Australia: Practical compliance guideline on intangibles arrangements

The Australian Taxation Office (ATO) on 17 January 2024 finalized its practical compliance guideline (PCG)—PCG 2024/1—with respect to intangibles arrangements.

The final PCG follows two draft PCGs released for consultation over the prior three years, the last one having been released in May 2023. Read TaxNewsFlash

Overview and scope of the PCG

The focus of the PCG is on the structuring aspects of intangible arrangements, that may then be relevant for applying the reconstruction provisions in the Australian transfer pricing rules and also the general anti-avoidance rules (including the diverted profits tax (DPT)).

The ATO makes clear that the PCG does not focus on pricing aspects of intangible arrangements, although the transfer pricing methodology and profit outcomes can impact on the risk rating under the PCG. The PCG also does not cover the potential for embedded royalties and/or royalty withholding tax considerations.

The final PCG maintains a three-part framework:

• Part 1 sets out the ATO’s compliance approach to intangibles migration arrangements
• Part 2 sets out the ATO’s risk assessment framework, which includes two risk assessment framework (RAF) tables that taxpayers must use to self-assess their intangible migration arrangements based on a points system
• Part 3 sets out the ATO’s evidence expectations

In addition, Appendix 1 now provides 15 examples of how the RAF tables are to be applied (including commonly observed arrangements such as centralization of intangible assets, bifurcation of intangible assets, migration of pre-commercialized intangible assets, cost contribution arrangements and contract R&D arrangements), and Appendix 2 provides examples of the ATO’s evidence expectations.

Arrangements involving the “migration” of intangible assets or arrangements with similar effect are in-scope of the PCG, which may include arrangements involving Australian development, enhancement, maintenance, protection and exploitation (DEMPE) activities of intangible assets held offshore. The definition of “intangible assets” continues to be consistent with the definition from the 2022 OECD Guidelines and some examples of intangibles in the final PCG (e.g., policies, manuals, standards or protocols) suggest the term is interpreted broadly.

Given the potential breadth of application of the PCG, one of the key changes in the final PCG are three categories of “excluded intangibles migration arrangements” that are carved out of scope of the final PCG:

• Excluded outbound distribution arrangements in which the taxpayer grants rights to intangibles to a foreign distributor
• Excluded inbound distribution arrangements under which the taxpayer is a distributor that has been granted rights to intangibles from an international related party (IRP)
• Low-value service arrangements involving low-value-adding intra-group services (as defined in the ATO’s PCG 2017/2 and the OECD Guidelines) provided in relation to intangibles

Another key change is that the ATO has adopted a colored zone system seen in the loan and distribution PCGs for risk differentiation. There are now five zones (replacing the three risk levels in the draft PCG), mapped to aggregate risk points from applying the risk assessment framework:

Additional modifications to the ATO’s compliance approach by risk zone were also made, in particular:

• More certainty for “Green Zone” (low-risk arrangements). Specifically, the ATO will not apply compliance resources for green zone arrangements to examine/audit the arrangement for structuring aspects (although pricing risk remains open), except to verify self-assessment)
• Introduction of a “White Zone” for arrangements in which there has been no material changes since the taxpayer had an ATO settlement, an Australian court decision or an ATO review/audit that resulted in a “low-risk” rating (with no further action) or a high-assurance rating (relevant to justified trust reviews) in relation to the intangible migration arrangement. Note this does not include transactions subject to an APA. For white zone arrangements, taxpayers do not need to apply the risk framework and the ATO is unlikely to apply compliance resources to re-examine the arrangements beyond verifying that the conditions for white zone are met. Furthermore, taxpayers can early engage by contacting the ATO’s intangibles arrangement functional mailbox or the taxpayer’s dedicated ATO relationship manager.

There also were changes made to the RAF tables in Part 2 of the PCG with accompanying explanations, as well as a reweighting of risk points for both RAF tables in the final PCG. Additional changes to the RAF tables include:

• RAF Table 2 does not appear to capture intangible arrangements where the Australian taxpayer is the intangibles owner.
• Inclusion of a fourth category (Category 3) as a response option to Question 3 in RAF Table 1, which covers circumstances where the migration does not involve a change in ownership of the intangibles, that the IRP receives rights/use of the intangibles for its own active business income and that the taxpayer includes a share of the residual profits in its assessable income. Question 3 in RAF Table 2 is new and reduces risk points when the taxpayer is entitled to a share of residual profits in relation to the relevant intangibles.
• In both RAF tables, IRPs that are wholly or predominantly holding or managing intangible assets are treated the same as IRPs that have no or little economic substance for the respective tables’ Question 3 response options.
• In Question 6 in RAF Table 1, in assessing if there is a reasonable expectation of a reduction in taxable income due to the migration, all upfront gains (whether on revenue or capital account) are excluded from the calculus.
• A new Question 7 was added to RAF Table 1 (under the heading of “undocumented or unrecognized dealings”) that increases the risk rating of migrations where there the IRP benefits or uses an Australian taxpayer’s intangibles, but there is no documentation identifying the relevant intangible assets or evidence of process/activities associated with the intangibles and the Australia taxpayer does not receive any compensation for use of its intangibles.

There remains, however, an inherent level of subjectivity in evaluating the factors in the RAF tables, which the ATO notes in the Compendium is unavoidable.

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

Jane Rolfe | janerolfe@kpmg.com.au

Aaron Yeo | aaronyeo@kpmg.com.au

Caleb Han | chan1@kpmg.com.au