20 March 2019
The ATO released Practical Compliance Guideline PCG 2019/1 on 13 March 2019 which outlines its compliance approach to transfer pricing issues for inbound distribution arrangements. The final PCG is broadly consistent with the draft PCG 2018/D8.
The PCG risk assesses inbound distributors by comparing their five year weighted average EBIT margin (EBIT/Sales) against EBIT margins in their relevant industry sector (refer diagrams below).
This generates a risk rating of:
- Green – low risk
- Amber – medium risk
- Red – high risk
If a taxpayer has losses in the current, and previous two income years, it will be considered very high risk.
The ATO has access to a lot of information and will be able to calculate inbound distributor risk ratings based on this information, including the information in income tax returns.
Taxpayers required to lodge a Reportable Tax Position (RTP) Schedule (i.e. those with Australian revenue greater than A$250m) will be required to self-assess their inbound distributor risk rating and disclose this risk rating on their RTP Schedule.
- Perform a risk self-assessment
Taxpayers should self-assess their risk rating under the PCG to understand the amount of attention they are likely to receive from the ATO in relation to their inbound distribution arrangements.
- Review transfer pricing documentation
A high risk rating (red zone) does not mean that the taxpayer’s transfer pricing policy is wrong.
If a taxpayer has appropriate transfer pricing documentation, and a reasonably arguable position, then it has some protection from penalties and a basis to dispute any ATO attempt to make a transfer pricing adjustment.
This is particularly important if a taxpayer’s global pricing policy generates Australian profit outcomes which are considered high risk under the PCG.
- Transition to the green low risk zone
A taxpayer may wish to consider transitioning to the green low risk zone.
If the taxpayer makes transfer pricing adjustments to move into the green low risk zone by 13 March 2020, and pays the additional tax, the ATO will generally remit shortfall penalties and the shortfall interest charge.
However transitioning to the green low risk zone could create transfer pricing risks for the related supplier and have a material impact on defending group transfer pricing policies in other jurisdictions.
- Consider benefits of early engagement with the ATO
Taxpayers should consider the benefits (or otherwise) of early engagement with the ATO, either through the Advance Pricing Arrangement program, or other less formal engagement processes.
The PCG provides guidance on whether you are “swimming between the flags” and therefore the level of attention you can expect from the ATO.
However depending on your circumstances, you may choose to swim outside the flags. In this case it will be important to manage the risks associated with this choice.