Offshore marketing hubs under the ATO’s lens
On 16 January 2017, the Australian Taxation Office (“ATO”) released its Practical Compliance Guideline (“Guideline”) which outlines the ATO’s compliance approach to transfer pricing issues relating to centralised operating models involving procurement, marketing, sales and distribution functions (referred to as offshore “hubs”). The Guideline is effective 1 January 2017 and applies to new and existing hub arrangements. At this stage, the Guideline only deals with offshore marketing hubs but over time its scope is intended to cover other types of hubs (such as procurement hubs).
Does the taxpayer have an offshore marketing hub?
The Guideline applies to Australian taxpayers who sell tangible products through an offshore related party and that related party assumes responsibility for the procurement and/or sale of products, without substantially adding value and/or altering those products. These hubs typically generate profits by charging a marketing services fee to members of the corporate group, or by way of a discount / commission on the price of the underlying products being purchased or sold. The hub arrangements covered by this Guideline include business models ranging from routine service providers through to full risk marketers and traders.
What is the objective of this Guideline?
The objective of this Guideline is to ensure that the amount brought to tax in Australia from cross-border hub arrangements reflects the arm’s length contribution made by Australian operations and the returns derived by the hub are commensurate with the hub’s economic substance and the level of value added activity being undertaken by the hub.
To that effect, the Guideline outlines the ATO’s approach to categorising taxpayers into different risk zones, based on criteria such as the profitability achieved by the hub, the impact of the hub’s operations on the Australian tax revenue and the taxpayer’s compliance behaviour. The risk categorisation will allow the ATO to prioritise its compliance resources and tailor its arrangements according to taxpayers risk profile. The ATO may ask certain large taxpayers (i.e., those with turnover above A$250 million), to report their risk rating via the Reportable Tax Position (“RTP”) schedule, which is required to be filed along with their income tax return. For other taxpayers, self-assessment of their risk rating is voluntary; however, if they opt out or are unable to self-assess, they will have to inform the ATO accordingly.
How should taxpayers risk rate their marketing hub?
The Guideline allows taxpayers to make a risk assessment based on the hub risk framework made up of the following six risk zones:
- White zone – self assessment of risk rating not necessary;
- Green zone – low risk;
- Blue zone – low to moderate risk;
- Yellow zone – moderate to high risk;
- Amber zone – high risk; and
- Red zone – very high risk.
These zones are discussed in further detail below.
White zone (or no risk zone)
Hubs that satisfy any of the following conditions will qualify for the white zone category and are unlikely to be subjected to any further investigation by the ATO:
- An advance pricing arrangement with the ATO applies to the current year; or
- A risk review was performed by the ATO in the last two years; or
- A settlement agreement has been negotiated with the ATO that applies to the current year; or
- An Australian court decision was handed down within the last two years covering the hub operations.
- There has been no material change in the pricing policy, and/or the functions, assets and risks of the hub since the period reflected in the agreement, decision or review.
In determining whether the taxpayer’s hub qualifies for the white zone category, the taxpayer should consider a risk rating provided by the ATO only after this Guideline has come into effect. The ATO provides risk ratings through various means, such as on completion of traditional review or audit activities or alternatively, via ‘sign-off’ letters provided under programs such as an Annual Compliance Agreement or a Pre-lodgement Compliance Review. It is important to ensure that the letter explicitly provides a low risk rating for the transfer pricing aspects of the taxpayer’s hub arrangement in order to meet the white zone categorisation.
To qualify for the green zone, taxpayers will need to test the financial outcome of their arrangements against the ATO’s risk benchmarks. If the hub derives a mark-up on its costs (e.g. salary of overseas staff, rent, etc) of 100 percent or less, the taxpayer’s hub will be in the green zone (low risk). Hubs in the green zone will generally not be subject to ATO review or audit and can rely on the simplified transfer pricing record keeping concessions.
Outside of Green zone
Hubs outside the green zone will be rated having regard to the following risk indicators:
- Hub profits greater than 100 percent of the hub’s cost;
- Net tax impact ranging from < A$5m (blue zone), or between A$5m to A$50m (yellow zone), or >A$50m (amber zone), or an unquantifiable amount (red zone); and
- Whether the taxpayer has transfer pricing documentation that satisfies the Australian documentation requirements.
Hubs outside the white and green zones are more likely to be reviewed by the ATO and therefore should ensure they have robust transfer pricing documentation. If such documentation is not available, the taxpayer will automatically move to a higher risk category i.e., from blue zone to yellow zone and from yellow and amber zones to red zone. Conversely, hubs in the red zone can reduce their risk and move to the amber zone, if they provide their transfer pricing documentation including details of their global value chain to the ATO on or before the tax return is filed.
Quantera Global comments
What can taxpayer’s do to mitigate tax risk?
The Guideline provides a useful reference tool for affected taxpayers in assessing and mitigating their tax risk associated with the operation of offshore marketing hubs. In particular, we suggest those taxpayers should:
- Assess if there is any potential risk in their hub arrangement. Taxpayers that fall outside the green zone will need to understand the ATO’s compliance approach and consider strategies to manage and/or mitigate any potential tax and transfer pricing risks;
- Voluntarily engage with the ATO to identify and resolve any risk associated with the existing or past arrangements; not doing anything is not an option as it will simply elevate the risk to the red zone category, meaning the ATO will accord highest priority in allocation of resources for risk review;
- Ensure transfer pricing documentation is available to support the hub arrangement. Whilst the income tax law does not expressly require taxpayers to prepare transfer pricing documentation, the Guideline states that the existence of transfer pricing documentation can significantly influence the ATO’s expected compliance approach. It is important that this documentation demonstrates that the returns derived by the hub are commensurate with the hub’s economic substance and the level of value adding activity being undertaken by the hub. If the documentation prepared does not meet the requirements of Subdivision 284-E of Schedule 1 to the Taxation Administration Act 1953, taxpayers will not be able to argue that they have a reasonably arguable position for the purposes of administrative penalties;
- Ensure primary evidence is prepared and kept on file. These will include documents such as legal agreements, financial outcomes (for example, management accounts, profit and loss statements), job descriptions, key performance indicators and cost/benefit analysis rather than merely a narrative description of those documents; and
- Consider if it is appropriate to ‘reprice’ the hub arrangement to fall within the Green Zone category. This will involve engaging with the ATO to resolve any open issues for ‘back years’ in a cooperative and practical manner. If the taxpayer makes voluntary disclosure and implements the required green zone adjustments relating to last four income years, the ATO will consider remitting penalties and shortfall interest that would have been otherwise payable.
In conclusion, we note that this Guideline does not constitute a ‘safe harbour’ and it does not relieve the taxpayer of their obligation to self-assess their compliance under the tax and transfer pricing laws; rather it is designed to give comfort to the complying taxpayers that the ATO will generally not allocate compliance resources to review the transfer pricing arrangements associated with low-risk hubs. Through this Guideline, the ATO has put the offshore marketing hubs ‘on-notice’ that their operations are being monitored from an Australian perspective. The “carrot” for companies in all of this is the prospect of a light-touch approach by the ATO.
About Quantera Global
Quantera Global is the world’s leading independent transfer pricing advisory firm, providing specialist and integrated transfer pricing services to multinationals of all sizes across the globe. We provide specialist transfer pricing consulting services in Asia, Europe and the Americas, in order to support multinationals to satisfy all aspects of their transfer pricing design, compliance and risk management requirements.
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