in recent years, so we are looking to provide further guidance to assist in providing certainty to taxpayers.

To best enable the administration of the enhanced international tax framework, in 2016 the Government established within the Tax Office the Tax Avoidance Taskforce.

The purpose of the Tax Avoidance Taskforce is to increase the ATO’s efforts in the scrutiny of the tax affairs of multinational enterprises, large public and private groups and wealthy individuals operating in Australia.

Taskforce funding has allowed the ATO to reinstate lost capacity in our multinational division and expand it to be able to deal with the new laws.

A ‘risk cluster’ approach has allowed us to concentrate our risk analysis, mitigation and treatment options to effectively deal with the risk.

The advent of the MAAL enabled us to see tremendous success in addressing the e-commerce risk. Our efforts in this area have seen us issue over $1bn in assessments, collect tax of over $800mil and achieve future revenue effects of more than $590mil.

Thanks to this success we can shift our focus onto other risks such as transfer pricing in the pharmaceutical industry. We currently have nine audits underway and we hope to achieve a similar success rate there. It is important, however, to note that we also have nine Advanced Pricing Arrangement applications underway in that industry. Again, cooperative channels remain open to any company who wants to go that way.

We will also be continuing to look at the energy and resources sector - specifically exploration expenditure, hubs (particularly marketing hubs) and related party financing such as debt funding, the use of derivatives to avoid interest withholding tax and cross currency interest rate swaps. With Australia projected to become the world’s biggest exporter of liquefied natural gas by 2019, the oil and gas industry is a particular focus for us. With big developments and long term contracts being a feature of the LNG industry, it is important we get the pricing right from the start.

The ATO remains committed to providing cooperative channels by which taxpayers can engage with us. A key mechanism for cooperative engagement is the APA program, which remains an important part of the Australian transfer pricing landscape. The ATO currently has 116 APA applications in progress and 105 that are in place. The program continues to be strongly supported by both industry and the ATO and is seen as an effective way to provide certainty and achieve good compliance outcomes.

As part of our recent refinement of our approach to APAs, we have moved away from the conventional mindset of assessing a transaction in isolation. Instead, we seek a holistic understanding of the economic group behind the transaction and the underlying value chain, rather than focusing purely on the pricing of isolated transactions.

Where holistically done, APAs also have a valuable role to play in supporting the introduction of new legislation such as the DPT. In order to provide certainty to MNEs seeking to do the right thing, we can include an assurance in an APA that the DPT will not be applied to the covered arrangements.

Our Mutual Agreement Procedures, or MAPs, will also be a focus in 2018 since Australia signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (‘MLI’) in June 2017. The MLI will not directly modify our existing bilateral treaties but it will introduce mandatory binding arbitration into the negotiation process for aged MAP cases.

Currently, based upon other jurisdictions’ provisional positions, the MLI is expected to modify 31 of Australia’s 44 bilateral tax treaties. These countries can choose to adopt mandatory binding arbitration under the MLI and Australia has chosen to do so for all of its Covered Tax Agreements (‘CTAs’).

13 of Australia’s bilateral treaties are expected to include mandatory binding arbitration. These jurisdictions are – Belgium, Canada, Fiji, Finland, France, Ireland, Italy, Malta, Netherlands, New Zealand, Singapore, Spain and the United Kingdom.

This may change as countries notify the OECD of their final positions under the MLI.

Arbitration is currently available under Australia’s treaties with Germany, New Zealand and Switzerland.

Where arbitration applies to a treaty, any issues arising from a Mutual Agreement Procedure (‘MAP’) case which have not been resolved after two years may be submitted for mandatory binding arbitration by the taxpayer (3 years in the case of France).

An arbitration panel is usually made up of three panel members. Each jurisdiction will select one panel member, who will in turn select a chairperson for the panel from a pre-agreed list.

Australia has selected final offer or ‘baseball’ arbitration as our preferred method for arbitration. Only one treaty partner (‘Malta’) has opted for a different method – independent opinion.

Final offer arbitration allows each jurisdiction to submit their proposed resolution of the issue in dispute along with a position paper. The panel then selects one of the proposed resolutions as the resolution for the case. No reason is provided and the decision has no precedential value. Whilst this method may encourage countries engage earlier and to be more measured in their proposals, a ‘winner takes all approach’ can be a gamble.

The arbitration decision is binding on tax administrations, except in situations where the courts overturn a decision on the basis of procedural unfairness. Taxpayers can choose to not accept an arbitration decision or pursue other legal remedies but this terminates the entire MAP process and prevents further consideration by the competent authorities.

As at 28 March 2018, Australia had 47 MAP cases on hand. Based on current reservations of jurisdictions, arbitration may be available for 15 of these MAP cases by 1 July 2019 if not resolved by that date.

The Australian Government and its tax office are committed to ensuring that multinational enterprises pay the correct amount of tax under the law. As I hope I have demonstrated, even within a period of rapid change, the Australian Taxation Office has continued to balance a strategy of cooperation with all those seeking to comply with the law and a resolute response to those seeking to not comply.

The transfer pricing landscape has had seismic shifts. Collectively their direction heads towards a transparent alignment of tax outcomes with value creation. For those MNEs who may previously have sought to game the system, there is increasing pressure to get on board and use real substance and real commercial drivers in making their pricing decisions. It is up to those MNEs and their advisers to get with those who have been doing the right thing all along and to get real.

Thank you.

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