What is transfer pricing?
“Transfer pricing is an increasingly complex issue facing international businesses, as more countries are recognising the importance of the issue and are developing their transfer pricing laws. Consequently businesses must ensure they offer transparency in all aspects of intercompany pricing arrangements.”
Ian Evans, Global Head of Tax, Grant Thornton International.
While seen as complex, transfer pricing involves a mixture of accounting, tax consulting, and economic analysis skills that allows a corporate group to set and defend its position in countries in which it carries on business.
For tax authorities, transfer pricing means a process of review of pricing methods applied to ensure profit shifts are not detrimental to the revenue of each country. Adjustment in one country however can lead to the potential for double taxation of cross border generated profit elements if tax authorities do not agree with how prices are determined and applied at both ends of the transaction.
How does the ATO focus on transfer pricing?
The ATO focuses its risk review and audit activity on the broad range of international tax issues associated with transfer pricing, controlled foreign companies, and withholding tax deducted from dividends, interest and royalties. It looks for international tax risk – is less Australian tax paid than would be if there were no international tax dealings?
Generally however the ATO relies on taxpayers to prepare transfer pricing documentation to explain and defend the pricing undertaken.
What does the ATO do in a risk review?
Back in 1998, the ATO issued income tax ruling TR 98/11 that sets out in detail what it expects to see in a transfer pricing documentation report and what it will do in reviewing it, or the steps it will take if no documentation is present in the form it expects to see.
The ruling sets out a “4 step process” and outlines how the ATO will score documentation in a risk review to determine if the ATO should move to an audit of the transfer pricing risk.
The scoring process has a risk checklist which reviews the document under the 4 steps and ranks the company on a scale of having no documentation coverage [high risk of audit to discover what is happening], to having adequate coverage [low risk of audit if the explanations are adequate].
The process also has an internal ATO economist review of the company’s annual profit and loss account over 5 years and they apply an ABC score that ranges from industry normal profit [low risk to the revenue] to continuing loss [high risk to the revenue warranting audit review].