International Tax and Transfer Pricing
This page deals with a brief introduction to:
and
- (2) Foreign Businesses doing business in Australia.
(1) Australian Companies engaging in Business internationally
When a Australian Company engages in transactions with a entity from a foreign tax jurisdiction, then international transfer pricing rules ensure transactions are at arms length.
For example, if a Australian company operating in Australia has one of its substantial shareholders that has influence or does not have influence over the Australian Company, ceases residence in Australia and takes up residence in a country outside of Australia, it is important that if the Shareholder continues to consult or engage in transactions with the Company, the shareholder and Australian Company need to ensure they deal at arms length to ensure they do not breach the international transfer pricing rules.
Australia’s double tax agreements and domestic legislation (Division 13) both rely on the arm’s length principle in determining transfer prices for both transactions in goods and in all sorts of services. The determination of arm’s length prices is not an exact science. Australia adopts the OECD principles of arm’s length pricing; that is, use of the comparable uncontrolled price method where appropriate or the resale price method or the cost plus method or if none of those are appropriate, some measure which is appropriate to the industry.
The Tax office takes the view that the Australian company is in the best position to know what the arm’s length price should be. The executives of that company should be able to say ‘yes, we would be willing to pay for that service or that product or whatever it may be to a third party’.
The basic test that we like to use is to question what would an independent Australian company have paid or expected to have been paid had that transaction been with an independent party overseas.
An example that was reported in a international transfer pricing address mentioned a company that took some millions of dollars off deposit in Australia, where it was earning at the time between 17 and 18 per cent interest and lent those moneys in Australian dollars to its UK parents at 6 per cent. The explanation given by the company was ‘that was the rate at which the UK parent could borrow money in the UK’. They completely ignored the denomination of the loan currency, the terms of the loan, the fact that it was unsecured, the fact that by doing so they were just plain losing more than 10 per cent on some millions of dollars and hundreds of thousands of dollars of profit from their own operations.
For more on international transfer pricing see <ATO-Link>.
For more on when a Australian company is doing business internationally see <ATO link>.
For more on tax residency of a person or company see <residency>.
(2) Foreign Businesses doing business in Australia.
Australian mid-size businesses and investors who have operations overseas or invest across borders should take a detailed look at their structures from a tax perspective following the High Court’s decision last week in Bywater Investments & Ors v FCT [2016] HCA 45.
In its unanimous judgement, the High Court found that four foreign companies were in fact Australian resident companies for tax purposes. Other business and family groups may suffer the same fate if they don’t administer their structures properly.
Critical to the decision was the finding that the boards of directors had abrogated their decision-making in favour of the controlling mind (who was Australian) such that the boards only met to mechanically implement or rubber stamp decisions made by him in Australia.
The process to reach this finding was painstaking and no doubt expensive, given that there were 19 challenges to the evidence and procedure throughout the litigation process.
Regardless of the background facts, it is clear that legal formality and structure is not enough. If foreign companies are not intended to be regarded as Australian tax residents, then the foreign activity needs to be much more than merely having boards of directors located overseas ratify decisions made from Australia, especially if merely through third party corporate service providers. And while in some situations Australia’s double tax treaties may provide some protection, even this may be limited.
Implementing well crafted governance protocols will assist to align what actually happens with the underlying intent, leading to a more robust tax profile within Australia and abroad.
Groups with entities offshore, or where “central management and control” is otherwise an issue in their structure, should take this decision as a prompt to review how their foreign structures are governed, to identify what unforeseen tax risks and unintended consequences are lurking, and to determine what actions they should take
to read the full case <click here>.