Scope
This Practice Statement is published as part of a package dealing with transfer pricing documentation and should be read in conjunction with Taxation Ruling TR 2014/8 Income tax: transfer pricing documentation and Subdivision 284-E, which sets out the Commissioner of Taxation's views on the transfer pricing documentation requirements of Subdivision 284-E of Schedule 1 to the Taxation Administration Act 1953 (TAA).
All legislative references in this Practice Statement are to Schedule 1 to the TAA, unless otherwise indicated.
This Practice Statement explains how we administer scheme penalties arising from the application of the transfer pricing rules in Subdivisions 815-B and 815-C of the Income Tax Assessment Act 1997 (ITAA 1997). Liability to these penalties arises under subsection 284-145(2B). In this Practice Statement, these penalties are referred to as 'transfer pricing penalties'.
This Practice Statement discusses: • when an entity will be liable for a transfer pricing penalty, and • how we will assess an entity's transfer pricing penalty, including determining remission.
This Practice Statement does not provide guidance on an entity's liability to scheme penalties under: • subsection 284-145(1) that arise from the application of the anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) • subsection 284-145(2) that arise from the application of former Division 13 of the ITAA 1936 and Australia's tax treaties, and • subsection 284-145(2A) that arise from the application of Subdivision 815-A of the ITAA 1997.
Background
An entity will be liable to a scheme penalty under subsection 284-145(2B) where either Subdivisions 815-B or 815-C [1] of the ITAA 1997 applies to impose a liability to pay additional income tax or withholding tax.
Subsection 284-145(2B) was introduced by the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013. This Act also introduced Subdivisions 815-B, 815-C and 815-D of the ITAA 1997 (collectively referred to as 'the transfer pricing rules' in this Practice Statement) and Subdivision 284-E.
Subsection 284-145(2B) of Subdivision 284-C imposes administrative penalties on an entity that gets a benefit under a scheme within Subdivisions 815-B and 815-C of the ITAA 1997. Subdivision 284-C is part of the uniform administrative penalty regime that applies to entities for failing to satisfy their obligations under the taxation laws.
Subdivision 815-B of the ITAA 1997 ensures that the amount of Australian tax from cross-border conditions between entities is consistent with the arm's length principle. Subdivision 815-C of the ITAA 1997 ensures that the amount of Australian tax from the attribution of profits by entities operating permanent establishments is consistent with the arm's length principle. Subdivision 815-D of the ITAA 1997 clarifies how Subdivisions 815-B and 815-C of that Act apply to trusts and partnerships. Subdivision 284-E sets out the special rules about unarguable positions for cross-border transfer pricing (including the documentation requirements).
Under Subdivision 815-B of the ITAA 1997, an entity will get a transfer pricing benefit where: • the actual conditions that operate between the entities differ from the arm's length conditions, and • the other requirements of section 815-120 of the ITAA 1997 are satisfied.
Under Subdivision 815-C of the ITAA 1997, an entity will get a transfer pricing benefit where: • the amount of profits attributed to the permanent establishment differs from the arm's length profits of the permanent establishment, and • the other requirements of section 815-220 of the ITAA 1997 are satisfied.
The entity is liable to a transfer pricing penalty based on the total additional amount of income tax or withholding tax [2] arising from the application of Subdivisions 815-B or 815-C of the ITAA 1997 as a result of an entity getting a transfer pricing benefit.
The transfer pricing rules replace: • Division 13 of the ITAA 1936 and its associated scheme penalty provision of subsection 284-145(2) for income years commencing on or after 29 June 2013, and • Subdivision 815-A of the ITAA 1997 and its associated scheme penalty provision of subsection 284-145(2A) for income tax years commencing on or after 29 June 2013.
Steps in the administration of scheme penalties
The administration of Subdivision 284-C scheme penalties involves 3 main steps [3] : • Step 1 – Determine whether the entity is liable for a penalty • Step 2 – Assess the amount of the penalty (a) determine the scheme shortfall amount (b) determine the base penalty amount (BPA) (c) increase or reduce the BPA, or both (d) decide whether to remit all or part of the penalty. • Step 3 – Notify the entity of the liability to pay the penalty.
This Practice Statement provides guidance on these 3 steps in the order they occur in the administrative process. The steps must be completed in the order specified in paragraph 3A of this Practice Statement. A decision about remission of penalty will normally be made in the course of assessing the amount of any penalty, as both are part of Step 2. However, a decision about remission of penalty can also be made after an entity has been notified of its liability to pay the penalty. [4]
Step 1 – determine whether the entity is liable for a penalty
An entity is liable to a transfer pricing penalty in relation to a scheme where [5] : (a) (i) the entity is liable to pay an additional amount of income tax for an income year under an assessment we amend, or (ii) the entity is liable to pay an additional amount of withholding tax under one or more withholding tax notices we serve [6] , or (iii) both (i) and (ii) of this paragraph apply (b) the amended assessment or withholding tax notice gives effect to Subdivisions 815-B or 815-C of the ITAA 1997, and (c) the additional amount of income tax or withholding tax the entity is liable to pay is more than its reasonably arguable threshold. [7]
An entity will be liable to a transfer pricing penalty (under subsection 284-145(2B)) only where the amended assessment or withholding tax notice gives effect to Subdivisions 815-B or 815-C of the ITAA 1997 in relation to a scheme. Those Subdivisions apply to income years commencing on or after 29 June 2013.
Meaning of reasonably arguable threshold
An entity will only be liable for a transfer pricing penalty where the entity's scheme shortfall amount is more than its reasonably arguable threshold. [8]
An entity's scheme shortfall amount is the total amount of additional income tax and additional withholding tax it is liable to pay from the application of the transfer pricing rules. [9] Guidance on calculating an entity's scheme shortfall amount is found under Step 2(a) in section 7 of this Practice Statement.
Subsection 284-90(3) provides that an entity's reasonably arguable threshold for an income year is: • if the entity is a trust or partnership, $20,000 or 2% of the entity's net income, whichever is the greater [10] , or • for all other entities, $10,000 or 1% of income tax payable, whichever is the greater. [11]
If the entity's scheme shortfall amount is equal to or less than the reasonably arguable threshold, the entity will not be liable to a transfer pricing penalty.
If an entity's scheme shortfall amount is higher than the reasonably arguable threshold, (provided all other conditions in subsection 284-145(2B) are satisfied) the entity will be liable to a transfer pricing penalty and we must assess the amount of the penalty under Step 2.
Matthew Co is liable to pay $20 million income tax based on its tax return for an income year. In that year, Matthew Co has received a transfer pricing benefit under Subdivision 815-B of the ITAA 1997 and has a scheme shortfall amount of $500,000. As Matthew Co is a company, the scheme shortfall amount must exceed the greater of $10,000 or 1% of the income tax payable by Matthew Co in that income year for a liability for an administrative penalty to apply. $200,000 is 1% of the income tax payable by Matthew Co. This is the reasonably arguable threshold.
Matthew Co has a scheme shortfall amount of $500,000, which is greater than its reasonably arguable threshold of $200,000. Matthew Co is liable to an administrative penalty on the full $500,000.
Step 2 – assess the amount of the transfer pricing penalty
Where, as a result of the application of Step 1, an entity is liable to a transfer pricing penalty, Step 2 requires that we assess the amount of the transfer pricing penalty.
Step 2a – determine the transfer pricing shortfall amount
As noted in this Practice Statement, an entity's scheme shortfall amount is the total amount of additional income tax and additional withholding tax payable from the application of the transfer pricing rules (transfer pricing shortfall amount). [12]
As it is necessary to calculate an entity's transfer pricing shortfall amount in Step 1 to ascertain whether the entity's transfer pricing shortfall amount is above or below its reasonably arguable threshold, the entity's transfer pricing shortfall amount should have already been calculated: • Where there is both an additional amount of income tax and an additional amount of withholding tax in relation to a particular income year, an entity's transfer pricing shortfall amount will be the total of these amounts it is liable to pay. [13] • A scheme benefit that an entity would have received from a scheme to which the anti-avoidance provisions in Part IVA of the ITAA 1936 apply is not included in the entity's scheme shortfall amount to the extent that it is already included in the transfer pricing shortfall amount under the transfer pricing rules. [14]
Step 2b – determine the transfer pricing base penalty amount
The transfer pricing shortfall amount is then adjusted by a particular percentage. The result of this adjustment is the base penalty amount (BPA).
The BPA is worked out by multiplying the transfer pricing shortfall amount by the relevant percentage.
The relevant percentage in the formula reflects whether or not: • having regard to any relevant matters, it is reasonable to conclude that an entity that (alone or with others) entered into or carried out the scheme, or part of it, did so with the sole or dominant purpose of that entity or another entity getting a transfer pricing benefit from the scheme (sole or dominant purpose) [15] • the entity has a reasonably arguable position that the transfer pricing rules do not apply to a matter in a particular way (reasonably arguable position) [16] , and • the entity treated the law as applying in an accepted way.
Subsection 284-160(3) provides specific rules for determining the BPA for transfer pricing penalties.
Under subsection 284-160(3), where an entity has a sole or dominant purpose and does not have a reasonably arguable position, the BPA will be equal to 50% of the transfer pricing shortfall amount. [17]
Where an entity has a sole or dominant purpose and does have a reasonably arguable position, the BPA will be equal to 25% of the transfer pricing shortfall amount. [18]
Where an entity does not have a sole or dominant purpose and does not have a reasonably arguable position, the BPA will be equal to 25% of the transfer pricing shortfall amount. [19]
Where an entity does not have a sole or dominant purpose and has a reasonably arguable position, the BPA will be equal to 10% of the transfer pricing shortfall amount. [20]
An entity cannot have a reasonably arguable position for the purposes of calculating the BPA where it has not met the documentation requirements specific to transfer pricing penalties arising from the transfer pricing rules. [21] See also paragraphs 8AM to 8AQ of this Practice Statement.
The Attachment to this Practice Statement contains a flow chart on how to determine the BPA for transfer pricing penalties under subsection 284-160(3).
Table item 1 of subsection 284-160(3) provides that to work out the BPA for transfer pricing penalties, we must consider whether: having regard to any relevant matters, it is reasonable to conclude that an entity that (alone or with others) entered into or carried out the scheme, or part of it, did so with the sole or dominant purpose of that entity or another entity getting a transfer pricing benefit from the scheme
Where an entity has a sole or dominant purpose, the entity will be liable to a higher BPA.
The following paragraphs of this Practice Statement set out guidelines to assist you in determining whether there is a sole or dominant purpose.
Table item 1 of subsection 284-160(3) provides that an entity must have a sole or dominant purpose of getting a 'transfer pricing benefit from the schem e'.
Subsection 995-1(1) of the ITAA 1997 states that 'transfer pricing benefit' has the meaning given by (among other things) sections 815-120 and 815-220 of the ITAA 1997. [22]
Subsection 815-120 of the ITAA 1997 provides that an entity gets a transfer pricing benefit from conditions that operate between the entity and another entity in connection with their commercial or financial relations (referred to collectively as 'tax advantages') if: • the actual conditions differ from the arm's length conditions • the actual conditions satisfy the cross-border test, and • had the arm's length conditions operated instead of the actual conditions, the result would be one or more of the following - the entity's taxable income being greater - the entity's loss being less - the entity's tax offsets being less, or - the entity's withholding tax payable being greater.
Where the transfer pricing penalty arises from the application of Subdivision 815-B of the ITAA 1997, the transfer pricing benefit will be equal to the total of the tax advantages listed in paragraph 8P of this Practice Statement.
Section 815-220 of the ITAA 1997 provides when an entity gets a transfer pricing benefit for the purpose of Subdivision 815-C of the ITAA 1997.
Subsection 815-220(1) of the ITAA 1997 provides that an entity gets a transfer pricing benefit from the attribution of profits to a permanent establishment if: • the actual profits attributed to the permanent establishment differ from the arm's length profits, and • had the arm's length profits been attributed, instead of the actual profits, the result would be one or more of the following (referred to collectively as 'tax advantages') - the entity's taxable income being greater - the entity's loss being less, or - the entity's tax offsets being greater.
Where the transfer pricing penalty arises from the application of Subdivision 815-C of the ITAA 1997, the transfer pricing benefit will be equal to the total of the tax advantages listed in paragraph 8S of this Practice Statement.
In order for the test in table item 1 of subsection 284-160(3) to be satisfied, the transfer pricing benefit must come from a scheme. [23] Subsection 995-1(1) of the ITAA 1997 defines 'scheme' as: (a) any arrangement; or (b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.
Subsection 995-1(1) of the ITAA 1997 states that 'arrangement': … means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.
The meaning of 'scheme' in subsection 995-1(1) of the ITAA 1997 is substantively the same as the meaning of 'scheme' in subsection 177A(1) of the ITAA 1936. [24]
The High Court considered the meaning of 'scheme' in subsection 177A(1) in Commissioner of Taxation v Hart [2004] HCA 26 (Hart) at [43], per Gummow and Hayne JJ: …Th[e] definition is very broad. It encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also (by its reference to "action" in the singular) the taking of but one step.
You will need to identify the particulars of the scheme or schemes to which subsection 245-145(2B) applies in order to ascertain whether there is a sole or dominant purpose.
Given the broad scope of the definition of 'scheme', the whole or part of the commercial or financial relations in connection with which the actual conditions operate may well be relevant in identifying a 'scheme' as defined in subsection 995-1(1) of the ITAA 1997. As a result, the requirement in table item 1 of subsection 284-160(3) for the existence of a scheme will generally be satisfied.
Step 2c – consider whether an increase or decrease of the BPA is required.
The BPA is then adjusted depending on the individual circumstances of the case. The adjustment formula is [32] : BPA + [BPA × (increase % − reduction %)]
Increase in the BPA
Subsection 284-220(1) provides that the BPA is increased by 20% where the entity: • prevents or obstructs us from finding out about the transfer pricing shortfall amount • becomes aware of the transfer pricing shortfall amount after the statement is made and does not tell us within a reasonable time, or • had a BPA worked out for this type of penalty previously.
The BPA is increased by 20% if one or more of the conditions apply. The increase in the BPA is not cumulative.
Further guidance on the conditions that increase the BPA is found in paragraphs 119 to 134 of PS LA 2012/5. The process for increasing the BPA in this Practice Statement is identical to the process for increasing the BPA for transfer pricing penalties. [33]
PS LA 2012/5 provides additional guidance, among other things, as to what taxpayer behaviour constitutes preventing or obstructing us from finding out about the shortfall amount. You should refer to PS LA 2012/5 when making decisions about increasing the BPA.
Decrease in the BPA
Section 284-225 provides that the BPA is reduced in certain circumstances where an entity makes a voluntary disclosure, in the approved form, about the transfer pricing shortfall amount or part of it.
The BPA is reduced by 20% if: • the entity tells us voluntarily in the approved form about a transfer pricing shortfall amount after being told by us that we will examine the entity's tax affairs, and • telling us can reasonably be estimated to have saved us significant time or significant resources. [34]
The BPA is reduced by 80% where the entity voluntarily tells us in the approved form about a transfer pricing shortfall amount before the earlier of: • the day we tell the entity that we will examine the entity's tax affairs, or • if we make a public statement asking entities to make a voluntary disclosure by a particular day – that particular day. [35]
The Commissioner has the discretion to treat an entity as having made a voluntary disclosure before being told of an examination of its affairs even though the disclosure was actually made after that day. [36]
Further guidance on reducing the BPA is contained in Miscellaneous Taxation Ruling MT 2012/3 Administrative penalties: voluntary disclosures and paragraphs 135 to 140 of PS LA 2012/5.
MT 2012/3 provides guidance on the meaning of key terms in section 284-225 and contains further guidance on reducing the BPA and the exercise of the discretion referred to in this Practice Statement. You should refer to MT 2012/3 when making decisions about reducing the BPA.
Subsection 284-155(3) provides that the amount of penalty worked out using the adjustment formula in paragraph 8A of this Practice Statement is doubled where the entity is a significant global entity that does not have a reasonably arguable position. [37]
Subsection 284-155(3) applies to scheme benefits that an entity gets in relation to an income year commencing on or after 1 July 2015. [38]
The meaning of the term 'significant global entity' is set out in section 960-555 of the ITAA 1997.
Step 2d – decide whether to remit all or part of the penalty
The Commissioner has the discretion to remit all or part of a transfer pricing penalty. [39] After Steps 2a to 2c have been applied correctly, a remission decision must be made.
You must consider whether remission is appropriate whenever an entity is liable to a transfer pricing penalty under subsection 284-145(2B). In making an assessment of the penalty, you must determine in every case whether the BPA or adjusted BPA amount should be remitted in full or part.
This Practice Statement provides guidance on how the discretion to remit the penalty may be exercised. It does not lay down conditions that may restrict the exercise of the Commissioner's discretion, nor does it represent a general exercise of the Commissioner's discretion. Rather, it is provided to: • guide you in the exercise of the Commissioner's discretion, and • ensure entities receive consistent treatment.
Subsection 298-20(1) states that 'the Commissioner may remit all or part of the penalty'.
The Commissioner's discretion in subsection 298-20(1) is unconfined in that the subsection does not state the considerations that you must take into account when exercising the Commissioner's discretion.
In Minister for Aboriginal Affairs v Peko-Wallsend Ltd [1986] HCA 40; 66 ALR 299 at [15], Mason J observed that [40] : … where a statute confers a discretion which in its terms is unconfined, the factors that may be taken into account in the exercise of the discretion are similarly unconfined, except in so far as there may be found in the subject-matter, scope and purpose of the statute some implied limitation on the factors to which the decision-maker may legitimately have regard.
The guiding principles are that you should exercise the discretion: • taking into account the particular circumstances of the entity [41] • taking into account the purpose of the transfer pricing penalty provisions [42] • so there is consistent treatment of penalty rates – the penalty rate is set by law and remission without just cause, arbitrarily or as a matter of course may compromise consistent treatment of penalty rates • to avoid an outcome that is unreasonable or unjust [43] , and • to treat entities in like circumstances consistently in accordance with the commitments made in the ATO Charter .
For example, where the entity has a BPA of 10% and: • has genuinely made a reasonable attempt in good faith to comply • has made its best efforts to have a documented transfer pricing treatment [44] , and • can satisfy us that it did not have a tax avoidance purpose,
The following general considerations should be borne in mind when considering whether or not to exercise the discretion to remit: • whether a calculation or mechanical process in the law results in an unintended or unjust outcome in the particular circumstances of the entity, and • whether the entity has made its best efforts to have a documented transfer pricing treatment having regard to efforts that would be considered reasonable in the particular facts and circumstances of the entity.
In a self-assessment regime, an entity will have made its best efforts to have a documented transfer pricing treatment if (objectively considering its risk of not complying with arm's length principle and taking account of its relative resources) the entity has taken all reasonable steps, in its particular facts and circumstances, to ensure that it has a documented transfer pricing treatment.
The following considerations are generally not relevant when considering remission: • the entity's capacity to pay, or whether payment of the penalty may cause financial hardship for the entity, except in exceptional situations [45] , or • the quantum of the penalty. This, of itself, is not a ground for remission as the penalty amount is a result of a calculation based on the transfer pricing shortfall amount and the rate set by parliament. 12L. The remission decision should be based on an objective analysis of all the relevant facts in the entity's particular circumstances. The considerations listed in this Practice Statement are not exhaustive and are not necessarily the only valid factors. Rather, they are designed to encourage an analytical approach to each case and the application of sound judgment in making the remission decision. 12M. A remission decision may result in no remission, partial remission or full remission of the penalty.
Step 3 – notify the entity of the liability to pay the transfer pricing penalty
We must make an assessment of the transfer pricing penalty. [46] In addition, where a transfer pricing penalty applies and has not been remitted in full, we are required by law to give written notice of the entity's liability to pay the penalty and our decision not to remit the penalty in full. [47]
The written notice (or notices) are required by law to include: • the reasons why the entity is liable to pay the penalty [48] , and • the reasons for the remission decision. [49]
Where the entity is not liable to a penalty, or where the entity is liable to a penalty but that penalty has been remitted in full, the law does not require us to give reasons for our penalty decision. [50] However, in these situations, you should provide the entity with a summary of the reasons for decision.
Where the entity is liable to a penalty which we have not remitted in full, we provide written reasons for the decisions made, setting out the findings on material questions of fact and referring to the evidence or other material on which those findings were based.
The law does not specify when the explanation for the decision must be provided to the entity. However, you should ensure that the reasons are provided prior to, or at the same time as, the entity has been notified of the penalty.
The entity should also be provided with an explanation of its review rights. An entity that is dissatisfied with an assessment of penalty may object to it in the manner set out in Part IVC of the TAA. The grounds of the objection may include all elements of the penalty assessment. In the usual situation, where a remission decision is made as part of an assessment of penalty, the affected entity that is dissatisfied with the assessment will need to include in their objection any grounds about their dissatisfaction with the remission. If a remission decision is made after an assessment of the penalty, the entity may object to the separate remission decision in the manner set out in Part IVC if the amount of penalty remaining after the decision is more than 2 penalty units. [51]