Transfer pricing: secondary transfer pricing adjustments

Can a 'repatriation' payment made in a foreign currency, at the conclusion of a mutual agreement procedure, by an Australian company to a related foreign company to 'conform accounts' under the foreign jurisdiction's secondary adjustment and related repatriation provisions, give rise to an allowable foreign exchange loss under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), or Division 3B of Part III of the Income Tax Assessment Act 1936 (ITAA 1936), or alternatively, a foreign exchange loss giving rise to an appropriate adjustment under Article 9 (2) of the Australia - United States Convention of Schedule 2 to the International Tax Agreements Act 1953 (The US Convention)?

No. A foreign exchange loss was not incurred as a result of the conforming of accounts.

The United States of America (US) raised primary transfer pricing adjustments against US Company in respect of that company's international dealings with related Australian Company. US taxation law also contains secondary adjustment and related repatriation provisions.

Australia and the US reached agreement under mutual agreement procedure (MAP) in respect of the 'appropriate adjustment', both in principle and amount, as allowed for under Article 9 and Article 24 of the US Convention, resulting in correlative relief (that is, allowance of a credit under Division 19 of the ITAA 1936) for Australian Company.

Under the agreement reached between the two revenue authorities, US Company was permitted to conform its accounts at the conclusion of MAP so as to avoid triggering secondary transfer pricing adjustment provisions.

The conforming of accounts was achieved by Australian Company repatriating the amount of the appropriate adjustment in the foreign currency (that is US dollars: USD) to US Company.

There was a considerable lapse of time between the date of the original cross border dealings, which were the subject of the US transfer pricing adjustments, and the date of the USD repatriation payment.

A so-called 'shortfall' resulted between the 'appropriate adjustment' amount and the USD amount repatriated, calculated by reference to the decrease in the value of the Australian dollar against the USD in the period between the earlier years of income (during which the cross-border dealings occurred and to which the US primary transfer pricing adjustment related) and the later income year in which the USD repatriation payment was agreed and made by Australian Company.

A foreign exchange loss may arise where, due to a variation in the rate of exchange, the amount actually required to be paid by a taxpayer (operating on an accruals basis) to discharge a liability incurred in a foreign currency, is greater than the amount of the liability as stated in the taxpayer's accounts in an earlier year of income during which the liability accrued.

In order for either section 8-1 of the ITAA 1997 or Division 3B of the ITAA 1936 to apply, the foreign exchange loss must be realised: Federal Commissioner of Taxation v. Energy Resources of Australia Ltd (1996) 185 CLR 66; 96 ATC 4536; (1996) 33 ATR 52. In determining whether a foreign exchange loss (or gain) has been realised, each case will need to be examined on its own merits.

In this instance, Australian Company made actual payment of the repatriation amount in USD. The proposition has been put to the Commissioner that the repatriation payment is directly linked to the original cross-border dealing, which was the subject of the transfer pricing adjustment, such that an exchange loss in relation to the repatriation payment can be determined by reference to exchange rates prevailing at the time of that cross-border dealing.

Although the repatriation payment may have some nexus with the original cross-border dealing, Australian Company had completely discharged its contractual liability to US Company in respect of the property it acquired under the contract some years prior to the payment of the USD repatriation amount. While the parties to a contract are usually free to vary its terms by further contract, the Commissioner considers that, at general law, there has been no variation of the contract price, as Australian Company's contractual obligations had previously come to an end by performance.

The payment of the further USD amount by Australian Company was made solely for the benefit of US Company to enable it to comply with US statutory obligations, and was made essentially because of the group relationship between the two companies. That is, the agreement or arrangement under MAP to make the USD repatriation payment is separate and distinct from the original contractual obligation (to pay a specified amount in USD in consideration for the supply of property) of Australian Company.

The 'shortfall' is merely a notional amount. In relation to both section 8-1 of the ITAA 1997 and Division 3B of the ITAA 1936, no allowable foreign exchange loss was incurred. In addition, the matter of foreign exchange fluctuations in this context is not within the purview of Article 9 (2) of the US Convention.