Last month, the Australian Tax Office (ATO) released a draft practical compliance guideline (PCG 2018/D2) in relation to the diverted profits tax (DPT), subject to comment by 9 March 2018.
In short, the guidelines:
- set out how the ATO will identify DPT risk in a company and, if a DPT risk is identified, how the company should engage with ATO;
- provide general guidance on how a company may risk assess and evidence its DPT positions; and
- outline the ATO approach to the sufficient economic substance test and presents low and high risk scenarios for that test.
Key takeouts
- The DPT rules will not necessarily be applied as a provision of last resort. In an apparent departure from the DPT Explanatory Memorandum, the ATO seems willing to bypass the practical application of the transfer pricing and other ordinary income tax provisions when applying the DPT rules to genuine commercial arrangements. This blurs the circumstances when a taxpayer's cross border arrangement will be subject to the transfer pricing provisions and when the DPT rules will apply.
- Companies should start preparing evidence immediately and consider how best to manage and present evidence to the ATO, given the DPT's wide application under PCG 2018/D2. In the ATO's view, it has tabled a non-exhaustive list of documentary and evidentiary considerations that should be contemplated by taxpayers in risk assessing their DPT position. The reality for many taxpayers is that compiling this kind of DPT evidence will be a very onerous and time consuming exercise. This is even more challenging where the cross border arrangements in question were entered into many years prior to the introduction of the DPT, but are nonetheless caught in its application.
- Determining the degree of DPT risk remains a complicated and ambiguous process. The guidelines provide framing questions, but do not prioritise or weight these questions so as to provide taxpayers with a practical risk management framework. Also, no guidance is provided on quantification of non-tax financial benefit.
- If a company has identified a DPT risk, it will almost certainly need to engage with the ATO, either by way of advanced pricing agreement (APA) negotiations, private binding ruling (PBR) application or informal discussions and submissions with the ATO's DPT Specialist Team.
Evidence - documents, requests and timing
PCG 2018/D2 provides an extensive (but not exhaustive) list of more than 35 categories of documentary evidence, as well as further documents highlighted in PCG 2017/4 (related party financing) and 2017/1 (marketing hubs). Accordingly, the scope of documents that companies should be prepared to provide in response to a request by the ATO is incredibly broad. By way of illustration, note the following broad classes of documents:
- in relation to principal purpose, the ATO may request presentations and papers circulated to a taxpayer's board or management, minutes of board meetings, and internal cost-benefit analysis;
- in relation to the sufficient economic substance test, the ATO may request global value chain assessments, transfer pricing documentation and other commercial, regulatory and tax advice.
Taking all listed classes together, it is conceivable that the ATO may request almost any commercial document held by the taxpayer. Without more specificity, PCG 2018/D2 provides only limited guidance for companies preparing evidence packages for risk assessment and DPT assessment purposes.
Furthermore, we would encourage the ATO to provide taxpayers with further clarity on when and how the DPT rules and their evidentiary requirements will co-exist with the practical application of Australia's transfer pricing laws. The DPT Explanatory Memorandum was clear and referred to the law only applying in very limited circumstances, and only after considering the operation of the ordinary income tax provisions.
However, PCG 2018/D2 appears to earmark the application of the DPT rules to genuine commercial arrangements, instead of reserving these powers to deal with arrangements that are perceived to be artificial or contrived in nature. Therefore given the DPT's wide application under PCG 2018/D2, companies should start preparing evidence immediately and consider how best to manage and present evidence to the ATO.
The evidentiary requirements in respect of a DPT review are significant:
- PCG 2018/D2 does not reinforce the strict timelines for gathering and relying on evidence in respect of ATO DPT assessment reviews (as contained in the Taxation Administration Act 1953 (Cth)). Rather, the compliance approach simply states that further information may be requested. In the absence of guidance, companies should assume that they may be required to collate evidence packages on short notice. In practice, we strongly encourage taxpayers to prepare now to have evidence packages ready to provide to the ATO, should it be necessary.
- The DPT assessment for a current year may relate to a scheme entered into at any time. Many of the document class descriptions contained in PCG 2018/D2 emphasise the importance of contemporaneous evidence of the parties' intentions and expectations in respect of an arrangement. Accordingly, companies need to be prepared to provide at short notice comprehensive and contemporaneous evidence from many years in the past.
- There is a serious risk with not managing the evidence gathering and document provision process effectively. It is important to remember that under the evidentiary rules provided in the TAA, documents will not be admissible in the Federal Court review proceeding if the documents are not either already in the ATO's possession at the time of assessment or provided by the taxpayer in the 12 month period following the initiation of the taxpayer's DPT assessment review. Note that the Commissioner can consent to the admission of the evidence and the court can give leave for evidence to be admitted. In providing documents during a compliance review, regard should be had to any potential Federal Court review proceeding should a DPT assessment be made.
Because of the breadth of documents which may be requested and the uncertainty regarding timing, companies might consider:
- what processes are in place to quickly collate past years' documentary evidence in relation to the economic substance of a transaction; and
- how best to present evidence to the ATO to jointly manage DPT, transfer pricing and other income tax positions.
DPT risk quantification
PCG 2018/D2 suggests that entities can assess their own DPT risk on the basis of a non-exhaustive list of 31 'framing questions'. The framing questions are indicative of the matters the ATO is likely to consider when assessing the risk that the DPT applies to an arrangement. The questions are indicative only and may overlap.
We note that:
- PCG 2018/D2 does not fully expand on the implications of certain answers to the questions, nor does it provide an indication as to the weighting on certain questions. Therefore it is unclear whether some questions are more determinative than others.
- one of the framing questions in respect of the principal purpose test refers to 'quantifiable non-tax financial benefits', but does not provide any further guidance. Further clarification could be offered in relation to the meaning of the phrase, and particularly in relation to the question of whether or not regard may only be had to outcomes that were anticipated at the time of entry into the scheme.
Engaging with the ATO
Whether a DPT risk is identified during a compliance review or identified by a taxpayer during its own risk assessment, engagement with the ATO will almost certainly be necessary. If a taxpayer reaches a conclusion that it has a DPT risk, then the taxpayer may apply for an APA, seek a PBR, or contact the DPT Specialist Team.
If a DPT risk is identified by the ATO during a compliance review, then the ATO will suggest a proposed compliance approach. The ATO may consider documents already held by it, but may request further documentation. Such requests are on a cooperative basis (and are not a formal exercise of ATO powers), but if a taxpayer does not cooperate then formal powers may subsequently be relied on.
PBRs may only be sought in limited circumstances in relation to DPT. The role of the DPT Specialist Team is unclear at this stage, but may involve providing informal submissions. An APA is likely to be the most commonly relied on medium in reaching a position regarding the application of the DPT.
How MinterEllison can help you?
MinterEllison has a multidisciplinary team of tax lawyers, accountants and economists that have extensive experience managing complex international tax issues for our clients. We can assist you by:
- performing document reviews to quickly identify key documents and DPT evidence gaps;
- managing evidence subject to ATO document requests and court proceedings;
- conducting an assessment of whether or not an arrangement has sufficient economic substance, having regard to the framing questions in PCG 2018/D2 and other factors; and
- engaging with the ATO in relation to APAs, PBRs and the preparation of other submissions.
If you have any DPT concerns or any questions regarding the above, please contact one of our partners.