Chapter 2 Issues in the Bill
A number of submitters to the inquiry raised concerns about aspects of
the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit
Shifting) Bill 2013 (the Bill). Many of these issues were previously raised
during the Treasury consultation processes on both schedules of the Bill.
Selected key issues are discussed below.
Schedule 1 – General anti-avoidance rules
Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) covers
schemes to reduce income tax. Schedule 1 of the Bill will amend the ITAA 1936
with an aim to ensure that Part IVA continues to counter schemes that comply
with the technical requirements but which, when viewed objectively, are
conducted in a particular way mainly to avoid tax.
In his second reading speech on the Bill, the Assistant Treasurer, the
Hon David Bradbury MP, comments that without these amendments ‘there would be
significant scope for taxpayers to plan their way around the law’s intended
operation and to undermine the revenue base’.
For Part IVA to apply, three elements must be satisfied:
- there is a scheme;
- that a tax benefit is obtained
in connection with the scheme; and
- it must be
reasonable to conclude that someone entered into the scheme for the sole or
dominant purpose of obtaining a tax benefit in connection with the scheme.
Submitters to the inquiry raised some concerns about the need for, and technical
aspects of, the proposed amendments in Schedule 1. These include the amendments
as a response to related court decisions, the clarity of the new law, the
effect of changes on commercial decision making, the requirement to disregard
tax consequences when considering alternative postulates, and some technical
issues. These issues are discussed below.
Response to court decisions
The Assistant Treasurer’s second reading speech on the Bill outlined
Some recent cases have focused on the ‘tax benefit’ element
of part IVA’s operation. A tax benefit exists if a scheme produces a tax
advantage (for example, reduced assessable income or increased deductions) being
an advantage that would not have been obtained, or might reasonably be expected
not to have been obtained, if the scheme had not been entered into.
Section 177C of Part IVA sets out consideration of whether a tax benefit
is obtained in connection with a scheme.
When announcing the Government’s plan to introduce amendments to Part
IVA, the then Assistant Treasurer, former Senator the Hon Mark Arbib, expressed
the Government’s concern that the outcome of certain cases —lost by the
Australian Tax[ation] Office (ATO) on the basis of the ‘do nothing’ argument—could
‘potentially undermine the overall effectiveness of Part IVA’.
The then Assistant Treasurer stated:
In recent cases, some taxpayers have argued successfully that
they did not get a 'tax benefit' because, without the scheme, they would not
have entered into an arrangement that attracted tax …
For example, they could have entered into another scheme that
also avoided tax, deferred their arrangements indefinitely or done nothing at
all. Such an outcome can potentially undermine the overall effectiveness of
Part IVA and so the Government will act to ensure such arguments will no longer
The Government amendments will confirm that Part IVA always
intended to apply to commercial arrangements which have been implemented in a
particular way to avoid tax. This also includes steps within broader commercial
The EM comments that ‘a number of
recent decisions of the Full Federal Court have revealed weaknesses in the way
in which the tax benefit concept in section 177C operates’.
The ‘do nothing’ argument in question
that has succeeded in certain cases is where taxpayers have argued that without
the offending tax benefit they would not have proceeded with the relevant
One such case (on appeal to the Full Federal Court of Australia) was RCI
Pty Limited v Commissioner of Taxation  involving whether the
Commissioner was correct in determining that the general anti-avoidance
provisions applied in the circumstances of a particular transaction entered
into by the James Hardie Group. It involved the James Hardie Group transferring
its operating companies into a new more tax effective structure headed by James
The matter concerned a dividend payment of around $478 million made by
James Hardie Holdings (JHH(O)), a US company, to RCI [an Australian subsidiary]
which was exempt under s. 23AJ of the ITAA 1936. This reduced the value of the
RCI’s shares and the subsequent capital gains when they disposed of the shares
during an international corporate reorganisation. The Commissioner of Taxation
took the view that the dividend payment was a tax avoidance measure taken in
anticipation of the restructure, and calculated that if the scheme had not been
entered into there would be an additional tax cost of $172 million. Following
appeal, the Full Federal Court rejected the Commissioner’s conclusion.
In this appeal case, the Hon Justices Edmonds, Gilmour and Logan found:
… in our view, if the scheme in either of its manifestations
had not been entered into or carried out, the reasonable expectation is that
the relevant parties would have either abandoned the proposal, indefinitely
deferred it, altered it so that it did not involve the transfer by RCI of its
shares in JHH(O) to RCI Malta or pursued one or more of the other alternatives
referred to in the Information Memorandum; but they would not have proceeded to
have RCI transfer its shares in JHH(O) to RCI Malta at a tax cost of $172
million. On this view, RCI did not obtain the tax benefit it was alleged by the
Commissioner to have obtained in connection with the scheme.
In its Decision Impact Statement in response to the court decision, the
ATO acknowledged the Court’s findings on dominant purpose ‘turned on the facts
of the case’. However, the ATO also asserts that:
The Commissioner will not automatically accept
unsubstantiated assertions that a particular commercial transaction would not
have been entered into if the tax advantage in question had not been available.
The onus of proof remains on the taxpayer to make good such assertions, for
example by reference to cogent evidence or compelling commercial logic.
Some submitters claimed that the amendments to Part IVA are an
‘over-reaction’ to the ATO court loses in these cases. The Corporate Tax
Association (CTA) argues that:
… the proposed changes represent an over-reaction to the
Taxation Office losing a number of court decisions that have quite limited
application. In addition, they appear to go beyond the scope of the then
Assistant Treasurer’s policy announcement in March 2012.
CTA is of the view that ‘these losses were not caused by deficiencies in
the legislation, but rather by the Taxation Office’s case selection and its
approach to running the cases it litigates’.
Similarly, the Law Council of Australia (LCA) argues that these case losses
do not signal a design flaw in Part IVA, stating:
The ATO is concerned that it has lost some recent cases on
Part IVA. This does not signal a design flaw in Part IVA. In the 1990's the ATO
lost the first case on Part IVA to reach the High Court of Australia. The ATO
overcame that loss and over 30 years has found Part IVA to be effective. Part
IVA has achieved its purpose. An administrator of a statute losing cases
occasionally is a healthy sign that the administrator is identifying where the
boundaries of the statute lie.
The Tax Institute also questioned the need for the changes, commenting
The Courts have applied the current rules appropriately to
find that a tax benefit exists in only those cases where the taxpayer’s actions have resulted
in a loss to revenue. Recent cases have not resulted in the effectiveness of
Part IVA being compromised and as such the amendments in the Bill are an
Further, the Tax Institute argues that the circumstances that lead to a
‘do nothing’ alternative postulate being successfully put in RCI Pty Limited
v Commissioner of Taxation were ‘reasonably unique’.
The EM comments that what cases like RCI Pty Limited v Commissioner
of Taxation highlight was that ‘it is permissible to reject an alternative
course of action on the basis that the tax costs involved in undertaking that
action would have caused the parties to do nothing, including deferring or
abandoning a wider transaction of which the scheme was a part’.
The EM asserts that ‘another view of the operation of section 177C has
become evident in a number of recent decisions’. The EM states:
The decision in Futuris is an example. Both at first instance
and on appeal, the underlying suggestion seems to be that the reference in
subsection 177C(1) to tax consequences that ‘would have [occurred], or might
reasonably be expected to have [occurred], … if the scheme had not been entered
into or carried out’ is a composite phrase requiring, in every case, a
postulate about what would have or might reasonably be expected to have
happened in lieu of the scheme. On this view of the provision, ‘would have’ or
‘might reasonably be expected to have’ represent ends of a spectrum of
certainty within which acceptable postulates must lie.
The EM further comments in relation to this court decision and others
that ‘it appears to be assumed that all acceptable postulates will involve a
prediction about events or circumstances, as opposed to a mere deletion of the
scheme’. The EM states:
The competing constructions of section 177C have yet to be
directly considered by a court. To achieve the intended outcome, these
amendments include provisions which put it beyond doubt that the 'would have'
and 'might reasonably be expected to' limbs of each paragraph of subsection
177C(1) represent separate and distinct bases upon which the existence of a tax
benefit can be demonstrated.
From a policy perspective, it is desirable that section
177C(1) should operate in this manner…that reconstruction be permitted in
addition to, and not to the exclusion of, voiding an arrangement.
The Treasury does not accept that these amendments are unnecessary or an
over-reaction to court decisions. The Treasury submits the following as key
points in this regard:
- The amendments are
necessary to ensure the ongoing effective operation of the general anti-avoidance
rule known as Part IVA;
- The amendments are a
measured response to exposed weaknesses in the operation of the 'tax benefit'
concept, not a reaction to whether the Commissioner won or lost a particular
- The amendments
protect significant amounts of revenue that would otherwise be at risk.
The Treasury further states that ‘the amendments are wholly directed at
addressing problems with the tax benefit test (section 177C) and do not amend
the substance of the purpose test (section 177D), which is the main means by
which Part IVA distinguishes between legitimate tax planning and impermissible
The committee notes that tax cases, and in particular Part IVA cases,
will normally depend on their particular facts and circumstances. However, the
reasoning used for decisions in a particular case can have implications for the
operation of the tax laws more broadly.
It is expected that Government will fully consider the implications of
relevant court decisions, and take action to ensure the effective operation of
legislation, with a view to preserving its policy intent.
This Bill aims to address the issues that recent cases have highlighted to
ensure that the legislation continues to provide a more comprehensive framework
to counter tax avoidance schemes.
Operation of alternative postulates
A Part IVA inquiry into a scheme (to which Part IVA applies) ‘requires a
comparison between the scheme in question and an alternative postulate’.
The EM outlines that ‘an alternative postulate could be merely that the scheme
did not happen or it could be that the scheme did not happen but that something
else did happen’.
The EM states that the amendments in the Bill aim to ‘put it beyond
doubt that the “would have” and “might reasonably be expected to have” limbs of
each of the subsection 177C(1) paragraphs represent alternative bases upon
which the existence of a tax benefit can be demonstrated’.
The EM further asserts with regard to these alternative postulates:
- …when obtaining a tax
benefit depends on the ‘would have’ limb of one of the paragraphs in subsection
177C(1), that conclusion must be based solely on a postulate that comprises all
of the events or circumstances that actually happened or existed other than
those forming part of the scheme; and
- …when obtaining a tax
benefit depends on the ‘might reasonably be expected to have’ limb of one of
the paragraphs in subsection 177C(1), that conclusion must be based on a postulate that is a reasonable
alternative to the scheme, having particular regard to the substance of the
scheme and its effect for the taxpayer, but disregarding any potential tax
Issues were raised by submitters on the process that will be used to
apply the alternative postulates. Cleary Hoare
asserts that ‘the language used in the EM when detailing the process for
having regard to the alternative postulates is uncertain’.
Cleary Hoare argues:
Specifically, paragraph 1.110 [of the EM] details that the
nontax results should simply be ‘comparable’ which seems to conflict with
paragraph 1.102 that outlines that in order to provide a meaningful comparison
the alternative postulate should achieve ‘substantially the same non-tax
results’ as those achieved through the arrangement.
CPA Australia (CPA) contends that:
More effort needs to be made to align the Bill with the EM.
For example, the EM should provide guidance on when subsection 177CB(2) will
apply rather than section 177CB(3).
The Treasury states however that the EM ‘…makes it clear that the
annihilation approach under subsection 177CB(2) and the reconstruction approach
under subsection 177CB(3) are intended to operate as alternative bases for
identifying tax benefits…’. The Treasury states:
The Commissioner is entitled to rely on either limb. This
will typically depend on the facts of the case.
It is important to note that, under either approach, a tax
benefit that the Commissioner purports to cancel must be a tax benefit that
exists as a matter of objective fact—it cannot depend upon the Commissioner’s
opinion or satisfaction that there is a tax benefit.
Moreover, the tax benefit must, viewed objectively, be
obtained by a taxpayer in connection with a scheme that was entered into or
carried out with the required tax avoidance purpose.
The Treasury responded to specific concerns about the language used to
explain alternative postulates:
At paragraph 1.102, the Explanatory Memorandum explains that,
under the reconstruction approach in subsection 177CB(3), the role of an
alternative postulate is to provide a meaningful comparison between the tax
consequences of the scheme and the tax consequences of ‘an alternative that is reasonably
capable of achieving for the taxpayer substantially the same non-tax results
and consequences as those achieved by the scheme’.
At paragraph 1.110, the Explanatory Memorandum explains that,
for a postulate to constitute a reasonable alternative to a scheme it would be
expected to ‘achieve for the taxpayer non-tax results and consequences that are
comparable to those achieved by the scheme itself’.
There is no conflict between the language of paragraphs 1.102
and 1.110. To say that a thing should be ‘comparable’ to something else is to
suggest that it should be ‘similar to’, ‘equivalent to’ or ‘analogous to’. To
say that something should be ‘substantially the same’ as something else has broadly
the same meaning.
The amendments to Part IVA of the ITAA 1936 make it clear that either the
annihilation and reconstruction alternative postulate can be applied by the
Commissioner to cancel a tax benefit. It is also clear from these provisions,
and from existing law, the Commissioner can only do so where, objectively
viewed, the relevant tax avoidance purpose exists (that is, there was a tax
benefit in connection with a scheme to which Part IVA applies).
It is also clear that if a decision to reconstruct a scheme is taken
under Part IVA, the Commissioner must have regard to the substance of the
arrangements, including the actual non-tax outcomes achieved by the
arrangements (ignoring the scheme).
Alternative postulates and commercial decision making
When Part IVA was introduced in 1981, the Government indicated that it
was not intended to impede normal commercial transactions:
… the explanatory memorandum made it clear that the ‘test for
application’ of Part IVA was ‘intended to have the effect that arrangements of
a normal business or family kind, including those of a tax planning nature’
would be beyond the scope of Part IVA.
The distinction between tax avoidance and legitimate
commercial and family arrangements was emphasised by the then Treasurer in his
second reading speech on the Bill. There he stated that Part IVA was not
intended to ‘cast unnecessary inhibitions on normal commercial transactions by
which taxpayers legitimately take advantage of opportunities available for the
arrangement of their affairs’.
Some submitters to this inquiry express concern however that the changes
to Part IVA under Schedule 1 of the Bill will negatively impact on the day to
day commercial decision making of businesses. This is further explored below.
CTA expresses its concern in relation to the Part IVA provisions that ‘…the
amended legislation could be administered in a way that would create unexpected
tax liabilities in relation to genuine commercial transactions containing no
element of contrivance or artificiality’. CTA asserts that:
The uncertainty that would persist until judicial
determination of a number of the new concepts introduced would constrain
commercial activity and adversely affect everyday business decision-making.
In relation to the dominant purpose test, CPA argues that ‘contrary to
the second reading speech and the EM, the provisions will impact normal
commercial transactions’. CPA comments:
For example, a decision to sell the shares in a company
rather than the underlying assets will often be made after taking into account
an analysis of costs including tax. Under these proposed amendments tax would
be excluded from the analysis, throwing up a tax benefit and, therefore, the
need for the taxpayer to demonstrate that there was not a dominant purpose of
Similarly, Cleary Hoare argues that the proposed changes disregarded the
commercial realities that business must consider when making decisions,
These proposed changes continue to demonstrate a complete
disregard for the commercial reality of decision making that relates to the
profitability of an enterprise and the employment of Australians in those
enterprises. By seeking to close the door on the ‘do nothing’ and the ‘unreasonable
tax burden’ alternatives, the legislation will be stepping away from the
realities of commercial decision-making. Australian businesses routinely decide
to not enter transactions on the basis that an excessive tax burden will make a
transaction uncommercial. Preventing this reality from being examined when
hypothesising alternative postulates would create an incongruency between
regular business decision making and the general anti-avoidance rules.
Cleary Hoare further argues that ‘by preventing consideration of
potential tax costs to alternative postulates, the legislation is removing a
tool for the judiciary to identify which transactions are tax-avoidant in
nature, and which are bona fide transactions meriting no condemnation’.
CTA expresses further concerns with the proposal to disregard tax costs
in alternate postulates (in new subsection 177CB(4)(b)) asserting that ‘while
such a rule might have some intuitive appeal, it is in fact unnecessary to
overcome the “do nothing” argument—the “substance of the scheme” and “result or
consequence of the scheme” rules already have that effect’.
There is a risk that a ‘disregard tax’ rule could potentially
be open to abuse by the Commissioner, as it could empower him to construct an
alternative postulate that involves what is clearly an excessive amount of tax—for
example by taxing the same economic gain twice. It has been suggested in the
consultation process that such an outcome would be unlikely as the Commissioner
would still have to be successful on the ‘purpose test’ in sec 177D. However,
it is far from clear how the purpose test would displace a statutory assumption
that tax should be disregarded or how the courts would interpret such a rule.
The Treasury responded to concerns about disregarding tax when proposing
an alternative postulate that ‘…Part IVA must be capable of exposing the
substance or reality of what it is that has been achieved for the taxpayer (tax
aside) to the ordinary operation of the taxation laws’.
The Treasury states:
…the focus of the reconstruction approach should be on
identifying whether or not there is a reasonable substitute for the scheme. It
is not conducive to the effective operation of Part IVA to inquire into whether
taxpayers would have pursued an entirely different course of action had they
not participated in the scheme.
As the Explanatory Memorandum explains, a tax advantage
cannot meaningfully be linked to a scheme by comparing the tax consequences of
that scheme to the tax consequences that would have flowed if the parties had
chosen to pursue some different objective.
The Treasury further emphasises that ‘having identified a substitute for
the scheme, it would undermine the operation of Part IVA to permit the tax
consequences of that substitute to be a reason for concluding that the
substitute is unreasonable’. The Treasury asserts:
To do so would be to allow the very tax advantage that Part
IVA is seeking to identify and measure to function as a shield against its
The fact that a taxpayer would not have entered into a
transaction if it had known in advance that it would be subject to tax should
be no answer to Part IVA. To accept such a proposition would be to accept that
there are situations in which it is reasonable for a taxpayer to avoid the
ordinary operation of the taxation law on the substance or reality of what they
have actually done. Applying Part IVA will not lead to more income tax being
payable than results from that ordinary operation.
Furthermore, the Commissioner has the power under existing
subsection 177F(3) to provide compensating adjustments where it ‘is fair and
reasonable’ to do so.
It is appropriate that alternative postulates under Part IVA can be
objectively and fairly applied to business transactions in order that they be
subject to the ordinary operation of taxation law. The committee acknowledges
that permitting businesses to avoid tax on commercial operations on the basis
that they would not have conducted these activities if they had been subject to
tax is an unacceptable proposition.
The amendments provide a judicious basis for the Commissioner of
Taxation to protect revenue that may otherwise be at risk and will not subject
businesses to higher tax than is required under the ordinary operation of the
law compared to what they did in substance.
Some technical issues were raised in the submissions with the operation
of proposed sections 177C(1)(bc), 177C(1)(g) and 177CB(3). Section 177C(1)(bc)
provides that non-payment of withholding tax shall be considered a tax benefit
to which Part IVA can apply. Section 177C(1)(g) is consequential to section
177C(1)(bc) and provides that where paragraph (bc) applies, the amount of the
tax benefit shall be taken to be the amount referred to in that paragraph.
Section 177CB(3) is a new provision introduced by the Bill and provides
A decision that a tax effect might reasonably be expected to
have occurred if the scheme had not been entered into or carried out must be
based on a postulate that is a reasonable alternative to entering into or
carrying out the scheme.
In relation to proposed section 177C(1)(bc) CTA asserts that:
…there is a technical deficiency in the drafting of proposed
sec[tion] 177C(1)(g). In its interaction with proposed sec[tion] 177C(1)(bc),
it appears to define the tax benefit in a withholding tax scenario as being the
gross amount on which tax would be withheld, rather than the quantum of the
withholding tax benefit itself.
The Treasury states that ‘…proposed paragraph 177C(1)(g) is a
consequential amendment designed to bring the avoidance of withholding tax
within the same list as the other tax benefits set out in section 177C’.
The Treasury states:
Proposed paragraphs 177C(1)(bc) and 177C(1)(g) replace, and
are consistent with, existing section 177CA of the 1936 Act, which provides
that a taxpayer who avoids paying withholding tax on an amount on which it
would have, or could reasonably be expected to have, paid withholding tax is
taken to have obtained a tax benefit equal to the amount on which withholding
tax is avoided.
In a similar way, where Part IVA applies to an amount of
assessable income, the cancelled tax benefit is the amount of assessable
income, not the tax payable on that assessable income. (The amount of tax
payable on that assessable income could then be reduced by other factors such
In relation to concerns regarding most likely alternative postulates, CTA
states that ‘…the use of the test “a reasonable alternative” in proposed sec[tion]
177CB(3) introduces a degree of uncertainty for taxpayers in assessing
alternative postulates as “a reasonable alternative” may not always be the most
The Treasury asserts that ‘Subsection 177CB(3) builds on existing
subsection 177C(1), which itself tests the reasonableness of alternative
postulates’. The Treasury states:
Proposed subsection 177CB(3)…will
introduce no greater uncertainty than currently exists in Part IVA.
These amendments are appropriate and necessary and reflect the existing
provisions of Part IVA regarding the reasonableness of alternative postulates.
It is also appropriate that Part IVA can apply to withholding tax liabilities
which would have been incurred but for the operation of a tax avoidance scheme.
These amendments are consistent with other sections of the ITAA 1936.
Schedule 2 – Modernisation of the transfer pricing rules
Schedule 2 of the Bill aims to modernise Australia’s transfer pricing
rules and ensure they are aligned with internally accepted principles, of which
the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations (OECD TPGs) are a crucial component.
On 1 November 2011, the then Assistant Treasurer, the Hon Bill
Shorten MP, announced that the Government would ‘reform the
transfer pricing rules in the income tax law and Australia’s future tax
treaties to bring them into line with international best practice, improving
the integrity and efficiency of the tax system’.
The Treasury indicated that following the consultation substantive
changes were made to the draft Bill, and the explanatory material was amended
to ‘provide further explanation and clarification in response to specific
issues raised in submissions’. 
Treasury notes that specific issues raised during the consultation
- the extent to which
certain concepts are defined in domestic law, as opposed to being left to the
- a suggestion that the
rules should allow a taxpayer to downward assess a liability;
- that the scope of the
documentation rules was too broad, as they require a taxpayer to prepare
documentation in respect of all conditions that satisfied the cross-border
- the link between
preparing documentation and having a reasonably arguable position in respect of
administrative penalties was inappropriate.
The Bill repeals Division 13 of the ITAA 1936 and introduces
Subdivisions 815-B, 815-C and 815-D to the ITAA 1997 and Subdivision 284-E into
Schedule 1 to the Taxation Administration Act 1953 (TAA 1953). The EM
states that these provisions ‘modernise and relocate the transfer pricing
provisions into the ITAA 1997 to ensure that consistent rules apply to both tax
treaty and non-tax treaty cases’.
Submitters to the inquiry raised concerns in relation to Schedule 2 of
the Bill about its consistency with OECD guidelines, the reconstruction of
transactions, the time limits to amend assessments, and record-keeping
requirements. These issues are explored further below.
Consistency with OECD Guidelines and reconstruction of transactions
The arm’s length principle is central to transfer pricing regimes. It is
the international standard that OECD member countries have agreed should be
used for determining transfer prices for tax purposes. The arm’s length
principle is set out in Article 9 of the OECD Model Tax Convention, and is
integral to tax considerations for multinational groups and tax
administrations. It provides a broad parity of tax treatment for members of
multinational groups and independent enterprises, and has been found to work
effectively in the vast majority of cases.
The OECD Transfer Pricing Guidelines for Multinational Enterprises
and Tax Administrations (OECD TPGs) provide guidance on the application of
the ‘arm’s length principle’, the approach to be taken when evaluating the
transfer pricing of associated enterprises, i.e. attributing a value, for tax
purposes, of cross-border transactions between associated enterprises.
The OECD TPGs defines transfer prices as ‘the prices which an enterprise
transfers physical goods and intangible property or provides services to
The OECD TPGs are widely recognised and used. The EM acknowledged that:
The OECD Guidelines are widely used by both member and
non-member tax administrations, and were described by the UK Special
Commissioners as ‘the best evidence of international thinking on transfer
The amendments proposed in Schedule 2 aim to ensure that Australia’s
transfer pricing rules in relation to multinational groups align with the OECD
In its summary of the consultation process on Schedule 2 of the Bill,
the Treasury noted that most of the submissions supported the alignment of
Australia’s domestic transfer pricing rules with the OECD TPGs.
Section 815-130 in the Bill deals with the relevance of actual
commercial or financial relations. Paragraph (1) provides the following basic
- The identification of the arm’s
length conditions must:
based on the commercial or financial relations in connection with which the
actual conditions operate; and
regard to both the form and substance of those relations.
Paragraphs (2) to (5) of 815-130 provide for exceptions to the basic
In its chapter on the arm’s length
principle the OECD TPGs provide for the recognition of the actual transactions
undertaken, specifying that:
A tax administration’s examination
of a controlled transaction ordinarily should be based on the transaction
actually undertaken by the associated enterprises as it has been structured by
them, using the methods applied by the taxpayer insofar as these are consistent
with the methods described in Chapter II. In other than exceptional cases, the
tax administration should not disregard the actual transactions or substitute
other transactions for them. Restructuring of legitimate business transactions
would be a wholly arbitrary exercise the inequity of which could be compounded
by double taxation created where the other tax administration does not share
the same views as to how the transaction should be structured.
The OECD TPGs then go on to outline two
exceptional circumstances where it may be both appropriate and legitimate for a
tax administration to consider disregarding the structure adopted by a taxpayer
in entering into a controlled transaction. These are where:
- the economic substance of a transaction differs from its
- while the form and substance of the transaction are the
same, the arrangements made in relation to the transaction, viewed in their
totality, differ from those which would have been adopted by independent
enterprises behaving in a commercially rational manner and the actual structure
practically impedes the tax administration from determining an appropriate
General consistency with OECD Guidelines
A number of submitters to the inquiry comment on the approach taken in
Schedule 2 to aligning Australia’s transfer pricing rules with the OECD TPGs.
GE questioned whether it was necessary to introduce the sections
proposed, and suggested that ‘the policy intent of the legislation could be
achieved by incorporating the OECD Guidelines directly into the legislation rather
than drafting unique stand-alone provisions’.
Further, GE argue that some provisions in Schedule 2 of the Bill
actually create uncertainty as to whether Australia’s transfer pricing rules
are consistent with the OECD TPGs. It states:
Using language in the Bill that is not the same as the
language in the OECD Guidelines could lead to differences in interpretation,
despite the intention that the new transfer pricing measures be consistent with
the OECD Guidelines.
The committee raised this issue with the Treasury, who reiterated that
it is the ‘clear policy intent of the Government in relation to these
amendments … to better align the rules with international best practice as
currently set out by the OECD’.
The Treasury maintains that the alignment of the rules with the OECD
TPGs ‘has been achieved through drawing heavily on the language of the relevant
treaty provisions and the Guidelines in the construction of the provisions’.
Proposed subsection 815-135 provides for guidance material which should
be referred to when considering the application of the arm’s length principle
to a given situation. The EM states that:
The identification of arm’s length conditions under
Subdivision 815-B must be done in a way that best achieve consistency with the
- the OECD Guidelines;
- any other documents,
or part(s) of a document, prescribed by the regulations for this purpose.
The Treasury argues that making provision for guidance material in the
Bill, including the OECD TPGs is ‘a mechanism that a number of countries have
introduced in various forms into their legislation or subordinate rules to
assist in the interpretation of what are frequently complex
cross-jurisdictional issues’. The Treasury outlined that:
In addition to using language drawn from the relevant treaty
articles and the OECD guidelines, a specific legal pathway is provided to
require regard to be had to the OECD material for interpretive purposes. The
provision requires that the identification of arm’s length conditions be undertaken
in a way that best ensures consistency with prescribed materials, currently the
While the language used in the Bill significantly draws from the OECD
TPGs, the provision in the Bill also allow for the inclusion or refocusing on
other reference sources, if in the future there are developments in
international best practice on transfer pricing methodology that may diverge
from, or substantially add to, the OCED TPGs. The Treasury submitted:
The Explanatory Memorandum explains that the provisions are
constructed to provide a mechanism to prescribe interpretive materials (or
remove them, for example, if they cease to represent international best
practice or are overtaken by more relevant alternative materials). The
provision of a regulation making power ensures the Australian Parliament will
always retain control over what materials are referred to in the laws of
Reconstruction of transactions
GE acknowledged that ‘the Bill more closely aligns with OECD principles
than the previous exposure draft of the provisions’.
However, in its submission it highlights that certain concerns remained. In
particular, that proposed section 815-130(4) does not appear to have an
equivalent in the OECD Guidelines.
Subsection 815-130(4) of the Bill provides for one of the exceptions to
the basic rule:
subsection (1), if independent entities dealing wholly independently with one
another in comparable circumstances would not have entered into commercial or
financial relations, the identification of the arm’s length conditions is to be
based on that absence of commercial or financial relations.
CTA shares GE’s concern about the perceived inconsistency of proposed
section 815-130(4) with the OECD TPGs, stating:
… proposed sec 815-130(4), which deals with instances where
independent entities dealing with each other at arm’s length would not have
entered into any transactions with each other at all, has no equivalent rule in
the OECD Guidelines. It is not entirely clear what this provision is attempting
to achieve but if, as we have been assured, the aim of Schedule 2 of the Bill
is no more than to import the OECD Guidelines into the Australian domestic law,
then it should not include provisions that are not to be found in the OECD
The Institute of Chartered Accountants Australia (ICAA) argues that the
Bill ‘appears to provide for a broader application for the reconstruction of
transactions than was intended’ by the OECD TPGs.
Some submitters argue that the Bill may
enable the Commissioner of Taxation to make changes to transactions in a wider
range of circumstances than the ‘exceptional circumstances’ envisage in the
OECD TPGs. They argue that these provisions should be removed or at least
qualified. CTA asserts that:
The scope of the Commissioner’s
power to reconstruct actual transactions appears to be very broad and to go
beyond what is contemplated by the OECD Guidelines. Heavy reliance is placed on
the Explanatory Memoranda and guidance material to read down the words in the
Bill so as to align the Bill to OECD principles. However, the Courts have
recently down played the role of Explanatory Memoranda in statutory
interpretation, and there is a significant risk that the Commissioner will use
this power routinely in circumstances other than the ‘exceptional
circumstances’ the OECD contemplates.
Similarly, Deloitte argues that any reconstruction rule in the
legislation ‘should be explicitly limited to the exceptional circumstances
prescribed in the OECD Guidelines’. Deloitte acknowledged that the Government
has amended the EM to include reference in paragraph 3.94 to the exceptional
circumstances ‘discussed in the OECD Guidelines in the context of
non-recognition and alternative characterisation of certain arrangements or
transactions’. However, Deloitte remains concerned that no corresponding
amendments were made to the Bill, and recommends that ‘explicit rules be
incorporated Subdivision 815-B to reflect the positions stated in paragraphs
3.94 … to allow for clear interpretation of the law’.
The LCA also did not support the Commissioner having wider powers in
relation to reconstruction, arguing that:
Reconstruction of transactions is an arbitrary exercise
liable to result in double taxation. The LCA considers that in certain cases it
may be necessary to go beyond the contractual terms and examine the functions,
assets and risks to identify the real transaction. However, that should be no
warrant for substituting some allegedly more commercially realistic arrangement
for that agreed by the parties.
The ICAA maintains that the relevant paragraphs in the OECD TPGs ‘are
clearly directed at tax administrations seeking to review transfer prices and
make it clear that the review should be of the “actual transactions undertaken”.
The ICAA does not believe that they were drafted with a view for inclusion in
domestic legislation. It submitted that:
Where reconstruction is considered necessary in line with the
OECD TPGs, our members are of the view that the ability to reconstruct should
only be relevant on determination by the Commissioner where the basis for the
determination is clearly set out. The current drafting of the Bill requires
taxpayers to self assess a reconstruction of a transaction which is an overly
complex and unnecessary exercise.
The ICAA cautions that uncertainty surrounding this provision could
‘heighten the risk of double taxation and increase the compliance burden…’,
which could negatively affect international perceptions of Australia’s
desirability as a location for capital investment.
In addressing concerns raised by submitters on this matter, the Treasury
emphasises that the concept of the arm’s length principle is at the core of the
OECD material, stating:
The internationally accepted articulation of this principle
is in paragraph 1 of Article 9 of the OECD Model Tax Convention on Income and
Capital and is replicated in all of Australia’s treaties. This reference is replicated
in the Explanatory Memorandum at 2.19 and the OECD guidelines at paragraph 1.6.
In its submission, the Treasury explained that the reconstruction of
actual dealings is a ‘key feature of all modern transfer pricing regimes’. It
The non-recognition and substitution (commonly referred to as
‘reconstruction’) of actual dealings or arrangements is one way of achieving an
arm’s length outcome consistent with the arm’s length principle.
The Treasury maintains that the Bill does not introduce a broad
reconstruction power. It argues that the proposed rules on reconstruction ‘draw
directly upon the language used in the OECD guidelines’. It further noted that
proposed subsection 815-130 has a subheading ‘exceptions’ to cover a number of
possible interpretations of the rules. The Treasury states:
Rather, the ability to reconstruct dealings or arrangements
under the proposed rules is entirely consistent with the OECD guidelines, which
only permit reconstruction in ‘exceptional circumstances’. Examples of
‘exceptional circumstances’ are described by the OECD as instances where:
- the economic substance
of the arrangements does not match the legal form; and
- where the
arrangements, viewed in their totality, differ from those which would have been
entered into by independent enterprises acting in a commercially rational
The Treasury noted other submitters’ contentions that the OECD TPGs
‘only contemplate non-recognition of arrangements where other arrangements are
substituted in their place’. However, the Treasury emphasises that:
… the clear focus of the arm’s length principle is on determining
what independent entities would have done in the place of the parties. As such,
if independent entities simply would not have entered into any arrangements at
all, non-recognition (and substitution with no arrangements) is entirely
consistent with the OECD guidelines.
It is important to note that this rule only has application
where it can be demonstrated that independent entities would not have done
anything. This imposes a high threshold because in any instance where an
alternative set of arrangements or dealings can be postulated, subsection 815-130(4)
The significant growth in MNEs operating across a number of
countries—and consequently different tax jurisdictions—has necessitated the
development of methodologies to assist countries to ensure that an appropriate
amount of tax is being received by a given country to reflect that country’s
contribution to the relevant commercial transactions. There is a risk that if
multinational groups operating various associated enterprises are only subject
to domestic law, their operations could be arranged in such a way that mean
they could avoid paying appropriate amounts of tax, or could be subject to
double taxation. Consequently, countries enter into tax treaties and
international guidelines are developed.
The OECD takes the view that this issue cannot
be effectively dealt with by a single country and that a broader international
approach must be taken. Accordingly, the group developed the OECD
Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations (OECD TPGs).
The OCED TPGs provide guidance on the application of the ‘arm’s length principle’,
the approach to be taken when evaluating the transfer pricing of associated
enterprises, i.e. attributing a value, for tax purposes, of cross-border
transactions between associated enterprises. The arm’s length principle aims to
treat the parties to a transaction as if they were independent, and to assess
what the tax outcomes would have been in that case.
The OECD TPGs are widely recognised as providing international best
practice on transfer pricing and application of the arm’s length principle. The
Australian Government aims to align Australia’s transfer pricing rules in the Income
Tax Assessment Act 1997 (ITAA 1997) with international best practice
through Schedule 2 of the Bill.
The committee agrees that rather than a simple wholesale incorporation
of the OECD TPGs it is appropriate to consider and apply them to the Australian
context. While it is clear that the OECD TPGs are currently the best thinking on
transfer pricing, the provision for guidance material also allows for reference
to other material as international developments are made in relation to
transfer pricing methodologies.
The Committee considers that ‘reconstruction’ powers are a necessary
part of all modern transfer pricing regimes. These amendments incorporate
reconstruction powers under the heading ‘Exceptions’, consistent with the OECD
TPGs and the overall objective of determining the most appropriate arm’s length
The language in the Bill and the EM draws significantly on the OECD
TPGs. Furthermore, the Bill includes a specific requirement that the core
principle of ‘arm’s length conditions’ be determined to ensure consistency with
the OECD TPGs.
The committee notes the Treasury’s advice that that it has drawn
significantly from the OECD TPGs in the language used in the Bill, and have
created a ‘direct legal pathway’ by requiring that the central concept of the
arm’s length principle is determined consistently with the OECD TPGs.
It is clear that the OECD TPGs, and the core principle of applying arm’s
length conditions to associated enterprises in respect of financial
transactions, are reflected in the Schedule 2 amendments in the Bill and
expanded on in the EM.
Time limits to amend assessments
Under the current tax laws, the Commissioner has an unlimited period to
amend an assessment to give effect to a transfer pricing adjustment under
Division 13 of the ITAA 1936, the tax treaty transfer pricing provisions,
or Subdivision 815-A of the ITAA 1997. Specific time limits in relation to
transfer pricing adjustments are also provided for in some tax treaties.
The proposed sections 815-150 and 815-240 in the ITAA 1997 provide that
the Commissioner can amend assessments in relation to transfer pricing
calculations, for a seven year time period after the day on which the
Commissioner gives notice of the assessment to the entity. As is currently the
case, some tax treaties will continue to impose specific time limits in
relation to transfer pricing adjustments.
The Assistant Treasurer, in the second reading speech, outlined the
introduction of the seven year time limit, stating:
The new rules also introduce a time limit in which the
commissioner may amend a taxpayer’s assessment to give effect to a transfer
pricing adjustment. Under the previous rules, the commissioner had an unlimited
period in which to amend an assessment. These rules reduce this period to seven
GE commended the introduction of a time limit for the Commissioner of
Taxation to make transfer pricing adjustments. However, GE and other
submitters felt that the seven years was not justified, and argue that the time
limit should align with the four year period applicable to general income tax
The American Chamber of Commerce in Australia comments that the transfer
pricing adjustment period in many jurisdictions ‘is considerably shorter than
Similarly, PricewaterhouseCoopers supports a four year limit, referring
in its submission to a survey performed by the OECD’s Forum on Tax Administration
that revealed that ‘the average resolution of transfer pricing cases (amongst
43 OECD and non-OECD countries) was 540 days’.
PricewaterhouseCoopers comments that their view was supported by the
Inspector General of Taxation’s findings in the Review into improving the
self assessment system, which recommended:
To improve the certainty in relation to the review of
transfer pricing matters, the Government should consider providing the same
period of review for these matters as exists for the general period of review.
In its response to the Inspector-General’s recommendation, the ATO
indicated that that was a matter for the Government.
CTA argues that the proposed seven year limit was too long, and for a
four year limit for transfer pricing adjustments, ‘the same as other tax
matters, some of which can be at least as complex as transfer pricing matters’.
However, the Treasury indicated that due to their cross-jurisdictional
nature, the review of transfer pricing assessments may take considerably longer
than a standard adjustment. It set out the reasons for this as follows:
- Transfer pricing
audits are typically highly complex in nature and often require substantial
time and resources in order to be properly conducted.
- In contrast to many
audits that consider individual income years, transfer pricing audits often require
the examination of dealings that take place over a number of income years. The general
amendment period does not provide sufficient time to conduct multi-period
- The ATO has advised
that obtaining the information required to conduct transfer pricing audits is
typically more difficult and time consuming than for other matters. This issue
is exacerbated by the cross-jurisdictional nature of transfer pricing because
the ability to acquire information can be impeded by resource constraints of
tax administrations in other jurisdictions.
It is important to provide taxpayers with certainty that ATO adjustments
to their assessments can only be made within a fixed number of years. The
committee notes the Treasury’s advice that it can take a number of years to
obtain relevant information from some jurisdictions when the ATO is reviewing a
transfer pricing assessment for possible adjustment.
The proposed seven year limit provides greater certainty than the
current unlimited period. It strikes an appropriate balance between providing
taxpayers with certainty, and allowing the ATO enough time to conduct transfer
pricing audits and make an adjustment to a taxpayer’s assessment.
Record keeping to support a ‘reasonably arguable’ position
General record keeping provisions of tax law currently apply to the
transfer pricing provisions.
The current section 284-15 of Schedule 1 of the Taxation Administration
Act 1953 (TAA 1953) provides for when a matter is ‘reasonably arguable’:
A matter is reasonably arguable if it would be concluded in
the circumstances, having regard to relevant authorities, that what is argued
for is about as likely to be correct as incorrect, or is more likely to be
correct than incorrect.
The proposed changes in Schedule 2 of the Bill will link the record
keeping requirements for establishing a reasonably arguable position to
administrative penalties if a transfer pricing adjustment is made to a
In Schedule 2, proposed subdivision 284-E in Schedule 1 of the TAA 1953
will cover the special rules about unarguable positions for cross-border
transfer pricing, including covering the documents required to be kept for the
application of subdivisions 815-B and 815-C of the ITAA 1997. In effect, it
‘sets out optional record keeping requirements’. The EM outlined that:
Records that meet the requirements are necessary, but not
sufficient to establish a reasonably arguable position for the purposes of
Schedule 1 to the TAA 1953.
If the documentation as specified in the Subdivision is not
kept in respect of a matter, an entity is not able to demonstrate that it has a
reasonably arguable position in relation to that matter for the purposes of
Schedule 1 to the TAA 1953.
To satisfy the requirements of Subdivision 284-E, transfer pricing
documentation must be prepared before the lodgement of the relevant tax return.
Establishing a reasonably arguable position is one way in which a taxpayer can
seek to lower administrative penalties they may incur if their assessable tax
is other than that lodged in their tax return, i.e. following an adjustment
made by the Commissioner.
In the second reading speech on the Bill, the Assistant Treasurer
emphasises that the new rules operate on a self-assessment basis, enabling
taxpayers to self-assess their Australian tax position in accordance with the
arm’s length principle. This self-assessment approach is in keeping with the
overall design of the Australian tax system. The Assistant Treasurer states
Specific rules linking voluntary documentation with a
reduction in administrative penalties are included under the new rules. This
approach balances compliance costs for taxpayers with incentives to adequately
document issues relevant to transfer pricing matters. It allows taxpayers to
risk assess matters that could be the subject of administrative penalties and prepare
The LCA agreed with linking base document obligations to the level of
penalties, but was strongly opposed to having document obligations as a
‘pre-condition to demonstrating a reasonably arguable position’, stating:
The assessment of whether a taxpayer has a ‘RAP’ [reasonably
arguable position] is an objective inquiry that ought not be pre-judged by
reference to the level of documentation …
CTA described the documentation requirements as ‘quite onerous’,
The standard and scope of the documentation required to meet
the requirements of the Bill is very high. Given the significant adverse
consequences of having documentation that does not meet these strict
requirements, the time frame allowed for document preparation is extremely
limited and should be extended.
PricewaterhouseCoopers took the view that while taxpayers may have made
an assessment of their ‘reasonably arguable’ position, they may not have
prepared formal transfer pricing documentation by the time of lodging their tax
return. They made two suggestions to improve the operation of the record
keeping requirements in relation to a taxpayer establishing a reasonably
- to allow for
documentation to be provided within 90 days of a requestion from the ATO; and
- the ATO to provide guidance,
as a matter of priority, on how they will assess whether a taxpayer’s transfer
pricing documents meets the requirements of proposed subsection 284-255 of the
TAA 1953, to ensure taxpayers have a clear understanding of what will be
required to establish a reasonably arguable positions in relation to the
transfer pricing arrangements.
The EM states that ‘while the Subdivision does not mandate the
preparation or keeping of documentation, failing to do so prevents an entity
from establishing a reasonably arguable position’.
However, this point is qualified in the EM:
Establishing a reasonably arguable position is one avenue
through which an entity can lower administrative penalties. However, nothing in
these amendments prevents the Commissioner from exercising a general discretion
to remit administrative penalties where appropriate (as currently available
under the law).
The Treasury outlined that under current administrative practice, the
Commissioner will generally reduce administrative penalties in cases where a
taxpayer has prepared documentation in accordance with ATO Tax Ruling 98/16.
The Treasury comments that ‘the proposed record keeping rules, including the
nature of the documentation, are consistent with the approach taken in that
ruling and therefore should be familiar to taxpayers’.
In its submission, the Treasury states that linking the preparation of
transfer pricing documentation to establishing a reasonably arguable position
leaves it at the taxpayer’s discretion to prepare documentation for
transactions for which they believe there is a higher risk of a transfer
pricing adjustment being made by the Commissioner of Taxation. The Treasury
This approach provides an incentive for taxpayers to evaluate
their cross-border dealings and prepare documentation in respect of matters
that they consider to be at risk of transfer pricing adjustments. Allowing
taxpayers to determine which matters, if any, should be documented provides
appropriate flexibility for smaller taxpayers and taxpayers with low-risk
dealings to self-assess whether transfer pricing documentation is needed to
support their cross-border dealings.
The Treasury also noted that special de minimis rules will also
apply to exempt transfer pricing adjustments under certain thresholds from
administrative penalties. It submitted:
These thresholds provide additional protection to smaller taxpayers.
The transfer pricing thresholds are directly linked to the general thresholds
under the law, ensuring that they will be automatically updated by any changes
to the general thresholds.
The reporting requirements will not be mandatory. Linking the
preparation of transfer pricing documentation to establishing a reasonably
arguable position leaves it at the taxpayer’s discretion to prepare
documentation for transactions for which they believe there is a higher risk of
a transfer pricing adjustment being made by the Commissioner of Taxation.
The Commissioner of Taxation will continue to have ‘broad discretion to
remit penalties where tax payers have not prepared documentation’, and
that further protection for taxpayers
is afforded to exempt transfer pricing adjustments under certain thresholds.
Schedule 1 of the Bill aims to ensure that Part IVA of the ITAA 1936 can
continue to counter schemes that comply with the technical requirements of the
law, but upon objective examination are clearly engineered to avoid tax. It is
appropriate for Government to legislate for weaknesses in existing taxation
legislation that have been revealed by recent decisions of the courts against
the Commissioner of Taxation. The amendments in Schedule 1 are an appropriate,
reasoned and measured response to these identified weaknesses in the
Schedule 1 provides that the Commissioner may use either the
annihilation or reconstruction approach to cancel a tax benefit. This is
appropriate as it will enable the Commissioner to protect legitimate revenues
that may otherwise be at risk. The committee does not accept that there is any lack
of clarity in how these provisions will operate, or that they will require
businesses to pay more tax than is fair or negatively affect commercial
activities. These provisions will enable the Commissioner to objectively and
reasonably enforce tax avoidance measures and collect revenue to which the
Commonwealth is entitled under the law.
Schedule 2 of the Bill is vital to modernise Australia’s transfer
pricing rules and bring these into line with accepted international arm’s
length principles recommended by the OECD. The committee agrees that rather
than a simple wholesale incorporation of the OECD TPGs, it is appropriate to
consider and apply them to the Australian context.
It is clear that the OECD TPGs are currently the ‘best thinking evident
in transfer pricing’ and the committee notes the advice from the Treasury that it
has drawn significantly from the OECD TPGs in the language used in the Bill.
The committee considers that ‘reconstruction’ powers in exceptional
circumstances are a core part of modern transfer pricing regimes. The Bill
implements these powers consistently with the OECD TPGs.
The House of Representatives pass the Tax Laws Amendment (Countering
Tax Avoidance and Multinational Profit Shifting) Bill 2013 as proposed.
Julie Owens MP
8 March 2013