After a nearly three-year wait[1], the ATO finalised the risk guideline targeting cross-border related party arrangements (collectively referred to as ‘Intangibles migration arrangements’) involving:

• Migration of intangible assets – ‘Migration’ refers to any restructure or change associated with Australian intangible assets that allows another entity to access, hold, use, transfer or benefit from the intangible assets, and
• Mischaracterisation / non-recognition of Australian activities connected with intangible assets – this includes arrangements relating to the Australian development, enhancement, maintenance, protection and exploitation (DEMPE) activities in connection with intangible assets held offshore.

The Guideline addresses concerns with arrangements:

• under which Australia-led intangibles are transferred, licensed to or otherwise held by an international related party
• lacking the requisite substance to perform or control DEMPE activities and/or assume associated risk and
• where value-adding DEMPE activities remain in the hands of Australian taxpayers.

The Guideline applies from 17 January 2024, and will apply to existing and new arrangements.

The Guideline does not reflect the ATO’s interpretation of tax laws, however serves as a cautionary notice that ATO will focus on scrutinising[2] risky arrangements.

The ATO’s compliance approach

The ATO’s approach to risk assessment is determined by two point-based Risk Assessment Frameworks (RAFs).

RAF Table 1

The below risk factors may trigger risk points for a completed intangible migration during the current year:

• in connection with a restructure or change had associated with intangibles, the Australian entity continues to hold certain economic relationship with the intangibles
• Operational and functional circumstances of the relevant international related party (IRP)o
• tax outcomes of the relevant IRP as well as the Australian entity
• undocumented dealing involving Australian intangible assets / DEMPE activities that are not recognised.  

RAF Table 2

RAF Table 2 becomes relevant where there was no intangible migration completed during the current year. It comprises the below risk factors:

• extent of Australia based DEMP activities in connection with intangible assets owned by an IRP
• operational and functional circumstances of the relevant IRP
• tax outcomes of the relevant IRP
• whether the ongoing intangible arrangement is connected to a past migration (if so, RAF Table 1 needs to be assessed on past migration).

The risk zones / ratings and corresponding compliance approaches are summarised in the table below.

Evidence expectations

Similar to previous drafts, the Guideline continues to place a high bar for evidence and documentation.

The expected evidence focuses on the following aspects:

• evidencing the commercial considerations and business decision-making
• evidencing the legal form and substance of Intangibles migration arrangements
• identifying and evidencing the intangible assets and connected DEMPE activities, and
• evidencing the tax and profit outcomes of Intangibles migration arrangements.

The complexity of taxpayers’ business, the extent to which their Intangibles migration arrangements contribute to that business, and the risk rating of the arrangement will influence the type and level of evidence the ATO expects from them to substantiate the arrangement. However, the Guideline does not serve as substitute for the transfer pricing documentation requirements under Australian tax law.

Examples

Appendix 1 of the Guideline includes 15 examples of Intangibles migration arrangements to illustrate how the RAFs should be applied by taxpayers. Our transfer pricing experts break down and explain these examples here.

Some positive improvements, but still challenging to handle

Compared with PCG 2023/D2, there appears to be some “taxpayer friendly” changes which show that the ATO adopted public feedback during the consultation process. Some positive changes include:

• Introduced ‘Excluded Intangibles Arrangements’ that are not subject to the Guideline – essentially vanilla outbound / inbound distribution arrangement, or low value service arrangement (subject to strict eligibility criteria).
• Expansion of lower end risk zones to White Zone and Blue Zone.
• Reallocation of risk scores – for example, uplifted the point threshold (from 25 to 35) for higher risk zone, and Migration of intangibles, by itself, does not immediately trigger a risk point.
• Providing more scenarios where ‘grouping’ of Intangibles migration arrangements is allowed.

On the other hand, the Guideline remains to place significant challenges and administrative burden on taxpayers:

• The Guideline has very broad application, encompassing scenarios beyond the immediate transfer of assets.  This requires a detailed function and risk analysis to demystify how the Australian entity and its relevant IRP interact in connection with DEMPE activities, regardless of the materiality[1] involved.
• The eligibility criteria for ‘Excluded Intangible Arrangements’ appears to be restricted, and the lack of any direct example for ‘Excluded Intangible Arrangements’ in the Guideline does not help provide confidence in application to the public.
• The Guideline scopes out consideration of other tax aspects such as ‘pricing’ of intangible arrangements. In the RAF, one significant risk trigger is ‘tax outcome’ which focuses on the tax treatment or condition of the IRP.  However, if the pricing is good enough from an Australian perspective, the overall tax risk to the Australian taxpayer could have been lower than that derived from the Guideline.  As such, the risk outcome derived from the RAF, by itself, could be misleading.
• Taxpayers are expected to self-assess their risk based on extensive evidential information, including information possessed by IRPs.  Obtaining intangibles related information or cooperation from overseas could be very challenging, due to confidentiality or other concerns.

Key takeaway for taxpayers

The Guideline’s finalisation highlights the ATO’s focus on tax risks connected to intangible arrangements with offshore related parties. It is relevant to a wide range of Australian taxpayers, regardless where the relevant intangibles are held. The asessment of the relevance and associated risk is not a straightforward process.  It is important for taxpayers to self-assess early and complete these self-assessments before tax returns for the relevant income year are lodged.

For larger taxpayers that are required to complete Reportable Tax Position (RTP) Schedules in the tax return, a new question on Intangibles migration arrangements will need to be completed.  Getting in touch with relevant IRPs early to obtain necessary evidential support is critical for the RTP disclosure.

Regardless of materiality, taxpayers need to ensure sufficient coverage on the arm’s length nature of relevant intangible arrangements is included in its contemporaneous transfer pricing documentation.  All the examples detailed in the Guideline have mentioned transfer pricing as a focus area under the ATO’s compliance approach across all risk categories.

How SW can help

Our experts can assist with:

• further clarification regarding the Guideline
• helping you understand more to what extent your arrangements will be subject to the Guideline
• assessing risk level of your arrangements
• ensuring your RTP disclosures are accurate and supportive
• putting in place transfer pricing documentation to provide a further line of defence for your intangible arrangements.

Reach out to your SW advisor for support from our specialist tax team.

Contributors

Elena Guo

[1] With initial PCG 2021/D4 released in May 2021, followed by PCG 2023/D2 released in May 2023.

[2] Including the potential application of the general anti-avoidance, transfer pricing, capital gains tax rules etc.

The post ATO issues final risk guideline on Intangibles migration arrangements appeared first on SW Accountants & Advisors.

Intangibles Arrangements is the long-awaited and last tranche of ATO’s focus areas following the revision of OECD Transfer Pricing Guidelines in 2017.

The Draft PCG discusses ATO’s risk assessment framework on Intangibles Arrangements based on the risk factors described as High, Medium, or Low.

The following examples have been adapted from the PCG, and illustrate the application of these risk factors.

High-risk example 1: Centralisation of intangible assets

Facts:

• AusCo owns, manages and controls DEMPE activities of the group’s intangible assets
• AusCo and the global group decide to transfer these intangible assets from AusCo to be centralised in a new foreign entity, NewCo
• NewCo will receive worldwide royalty income from the rights to exploit the Existing Intangibles and any New Intangibles developed, while AusCo receives a declining royalty from NewCo associated with the exploiting the Existing Intangibles
• AusCo continues to undertake majority of DEMPE activities while receiving a cost-based remuneration under the R&D service agreement. NewCo hires additional staff and acquires additional assets, but these are not sufficient to allow NewCo to wholly manage, perform and control the DEMPE activities for the intangibles.

The above arrangement is regarded as a High-Risk Intangibles Arrangement because:

• There is a risk that this arrangement is not commercially rational for AusCo and may not be consistent with AusCo’s best economic interests having regard to the commercial options realistically available, disregarding potential tax impacts. The risk is emphasised when no documentation is available to substantiate the decision making or potential tax impacts that were taken into account
• AusCo has not been properly remunerated for the DEMPE activities it performs
• In the absence of this arrangement, AusCo would continue to own and derive income from the intangibles. AusCo would not need to pay royalties to NewCo.

High-risk example 2: Non-recognition of Australian intangible assets and DEMPE activities

Facts:

• AusCo owns trademarks connected to products and services exclusively distributed in Australia. AusCo manages, performs and controls DEMPE activities and assumes associated risk of the intangibles
• AusCo’s DEMPE activities increase in intensity, resulting in new intangible assets. AusCo does not account for these in its financial statements or register them for legal protection. Likewise, AusCo’s global group does not maintain a comprehensive contemporaneous R&D or intellectual property policy or other relevant guidelines
• AusCo’s international related parties (IRPCos) are granted access to the new intangible assets to improve their products and services. No documentation is available for this arrangement
• The profitability of IRPCos increases as a result of accessing and exploiting the new intangibles and the DEMPE activities performed by AusCo
• AusCo does not receive any compensation for the intangibles.

The above arrangement is regarded as a High-Risk Intangibles Arrangement because:

• The absence of legal agreements may impede AusCo’s ability to protect its interests of the intangibles
• The lack of compensation for the use of the intangibles may be inconsistent with arrangements expected between independent parties.

High-risk example 3: Migration of pre-commercialised intangible assets

Facts:

• AusCo undertakes years of R&D in Australia to develop a new product range, which results in the development of pre-commercialised intangible assets. The intangibles are owned by AusCo and are strategically important to the business
• Prior to the commercialisation of the intangibles, AusCo and the global group decide to incorporate a new offshore entity, NewCo, to own the rights to the intangibles. NewCo does not have sufficient assets to undertake DEMPE activities while AusCo has the capability and capacity to develop, manufacture and commercialise products associated with the intangibles. No documentation is available to substantiate the commercial rationales underpinning this decision or consideration of potential tax impacts
• AusCo and NewCo enter into a license agreement, which transfer the effective control of the intangibles from AusCo to NewCo. All the worldwide income that will be received from the global commercial sales of the related products will be derived by NewCo. NewCo pays ongoing royalties to AusCo in relation to worldwide sales of related products. No documentation is available to substantiate the arm’s length nature of the pricing or terms of this arrangement
• NewCo enters into a service agreement with AusCo where AusCo agrees to provide services for the development, manufacture, and distribution of the new products for a cost-based remuneration. No documentation is available to substantiate the arm’s length nature of the pricing or terms of this arrangement
• After the transfer, AusCo continues to employ specialised staff and uses its expertise and assets to manage, perform and control DEMPE activities associated with the intangibles. In the meantime, NewCo has limited relevantly qualified staff and manages and performs limited activities, owns limited assets, and assumes limited risks in connection with the intangibles
• AusCo employs specialised staff and uses its expertise and assets to manufacture and sell related products to the global market under the service agreements while it only receives cost-based remuneration. NewCo continues to have limited qualified staff, manages, and performs limited activities, and assumes limited risks in connection with the manufacture, distribution and marketing of related products while it derives worldwide income from the sale of related products

The above arrangement is regarded as a High-Risk Intangibles Arrangement because:

• There is a risk that AusCo’s entry in the license agreement and service agreement is inconsistent with comparable arrangements expected between independent parties. The risk is emphasised when no documentation is available to substantiate its decision making or potential tax impacts that were taken into account
• AusCo does not require NewCo as a partner to develop or commercialise the intangibles as it had the capability, expertise and capacity to do so
• The transfer results in AusCo not being able to derive worldwide income from the sale of related products
• NewCo did not have the capability or capacity to manage and be responsible for the rights and obligations it had under the Licence Agreement in connection with the Product Intangibles and the New Products which were instead, in substance, controlled and managed by AusCo.

Key takeaways

While the Draft PCG provides a detailed framework intended to facilitate taxpayers’ self-assessment of risks associated with related party intangible arrangements, the framework lacks quantitative risk indicators (as opposed to other PCGs). The framework reflects a move away from the traditional focus on legal ownership of intangibles to where the DEMPE activities are performed and the entity able to bear the risks associated with those activities.

In documenting where the DEMPE functions are performed, multinationals should have regard to commercial evidence (i.e. internal reviews / board presentations / briefing materials) associated with intangible arrangements, which may not be reflected in conventional transfer pricing documentation.

It is noteworthy that self-assessment of Intangible Arrangements are required for taxpayers who complete a Reportable Tax Position (RTP) schedule (i.e. Part of Category C disclosures).
The level of uncertainty resulting from transfer pricing disputes involving Intangibles Arrangements could be significant. Taxpayers should take prompt actions to thoroughly assess their material Intangibles Arrangements.

How SW can assist

Contact one of our experts below to discuss how the Draft PCG affects your Intangible Arrangements.

Get in touch

Helen Wicker

E hwicker@sw-au.com

Daren Yeoh

E dyeoh@sw-au.com

Yang Shi

E yshi@sw-au.com

The post ATO draft guidance on Intangibles Arrangements between related parties appeared first on SW Accountants & Advisors.