Scope
This Practice Statement explains how we will administer scheme penalties arising from the application of Subdivision 815-A of the Income Tax Assessment Act 1997 (ITAA 1997) and section 815-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997) for income years commenced on or after 1 July 2004 and before 1 July 2012 (transition period). It deals with: • when liability for a transfer pricing scheme penalty arises • applying a scheme penalty • assessing an entity's scheme penalty, and • remission considerations – to ensure decisions to exercise the Commissioner's discretion to remit all or part of a scheme penalty are consistent.
All legislative references in this Practice Statement are to Schedule 1 to the Taxation Administration Act 1953, unless otherwise indicated.
This Practice Statement does not deal with scheme penalties that arise from the application of: • Subdivisions 815-B and 815-C of the ITAA 1997 [1] , and • Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936).
Background
For income years which commenced on or after 1 July 2004 and before 29 June 2013, Subdivision 815-A of the ITAA 1997 applies to bring to tax a 'transfer pricing benefit' [2] by empowering the Commissioner to make a determination under section 815-30 of the ITAA 1997 by increasing taxable income, decreasing tax losses or decreasing net capital losses, as appropriate (Subdivision 815-A Determination).
Subdivision 815-A of the ITAA 1997 is only relevant to entities to which one of Australia's tax treaties containing the transfer pricing articles applies – that is, where the entity is a resident of one or both of the contracting states to the tax treaty.
The references in Subdivision 815-A of the ITAA 1997 to international tax agreements, or to parts of them, ensures that if an entity gets a transfer pricing benefit, the benefit and the amount of that benefit is consistent with Australia's tax treaties. [3]
Former Division 13 of the ITAA 1936 [4] can also apply during the transition period to allow the Commissioner to deem arm's length consideration to be given for tax purposes for certain international dealings.
Importantly, section 815-40 of the ITAA 1997 ensures that an entity's transfer pricing benefit that is negated under Subdivision 815-A of the ITAA 1997 is not to be taken into account again under another provision. This includes former Division 13 of the ITAA 1936.
If the Commissioner makes a Subdivision 815-A Determination to negate a transfer pricing benefit of an entity, subsection 284-145(2A) [5] applies a scheme penalty to an entity's scheme benefit for an income year which commenced on or after 1 July 2012 but before 29 June 2013.
Similarly, if the Commissioner applies former Division 13 of the ITAA 1936, subsection 284-145(2) [6] applies a scheme penalty in relation to that entity's scheme benefit.
Significantly, for income years which commenced within the transition period, section 815-10 of the IT(TP)A 1997 ensures that an entity will only be liable to a scheme penalty in relation to the scheme benefit which could have been denied by another provision of the tax law had Subdivision 815-A of the ITAA 1997 not been enacted. [7]
In summary, the transfer pricing rules, including relevant scheme penalty provisions, apply as per Diagram 1 in Attachment A to this Practice Statement.
Moreover, Diagram 1 in Attachment A to this Practice Statement highlights the transition period applicable to this Practice Statement.
Statement
If the Commissioner makes a Subdivision 815-A Determination in respect of an income year commencing within the transition period, we are to exercise sound judgment in each instance in deciding whether we should allocate resources to assess a scheme penalty. In so deciding, we need to take into account whether: • extra complexity or costs arise in applying former Division 13 of the ITAA 1936, and • the scheme penalty, if assessed, would be remitted in full in accordance with the guidelines set out in this Practice Statement.
No further resources should be allocated to applying former Division 13 of the ITAA 1936 in order to impose a scheme penalty if we decide that: • applying former Division 13 will be overly complex or gives rise to unnecessary costs, and • it is appropriate to fully remit the scheme penalty that otherwise applies.
If you decide in appropriate circumstances that a scheme penalty should apply, you should: • apply former Division 13 of the ITAA 1936, including making former Division 13 Determinations, where the conditions for the application of former Division 13 have been satisfied, in assessing the scheme benefit (scheme shortfall amount), and • calculate the scheme penalty in accordance with Subdivision 284-C using the scheme shortfall amount. The scheme shortfall amount is the additional amount of income tax the entity is liable to pay as a result of the application of former Division 13 of the ITAA 1936. [8]
The effect of doing this in appropriate circumstances is that the entity will: • be liable to primary tax arising from us negating a transfer pricing benefit by making a Subdivision 815-A Determination (the entity's primary tax will be equal to the amount in the Subdivision 815-A Determination multiplied by the applicable tax rate) • not be liable to primary tax arising from the application of former Division 13 of the ITAA 1936 unless in extremely rare instances the amount determined under that Division is greater than the amount determined under Subdivision 815-A of the ITAA 1997, and • only be liable to a scheme penalty under subsection 284-145(2) arising because of the application of former Division 13 of the ITAA 1936.
In the majority of instances, the amount of the transfer pricing benefit negated under Subdivision 815-A of the ITAA 1997 will be the same as the difference between the arm's length and actual consideration under former Division 13 of the ITAA 1936 for the same cross-border dealings. In such instances, the scheme shortfall and scheme penalty amounts applicable will also be the same. However, Example 1 of this Practice Statement deals with a scenario where these amounts are different and, for illustration purposes, does not take into account the extra complexity or costs that may arise and the penalty remission guidelines.
Importantly, section 815-10 of the IT(TP)A 1997 does not apply to income years commencing after 30 June 2012. Diagram 2 in Attachment A to this Practice Statement summarises in a flow chart the process for determining the type of scheme penalty we can impose.
For the 2010–11 income year, we make a Subdivision 815-A Determination in respect of Australian resident Lachlan Co's cross-border dealings with its parent company Jessica Co, a resident of a tax treaty partner country. We determine that Lachlan Co gets a transfer pricing benefit equivalent to the difference between what would have been its taxable income had arm's length conditions applied and its actual taxable income. The transfer pricing benefit in respect of the Subdivision 815-A Determination is $40 million. The primary tax payable in respect of this transfer pricing benefit is $12 million ($40 million × 30%).
We also determine that the actual consideration for the cross-border dealings differs from the arm's length consideration and apply former Division 13 of the ITAA 1936. The difference between the actual consideration received and the arm's length consideration under former Division 13 is $30 million.
Lachlan Co does not have a sole or dominant purpose of getting a scheme benefit from a scheme but does not have a reasonably arguable position. [9]
Lachlan Co's scheme shortfall amount is $12 million in relation to the Subdivision 815-A Determination and $9 million ($30 million × 30%) in relation to the former Division 13 Determination.
Lachlan Co is liable to tax of $12 million on the transfer pricing benefit. Lachlan Co is also liable under former paragraph 284-160(b)(i) [10] to a scheme penalty of $2.25 million ($9 million × 25%).
Remission of transfer pricing scheme penalties
When making remission decisions concerning transfer pricing penalties for income years commencing within the transition period, you must ensure that the Commissioner's discretion under subsection 298-20(1) is exercised in accordance with the principles set out in this Practice Statement. [11]
You should exercise the Commissioner's discretion regarding transfer pricing penalties to reduce the base penalty amount otherwise applying from 10% to nil where the taxpayer: • has genuinely made a reasonable attempt in good faith to comply with the arm's length principle in preparing the tax return, having regard to what a reasonable business person in the taxpayer's circumstances would do • has used their best endeavours to document the process of selecting and applying an arm's length method at the time the transaction was negotiated, or at the time the relevant tax return was prepared, on the basis of the information in their possession and any other information that was reasonably available to them at the time • can satisfy us that there was no tax avoidance intention or purpose in adopting the pricing outcomes arrived at from performing the process mentioned in the prior dot point, and • has fully cooperated with us (where the transfer pricing adjustment is made as a result of audit action), including providing all relevant information in their possession or reasonably available to them so as to achieve an expeditious conclusion of the audit.
Full remission will not be granted in instances where a transfer pricing adjustment has been made because of the failure by the taxpayer to furnish the tax return in accordance with the terms of any relevant advance pricing arrangement that the taxpayer has with us.
The following matters are relevant to our discretion to remit: • the quality of a taxpayer's process and the adequacy and relevancy of documentation created and maintained in applying the arm's length principle, and • the reasonable availability of guidance to taxpayers on transfer pricing at the relevant time.
In relation to the first point in paragraph 4D of this Practice Statement, taxpayers assessed as falling in the medium-high quality and high quality categories under Chapter 4 of Taxation Ruling TR 98/11 Income tax: documentation and practical issues associated with setting and reviewing transfer pricing in international dealings will be regarded as having satisfied the requirements of the first 2 dot points of paragraph 4B.