PCG 2018/5EC: Compendium
Document type: Compendium
Status: Draft







Compendium: This is a compendium of responses to the issues raised by external parties to draft Practical Compliance Guideline PCG 2018/D2 Diverted profits tax. This compendium of comments has been edited to maintain the anonymity of entities that have commented. Provide guidance on a non-exhaustive list of factors that would cause the Commissioner to consider that a taxpayer may have engaged in a contrived arrangement with a related party (subsection 177H(1)) such that there is a principal purpose to obtain a tax benefit (subsection 177J(1)). Provide guidance on features of a transaction that would be likely to cause the ATO concern. In particular, in response to this feedback, the transaction-specific framing questions have been revised (paragraph 29) and are provided to demonstrate our approach to assessing DPT risk. In addition, we will generally consider the principal purpose test framing questions to assist us to determine whether a requisite purpose is likely to exist. Refer to paragraphs 30 and 31 of the final Guideline. The ATO should include a reference to the effect that it will take into account the words of paragraph 1.18 of the EM [2] in administering the DPT. Provide guidance that regard will be given to Law Companion Ruling LCR 2015/2 Section 177DA of the Income Tax Assessment Act 1936: schemes that limit a taxable presence in Australia and the revised Explanatory Memorandum when applying the principal purpose test. Paragraph 15 has been inserted into the final Guideline to address this feedback. It makes it clear that the DPT, unlike the transfer pricing rules in Division 815 of the Income Tax Assessment Act 1997, can only apply if the principal purpose test and the other conditions contained in subsection 177J(1) are satisfied. Paragraph 15 also clarifies that an analysis of the potential application of the DPT may be undertaken concurrently with an analysis of the ordinary provisions in the income tax law. Footnote 2 of the final Guideline provides that in considering the application of the principal purpose test we will have regard to paragraphs 11-16 of LCR 2015/2 Section 177DA of the Income Tax Assessment Act 1936: schemes that limit a taxable presence in Australia. Paragraph 8 has been inserted into the final Guideline to reference Law Administration Practice Statement PSLA 2017/2 Diverted profits tax assessments to highlight the rigorous internal process to be followed by staff in order to make a DPT assessment and after a DPT assessment is made. Paragraph 12 has been inserted into the final Guideline and outlines when you can expect communication from the ATO. Refer also to our response to issue 2 regarding the concurrent analysis of the DPT and other income tax provisions. The framing questions for the SES test (paragraph 31 of the final Guideline) have been revised to outline that affirmative answers to the questions increase the likelihood that the SES test will be satisfied. Ascertaining a conclusion in relation to principal purpose in respect of a transaction or arrangement will be based on the specific facts and circumstances of the case and is a different examination to that required in considering the SES test. The scenarios are provided for guidance on our approach to assessing risk in the context of the SES test. We consider that incorporating additional DPT conditions may complicate the scenarios. The framing questions provide guidance on our approach to administering the principal purpose test. This is consistent with our general approach to providing guidance on 'purpose' in respect of other anti-avoidance provisions. Refer also to our response to issue 2 regarding the additional content included in LCR 2018/6 on the principal purpose test. No change has been made to the final Guideline. Delete the transaction specific framing question in paragraph 45(h) in the draft PCG (i.e. ' any other features that are unusual having regard to the nature of the relevant business operations '). Additional changes have also been made to the transaction-specific framing questions in paragraph 29 of the final Guideline. Further clarification has been provided in the framing question at paragraph 29(i) in the final Guideline relating to ' other features that are unusual '. This paragraph is included in the section of the Guideline that addresses matters relevant to the application of the SES test. In our view the objectives are a guide and their relevance is explained in section 950-150 ITAA 1997. This issue is addressed at Issue 9 of the compendium for LCR 2018/6. Concerned that an anti-avoidance analysis will be part of ordinary transfer pricing compliance. (Paragraph 60(h) of the draft PCG refers to documentation relating to the rationale for a change in transfer pricing policy). It is considered that this could result in increased costs and compliance burden (whereas paragraph 1.133 of the revised EM refers to the SES test not requiring a greater evidentiary or compliance burden to that required by the OECD Transfer Pricing Guidelines for transfer pricing). The revised EM (at paragraph 1.133) refers to compliance and documentation in the context of the SES test and not more broadly in the context of the DPT. Importantly, consideration of the DPT is a different enquiry to that of transfer pricing and, accordingly, the documentation that may be relevant could be different. No change has been made to the final Guideline. No change has been made to the final Guideline. If the SES test is determined on a basis inconsistent with the associated enterprises articles contained in the tax treaties, there is a question as to whether Australia will have met its treaty obligations if an APA is not proceeded with - refer to paragraph 21 of the draft PCG. When we are considering entering into an APA we will consider the anti-avoidance rules. Where DPT is a collateral issue it may make it inappropriate for us to proceed with an APA. The SES test questions at paragraph 31 of the final Guideline have been re-framed to indicate where affirmative responses are more likely to indicate that the profit made reasonably reflects the economic substance of the relevant entity's activities in connection with the scheme. The client engagement section of the final Guideline (paragraphs 47 to 58) provides a number of ways that a taxpayer can engage with us to obtain more certainty about their arrangements. Paragraph 36 of LCR 2018/6 sets out our view that the SES test requires determination of whether the profit made by an entity in respect of the relevant activities represents a reasonable reward in relation to those activities. No change has been made to the final Guideline. A DPT assessment could result even where the taxpayer has used comparable uncontrolled pricing as 'the most direct and reliable way' to apply the arm's length principle. The PCG should make it clear that the DPT will operate within the international transfer pricing rules and guidelines. The implications of any other position are too significant to be dealt with by inadequate guidance. The term reasonably or reasonable is defined in the Oxford English Dictionary as 'in a sensible way, to a moderate or acceptable degree; fairly.' Therefore, the profits made by each entity are only required to moderately reflect the economic substance, not absolutely. It is therefore considered that the Commissioner's view of what is a reasonable reflection in this context is explained by the second last sentence in that paragraph and no further clarification is considered necessary. No change has been made to the final Guideline. Our client engagement framework in paragraphs 47 to 58 of the final Guideline has been provided to assist taxpayers in identifying the most suitable option for engaging with us based on the relevant circumstances. No change has been made to the final Guideline. The question identified (now in paragraph 29(g) of the final Guideline is merely an indicator of risk, rather than an assessment of the entire position. No change has been made to the final Guideline. Paragraph 46(a)(b)(c)(d)(e) and (f) of the draft PCG - these paragraphs contain references to genuine commercial rationale, expected changes, legal form and documentation, evidence of market conduct, aspects that are not expected and whether centralisation is common in the relevant industry. These matters are not relevant to economic substance. The questions in the 'framing questions relevant to the SES test' section (paragraph 31 of the final Guideline) are indicative of risk and we acknowledge that there is overlap in questions specific to the SES test and the understanding of the overall scheme. We specify this in paragraph 26 of the final Guideline. We consider the use of these words clarifies that the list is not exhaustive. No change has been made to the final Guideline. This is in keeping with the paragraphs explaining the purpose of the scenarios (in paragraphs 33 and 34 of the final Guideline). 'We will discuss our proposed compliance approach with you, which may include informing you that we have decided that based on the information provided, the DPT does not apply to the arrangement as currently structured'. Similar changes were also proposed for paragraphs 16 and 24 of the draft PCG. The client engagement framework outlined in paragraphs 47 to 58 of the final Guideline also clarifies that further certainty can be obtained through a private ruling or the APA program. No change has been made to the final Guideline. Paragraphs 42 and 43 have been incorporated in to the final Guideline and outline that where taxpayers qualify for three of the specified simplified transfer pricing record keeping options in PCG 2017/2 we will generally only dedicate compliance resources in accordance with that Guideline. Paragraph 117 refers to the functions, risks etc. as per the contract as opposed to the actual arrangement. It therefore appears that the ATO is taking a form over substance approach. This could be a more appropriate Subdivision 815-B of the ITAA 1997 case. Suggested that improvements are made to clarify this issue. Importantly, these paragraphs clarify that when we are determining whether the profit made by an entity reasonably reflects the economic substance of the entity's activities in connection with the scheme, the appropriate method will depend on the circumstances of the particular case.

Summary of issues raised and responses | ATO Response/Action taken | Provide guidance as to the triggers which may lead to the commencement of a DPT analysis. | Provide a paragraph to highlight that the scenarios relate specifically to the SES test and are not intended to represent, and do not contain, a full analysis of the DPT. | Concerned that taxpayers cannot assess risk as there is no discussion on the identification of DPT risk. The framing questions are of no assistance in determining DPT risk. Inadequate explanation of how the framing questions and components will be brought together to apply the tax. | It would be useful if the guidance included an explanation of how the use of CUPs as a primary transfer pricing method can be approached under the SES test. This should include recognition of intangible assets (formal and informal) as contributing value to the activities and representing economic substance beyond personnel and other tangible factors. | Paragraphs 36 and 37 of the final Guideline have been revised to make it clear that we will consider, when we are determining whether the profit of an entity reasonably reflects the economic substance of the entity's activities in connection with the scheme, both the traditional transaction methods and the transactional profit methods. The appropriate method will depend on the specific facts. | Paragraphs 36 and 37 of the final Guideline have been revised to provide further guidance in relation to the relevance of the OECD guidelines (including the use of the transfer pricing methods) and other documents covered by section 815-135 of the ITAA 1997 for the purpose of the SES test. | Taxpayers should be able to lodge a private ruling request on the application of the DPT (paragraph 36 of the draft PCG does not include this as a suggested subject for a ruling request). | Recommended change to paragraph 32 of the draft PCG that addresses APAs. Proposed wording: '... if the procedures set out in the APA are not followed or if adjustments are not otherwise made in tax returns to reflect ranges agreed in an APA.' | Revisions have been made in the final Guideline to the APA content addressing the monitoring of compliance. Paragraph 21 specifies that a breach will be dealt with in accordance with Law Administration Practice Statement PS LA 2015/4 Advance Pricing Arrangements. | Paragraph 45(g) of the draft PCG should specifically mention, in addition to staff headcount and /or capability, '... functions, assets and risks ...' as they are directly relevant to economic substance. | Paragraph 55 of the draft PCG - this paragraph should be revised to make it clear it is not an exhaustive list of documentation (in the ATO's possession) that the ATO will consider in relation to the DPT. | It should be clarified that the scenarios addressing the SES test are only relevant if the principal purpose test is satisfied. | Paragraph 33 and 34 of the final Guideline have been revised and make it clear that the scenarios are relevant to illustrating the consideration of risk in the context of the application of the SES test. | The SES test scenarios in the draft PCG do not adequately explain how the ATO reaches the conclusion that the SES exemption does not apply. This rationale should be explained in more detail. | Request that taxpayers that are eligible for simplified transfer pricing records options (Practical Compliance Guideline PCG 2017/2 Simplified Transfer Pricing Record Keeping Options ) should be viewed as low risk for the purpose of the DPT and a statement to this effect be included in the PCG. | Paragraph 120 in Scenario 5 of the final Guideline has been revised to clarify that the economic substance of an entity's activities are determined by reference to the available evidence rather than the terms set out in the contract. | A consistent approach to inbound and outbound arrangements would be more in line with the preferred OECD methodology for re-sellers of products. References made to scenarios 5, 6 and 9 in the draft PCG in regards to an appropriate profit level indicator being operating margin or similar, whereas PCG 2017/1, in relation to hubs, refers to a net cost plus profit level indicator. | Request a low risk example for a marketing hub is included in the PCG. | A low risk marketing hub scenario (Scenario 10 in Appendix 2 of the final Guideline) has been incorporated in response to this feedback. | Question why scenario 10 in the draft PCG only addresses captive insurance arrangements and not reinsurance generally. | The insurance scenario (Scenario 12 in Appendix 2 of the final Guideline) has been revised in response to this feedback. The scenario outlines a low risk general reinsurance arrangement in the context of the SES test. | Request guidance on what the ATO considers would indicate sufficient economic substance for a financing arrangement. | A financing scenario (Scenario 11 in Appendix 2 of the final Guideline) has been incorporated in response to this feedback. Whilst the scenario outlines a high risk arrangement in the context of the SES test, we provide guidance on where an entity providing financing is likely to have profit that reasonably reflects the economic substance of its activities in connection with the scheme.

Related rulings and determinations: LCR 2015/2 | LCR 2018/6 | PS LA 2005/24 | PS LA 2015/4 | PSLA 2017/2