Making it easier for SMEs to do business internationally

Boards and business owners are focussed on doing what they do best – running the business and making money for the benefit of their stakeholders. They need to remain innovative, competitive and not burdened by unnecessary red-tape. For any SME doing business internationally, fully complying with the complex transfer pricing rules for tax purposes has always been a costly exercise, or, simply ignored and placed in the too-hard basket.

Finally, the ATO has released its ‘simplified transfer pricing (TP) record keeping’ approach for SMEs which should reduce much of the red-tape for Australian businesses expanding offshore, or foreign businesses coming into Australia.

Here’s the key things you should know about the ATO’s new approach:

1. Transfer pricing is a tax fiction

Businesses with offshore related parties are required by law to transact for tax purposes at ‘arm’s length’ to ensure there is no profit shifting between different tax jurisdictions in order to minimise your global tax.

Of course, related parties in the SME market typically do not transact in this way, as they do business in the most beneficial and convenient way for the group rather than as stand-alone entities. As such, the TP rules are a tax fiction created to determine a commercial tax profit, rather than reflect the real way in which a group may commercially or practically organise itself, irrespective of tax motives.

2. International tax is not international

The rules apply irrespective of a profit shifting or tax avoidance motive and the ATO can substitute a ‘arm’s length’ conditions to arrive at an adjusted tax profit, possibly resulting in more tax – or even double tax if the foreign country does not make a similar corresponding adjustment. Often international tax is not ‘fair and equal’ and each country is competing for its own slice of the cake.

3. Let them eat cake

To protect against a tax adjustment and severe penalties by the ATO, the law specifies that related parties should maintain a ‘TP documentation file’ to demonstrate international related party dealings are at ‘arm’s length’. This would include documenting details of the business environment and the transaction, pricing the related party transactions and then benchmarking (economic analysis) the outcome with comparable transactions between unrelated / independent parties. This can be a complicated and costly exercise for SMEs.

The good news

Entities who qualify for the ‘safe harbour’ options below can elect to apply the simplified record keeping approach and are assured by the ATO that they will not devote any active compliance action to review your transfer pricing documentation file for the 2014, 2015 and 2016 income years.

The not so good news

The not so good news is that several exclusions apply, depending on the option chosen. Generally, these exclusions apply where:

  • there has been three consecutive years of losses related to party licensing, royalty or Research and Development arrangements,
  • there has been a restructure or a strategic activity involved which adds significant value to Australia (including a sales, marketing and relationship management function).
  • Interestingly, outbound loans are not covered at all.

    Taxpayers who do not qualify (even if they are ‘small’) must maintain a full transfer pricing file.

    The fine print – it’s not the law!

    Reading the fine print on the qualification criteria and the exclusions is necessary to ensure you don’t get into hot water. Importantly, the options do not exempt taxpayers from ensuring that their related party transactions are at arm’s length, as required by law. They merely reduce the need for a detailed transfer pricing analysis.

    As such, taxpayers should still document their related party transaction by way of legal agreements and have a sound basis for determining the prices in order to make an assessment as to whether the transactions are at arm’s length. This should be undertaken before a transaction is entered into. The general tax record keeping rule still apply.

    It’s just good business

    Good financial management dictates that much of the information for TP purposes should already be maintained on-hand. As part of their standard business practices, managers will have documented the business environment and have industry and competitor analysis / benchmarking.

    It’s just good business to collate and document such information if you want your business to grow and be successful in a competitive environment.