Contributed by Michael Bona, Peter Collins, Jonathan Malone, Greg Weickhardt, Chris Morris, Paul McNab, James Nickless and Angela Danieletto, PwC Australia

In brief

The ATO released its finalised guidance on the diverted profits tax (DPT), Practical Compliance GuidelinePCG 2018/5 and Law Companion Ruling LCR 2018/6, on 26 September 2018.

The PCG was previously released as Draft PCG 2018/D2 and the LCR as Draft LCR 2017/D7. In finalising the PCG and LCR, the changes made to the previously issued drafts are not considered to be major, but do address a number of matters that were raised during the consultation process and assist in clarifying how the DPT will be considered and administered by the ATO.

The updates can be summarised under the categories listed below.

• • Context and broader DPT criteria — the draft PCG was narrowly focussed on the sufficient economic substance (SES) test. The finalised PCG and LCR both emphasise broader DPT criteria (such as the existence of a tax benefit and the principal purpose test).
• • Approach to DPT compliance — the finalised PCG explains that the DPT is not a provision of last resort but also states an expectation that the DPT will be applied in limited circumstances. However, it also highlights that the DPT may be considered concurrently with other tax rules such as the transfer pricing provisions.
• • Updated examples — the finalised PCG now includes a low-risk marketing hub example in relation to the oil and gas industry (previously there was only a high-risk marketing hub example in relation to commodities). A high-risk financing example has also been added in relation to cross-currency interest rate swap arrangements only (previously the draft PCG did not include an example for financing transactions).

The finalised PCG serves as a risk assessment tool for taxpayers considering their potential exposure to the DPT and also acts as a framework document for taxpayers in determining the manner in which they should engage with the ATO.

The finalised LCR should be read in conjunction with the DPT legislation and explanatory memorandum when analysing the potential application of these provisions.

In detail

By way of background, Australia’s DPT legislation applies to significant global entities (broadly, groups with annual global income of A$1b or more) in respect of income years commencing on or after 1 July 2017 in circumstances where the amount of Australian tax paid is reduced by diverting profits offshore through related-party arrangements and certain other conditions are satisfied. A 40% tax applies to DPT tax benefits, irrespective of whether or not the tax benefit arises in connection with a scheme that was entered into, or was commenced to be carried out, before 1 July 2017.

Our expectation in relation to the DPT, and the expectation of the ATO, is that taxpayers will review the PCG in an attempt to perform their own risk assessment for potential DPT exposure based on the legislation itself, the LCR, the PCG framing questions provided and suggested documentation/evidence.

In the event that taxpayers conclude that there is a potential DPT risk associated with their arrangements, taxpayers can consider engaging with the ATO in order to obtain greater certainty on the application (or otherwise) of the DPT. The ATO’s suggested avenues for engagement include entry into the advanced pricing agreement (APA) program, applying for a private ruling, or contacting the ATO’s specialist DPT team.

The finalised examples which illustrate the ATO’s approach to risk assessment in relation to the SES are listed below:

• • lease-in lease-out arrangements
• • intangibles migration (pharmaceutical industry specific)
• • intangibles migration (previously described as a run-up run-down arrangement)
• • distributor arrangements (previously described as a limited-risk distributor arrangement)
• • marketing hub arrangements
• • financing arrangement (involving a cross-currency interest rate swap), and
• • insurance arrangements.

A concern remains that many taxpayers will have circumstances that do not fit neatly into the examples provided in the finalised PCG and therefore it may be difficult to predict the level of risk perceived by the ATO in many circumstances. Regardless, the ATO expects taxpayers to engage with them if “there is a potential DPT risk associated with your arrangement”, having regard to the PCG’s risk assessment framework.

The takeaway

All taxpayers with cross-border related party dealings are encouraged to assess the potential application of the DPT. This will start with the preliminary consideration of whether the taxpayer is a significant global entity that has, in broad terms, Australian income in excess of A$25m, and then a specific consideration of particular transactions within the framework of the DPT law.

Beyond these initial framing questions, we recommend that taxpayers undertake a process to evaluate their risks and supporting documentation for the more complicated areas of the DPT law, namely the principal purpose test and whether it could be concluded that an Australian tax benefit exists, as well as the SES and sufficient foreign tax tests.

The ATO’s finalised DPT materials should be considered by all affected entities in framing up an assessment of the potential application of the DPT and the likely approach to be taken to engage with the ATO in managing compliance risk.