The ATO has now made public its approach in allocating resources to interact with inbound distributors.
Distributors that are part of a global group have always been exposed to jurisdictional Transfer Pricing (TP) risks. Approximately 60% of the Advanced Pricing Arrangement (APA) cases previously provided by the ATO were in relation to the purchase and sales of goods.
On 13 March 2019, the ATO released the Practical Compliance Guideline 2019/1 - Transfer pricing issues related to inbound distribution arrangements (known as the PCG), which sets out the framework to assess the TP risk of inbound distributors.
The framework covers three specific industry segments and inbound distributors generally. The Earnings Before Interest and Tax (EBIT) margin (EBIT relative to sales) is used as the key profit indicator to assess tax risk. Inbound distributors include:
Taxpayers that distribute goods purchased from related foreign entities and resale in Australia
Taxpayers that distribute digital products or services where the intellectual property in those products or services is owned by related foreign entities.
Regardless of the level of risk, taxpayers should consider preparing TP documentation. The TP documentation can help taxpayers to justify the rationality of its related party arrangements during the ATO review process. This will mitigate transfer pricing risks, provide for a reasonably arguable position and demonstrate stronger tax governance and controls.
Taxpayers should not limit their focus to the profit level itself, but also consider the following matters:
Key drivers for the profit outcome in particular the commercial drivers for any poor performance (which are unrelated to the pricing of international related party transactions).
Fluctuations in profit levels frequently originate from industry and market conditions. For example, the Australian automotive industry is highly competitive, and new car distributors often experience low profit levels as they attempt to penetrate the market and gain market share. According to historical data released by Australian Automotive Intelligence, Kia spent seven years to reach a 2% market share, while it took Peugeot more than ten years to reach 1%.
‘Non-high-risk’ taxpayers may consider applying for pre-qualified APA in due course in order to minimize the TP risks in future years. This will provide a greater level of certainty with respect to their TP arrangements.
The ATO suggests that High-risk taxpayers may consider adjusting the current TP policy. Within the 12-month transition period granted by the PCG (from 13 March 2019), the ATO will consider remitting penalties and reducing interest charges, provided taxpayers adjust their TP arrangements to fall within the low risk zone. However, it is noted that falling outside the low risk zone does not mean that international related party transactions are not priced based on arm’s length principles.
The PCG expressed the ATO’s regulatory position on distributors, but it should not be used as a basis for determining whether a TP arrangement is reasonable or not.
Taxpayers should establish their own compliance programs according to their own and macro (such as industry) conditions and make their own decisions.