Increased globalisation means that more and more SMEs deal with customers or suppliers outside of Australia. While this can open up some lucrative opportunities, it also introduces a range of new tax issues that need to be addressed – particularly if your business has dealings with a related entity overseas.
Transfer pricing is a tax trap for unwary companies. The transfer pricing rules often affect Australian companies that have dealings with an international parent.
For example, an Australian subsidiary of a foreign parent company may rely on that parent company to supply products or management services.
The Australian Tax Office (ATO) is looking closely at these relationships to ensure that the prices charged for goods and services between related parties are consistent with the prices that would be charged by a completely independent provider (i.e. the "arm's length" principle) to avoid profits being shifted outside of Australia (e.g. a foreign parent company may charge management fees that exceed the value of the services provided).
If the ATO believes that a profit shifting arrangement is in place or the profits being reported in Australia are not appropriate, the Commissioner can make adjustments for tax purposes.
All this means that not only do you need to have your pricing right, but your paperwork must be in place as well.
Generally, this means the creation of some documentation that would not otherwise be created in the ordinary course of business. The ATO expects SMEs with related party dealings to carry out the following four-step process:
- Identify and record the nature of transactions with foreign related parties and how these transactions fit into the everyday business.
- Select the most appropriate transfer pricing methodology and document the choice that is made.
- Apply the transfer pricing method and determine the arm's length outcome. This would typically involve a benchmarking study to demonstrate that the outcome is consistent with arm's length transactions.
- Review the transaction pricing and benchmarking study on a regular basis to ensure that any material changes are reflected and documented.
One of the key things the ATO will look for in a transfer pricing review is whether the business has maintained "contemporaneous documentation". This refers to documentation that existed or was created at or before the time of preparing the tax return for the relevant income year.
This issue is particularly relevant for businesses that need to disclose details of international related party dealings on an International Dealings Schedule. This schedule must be lodged with the tax return when a business has dealings with foreign related parties of $2m or more (including loan balances) and is used by the ATO to identify situations where there might be a risk of profit shifting.
Putting a comprehensive transfer pricing file in place is a great way to satisfy the ATO's expectations and provide the first line of defence in the event of an ATO review or audit.
Contact us on 02 9957 4033 to speak to one of our International tax and cross-border specialists. You can also download our fact sheets Transfer Pricing
Profits from Australian Activities of foreign-owned enterprise
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Last updated October 2012. This article is provided for information purposes only and should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.