Transfer pricing…I’m a small-medium sized business, why do I care?
Australia’s transfer pricing rules apply to all businesses that have transactions with international related parties. It’s not just a thing for the big end of town. The Australian Taxation Office (ATO) expects that tax returns are lodged on the basis you have considered and applied the transfer pricing rules to any relevant transactions with international related parties and that the documentation requirements have been satisfied.
However, as a small-to-medium sized business with revenue of less than $50m, you potentially have access to concessions to reduce the level of documentation required to support your pricing of international related party transactions.
By understanding and applying these concessions, businesses can reduce their compliance burden while ensuring they meet their Australian tax obligations.
Transfer pricing and international related party transactions
Singapore and the USA have consistently been the Top 2 countries for related party expense payment transactions made by Australian businesses.
Overview of Australia’s transfer pricing rules
Transfer pricing refers to the pricing of transactions between international related parties, such as transactions between you and your foreign parent company or foreign subsidiary. The ATO enforces transfer pricing rules to ensure that international related-party transactions reflect arm’s length prices that would be charged between unrelated parties.
Australian businesses have significant dealings each year with related parties in other countries. Based on the recent ATO published data, in the 2022 financial year, Australian businesses disclosed ~$316.5billion in expense transactions with overseas related parties, reflecting a 17% increase of A$46.2 billion from the 2021 financial year. The highest value of revenue and expense transactions has consistently been with Asia, with the top 2 countries for expense transactions (i.e. expenses incurred by Australian businesses and paid to related parties overseas) being Singapore and the USA. See the adjacent charts summarising the 2017-2022 years for both these countries.
Supporting the pricing of related party transactions
Compliance with transfer pricing rules is required to ensure that cross-border transactions are appropriately documented to avoid tax penalties.
The ATO expects businesses to assess their related-party transactions and ensure they align with the arm’s length principle. In this context, 'arm’s length' means that the terms and pricing of transactions between related entities should be consistent with what would be agreed upon by independent parties in a comparable transaction under similar circumstances.
Simplified transfer pricing record keeping rules
Recognising that full compliance with transfer pricing documentation requirements can be burdensome for smaller businesses, the ATO provides an administrative concession for eligible businesses called the Simplified Transfer Pricing Record Keeping (STPRK) options. These concessions generally reduce the level of documentation required for businesses that meet certain criteria.
There are 7 options available for taxpayers to access the simplified record keeping concessions:
Small taxpayers
Distributors
Low value adding intra-group services
Low-level inbound loans
Materiality
Technical services, and
Low-level outbound loans.
These options reflect the types of transactions or activities that the ATO believe are low risk in the context of international related party dealings. The ATO has published guidelines as to the criteria for taxpayers to self-assess eligibility to use one or more of the above 7 simplification options.
The concessions for simplified record keeping should be assessed on a transaction-by-transaction basis. For example, if you are a small business taxpayer qualifying under the Option 1 concession, then this option would not cover your related party loans (because they are excluded). You would instead, have to test whether Option 4 or Option 7 applies to your loans in order to access the simplified record keeping concessions for those transactions.
Eligibility criteria to access the simplified rules as a small business
Generally, a business may qualify for the simplified record-keeping options if it meets the following conditions under the “small taxpayers” concession in Option 1:
Turnover Threshold – The business’s aggregated turnover is below A$50 million and you are not a “distributor” business (distributor businesses typically purchase and on-sell, including on a commission basis)
Related-Party Transactions – The total value of specific international related-party transactions does not exceed specified thresholds
Low-Risk Indicators – The business’s transactions must meet low-risk criteria, such as not having sustained losses, maintaining profit levels within ATO-approved turnover margins, the business has not undertaken a restructure of its affairs within the year and you have assessed your compliance with the transfer pricing rules.
Importantly, the small taxpayer option does not apply to simplify the documentation requirements for the following transactions:
(a) royalties, licence fees or research and development (R&D) arrangements
(b) financing transactions including loans and guarantee fees etc (note, a separate simplified reporting option can be available for certain loans)
(c) capital transactions
Outcome of satisfying the eligibility requirements to apply the simplified rules
Generally, businesses with international related party transactions of greater than A$2 million will need to prepare and lodge an International Dealings Schedule (IDS) as part of their annual tax return
If a business satisfies the above eligibility criteria, it can significantly reduce its compliance burden (although as noted above, you still need to document how you qualify for the simplified rules in the first place).
Generally, if the simplified options are applied, the ATO will not look to review the transactions for transfer pricing purposes, other than to review your eligibility to use that simplified option. If you meet the criteria for one or more of the 7 simplification options, you should be eligible to apply that option to your relevant international related-party dealings. You should document your position to substantiate your eligibility for the option you have applied.
So in short, if all is in order with your eligibility for the concessions, then you should not be reviewed/audited by the ATO if they want to take a look at your international related party transactions as part of your tax return (beyond checking your eligibility for the concessions).
Disclosure of your transactions in your tax return
Generally, businesses with international related party transactions of greater than A$2 million will need to prepare and lodge an International Dealings Schedule (IDS) as part of their annual tax return. Eligibility for simplified record-keeping does not automatically exempt a business from submitting an IDS.
If you are required to prepare an IDS as part of your Australian tax return, and you are eligible for the simplified recording keeping options, you need to make certain disclosures in the IDS against the relevant transactions for which you have applied the concessions.
As noted above, applying the small taxpayer’s concession (Option 1) does not reduce the documentation requirements for certain transactions such as royalties, licence fees or loans etc (although certain loans can be subject to their own separate simplified record keeping options as noted above).
Examples of key types of international related party transactions based on ATO data
The adjacent charts summarise the following common transactions between Australian businesses and their foreign related parties. This data is based on published ATO data for the 2022 financial year:
(1) The top types of revenue earned by Australian entities from international related party transactions for the 2022 year, based on the highest % change from the 2021 year; and
(2) Total revenue earned by Australian entities from management and administration services from international related parties between the 2016 to 2022 years.
Recent ATO guidance on compliance concerns for transfer pricing
The ATO regularly issues guidance on specific compliance risks associated with related-party transactions. One notable area of focus is inbound related-party financing in the property and construction industry.
The ATO has highlighted concerns that some businesses may not be adhering to arm’s length pricing principles in their financing arrangements, leading to potential tax risks including shifting profits overseas.
For more details, refer to the ATO’s guidance on this issue: Inbound Related-Party Financing for Private Groups in Property and Construction.
More information
Businesses must ensure compliance with transfer pricing rules and maintain adequate documentation where required. The ATO provides detailed guidance on these requirements, including eligibility criteria for simplified record-keeping.
For more information, refer to the ATO’s official transfer pricing resources:
By understanding and applying these rules, SME’s can reduce their compliance burden while ensuring they meet Australian tax obligations.
Click on the link below to review our interactive dashboard which analyses the latest ATO published data on international related party transactions.
Notes
[1] The ATO introduced the simplified transfer pricing rules in 2014. Under these reduced documentation requirements in the simplified rules, businesses would not required to prepare full transfer pricing documentation as per Subdivision 284-E of the Taxation Administration Act 1953.
[2] The above comments are general in nature and based on the ATO’s published guidelines in Practical Compliance Guideline (PCG 2017/2). In this Guideline, the ATO notes that applying one of the simplified options in this Guideline acts as an ‘‘administrative safe harbour’’ and does not, of itself, meet the requirements of Subdivision 284-E of Schedule 1 to the TAA and Subdivisions 815-B, 815-C or 815-D of the Income Tax Assessment Act 1997 (ITAA 1997). Applying an option also does not limit or waive how the law operates, but demonstrates you have self-assessed your relevant transactions for compliance with the transfer pricing rules.
[3] PCG 2017/2 provides that you are a distributor if your main business activity is recorded on your tax return using the Australian and New Zealand Standard Industrial Classification (ANZSIC) Wholesale Trade code.
More information
Please reach out to us if you would like more information in relation to transfer pricing and to discuss your specific circumstances in more detail.