ATO’s draft compliance guidance on intangibles arrangements

26 May 2021

On 19 May 2021, the Australian Taxation Office (ATO) released a draft practical compliance guideline on intangible arrangements, PCG 2021/D4 Intangibles Arrangements[1] for comments. The draft guideline sets out the ATO’s compliance approach to intangible arrangements, including the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets, and migration of intangible assets.

The guideline provides insight on the ATO’s expectation from taxpayers regarding intangible arrangements, however, businesses may find the difficulty lies in meeting these expectations.

The draft guideline focuses on tax risks arising from the application of the transfer pricing provisions, withholding tax (WHT) provisions, capital gains tax (CGT), capital allowances, general anti-avoidance rule (GAAR) and diverted profit tax (DPT) associated with these arrangements.

It supplements other tax payer alerts issued by the ATO on this issue[2] and has two parts:

  1. Compliance approach
  2. Risk assessment framework

Compliance approach

The ATO will seek to identify mischaracterisation of intangible arrangements, which are not arm’s length in nature or may be structured to avoid tax obligations. The ATO will try to achieve consistency with relevant chapters of the OECD Transfer Pricing Guidelines (OECD TPG). Specifically, the ATO will:

  • Follow the OECD TPG while analysing intangible arrangements (identification and ownership of intangibles, undertaking DEMPE activities, business restructuring situations, etc.).
  • Verify if the parties have complied with tax provisions relating to CGT and capital allowances.
  • Review arrangements if they have been mischaracterised to avoid WHT provisions.
  • Consider GAAR and DPT in cases where arrangements lack commercial rationale and/or substance.

Risk assessment framework

Similar to other compliance guidelines, PCG 2021/D4 seeks to rate arrangements as High, Medium and Low risk in nature. The risk assessment is based on:

  • Risk factors.
  • Documentation and evidence expectations.

The risk factors set out in the draft guideline focus on:

  • Commercial considerations.
  • Legal form of the intangible arrangements.
  • Identifying the intangible assets and connected DEMPE activities.
  • Analysing the tax and profit outcomes.
  • Understanding the type of example arrangements as per Appendix 2 of the draft guideline.

The risk rating is based on the quality of documentation maintained to substantiate these risk factors. For example, lack of sufficient documentation results in a high risk rating.

The ATO has provided detailed guidance on documentation and evidence expectations for each risk factor. This includes:

Commercial considerations:

  • Contemporaneous documentation to verify market value of intangible assets.
  • Documents considering tax and commercial objectives, including any alternative arrangements.
  • Documents quantifying benefits / gains arising from these arrangements.
  • Minutes of board meetings or other meetings where alternative options were discussed.

Legal form

  • Details of planning in connection with setting up these legal arrangements such as planning on choice of personnel to be appointed as directors of new entities and policies to protect intangible assets.
  • Transfer pricing documentation, supplementary analysis, valuation reports, etc.

Identifying the intangible assets and DEMPE activities

  • Asset registers, registration documents, R&D stage-gate documents, R&D incentive claims.
  • Correspondence of relevant personnel.
  • Meeting minutes which demonstrate functions performed, assets used, and risks assumed in connection with DEMPE activities.
  • Documents detailing the capabilities of relevant entities such as employment contracts, key performance indicators, employee head count and qualifications, etc.

Tax and profit outcomes

  • Comparability studies, financial modelling, etc. on anticipated tax impact.
  • Evidence of actual cash flows.
  • Tax information for relevant entities including foreign income tax returns, notices of assessment, approval of any tax holidays, etc.

Reporting by taxpayers: Taxpayers required to prepare the Reportable Tax Position Schedule may need to disclose the result of the application of this guideline, or the non-application of this guideline.

Date of effect: When finalised, the guideline is proposed to apply before and after its date of issue.

Our comments:

  • There is no materiality threshold for application of this guideline. Hence, the requirements could be quite arduous if the tax impact is minimal.
  • The guideline is subjective in its application as the risk rating is based on the quality of documentation maintained.
  • There is no priority of risk factors such that if there is documentation to meet three out of the four risk factors, then the arrangement may still be considered as high risk.
  • The requirement of documentation could be onerous, especially if the Australian entity was not an active participant in the discussion on intangible arrangements. The retrospective application of the guideline could make it difficult to obtain such detailed documentation for past arrangements.
  • Identification of intangibles and DEMPE activities is quite complex. The guideline does not provide guidance on this analysis, but rather lists the documentation expected to be maintained to support this analysis.
  • The examples help in understanding the ATO’s position on certain types of transactions. However, the examples may not align with commercial realities and could lead to uncertainty for some taxpayers.

The retrospective application of the guideline means that, despite the draft nature of the PCG, taxpayers should start assessing what documentation they have, and where the gaps are. If you require assistance with this or advice relating to intangible arrangements, please contact your adviser or get in touch with the Findex Tax Advisory team.

[1] PCG 2021/D4 Intangibles Arrangements

[2] Taxpayer Alerts TA 2018/2 Mischaracterisation of activities or payments in connection with intangible assets and TA 2020/1 Non-arm's length arrangements and schemes connected with the development, enhancement, maintenance, protection and exploitation of intangible assets.