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Australia: Transfer pricing risks and offshore drilling-related leasing arrangements

Australia: Transfer pricing risks and offshore drilling

The Australian Taxation Office (ATO) on 26 September 2019 released a draft compliance approach to transfer pricing issues related to projects that involve the use, in Australian waters, of non-resident owned mobile offshore drilling units (MODUs).

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The draft compliance approach—PCG 2019/D5—would primarily affect Australian taxpayers that lease vessels from non-resident related parties under bareboat charter arrangements for drilling and drilling-related activities (such as pipe-laying and heavy-lift vessels) in Australian waters.


Key highlights

  • The draft PCG would apply to both Australian tax residents and actual or deemed Australian permanent establishments (PE) of non-resident entities.
  • When finalised, the draft PCG is proposed to apply retroactively as well as after its issue date.
  • Before applying the draft PCG, taxpayers must first assess whether the substance and form of the arrangements are aligned and whether any of the exceptions in the Australian “reconstruction provisions” apply.
  • In line with previous PCGs released by the ATO, the draft PCG applies a colour-coded rating system to enable taxpayers to self-assess their transfer pricing risk associated with cross-border MODU leasing arrangements.
  • The risk framework is made up of the following four risk zones based on the earnings before interest and tax (EBIT) / (third-party contract) revenue margin earned by the Australian operations.
TaxNewsFlash-Transfer Pricing

The implications of being in the different coloured zones broadly align to previous PCG’s issued by the ATO as follows:


The white zone

If an arrangement is in the white zone, the ATO has already reviewed the transaction and agreed to the transfer pricing outcomes, or agreed to an advance pricing arrangement (APA). If an arrangement is in the white zone, it will generally not be subject to further ATO review.


The green zone

To qualify for the green zone and be considered “low risk,” the profitability of the Australian operations compared to the total contract revenue of the Australian operations must be at least 10.5% for the relevant income year.

In determining the profitability of the Australian operations, taxpayers will need to consider the entirety of the drilling and associated activities of the operator in Australia—and this may mean combining the financial results of more than one entity. This could be a challenging exercise for some taxpayers.

An arrangement in the green zone will generally not be subject to ATO review or audit, and may qualify for a simplified transfer pricing recordkeeping concession.


Outside the green zone

Arrangements outside the green zone are more likely to be reviewed by the ATO as matter of priority. The ATO has also outlined in the draft PCG, the extensive information they will most likely request in a review or audit context that includes a significant level of detail from the vessel owner. Taxpayers with red zone arrangements need to determine that they have robust transfer pricing documentation in place to support the arm’s length nature of the arrangements.


Transitioning to the green zone

The ATO will consider imposing shortfall penalties at nil and shortfall interest charge at the base rate if certain pre-conditions are met (for a period of 12 months after publication of the PCG). In order to be eligible for this concession, taxpayers would be required to make a voluntary disclosure in relation to historic, current and prospective income years when the arrangements are in place and adjust to reflect an appropriate transfer pricing outcome.


KPMG observation

Guidance from the ATO in relation to this issue has been long awaited and therefore will be welcomed on one level. Notwithstanding this, at first glance, the benchmark to qualify for the low-risk green zone appears high, particularly given the economic conditions affecting the oil and gas industry in recent years. It therefore remains to be seen how many taxpayers will find themselves in the green zone under the proposed arrangements.

The ATO has invited comments on the draft PCG by 25 October 2019. Taxpayers engaged in leasing arrangements covered by the draft PCG need to consider their leasing arrangements in light of the draft guidance. When an arrangement is outside of the green (low-risk) zone, taxpayers need to determine that they have robust transfer pricing documentation in place that supports an alternative outcome as being consistent with comparable arm's length outcomes or they may consider a voluntary disclosure.


For more information, contact a KPMG tax professional in Australia:

Michael Fortmann | +61 8 9263 7444 | mfortmann1@kpmg.com.au

Nick Warth | +61 8 9263 7731 | nwarth1@kpmg.com.au

Kobus Meyburgh | +61 8 9263 4835 | kmeyburgh1@kpmg.com.au

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