background image
13.4.2. Accepted Methods

At the cornerstone of the current Australian transfer pricing provisions is the internationally-recognized principle of arm’s length. The domestic provisions, along with the interpretive aids published by the ATO are designed to reflect the manner in which the principle will be applied to the actual business context in Australia. All of Australia’s double taxation treaties also contain the standard article 9 provision providing for adjustments in the case of international related party dealings on other than an arm’s length basis. The domestic provisions and Australia’s treaty framework are recognized as constituting alternative means through which transfer adjustments may be made by the authorities. Where, however, the provisions of a particular treaty are inconsistent with the domestic rules, the treaty provisions prevail over the domestic rules unless the treaty assigns precedence to the domestic law.

No specific method is prescribed for use in establishing the arm’s length nature of any dealings or transactions between related parties. However, in practice the Commissioner accepts the transactional methods identified in the OECD guidelines, namely the comparable uncontrolled price method, the cost-plus method and the resale price method. Paragraph 815-125(2) of the Income Tax Assessment Act 1997 (ITAA 1997) notes that the possible methods for establishing the arm’s length nature of any dealings or transactions between related parties include the methods set out in the OECD guidelines.

The considerations governing the choice of any of these methods are discussed and spelt out in greater detail in the ATO’s ruling. The most appropriate method chosen in any case should be the one producing the highest practicable degree of comparability for the case under examination, taking into account factors such as the relevant market and business, the functions to be performed, the assets and skills used and the degree and nature of the risks assumed by each party and the accompanying reward.

Where none of the above three methods is appropriate in itself in a particular case, as for example because of the absence of a comparable (e.g. in the case of intangibles), the ATO is prepared to accept an approach adopted by a taxpayer involving a combination of these 3 methods. Alternatively, the taxpayer may use any other methods or a combination of other methods that could achieve a result as consistent as practicable with the arm’s length principle. Alternative methods specifically identified for this purpose consist of transactional profit methods, comprising the profit split method and the transactional net margin method. Global formulary apportionment methods are seen as an unacceptable alternative to the arm’s length principle.

Ranking of Methods

There is no prescribed preference by the Australian authorities for any of the recognised transfer pricing methodologies, nor the order in which they are applied. The fundamental objective is rather to ensure that the most appropriate method is to be chosen is one that fits the circumstances of each particular case and produces an outcome that is commercially realistic.

Further, the domestic law also makes a reference to the OECD guidelines with respect to selecting and applying the most appropriate method.

However, the ATO favours the use of a four-step process in the setting and review of transfer pricing, each with appropriate contemporaneous documentation (see Sec. 13.4.4.).

Use and Availability of Comparables

The domestic laws generally follow the OECD guidelines with respect to comparability analysis, which inter alia provides that in identifying the comparable circumstances, regard must be made to all the relevant factors, including the following:

  • Functions performed, assets used and risks borne by the entities;
  • Characteristics of any property or services transferred;
  • Terms of any relevant contracts between the entities;
  • Economic circumstances; and
  • Business strategies of the entities.

Taxpayers may use internal or external comparable as well as domestic or foreign comparables, for determining the arm’s length price. However, the ATO prefers to use domestic comparables where the Australian entity is the tested party as these would generally provide closer comparability especially in terms of economic circumstances, subject to the particular facts, circumstances and the availability of reliable data. Further, the tax authorities are precluded from using any secret comparables for transfer pricing assessment purposes.