Practical Compliance Guideline (PCG 2021/D4) Valuation

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If you have a regional or global footprint and valuable intangible assets which are developed and used in multiple jurisdictions, the Australian Taxation Office (ATO) recently issued new draft Practical Compliance Guideline (PCG 2021/D4) is relevant to your risk management practices.

PCG 2021/D4 outlines how the ATO perceives risk in relation to intangible arrangements, which are defined broadly to include international arrangements connected with development, enhancement, maintenance, protection and exploitation (DEMPE) activities of intangible assets and/or involving the migration of intangible assets.

The ATO will use the framework set out in the PCG 2021/D4 to assess tax compliance risks associated with a taxpayer’s intangible arrangements and tailor their taxpayer engagement accordingly. It does provide important insights into the ATO expectations regarding documentation and evidence it wants to see to assess risks related to intangible arrangements.

The Documentation and Evidence Expectations in the PCG 2021/D4 Cover the Following Categories:

  • Understanding and evidencing the commercial considerations and your decision-making,
  • Understanding the legal form of your intangible arrangements,
  • Identifying and evidencing the intangibles assets and connected DEMPE activities
  • Analyzing the tax and profit outcomes of your intangible arrangements

The risk matrix provided grades risk in relation to these categories based on whether they are unsubstantiated (high risk), incomplete (medium risk) or substantiated (low risk).

In addition, risk is calibrated based on examples of intangible arrangements provided by the ATO. Some of these arrangements such as the bifurcation of intangible assets or the non-recognition of Australian intangible assets and DEMPE activities were the subject of the Taxation Alert 2020/1. Twelve examples are provided ranging from the offshore centralization of intangibles (high risk) to the transfer of rights to intangible assets via a license agreement (medium risk) to contract research and development and cost contribution arrangements (low risk). It is not clear from the matrix, but it would seem that while you may have a high-risk arrangement, as long as you meet the documentation and evidence requirements, you may still be in the low risk category.

The documentation and evidence provisions outlined are the most concerning. The ATO believes that these provisions will assist the taxpayer in assessing whether they have maintained documentation that adequately supports and substantiates the position taken concerning intangibles arrangements and their risk assessment according to the risk assessment framework; hence the level of ATO engagement. The ATO notes that it will also assist the taxpayer in supporting and or verifying their transfer pricing documentation for Subdivision 284-E of Schedule 1 of the Taxation Administration Act 1953.

It is noted, however, that the documentation and evidence expectations go well beyond normal documentation requirements and would more reflect the ATO's information requirements for an audit process. For example, expectations around understanding and evidencing the commercial considerations and your business decisions include "…the documents created or provided by personnel or tax advisers disclosing anticipated or potential Australian tax effects of the intangible arrangements….."

For those taxpayers that are required to complete a reportable tax position schedule, the Guidance notes that they may be asked to disclose how their Intangible Arrangements compare to each of the risk factors outlined in the Guideline. It further notes that the ATO may in the course of its ordinary assurance activities fact check a taxpayer’s self-assessment of tax risk in relation to Intangible Arrangements. If a taxpayer is unable to provide adequate evidence to support their assessment or the ATO disagrees, they may undertake further assurance activity.

Areas of Particular Relevance Arising From This Guideline Include:

  • The need for clear commercial reasons for a restructure relating to intangible assets
  • Where there is a restructure ensuring that there is a consideration of the options realistically available
  • Being able to demonstrate that there are clearly quantifiable non-tax financial benefits
  • The form of the arrangements is consistent with the substance
  • Ensure that there is a thorough identification of all the DEMPE activities associated with your intangible assets and particularly that those entities carrying out these activities have the necessary capability, financial capacity and/or assets in substance
  • Tax and profit outcomes are consistent with the commercial or economic substance of the intangible arrangements

While the Guideline is still a draft, we would not expect significant changes particularly as it is largely consistent with the re-write of Chapter VI of the OECD Transfer Pricing Guidelines 2017. We know that the ATO has been concerned about the risk to the revenue of the migration of intangible assets given the higher corporate tax rate in Australia compared to other major trading partners. This is reflected in the Guideline. What is clear is that this Guideline significantly lifts the bar on documentation requirements to manage risks associated with geographically dispersed DEMPE activities and particularly where there has been a restructure associated with your intangible assets.

We would advise taxpayers with intangible assets used or developed across borders to urgently consider the level of documentation currently in place and carry out the necessary additional analysis to support their outcomes to comply with the requirements of this draft Guideline.  With year-end approaching, we would also suggest that there is still an opportunity to adjust your transfer pricing model as necessary to ensure profit outcomes align to economic substance.

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