As in many other industrialized countries, an integral feature of Australia’s tax system is the opportunity made available to taxpayers to conclude an advance pricing agreement (APA) with the ATO or may obtain a ruling from the ATO covering contemplated transactions or continuing arrangements with their related entities. The objective of the ATO in such cases is to provide the taxpayer with a holistic solution that covers all of the taxpayer’s international dealings with such related parties. Among other things, the program provides taxpayers with greater certainty regarding the tax treatment of their dealings, particularly as regards the choice of pricing methodology, while removing the risk of a later transfer pricing audit that could result in the imposition of penalties for non-compliance with the tax law.
Not every taxpayer needs to conclude an APA. In particular, small and medium enterprises, together with large business taxpayers that have lower levels of international related party dealings or whose transfer pricing arrangements are less complex, may avail themselves of the ATO’s alternative facilities for obtaining an advance determination of their susceptibility to a transfer pricing audit. These alternative facilities are available either upon direct application to the ATO or through a tool developed by the ATO for use by the taxpayer on a self-assessment basis.
The "APA product" is well developed by the tax authorities, with the details thereof being spelt out in a comprehensive guide published by the ATO in the form of a Practice Statement (LA 2015/14). The Statement covers, among other things, eligibility requirements, the types and kinds of agreements available, mutual expectations of the parties thereto, the procedures involved, renewals, audits, rollbacks, and the administration of the APA program. The essential elements of the APA program are summarized below.
The APA product may be of any of the following three kinds:
(a) Unilateral: where the agreement is one between the ATO and the taxpayer, without the participation of any other foreign tax authority.
(b) Bilateral: where the agreement is one involving a foreign tax authority, usually concluded with a treaty partner through the Mutual Agreement Procedure (MAP) of the applicable treaty.
(c) Multilateral: where the agreement is concluded with two or more treaty partners.
Regardless of the type or kind of APA product, there is an established procedure to be followed, leading up to the finalization of an agreement, involving the following stages:
Stage 1 Early Engagement, which includes:
- Triage - a looks into the taxpayer's compliance history, past transfer pricing documentation and other areas to determine whether an APA request can and should proceed further;
- Preliminary discussions - discussions with the taxpayer as part of the cooperative relationship to explore avenues for the appropriate treatment of the covered cross border dealings and any collateral issues; and
- APA Request Review Workshop - a workshop to assist the APA team leader to make a decision on whether the taxpayer will be invited to lodge a formal APA application.
Stage 2 APA Application, which includes:
- Analysis and evaluation - The APA team analyses critically and evaluates the APA application to verify that:
- The proposed APA results in arm's length outcomes for the cross border dealings to be covered;
- There is sufficient information in support of the APA application so as to allow the ATO to fully evaluate it;
- The proposal in the APA application is consistent with the taxpayer's request and preliminary discussions in the early engagement stage;
- Negotiation - A mutual discussion and arrangement of the terms of the transaction or agreement
- Agreement - After negotiating the terms and conditions of a proposed APA with the relevant parties, the parties will usually have reached an agreement at least on the matters set out below:
- The names, addresses and countries of residence for taxation purposes of the parties to the APA;
- Terms of the APA;
- The cross border dealings covered by the APA;
- The agreed TP method and how it is to be applied;
- The arm's length amount, rate, range or other arm's length outcome;
- Critical assumptions, any breach of which need to be notified to the ATO in writing;
- A definition of each of the key terms in the APA;
- A statement of the accounting standards on which the taxpayer's financial statements are based, for example, AIFRS; and
- Procedures for making a compensating adjustment, if necessary.
Stage 3 Monitoring Compliance - This includes the submission of an annual compliance report by the taxpayer that must include:
- An analysis of compliance with the APA including the information and calculations demonstrating the outcome of the application of arm's length methodology;
- Details of any compensating adjustments made and how each was effected in the income tax return; and
- Whether there has been a breach of any critical assumptions.
Stage 1 is to be completed within 6 months; Stage 2 is to be completed within 18 months; and Stage 3 is ongoing.
APAs are normally designed to be in force for a limited period of time, usually between 3 and 5 years. They may be renewed for another term if all the parties agree and provided that certain conditions have been met, including that the taxpayer has substantially complied with the terms of the original agreement and that the relevant facts and critical assumptions upon which the original APA was based remain valid.
APAs are usually concluded based on certain critical factors and assumptions. The ATO considers a critical assumption to be "any fact, about the taxpayer, an affiliate, a third party, an industry or general economic conditions that, if it changed, would significantly affect the appropriateness of the substantive terms of the APA or the basis upon which it was agreed." Usually, where there is a change in the critical assumptions, including as a result of the breach by the taxpayer, an attempt will be made by both parties to revise the methodology agreed upon in the original APA and to modify the APA accordingly. However, failure to resolve the matter may lead to the suspension or cancellation of the APA with effect from the start of the year of income in which the event giving rise to the change in circumstances happened.
In response to the COVID-19 pandemic, the ATO has published guidance on the breach of APA as a result of the pandemic. The guidance states that in the event of a breach of APA, the ATO will consider various appropriate outcomes which include:
- Business as usual;
- Renegotiating the APA over the time period of the demonstrable impact; and
- Suspending or modifying the APA for a set period.
The ATO has clarified that standard APA processes and analyses are applicable on economic performance not significantly impacted by COVID-19 pandemic. For businesses significantly affected by the pandemic, the APA will be difficult to process without objective evidence showcasing impact experienced or high uncertainty around potential outcomes.