After the flood, more rain!

The past year has seen a continuation of new legislation, a ramping up of ATO compliance activity and a significant ATO win in the courts in relation to transfer pricing.

For example, in April 2017, we saw the somewhat unusual event of the treasurer and assistant treasurer issuing a joint media release highlighting the ATO's transfer pricing compliance activities:

• 71 audits currently underway in the large business area covering 59 multinational enterprises (MNEs); and

• At least seven major multinational audits expected to come to a head before June 30 (four in e-commerce and three in energy & resources) with expected liabilities to total in excess of A$2 billion ($1.5 billion).

Then in late May, the ATO indicated that it expected to issue A$4 billion of tax liabilities in 2017 against MNEs of which about A$3 billion is directly related to transfer pricing matters with e-commerce cases accounting for about A$1 billion, related party financing accounting for about A$1.5 billion and marketing hubs accounting for about A$500 million.

Also in April, the Full Federal Court delivered the Commissioner of Taxation a significant win by upholding the Federal Court's October 2015 decision against Chevron Australia in one of Australia's largest tax cases.

And while the above has been happening, the past 12 months have also seen further significant legislative developments relevant to transfer pricing, particularly if you are a Significant Global Entity (SGE) (broadly where the global group has annual global income of A$1 billion or more) with the:

• Introduction of the diverted profits tax – to apply from July 1 2017;

• Adoption of 2015 OECD BEPS Actions 8-10 – to apply to years of income commencing on or after July 1 2016; and

• A significant increase in penalties for SGEs – to apply from July 1 2017.

This country update discusses the above matters in more detail.

The most significant legislative development relevant to transfer pricing over the past year has been the introduction of the DPT. In February 2017, the prime minister of Australia described the DPT as "one of the most advanced and some would say draconian measures of its kind, in the world" for the purpose of stamping out corporate tax avoidance. Australia's DPT is similar to the second limb of the UK's DPT.

In summary, the DPT is intended to provide the ATO with additional powers, within Australia's general anti-avoidance regime framework, to deal with global groups who have 'diverted' profits from Australia to offshore associates, using arrangements that have a 'principal purpose' of avoiding Australian income or withholding tax. The DPT will apply to SGEs carrying on business in Australia.

Where the DPT applies, tax is imposed on the amount of the diverted profit at a rate of 40% (Australia's corporate income tax rate is 30%). Any DPT imposed is payable within 21 days of the DPT assessment. The taxpayer has a 12 month review period in which to provide the commissioner with further information disclosing reasons why the DPT assessment should be reduced (in part or in full). If, at the end of that period of review, the relevant taxpayer is still dissatisfied, the taxpayer will have 60 days to challenge the assessment by filing an appeal with the Federal Court. However, and significantly, the taxpayer will generally be restricted to adducing evidence that was provided to the commissioner before the end of the period of review in any Federal Court proceedings.

Managed investment trusts, collective investment vehicles, sovereign wealth funds, complying superannuation funds and foreign pension funds are generally exempted from the application of the DPT.

Importantly, the DPT will not apply where it is reasonable to conclude that one of the following exceptions apply:

• Exception 1: The A$25 million turnover test – where the turnover of the taxpayer and other Australian entities in the same global group does not exceed A$25 million for the year (provided no income is artificially booked offshore).

• Exception 2: Sufficient foreign tax test – where the increase in the foreign tax liability is equal to or exceeds 80% of the corresponding reduction in Australian tax.

• Exception 3: Sufficient economic substance test – where the profit made as a result of the scheme by each entity connected with the scheme reasonably reflects the economic substance of the entity's activities in connection with the scheme.

In practice, exception 3 will likely be a key area of focus for MNEs and will require applying an Australian transfer pricing lens to the functions, assets and risks of the activities carried out in Australia, as well as to each entity outside of Australia that is connected with the scheme, to demonstrate that the profit made by each entity as a result of the scheme reasonably reflects the economic substance of the entity's activities in connection with the scheme.

Taxpayers likely to be most at risk of the ATO seeking to apply the DPT include taxpayers currently involved in a transfer pricing dispute with the ATO where large cross-border loans or a marketing hub is involved, taxpayers who have undertaken business restructures, taxpayers with arrangements covered by taxpayer alerts (e.g. cross-border leasing) and taxpayers who have migrated intellectual property from Australia.

Under Australia's transfer pricing rules, arm's length conditions (relevant to cross-border dealings between separate legal entities) and arm's length profits (relevant to cross-border dealings within a single legal entity) are required to be identified so as best to achieve consistency with certain guidance material. Until the recent amendment, the relevant guidance material included the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as approved by the Council of the OECD and last amended on July 22 2010 (2010 OECD Guidelines). The effect of the amendment is that the 2015 OECD BEPS Actions 8-10 report will also be relevant guidance material for purposes of Australia's transfer pricing rules for years of income commencing on or after July 1 2016.

Notwithstanding the doubling of penalties associated with transfer pricing adjustments for

SGEs in the absence of a 'reasonably arguable position' (RAP) in late 2015, administrative penalties for SGEs have now been significantly increased in relation to 'failure to lodge on time' penalties and penalties relating to statements and failing to give documents to the ATO, with effect from July 1 2017.

From July 1 2017, FTL administrative penalties for SGEs will be as high as A$525,000 for covered documents lodged 16 weeks or later. FTL penalties can apply where there is a failure to lodge an income tax return, notice, statement or other approved form with the ATO by the due date. For SGE's, FTL penalties will also apply to CbC reports and general purpose financial statements not lodged in the approved form by the due date.

In addition to the increase in FTL penalties, the base penalty amounts for SGEs in respect of penalties relating to making false or misleading statements or failing to give documents to the ATO ('culpable behaviour' penalties) have been doubled. 'Culpable behaviour' penalties are of general application and not specific to transfer pricing cases.

By way of example, the following base penalty amounts will apply to SGEs from July 1 2017 where a false or misleading statement results in a shortfall amount:

Intentional disregard:	150% of the shortfall amount (previously 75%)
Recklessness:	100% of the shortfall amount (previously 50%)
No reasonable care:	50% of the shortfall amount (previously 25%)
No RAP:	50% of the shortfall amount (previously 25%)

As SGEs turn their corporate mind to the practicalities of preparing the CbC report, Australian local file (ALF) and master file, the ATO has continued to assist by providing guidance on its website. In particular, the ATO issued the combined XML schema for the local file and master file and also the detailed design for the local file and master file (which built upon the local file – high level design document issued in June 2016) in April 2017.

Common questions asked by taxpayers as they navigate through the new processes are shown in Table 1.

Table 1
Question	Answer
When are the CbC report, master file and ALF due?	CbC reports are due 12 months after the end of the CbCR period. For December 31 year ends, the first filings are due by December 31 2017.
How do I file the various reports?	The master file and ALF must be lodged directly with the ATO in the approved XML schema format. The primary obligation to lodge the CbC report is on the Australian taxpayer, but can be satisfied by the parent entity lodging the report with its home jurisdiction and then sharing with the ATO.
Do I have to notify the ATO who is lodging the CbC report?	Yes, the notification will be made in the ALF when that is lodged i.e. there is no obligation in Australia to notify in advance.
Are exemptions from the CbC regime available and in what circumstances?	Yes, an exemption may be available in limited circumstances and must be applied for. The two main grounds are: • For Australian subsidiaries/branches, if the home jurisdiction has not yet implemented CbCR, a transitional one-year exemption from the CbC report and master file may be available; and • For Australian headquartered groups, that the group does not have foreign operations.
Does the ALF replace the transfer pricing documentation rules in Australia?	No, the ALF is separate and in addition to the existing transfer pricing documentation rules. The ALF is also very different to the OECD Local File.
Has the ATO provided any administrative concessions to minimise the compliance burden?	Yes, taxpayers will not have to prepare section A of the IDS if they lodge part A of the ALF at the same time as they lodge their income tax return.

On 21 April 2017, the Full Federal Court delivered the commissioner of taxation another significant win in its ongoing battle with Chevron Australia in relation to the transfer prices it used on certain cross-border related party loans with all three judges finding for the commissioner. The decision in Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation [2017] FCAFC 62 addresses the question of whether the interest paid by Chevron Australia on a loan from its US subsidiary exceeded an arm's length price.

While the Full Federal Court's decision covered a wide range of matters and addressed Australia's now superseded transfer pricing rules in Division 13 and Subdivision 815-A, the following key themes are worth noting:

• The independence hypothesis (underpinning the statutory expression of the arm's length principle) is not to be undertaken as if the Australian borrower was an "orphan" (separate from, and independent of, its multinational parent);

• The fundamental purpose of the reasonable expectation hypothesis is to understand what the taxpayer, or a person in the position of the taxpayer and in its commercial context would have given by way of consideration in an arm's length transaction; and

• If the evidence reveals (as it did here) that the borrower is part of a group that has a policy to borrow externally at the lowest cost and that it has a policy that the parent will generally provide a third party guarantee for a subsidiary that is borrowing externally, there is no reason to ignore those essential facts in order to assess the hypothetical consideration to be given.

The importance of having comprehensive, relevant commercial and economic evidence to support transfer prices of related party transactions was emphasised by the Federal Court at first instance, and again highlighted in the Full Federal Court's decision.

Chevron has recently lodged a special leave application to the High Court.

The ATO was given substantial additional funding last year to establish and resource a new tax avoidance taskforce. This taskforce has now been established and resourced with over 1,000 staff, with many coming from the private sector and having transfer pricing experience.

As indicated in the introduction, the ATO is active in its transfer pricing-related compliance activities and continues to focus on marketing and procurement hubs, loans including foreign currency loans coupled with cross-currency interest rate swaps, intangible transfers, loss-making companies and the potential application of the Multinational Anti-avoidance Law (MAAL). More recently KPMG professionals have seen an increased focus on the Australian pharmaceutical industry and also the automotive sector in light of the impending closure of the remaining automotive manufacturers operating in Australia.

Complementing its transfer pricing-related compliance activities, the ATO has recently issued a number of practical compliance guidelines (PCGs) that convey the ATO's assessment of relative levels of tax compliance risk across a spectrum of behaviours and arrangements:

• PCG 2017/1 – Sets out the ATO's compliance approach to offshore related party procurement, marketing, sales and distribution hubs. The PCG assigns hub arrangements one of six different transfer pricing (TP) risk categories or zones. Hubs outside the green zone are more likely to be reviewed by the ATO.

• PCG 2017/2 – Updates previously released guidance on Simplified Transfer Pricing Record Keeping (STPRK) options that reduce the compliance burden for certain taxpayers and/or international related party dealings (IRPDs). To the extent taxpayers can apply the STPRK options, the ATO will not dedicate compliance resources to qualifying taxpayers/IRPDs.

• PCG 2017/D4 (Draft only) – Sets out the ATO's proposed compliance approach with respect to cross-border related party financing arrangements. The draft PCG continues the ATO's colour spectrum approach to assessing tax risk (adopted in PCG 2017/1) to funding arrangements and allocates scores to various attributes of the funding arrangements. It is noted that the scores allocated to the green low-risk rating are largely features only ascribed to AAA-rated loans as opposed to ratios reflecting a broader range of investment grade funding.

The Australian transfer pricing landscape has become a more difficult one for MNEs to safely navigate, particularly where the Australian entity qualifies as an SGE. There are some unique or exceptional features such as the MAAL, DPT and the ALF which deviate in material ways from the OECD/G20's BEPS project and therefore make Australia an outlier. Proceed with caution!

Damian Preshaw

KPMG Australia c/- Tower Two, 727 Collins Street Melbourne, Australia, 3008 Tel +61-423 780 219 dpreshaw1@kpmg.com.au Damian is a consultant to KPMG and is a transfer pricing specialist with more than 20 years' experience in both the private sector and with the ATO. Prior to establishing Damian Preshaw Consulting Pty Ltd in October 2015, Damian was a director in KPMG's Transfer Pricing Services group in Melbourne for 12 years. In this capacity, Damian advised a wide variety of multinational clients on transfer pricing and profit attribution issues with a special focus on dispute resolution, financial services, financial transactions and business restructuring. Prior to joining KPMG, Damian was an international tax counsel in the ATO's Transfer Pricing Practice in Canberra and was an Australian delegate to the OECD's Working Party No.6 (Taxation of Multinational Enterprises) from 1994 to 2003. Damian is a member of The Tax Institute's (TTI) Large Business and International Committee and represented TTI on the ATO's Division 815 Technical Working Group.