Multinational groups who use intangible assets as part of their operations should be aware of two new guidance documents published by the Australian Taxation Office (ATO).
These guidance materials have been published in the context of the ATO’s current focus on what it considers to be multinational profit shifting. The extensive evidentiary expectations outlined in PCG 2024/1, and aspects of the interpretation approach set out in TR 2024/D1 are broadly consistent with what we are observing in practice.
The PCG 2024/1 reveals that the ATO continues to expect evidence beyond routine transfer pricing documentation in relation to higher risk intangibles arrangements. Multinational groups will need to demonstrate the commercial reasons for the arrangement. Under the PCG, taxpayers will be required to self-assess tax risk against the ATO’s framework as part of annual reporting and tax return obligations. The self-assessment will need to be produced to the ATO, as part of annual compliance obligations and/or in the context of an Advance Pricing Arrangement. Higher risk cases can expect the ATO to review the evidence supporting their risk assessment.
The revised draft software ruling, TR 2024/D1 controversially adopts an interpretation approach that is broadly cast and is pro-revenue authority, with little said about the circumstances which would not be considered to be a royalty. While the detail of the ruling relates to software, it would not be unreasonable to expect the same position to be adopted in relation to any arrangements involving intellectual property, consistent with what we are observing in practice.
Multinational related party arrangements involving an Australian entity and functions concerning the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets will need to be examined, regardless of when those arrangements were entered into.
The ATO will likely want to verify arrangements where the Australian entity has historically owned, managed or controlled the DEMPE activities associated with the intangibles, has assumed risk and received income, and following a change in arrangements there is reduced tax in Australia. Examples of the types of arrangements that will attract scrutiny include:
The PCG sets out the ATO’s risk assessment framework. The framework allocates points to arrangements with certain attributes. There is a focus on:
The ATO’s risk assessment framework contains a long list of pre-populated questions, together with 15 examples. The answers to those questions are allocated points, with the overall points informing which of the four zones the taxpayer’s arrangement falls within.
In a welcome development there is greater clarity and explanation regarding the assessment of risk, this includes an explanation of arrangements which will be excluded from consideration, such as certain distribution and low-value services arrangements.
Many of the responses required to the risk assessment framework will be subjective in nature, and so there is the potential for the ATO to form a different view to the taxpayer on the arrangements (similar to what is commonly experienced by taxpayers in transfer pricing disputes in Australia). Extensive and detailed evidence regarding the functions, assets and risks of the entities of the group will be required to meet the ATO expectations for higher risk cases.
This is a further draft of the ATO’s views on the circumstances where the ATO considers an amount paid under a software arrangement to be subject to royalty withholding tax.
TR 2024/D1 sets out the technical interpretation that will be adopted by the ATO. In the eyes of the ATO, a royalty, and hence royalty withholding tax, will need to be recognised where an agreement provides for:
The ruling, once finalised, will apply retrospectively as well as prospectively.
The analysis adopted by the ATO in this draft draws heavily from concepts in copyright law for the purposes of determining whether a royalty arises for tax purposes. There is significantly more detail compared to the earlier draft ruling regarding the key concepts relevant to royalty analysis. In addition, the draft ruling deals with the interaction between the domestic law definition of royalty and the treaty definition.
Some of the points of interest covered by the draft ruling include:
Absent from this draft ruling are the examples that featured previously in TR 2021/D4. In its place, two common “scenarios” are discussed:
The ATO’s view is that under both of these scenarios a royalty will need to be recognised. In relation to Scenario 2, the ATO states that apportionment can be applied if the taxpayer has sufficient evidence that establishes that the distribution rights (or other rights outside of the definition of royalties) had substantial value independent of the right to use copyright and other IP. The ruling does not go on to explain further what evidence would be required.
Taxpayers will need to work through the ATO’s new approach to interpretation as it signals that the ATO may form the view that an obligation to pay RWHT may apply in circumstances where it did not previously.
We note that taxation rulings outline the ATO’s views on the interpretation of certain taxation laws (i.e. they do not have the force of law themselves). There may be alternative arguments to the ATO’s approach.
We are aware that the ATO is already conducting reviews into arrangements in a number of sectors including e-commerce, pharmaceutical, health and science and resources sectors, with aggressive positions being adopted in relation to both technical and pricing outcomes.
While the ATO is adopting a strong stance in relation to these matters, there are a number of opportunities for taxpayers to maximise on their inherent advantages regarding these arrangements and look to achieve more reasonable outcomes. Clear objective evidence and independent valuation expertise are essential to displace the ATO’s pro-revenue starting position on pricing outcomes for intangible arrangements.
 Previously only 13 examples in PCG 2023/D2.
 It replaces the now withdrawn ruling TR 93/12 relating to the use of a local distributor of “simple use” software, and also replaces draft Taxation Ruling TR 2021/D4.
 The ATO notes that there are material differences in the meaning of royalty for domestic and treaty purposes in the US, Mexican and Singaporean tax treaties, although the focus in the draft is on the standard treaty.
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