Australia: Tax audit and controversy trends and key issues

Tax Controversy and Dispute Resolution Alert
Pricing Knowledge Network Alert
Australia: Tax audit and
controversy trends and key issues
February 14, 2013
In brief
The tax audit and controversy landscape in Australia continues to shift and evolve due to a number of key
trends and emerging issues. Many of them correlate with more macro, broader trends occurring on the
global stage, which is apparent from the recent release of the report by the Organisation for Economic
Co-operation and Development (OECD) addressing base erosion and profit shifting. Not surprising
given that the Australian government and the Australian Taxation Office (ATO) hold active and
influential roles with respect to global tax developments affecting multinational enterprises.
Key trends in Australia include the ATO's sharpened focus on information gathering and expanded use of
risk assessment as a method of choosing which taxpayers to audit. The ATO is also commencing
compliance reviews before a return is lodged, consistent with their desire to have real-time dialogue with
taxpayers. At that same time, there are various 'hotspot' issues for multi-national enterprises -- those
issues of keen interest to the ATO that are arising more frequently during audits. Examples include the
transfer pricing methods used by taxpayers and the pursuit of cross-border arrangements for treaty
shopping purposes.
The Australian legislature is also shaping the environment. Just yesterday, amendments were
introduced to potentially expand the scope of the anti-avoidance rules as well as strengthen Australia's
transfer pricing rules in order to help mitigate base erosion and profit shifting. These developments
along with the increasing introduction of retrospective legislation, sets the stage for enhanced
enforcement and revenue gathering. The Australian government, with advice from business
representatives, tax professionals (such as PwC) and other stakeholders, is also now examining whether
new criteria should be the driving factors for corporate taxation -- a development that has the potential to
alter the legal cornerstones of taxation upon which businesses rely.
This alert highlights some of these key trends and issues and suggests ways for multinational enterprises
to navigate through this period of uncertainty and potential change.
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In detail
Audit process and
administration trends
Application of general anti-avoidance
rules (GAAR)
The ATO has continued to review
corporate restructures and
transactions and has aggressively
sought to apply Australia‟s GAAR to a
number of circumstances. Australia‟s
GAAR was enacted as Part IVA of the
Income Tax Assessment Act 1936
(Cth) (Part IVA) and applies to cancel
tax benefits arising from schemes
where the dominant purpose for
entering into the scheme is to obtain a
tax benefit. The GAAR requires an
assessment of the tax benefit obtained
by a taxpayer and an analysis of the
reasonable alternative scenarios that
could have been undertaken to
achieve the taxpayer‟s commercial
objectives (alternative postulate).
The ATO will consider the application
of Part IVA where there is an
indication of contrivance in an
arrangement. The ATO will look for
„warning signs‟ that the arrangement
is „tax driven‟ including, where the
arrangement contains a step or series
of steps that appear to serve no real
purpose other than to gain a tax
advantage, where the tax result of the
arrangement appears at odds with its
commercial or economic result, as
well as instances where the parties to
the arrangement are operating on
non-commercial terms or in a non
arms-length manner.
In Court, the Commissioner has
successfully defended the application
of Part IVA on a range of transactions
resulting in additional assessable
income and the denial of deductions,
capital losses or foreign income tax
offsets. However, taxpayers have been
successful in cases when they have
submitted key evidence
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demonstrating the commerciality of
an arrangement or the
unreasonableness of the
Commissioner‟s alternative
postulates.
might reasonably be expected to have
happened absent the scheme ... it may
be necessary to undertake a more
forensic exercise in analysing all
possible counterfactuals”.
Keen focus on information gathering
We are also aware that the ATO has
increased its number of requests for
the production of documents
contained in foreign countries as a
result of increased cooperation and
coordination between members of the
Joint International Tax Shelter
Information Centre (JITSIC) (see
discussion below).
The ATO has significantly altered its
approach to information gathering
during the audit phase. This is in
response to an increasing number of
court losses (particularly those
involving the potential application of
the GAAR) and changes to the court
listing rules placing limitations on the
Commissioner‟s ability to undertake
full discovery.
It is now increasingly common in
cases involving the potential
application of the GAAR, for the ATO
to seek access to considerable
quantities of documents and
information. In a number of recent
cases, the ATO is using its domestic
formal information gathering powers
to obtain information. It is also
requesting information held offshore
by issuing taxpayers using an offshore
information notice (see section 264A
of the Income Tax Assessment Act
1936 (Cth)). In this situation, it is
important to carefully manage the
process as any information that is not
provided might not be eligible for use
in any subsequent court proceedings.
The change to the ATO audit
information gathering approach is
largely attributed to the
Commissioner‟s losses in
Commissioner of Taxation v Axa Asia
Pacific Holdings Ltd [2010] FCAFC
134 (AXA) and RCI Pty Ltd v
Commissioner of Taxation [2011]
FCAFC 104 (RCI). In response to the
AXA decision, the Commissioner
observed that the “clear implication of
the Court's decision is the need for the
Commissioner to test any evidence
supporting assertions or statements
by taxpayers about what would or
Risk differentiation framework
The ATO's Risk Differentiation
Framework (RDF) continues to
require consideration by both large
and small/medium taxpayers (SMEs,
with turnovers less than A$250m)
operating in Australia. The RDF
explains the approach taken by the
ATO in assessing the level of tax risk
attributable to taxpayers in Australia
on a real-time basis. The „risk rating‟
applied to a company has a material
impact on the manner in which the
ATO will engage with that taxpayer.
For example, the ATO will adopt an
enforcement focus for those
characterised as higher or medium
risk or will adopt an assurance or
service focus for those it considers to
be of lower risk. The ATO‟s focus on
this area has successfully gained the
attention of many corporate Boards
across Australia.
The framework contains four risk
categories including higher risk
taxpayers, key taxpayers, medium risk
taxpayers and lower risk taxpayers.
The risk category assigned to a
taxpayer will determine the type and
level of intensity of the ATO‟s
enquiries into that taxpayer (i.e.,
continuous review, continuous
monitoring, periodic review, and
period monitoring). The factors
which determine the risk rating
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assigned to a taxpayer include past
compliance behaviour, business
performance relative to tax outcomes,
significant transactions, intelligence
from foreign revenue authorities and
JITSIC, intelligence from Australian
government agencies, and the risks
associated with the introduction of
new law.
The ATO considers that its use of the
RDF model has been generally
successful in the large market. The
ATO has advised that it intends to
apply the RDF model to SMEs and
high net worth individuals in 2012-13.
The risk management approach taken
by the ATO for these groups will
depend on the perceived likelihood of
non-compliance by the taxpayer, and
also the consequences of the outcomes
of non-compliance.
The RDF for SMEs and high net worth
individuals will also differentiate
taxpayers between „high risk‟, „key
taxpayers‟, and „medium-risk
taxpayers‟ and „lower-risk taxpayers‟.
The key risks that the ATO will look
for include a substantial variance in
tax performance from business
performance, inconsistencies in
activity statements or spikes in refund
claims, large, one-off or unusual
transactions, unexplained losses, a
history of aggressive tax planning and
poor governance and risk
management systems.
Real-time, pre-lodgement compliance
reviews
The ATO has commenced the use of
Pre-lodgement Compliance Reviews
(PCRs) in an effort to engage with
taxpayers prior to the lodgement of
their income tax returns. A PCR is a
real-time review mechanism which is
designed to assist the ATO in
identifying potential tax risks in the
period leading up to the lodgement of
returns. The nature and scope of the
review conducted by the ATO will
depend on the specific PCR plan or
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framework that is established between
the ATO and the taxpayer. The scope
and nature of the plan will reflect the
ATO‟s assessment of the taxpayer
within its RDF. At the conclusion of
the PCR process, the ATO will
determine if there are potential risks
outstanding and whether further
action by the ATO will be necessary.
As at the date of this publication, the
ATO has commenced 93 PCRs.
Reportable tax positions
The ATO has developed and
implemented the use of Reportable
Tax Position schedules. These must be
completed by certain taxpayers who
receive written correspondence from
the ATO informing them of this
obligation. In 2012-13, approximately
170 taxpayers from the largest
economic groups of taxpayers will
receive this correspondence.
The schedule requires the disclosure
of contestable and material aspects of
a taxpayer‟s filing position and
addresses three categories. A Category
A position is one where it would be
concluded in the circumstances that
the position taken by the taxpayer is
as likely to be correct as incorrect, or
less likely to be correct than incorrect.
Category B is concerned with
positions where there is uncertainty
about taxes payable or recoverable as
recognised by the taxpayer or
disclosed in their financial statements
or those of its related entities.
Category C requires the disclosure of
significant transactions or events of
particular key issues identified by the
ATO.
The ATO has indicated that the
schedule will be integrated into its
PCR processes. The proposed
integration is designed to ensure that
corporate taxpayers who have not
engaged with the ATO in respect of
their material and contestable
positions will still be required to
disclose the reportable positions in
their returns.
International cooperation
Identifying it as a useful way of
“putting the picture together on a
global level”, the ATO has continued
using its participation in JITSIC to
address abusive international tax
haven and evasion activities. In 2004,
JITSIC was established by the tax
commissioners of the United States,
Canada, United Kingdom, and
Australia. It now has nine member
countries (Australia, Canada, Japan,
United Kingdom, United States, South
Korea, China, France and Germany).
JITSIC was set up to deter the use of
abusive cross-border tax schemes.
Members of JITSIC seek to exchange
information in respect of complex
cases that involves avoidance schemes
concerning multiple tax jurisdictions.
Members also share expertise,
practices, market intelligence, and
experiences with each other to address
cross-border tax avoidance
arrangements. The ATO has
acknowledged that its participation in
JITSIC has enabled it to engage other
tax administrations in a practical
manner at an early stage in relation to
abusive international tax haven and
evasion activities. To date, its key
achievements include the deterrence
of abusive tax arrangements on an
international scale, intelligence
sharing and joint audits between
member countries, exchanges of
information and building
international relationships.
Hotspots for multi-nationals
Preferred transfer pricing methods
Significant developments in the area
of transfer pricing have occurred in
Australia over the last two years.
Yesterday the Australian government
introduced draft legislation to replace
the current transfer pricing rules with
updated ones that are more robust
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and aligned with principles set forth
by the OECD. These changes are part
of the larger effort to ensure "an
appropriate return" with respect to a
multinational group's Australian
operations (the PwC Transfer Pricing
Network will be separately
commenting on these reforms.)
Changes have also occurred with
respect to a taxpayer's use of specific
transfer pricing methods. On June 1,
2011, the Full Federal Court affirmed
the decision of the primary judge in its
decision in SNF (Australia) Pty Ltd v
FCT [2010] FCA 635 that the
comparable uncontrolled price (CUP)
approach is the preferred method for
the transfer pricing provisions in
Australia. In this case, the taxpayer
was a wholly owned subsidiary of a
chemical company who was a resident
of France. The Australian resident
subsidiary purchased chemicals from
related parties in China, the United
States and France. The company
produced trading losses which the
Commissioner determined were due
to the overpayment for the chemicals
supplied by the related entities. The
Commissioner issued amended
assessments for six income years.
The Commissioner relied on the
transaction net margin method
(TNMM) to argue that the negotiated
price between the taxpayer and the
related entities from which the
taxpayer was purchasing the
chemicals was a true arm‟s length
price. As a result, they agreed that the
taxpayer should have paid A$12.3
million less for the products over the
income years under consideration.
On the contrary, the Full Federal
Court held that the consideration paid
was arm‟s length consideration. In
doing so, the court held that the global
market of the chemicals allowed for
the CUP analysis involving different
international transactions to be relied
upon. It also rejected the use of the
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TNMM method in these
circumstances given the availability of
comparable transactions. Relevantly,
the court held that OECD guidelines
for transfer pricing could not be relied
upon as an interpretative tool for the
construction of double taxation
treaties, or the interpretation of
Division 13 of the ITAA 1936.
This year, a new subdivision (815-A)
was inserted into the ITAA 1997,
allowing the Commissioner to apply
the transfer pricing provisions when
(a) an entity receives a transfer pricing
benefit and (b) either a bilateral tax
treaty that contains an Associated
Enterprises Article or a Business
Profits Article applies. This new
subdivision allows for the
Commissioner to calculate a transfer
pricing benefit in accordance with the
Associated Enterprise Article or the
Business Profits Article. This figure
can then be used to increase the
taxable income or decrease the losses
of a taxpayer that would have
otherwise received a transfer pricing
benefit.
Treaty shopping
Australia is a party to a number of bilateral international taxation
agreements which seek to avoid
double taxation and prevent fiscal
evasion. The ATO is concerned with
the interposition of conduit entities in
treaty countries for the purpose of
obtaining treaty relief to avoid the
payment of Australian tax. On
December 1, 2010, the ATO issued a
public ruling, Taxation Determination
TD 2010/20 which outlines the ATO‟s
view that Australia‟s GAAR will apply
in circumstances where a taxpayer
enters into an arrangement that is
designed to alter the intended effect of
Australia‟s international tax
agreements network.
The ATO is particularly focused on
cross border arrangements which, for
no apparent commercial reason, have
interposed entities that are residents
in countries that have a double
taxation agreement with Australia
(e.g., the Netherlands and
Luxemburg), that are entered into for
the purpose of accessing the treaty
relief in respect of business profits
derived from the sale of an asset. The
ATO is particularly focused on private
equity or leveraged buy outs.
Emerging legislative factors
Increased use of retrospective
legislation
Recently, the Australian government
has introduced or announced its
intention to introduce retrospective
legislative amendments to key tax
topic areas. This emerging trend has
given rise to significant debate
between the Australian government,
the ATO, professional bodies, industry
groups, and taxpayers. The issue has
also been the subject of submissions
by professional bodies and industry
groups expressing their concerns over
the potential adverse impact of these
new laws to taxpayers. Examples of
retrospective amendments include the
following:
Transfer pricing
A new subsection 815-A has been
inserted into the Income Tax
Assessment Act 1997 (Cth) to amend
the existing transfer pricing regime.
This amendment allows the
Commissioner to issue transfer
pricing assessments pursuant to the
Associated Enterprises or Business
Profits Articles of Australia‟s double
tax agreements. Importantly, the
amendment applies retrospectively to
the income years commencing on or
after July 1, 2004.
Rights to future income
Further amendments to the tax
consolidation regime were passed on
June 29, 2012 to repeal and limit the
Rights to Future Income measures
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introduced earlier in 2010. These
changes have retrospective
application to the year commencing
July 1, 2002 and will affect
transactions which took place prior to
the introduction of the measures in
2010. The Right to Future Income
measures operate such that if an
entity that joins a consolidated group
holds an asset that is a right to future
income, the tax cost that is allocated
to the asset is deductible over either
the life of the relevant contract, or 10
years (whichever is lesser). The repeal
of these measures and its
retrospective application to taxpayers
were met with strong opposition from
professional bodies and industry
groups.
GAAR
Yesterday, the Australian government
introduced amendments regarding
Australia's GAAR to Parliament. This
development follows the Australian
government's release of draft
provisions on November 16, 2012,
which proposed to rewrite aspects of
Australia‟s GAAR particularly the
provisions dealing with the existence
of a „tax benefit‟. The draft provisions
were accompanied with draft
explanatory material and public
comments were sought in relation to
the proposals. Submissions were
made on behalf of various professional
bodies and industry groups with the
generally held view that the proposed
reforms were too wide ranging and, if
enacted in the proposed form, may
have unintended consequences.
Review of international tax system
for businesses
The Australian government has
recently announced two new
measures to examine the corporate
taxes paid by large and multinational
companies. First, on December 10,
2012, Assistant Treasurer David
Bradbury announced the formation of
a specialist reference group to address
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the tax minimisation practices of
multinational enterprises. The
announcement follows a concern by
the Australian government that tax
planning and structuring practices are
being undertaken by multinational
corporations for the purpose of
permanently avoiding the Australian
tax base. Similar enquiries are
currently being made in other
jurisdictions including the United
States, the United Kingdom, and
France.
The background and context of the
review was outlined in a speech by the
Assistant Treasurer on November 22,
2012, where it was expressed that the
advances in digital technology and the
internet have transformed the way
economic activity is occurring, putting
pressure on the corporate tax system
in Australia and around the world. In
turn, this “challenges some of the
concepts that form the building blocks
of our current international tax
architecture – source, permanent
establishments and residency”. As a
part of the review, the Australian
government will be considering
whether to tax corporate groups based
on different criteria including the
location of economic activity and
consumption.
Second, on February 4, 2013, the
Australian government also
announced that it will consider ways
of improving the transparency of taxes
paid by large and multinational
companies. The Australian
government, with advice from the
specialist reference group, will
examine what legislative changes are
appropriate to allow the tax
information of these companies to be
made publically available. The
specialist reference group is
comprised of business
representatives, tax professionals,
academics and includes PwC Tax
Controversy Partner, Michael Bersten.
The takeaway
So how can multinational enterprises
navigate through this period of
uncertainty and potential change?
Now more than ever, taxpayers should
have the relevant analysis,
documentation, and evidence ready to
support its positions in case of
challenge by the ATO.
Preparedness is a critical tool,
particularly the ability for an
enterprise to be ready to engage in a
real-time dialogue with the ATO in
advance of a formal audit.
Many of the trends and issues above
underscore the critical need for
taxpayers to be ready. Most
importantly, the ATO now has earlier
access to a wider range of taxpayer
information i.e., through the
expansion of the RDF, the sharpened
focus on information gathering, and
increased international cooperation
between tax administrations. And the
ATO is specifically seeking these
upfront, real-time dialogues as
evidenced by the introduction of
PCRs. Taxpayers should expect the
ATO to pursue more detailed
information requests even prior to the
audit stage.
A crucial ingredient to being prepared
is having in-depth, local knowledge
about the specific 'hotspots' on
which the ATO is focusing. Multinational enterprises should closely
review the potential application of
Part IVA and the use of certain
transfer pricing methods. Do these
developments affect their future or
existing tax positions? Are there
available options and strategies in
Australia that could enable greater
upfront certainty regarding their tax
liability? This review should be ongoing and include periodic monitoring
of further developments in these
dynamic areas.
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Let’s talk
For a deeper discussion of how this issue might affect your business, please contact:
Tax Controversy and Dispute Resolution
Michael Bersten, Sydney
61 2 8266 6858
[email protected]
Paul McCartin, Melbourne
61 3 8603 5609
[email protected]
Caleb Khoo, Sydney
61 2 8266 6526
[email protected]
© 2013 PricewaterhouseCoopers LLP. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers (a Delaware limited liability partnership),
which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.
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