Transfer pricing in Australia

Australia’s transfer pricing rules, as set out in Division 13 of the Income Tax Assessment Act 1936, were introduced in 1982 to address emerging concerns about cross-border profit shifting and to coincide with new Organisation for Economy Co-operation and Development (“OECD”) guidance on this global tax concern. 

Each of Australia’s tax treaties contains articles that deal with transfer pricing including the associated enterprise article and the business profits article (the treaty transfer pricing rules). The treaty transfer pricing rules, interpreted through the framework of the OECD guidance, require profits that relate to cross-border intra group dealings to be calculated consistently with the arm’s length principle. This internationally accepted principle is set out in the OECD Model Tax Convention on Income and on Capital (OECD Model) and explained in associated guidance material. Australia incorporates its international tax treaties into domestic law through its income tax assessment act. 

New cross border transfer pricing legislation will be inserted into the Australian Income Tax Assessment Act 1997. The new legislation contained in Subdivision 815-A will: 

1. Ensure that the tax treaty transfer pricing rules are able to be applied independently of existing “domestic” transfer pricing rules and should provide a separate assessment authority. An express reference to the tax treaty pricing rules will be included in the Income Tax Assessment Act 1997; and

2. Require the arm’s length principle to be interpreted as consistently as possible with relevant guidance issued by the OECD – by providing direct access to OECD guidance material when interpreting Australia’s enacted transfer pricing rules; and 

3. Clarify how the transfer pricing rules will interact with Australia’s thin capitalisation rules. 

New Subdivision 815-A will authorise the Taxation Commissioner to make a determination to negate a transfer pricing benefit for an Australian resident entity where the requirements of an associated enterprises article or the business profits article are met. That is, the new Subdivision will only apply where there is a relevant tax treaty. Broadly, a “transfer pricing benefit” is based on the difference between the profits that an entity would have made having regard to the arm’s length principle, and the amount it actually made. The Taxation Commissioner may make a determination under Subdivision 815-A to adjust the entity’s tax position in order to “negate” a transfer pricing benefit. These rules require an allocation of profits consistent with the conditions that might be expected to have operated between independent parties in comparable circumstances dealing on a wholly independent basis. 

New Subdivision 815-A will apply retrospectively from 1 July 2004 to ensure that there is alignment between Division 13 and the treaty transfer pricing rules. However, this will mean that entities trading with treaty partners will be subject to stricter transfer pricing rules than those that apply to non-treaty trading partners. Administrative penalties will only apply from 1 July 2012. 

The interaction between Australia’s thin capitalisation and transfer pricing provisions will also be addressed in the new Subdivision 815-A. The new Subdivision 815-A makes it clear a transfer pricing benefit relating to debt deductions will only arise in relation to an adjustment to the rate of interest and not the level of debt (the thin capitalisation rules operate to determine the maximum level of debt). However, in determining the arm’s length rate of interest, it will be necessary to have regard to the level of debt that would be likely to exist if the parties were independent of each other.