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Australia: Transfer pricing risks and offshore drilling-related leasing arrangements (final guidance)

Australia: Transfer pricing risks and offshore drilling

The Australian Taxation Office (ATO) on 19 February 2020 issued final guidance concerning transfer pricing issues of non-resident owned mobile offshore drilling units.


Related content

The guidance—PCG 2020/1, Transfer pricing issues related to projects involving the use in Australian waters of non-resident owned mobile offshore drilling units—finalises rules that generally follow the draft version (PCG 2019/D5) released in September 2019, and primarily affects Australian taxpayers that lease a vessel (a mobile offshore drilling unit (MODU)) from a non-resident related party under a bareboat-charter arrangement for drilling and drilling-related activities (e.g., pipe-laying and heavy-lift vessels) in Australian waters.

Key amendments

The key amendments in the final guidance (from the draft version of the PCG) include:

  • Additional clarification regarding the meaning of the term “the operator”—the ATO confirmed that the term operator includes the entity or entities that ensure performance of the drilling contract in satisfaction of the project specifications, coordinating both the MODU and highly skilled personnel
  • Confirmation that taxpayers do not need to apply the PCG when they have been awarded a “high assurance” rating in relation to justified trust
  • Confirmation that the “green zone” (low risk) rating applies to entities with an earnings before income tax (EBIT) margin of 10.5% (the draft version stated at least 10.5%)
  • Removal of the option for simplified recordkeeping—taxpayers will be required to prepare full transfer pricing documentation in order to support their positions

KPMG observation

Question 7 of the Reportable Tax Position (RTP) schedule currently requires disclosure of whether the taxpayer has entered into any arrangement or variation of an arrangement described in Taxpayer Alert TA2016/4; however, the instructions state that Question 7 will be updated to seek disclosure of the self-assessed PCG risk rating once the PCG has been finalised. Tax professionals expect that the RTP instructions will soon be updated to require disclosure of taxpayers’ self-assessed risk rating under PCG 2020/1. 

Key elements of PCG 2020/1

  • The PCG applies to both Australian tax residents and actual or deemed Australian permanent establishments (PE) of non-resident entities.
  • The PCG applies both before and after its issue.
  • Before applying the 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 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 four risk zones based on the EBIT/(third-party contract) revenue margin earned by the Australian operations.
TaxNewsFlash-Transfer Pricing

$ = Australian dollar

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

White zone

If an arrangement is in the white zone, the ATO has already reviewed the transaction and agreed to the transfer pricing outcomes (post issuance of PCG 2020/1), or agreed to an advance pricing agreement (APA). If an arrangement is in the white zone, it will generally not be subject to further ATO review.

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 10.5% or greater 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 which may mean combining the financial results of more than one entity. This may be a challenging exercise for some taxpayers. An arrangement in the green zone will generally not be subject to ATO review or audit.

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 PCG the extensive information that it will most likely request in a review or audit context, which includes a significant level of detail from the vessel owner. Taxpayers with red zone arrangements may want 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 remitting shortfall penalties to nil and shortfall interest charge to 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 are 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

The provision of guidance from the ATO in relation to this issue is long awaited and therefore will be welcomed on one level. Nevertheless, the ATO has maintained the high benchmark required to qualify for the low-risk green zone in the final version of the PCG, 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. Taxpayers engaged in leasing arrangements covered by the PCG need to consider their leasing arrangements in light of the finalised guidance. When an arrangement is outside of the green (low risk) zone, taxpayers will want 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 |

Nick Warth | +61 8 9263 7731 |

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