Transfer Pricing: the Arm’s Length Principle
In Australia, the transfer pricing regime puts a significant burden on the entity to ensure that related party pricing is arm’s length and supported by appropriate documentation. If the amounts for the transactions do not comply with the arm’s length principle then this can result in higher tax penalties in the event on an ATO audit.
‘Transfer pricing’ broadly refers to the price at which international transactions between related parties take place. These can involve different types of property and services including tangible goods, the licensing of intangibles and financial and management services. The ATO expects taxpayers to exercise commercial judgement in assessing an entity’s compliance with the arm’s length principle under the transfer pricing rules.
The arm’s length principle uses the behaviour of independent parties as a guide to determine the pricing of goods and services and how income and expenses are allocated in international dealings between related parties. It involves comparing what a business has done and what an independent party would have done in the same or similar circumstances. This is often easier to do with commodities, rather than intangibles, as the price can easily be ascertained by looking up comparable pricing from non-related party transactions in the open market.
Australia’s transfer pricing rules do not prescribe any particular methodology or preference for the order in which methodologies should be applied to arrive at an arm’s length outcome. The
ATO relies on taxpayers employing methods that are appropriate and reliable with regards to all the relevant factors and circumstances. Some of the more widely used transaction-based methods include comparable price method, the resale price method and the cost plus method.
Where the above methods are unsuitable for a particular transaction, the ATO accepts the use of profit-based methods such as the profit split method or the transactional net margin method as appropriate. A novel method can also be used where the taxpayer can show that the result is consistent with the arm’s-length principle.
An entity’s transfer pricing policy can have a significant impact on a business’ profitability and the amount of Australian tax paid. Therefore, it is important to manage and optimise an entity’s transfer pricing policy and methodology.
For advice or assistance please contact our team of tax solicitors at The Quinn Group on (02) 9223 9166 or submit an online enquiry form today.