Proposals to change Domestic Taxation in Australia will have serious implications for New Zealand businesses with Australian operations.
The key takeaway for business is the inconsistency of approach.
The Australian Courts have favoured use of actual transactional data, where available (and sufficiently comparable), to benchmark the pricing of internal transactions. The Australian Taxation Office (ATO) prefers to look at net margins and consider if these are consistent with industry averages.
This provides uncertainty for taxpayers.
One of the issues is that both ATO’s and Inland Revenue’s reluctance to accept “loss making” comparables in net margin analyses, which can skew the results.
Inland Revenue has clarified that losses may be attributable to extraordinary circumstances, such as the Global Financial Crisis and Canterbury earthquakes. In those cases, a thorough analysis of the loss drivers will be required.
Revenue authorities are not alone in placing over-reliance on profit-based methods. It is common practice for businesses to do the same, without sufficient analysis of whether independent transactions or global data may be better comparables for internal transactions.
The SNF (and Roche) cases establish that this additional analysis is required.
The proposed Australian legislative changes would retrospectively allow the ATO to use profits-based analyses for transfer pricing purposes, following the Australian Courts’ dismissal of arguments in their favour.
The OCED Transfer Pricing Guidelines arguably provide greater flexibility over the choice of transfer pricing methods, although they require use of the most appropriate method.
Implied Services
New Zealand’s legislation already contains the OECD methods.
The scope for ATO to argue “implied services” will be of importance to New Zealand companies deciding on entering the Australia market.
The plan to codify legislative changes, with retrospective effect from July 2004, has rattled cages with Australian taxpayers and practitioners.
KPMG Australia Transfer Pricing Partner Anthony Seve noted that the plan to introduce new laws would “focus too heavily on profit based approaches… and constrain taxpayers from properly defending themselves when they have low profits or losses.”
The discussion paper also calls for comments on the desirability of moving from ‘Same Legal Entity’ approach to taxing Australian branches of foreign entities.
This means attribution of third party income and expenditure between the branch and head office depending on where income arises/costs sit).
Different Approaches
‘Separate Legal Entity’ approach treats head office and the branch as separate entities, for transactional purposes. This would align the treatment of branches and Australian subsidiaries.
The key difference is that Separate Legal Entity approach supports transactions, which would not otherwise occur within the Same Legal Entity (e.g. separate entities could enter into funding arrangements, whereas a single legal entity cannot lend funds to itself). Same Legal Entity approach provides greater flexibility and is the international/OECD norm for branch taxation.
The Inland Revenue, however, continues to interpret the current branch (permanent establishment) provisions in our Double Tax Agreements as supporting the Same Legal Entity approach.
Australia’s move to Same Legal Entity approach would raise serious questions about the potential for double taxation if New Zealand stays its current course.
Under the Double Tax Agreement, a New Zealand entity would have a permanent establishment in the other country, if it provided services in that other state for 183 days or more in any 12 month period.
Double Taxation affected
In the ATO’s view, where an Australian subsidiary of a New Zealand parent has a project, which continues for more than 183 days, the subsidiary will create a permanent establishment for the New Zealand parent, where an employee of the parent works on the project in Australia for even a single day.
The ATO interpretation (which is an extension of its position on a similar provision in the Double Tax Agreement between Australia and UK), effectively makes the 183-day rule redundant.
It will create a significant Australian tax exposure for New Zealand businesses that provide expertise on Australian projects to their Australian subsidiaries (or parents, as the case may be), and may require restructuring such contracts to avoid creating an Australian taxable presence.
The ATO approach makes no sense; our understanding is that the associated enterprises provision in the tax treaty was designed to stop contract splitting between entities in the same jurisdiction, not cross-jurisdictionally.
We understand that the Inland Revenue is looking at options to resolve this issue with its Australian counterparts.
Kim Jarrett is KPMG Partner (Transfer-Pricing & Customs) based in Auckland and John Cantin is the firm’s Partner Tax, based in Wellington. KPMG was the Sponsor of the Business Excellence in Agriculture & Horticulture Category of the Indian Newslink Indian Business Awards 2011.
