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Australian Taxation Office releases draft update on guidance regarding transfer pricing risk for certain offshore shipping service hub arrangements

Executive summary

On 8 November 2018, the Australian Taxation Office (ATO) released a draft update to Practical Compliance Guideline (the PCG) 2017/1 (effective 1 January 2017) in the form of a new draft Schedule 3 and Attachment C. The PCG sets forth the ATO’s compliance approach to transfer pricing issues related to the location and relocation of certain business activities and operating risks into a centralized operating model, commonly referred to as “hubs.”

The risk assessment framework included in new Schedule 3 and Attachment C for certain types of offshore shipping service hub arrangements indicates that taxpayers generally exit the green zone when hub profits exceed a 25% mark-up of hub costs.

The PCG, combined with the new draft Schedule 3 and Attachment C addressing the transfer pricing risks for certain types of offshore shipping service hub arrangements, is designed to:

  • Explain the ATO compliance approach and evidence required, which will be driven by the perceived risks of businesses’ particular hubs and risk profiles
  • Assist the taxpayer in assessing the ATO’s perceived compliance risk of the transfer pricing outcomes of hubs and to work with the ATO to reduce the transfer pricing risk exposure in relation to hubs

It is important to note that the PCG is not a formal technical analysis of the Australian transfer pricing law, nor its requirements or what is supportable under the law.

The draft Schedule 3, when finalized, will be effective for income tax years commencing on or after 1 January 2019.

Detailed discussion

Shipping services covered by this Schedule

The risk indicators in Schedule 3 are only relevant to shipping or shipping services provided by an offshore shipping service hub for the following natural resource commodities or products:

  • Iron ore
  • Liquefied natural gas (LNG)
  • Thermal coal
  • Metallurgical coal
  • Aluminum (including alumina and bauxite)
  • Precious metals or stones (if transported by sea, including gold, silver and diamonds)
  • Crude oil (including condensate)
  • Petroleum products (including LPG, blendstocks and feedstocks), and
  • Other metals, minerals or mined elements (including lithium, rare earths, uranium, copper, lead, zinc and nickel)

Offshore shipping service hub defined

For the purposes of this Schedule, an offshore entity will be an offshore shipping service hub if it:

  1. Is a related offshore entity or a permanent establishment of a related Australian entity or related foreign entity

    Or

  2. Is engaged in the provision or organization of shipping or shipping services in connection (either directly or indirectly) with Australian exports.

De minimis threshold – combined low risk benchmark

  • Where an entity is both an offshore shipping service hub and an offshore marketing hub and the costs relating to the provision of marketing and shipping services incurred by the entity are equal to or less than AU$2 million,1 the low risk benchmark is Hub profit less than or equal to a 100% mark-up of hub costs.

Where the entity does not meet the de minimis threshold, the standard low risk benchmark for the offshore shipping service hub (as well as the low risk benchmark for the marketing hub) will need to be applied.

Risk assessment framework

The PCG includes a risk assessment framework in Attachments A, B and new C for categorizing taxpayers through risk ratings. ATO compliance enforcement depends on the hub’s risk rating - with a low engagement for a low risk zone, consequently followed by a detailed and comprehensive review for higher risk hubs.

The risk assessment framework indicates the risk rating of taxpayers would increase beyond the green zone (low risk) for:

  • Offshore marketing hubs when core marketing hub profits exceed a 100% mark-up of hub costs
  • Certain offshore shipping hubs and non-core procurement hubs when hub profits exceed a 25% mark-up of hub costs

The tax impact thresholds are different in the risk assessment frameworks for offshore marketing hubs and offshore non-core procurement hubs:

Schedule
Risk rating
Schedule 3: Offshore Shipping
Attachment C
Schedule 1: Marketing hubs
Attachment A
Schedule 2: Non-core procurement hubs
Attachment B

Blue zone*

Tax impact below $5 million annually

Tax impact below $5 million annually

Tax impact below $2 million annually

Yellow zone**

Tax impact between $5 and $15 million annually

Tax impact between $5 and $50 million annually

Tax impact between $2 and $5 million annually

Amber zone**

Tax impact above $15 million annually

Tax impact above $50 million annually

Tax impact above $5 million annually

Red zone

Unable/choosing not to apply risk framework or calculate tax impact

* Will automatically move to yellow zone if transfer pricing documentation has not been prepared in accordance with TR 2014/8

** Will automatically move to red zone if transfer pricing documentation has not been prepared in accordance with TR 2014/8

Again, this is not a technical analysis by the ATO of the transfer pricing law or its requirements. The language is related to the often-used ATO analogy of “swimming between the flags.” The takeaway from PCG 2017/1 is that taxpayers who swim outside the green zone should have their flotation devices ready, in the form of transfer pricing documentation, to support the basis for their pricing and profitability decisions.

Endnote

1. Currency references in this Alert are to AU$.

EYG no. 011938-18Gbl

Download this Tax Alert as a PDF file.

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