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Diverted Profits Tax – the PCG is no longer MIA

Diverted Profits Tax – the PCG is no longer MIA

Alia Lum outlines the draft Diverted Profits Tax PCG released today by the ATO.

Alia Lum

Partner, Superannuation and Funds

KPMG Australia


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Almost a year after the Government introduced the Diverted Profits Tax (DPT) Bill into Parliament and more than 6 months after the commencement of the regime on 1 July 2017, the Australian Taxation Office (ATO) today released the draft Practical Compliance Guide (PCG) 2018/D2. It sets out the ATO client engagement framework to assist taxpayers in assessing their level of risk under the DPT. It follows the other DPT guidance released prior to Christmas; namely draft LCG 2017/D7 and the finalised PS LA 2017/2.

The PCG contains a number of useful framing questions for assessing risk which are categorised into those that are transaction specific, relevant both to the consideration of the application of the sufficient economic substance (SES) test and the principal purpose test. It also sets out the types of documents that will likely be requested to evidence a position and a client engagement framework.

Additionally, the PCG contains high and low risk examples for five different scenarios that focus on the SES test only. This is based on feedback that these scenarios will be the main focus area for taxpayers.

High risk examples

  • Cross-border lease-in-lease-out (LILO): where a reduction in royalty withholding tax arises from the use of a related party sub-lessor in a treaty country. There is a focus on the active functions undertaken by the sub-lessor, such as negotiation and risk management. Whilst the profits attributable to the Australia Co reasonably reflect economic substance, the SES test is failed as the profit split between the two foreign leasing entities does not reflect their respective activities. This indicates the ATO is prepared to use the DPT in cases where the local transfer pricing may be adequate.
  • Intangibles migration to low tax jurisdiction: where evidence indicates Australia Co continues to undertake manufacturing, commercialisation and functions to maintain, protect and exploit intellectual property (IP). There is also a separate set of high/low risk examples for IP migration run up and run down, where the old IP held by Australia is run down and new IP, which is wholly reliant on the exploitation of the old IP, is run up in a low tax jurisdiction.
  • Limited risk distributors (LRD): notwithstanding the contractual arrangements, evidence shows the Australian LRD is really a full risk distributor. The examples also highlight that the SES test looks at functions undertaken as it relates to the transaction, not just the staff levels in entity as a whole.
  • Marketing hubs: this focuses on excessive profits allocated to the hub relative to functions undertaken.

There are no real surprises in the examples chosen, with scenarios largely reflecting existing focus areas from taxpayer alerts or other PCGs. There is a notable absence of loan examples. The closest reference is to PCG 2017/4: cross-border related party financing transactions, where it notes green zone arrangements are unlikely to require further engagement on the DPT and for white zone arrangements compliance will be limited. Given the limited transactions expected to fall within these zones, this will likely be of little practical assistance to taxpayers.

The consultation period for the draft PCG runs to 9 March 2018. With the release of the draft PCG and substantive changes to the final unlikely, and a start date of 1 July 2017, taxpayers should now take steps to review their arrangements. The PCG makes clear that the ATO expects taxpayers to self-assess the risk that the DPT may apply. To do this, input should be sought from a multi-disciplinary perspective as the DPT crosses over transfer pricing, anti-avoidance and unique documentary and evidentiary requirements. In the event there is a potential DPT risk, the ATO expects taxpayers will engage with them early.

As always, any engagement approach with the ATO should be tailored to the circumstances at hand and the particular risks identified.

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