ATO Releases Draft Practical Compliance Guide on the Diverted Profits Tax
PCG 2018/D2 sets out the ATO's framework for engaging with taxpayers on the DPT, including their approach to DPT compliance and the interaction with the Advance Pricing Arrangement (APA) process.
Once finalised, the PCG is intended to serve as a risk assessment tool for taxpayers on the DPT and potential engagement with the ATO. Notably, the ATO expects taxpayers to identify and proactively engage with the ATO in circumstances where the DPT is a potential area of concern.
In this update, we have outlined a summary of notable points from the PCG and potential dispute resolution options. The ATO is seeking comments on the PCG by 9 March 2018. We would be happy to take comments and make a submissions on a confidential basis on behalf of taxpayers.
ATO's Compliance Approach
The ATO expects that they will identify DPT risks in the course of ordinary compliance activity. Where the ATO have advised a taxpayer that they are considering the application of the DPT during the course of a review the ATO will seek to communicate their findings to the taxpayer at the end of the review, including whether the DPT matter should be escalated to an audit.
In some cases the ATO may identify other treatment strategies where there is an identified DPT risk which is not able to be resolved during the course of a review, and is not considered to suitable for audit. This may include a recommendation for the taxpayer to seek an advanced pricing arrangement (APA) or a private ruling.
Taxpayer Driven Engagement
The ATO expects taxpayers to engage with them in certain circumstances where the DPT is a potential area of concern. Taxpayers are to self-assess their risk level with regard to certain “framing questions” set out in the PCG. The framing questions generally relate to the specific type of the transaction, sufficient economic substance and principal purpose. Please see further detail on these framing questions below.
Where a taxpayer considers that the DPT is an area of concern for their arrangements, and requires further engagement with the ATO, the main avenues of engagement are:
- seeking entry to the APA program;
- applying for a private ruling; and
- contacting the DPT specialist team.
DPT Risk Assessment Framing Questions
Initially, certain preliminary framing questions should be considered to evaluate whether the DPT could potentially apply to the taxpayer. Assuming that the taxpayer meets the relevant DPT threshold tests, a taxpayer must then evaluate the risk of DPT applying to the particular arrangements in place or being considered. This may involve assessing whether the arrangements involve:
- the transfer or effective transfer of valuable intangible assets offshore and/or centralisation of functions and/or risks offshore;
- the use of hybrid entities and/or instruments or back-to-back or flow-through arrangements; and
- a significant transfer of value relative to overall profitability or the booking of profit offshore in a manner disproportionate to staff headcount and/or capability.
Where a taxpayer is of the view that there is some level of DPT risk to their arrangement, they should then consider the application of the sufficient economic substance (SES) and principal purpose tests.
In assessing whether an arrangement satisfies the SES test, the PCG notes taxpayers should generally consider (amongst other things) whether:
- there is a genuine commercial rationale for the arrangement under consideration and whether the arrangement achieves that end, and whether there is evidence of market conduct that resembles the arrangement;
- the legal form and documentation are consistent with the economic substance of the arrangement;
- the arrangement involves the transfer of valuable intangible assets offshore, in which case a question arises as to whether there is a corresponding change in the functional profile of the relevant entities and whether the recipient entity possesses the competencies necessary to manage the assets; and
- the arrangement involves the transfer of functions offshore, in which case a question arises as to whether there is a corresponding change in the functional profile of the relevant entities and does the recipient entity possess the competencies necessary to perform the functions.
Principal Purpose Test
The ATO expects that the principal purpose of the arrangements may be tested by assessing such considerations (amongst others) as:
- whether there is a more straightforward way that the commercial objectives of the arrangement could be achieved, or other ways (for example, more convenient, commercial or cost-effective ways) to achieve the same commercial end;
- if any alternatives to the arrangement considered, and if so, why they were rejected; and
- what the commercial reasons and rationale for setting up in each jurisdiction involved are, and whether the arrangement is more complex contains more steps than is necessary to achieve the commercial objectives.
DPT Resolution Options
The PCG notes several resolution options including APAs, private rulings and settlements.
The PCG notes that the APA program can provide certainty with respect to the application of the DPT to covered transactions for an agreed period and that where possible, the ATO will seek to deal with the potential application of the DPT concurrently with transfer pricing issues as part of the development of an APA.
Where it is not possible to address and resolve a DPT risk through a proposed APA, the PCG notes it is unlikely that the ATO will proceed with the APA and that the matter may be referred internally for further consideration.
Further, APAs may be treated differently depending on whether the APA application was submitted and/or entered into prior to 4 April 2017, the date on which the DPT was enacted. Where an APA application is received on or after 4 April 2017, and the taxpayer subsequently enters into an APA, the covered transactions will be considered to be low risk for the purposes of the DPT for the period of the APA. Generally, no assurance relating to the DPT is provided to a taxpayer by an APA entered into prior to 4 April 2017.
Taxpayers may lodge a request for a private ruling on the application of the DPT in relation to a particular arrangement. A private ruling may be appropriate where a taxpayer requires a greater level of certainty in relation to the application of the law to an arrangement.
However, it should be noted a taxpayer will only attain a greater level of certainty if the arrangement being ruled upon is the arrangement actually carried out, and all the relevant facts are disclosed by the taxpayer as part of the arrangement.
The PCG notes that where there is a risk that the DPT may apply to an arrangement covered by a proposed settlement under another tax compliance process, that the ATO will generally seek to resolve the DPT matter before proceeding with the settlement. Depending on the circumstances, the ATO may include a clause relating to the DPT in the settlement deed.
Specifically, at the taxpayer’s request, the ATO may include a clause covering the application of the DPT in a Multinational Anti-Avoidance Law (MAAL) settlement, although the inclusion and content of such a clause will depend on the circumstances of the particular case.