Transfer Pricing PCG 2024/1: Intangibles Arrangements Compliance Approach

PCG 2024/1 scope

The ATO published Practical Compliance Guideline PCG 2024/1 ‘Intangibles arrangements’ in January 2024. This guideline details the ATO’s compliance approach to cross-border intangibles arrangements involving Australian taxpayers. It is designed to provide clarity and guidance to taxpayers and the ATO.

The scope of PCG 2024/1 covers arrangements relating to the development, enhancement, maintenance, protection or exploitation of intangibles (DEMPE functions). This aligns with the OECD Transfer Pricing Guidelines.

This guideline incorporates changes following the High Court decision in Commissioner of Taxation v PepsiCo Inc and others regarding royalty withholding tax. It introduces a risk assessment framework to categorise arrangements as low, medium, high or very high risk.

Risk rating framework

The PCG incorporates a risk rating framework to guide the ATO’s compliance approach to transfer pricing arrangements. This framework assesses arrangements based on factors including the substance of the Australian entity’s contribution to development, enhancement, maintenance, protection, and exploitation (DEMPE), the appropriateness of profit allocation, and the extent of arm’s length compliance.

Arrangements assessed as ‘low risk’ are generally unlikely to be subject to ATO compliance review. ‘Medium risk’ arrangements may receive ATO consideration, with the level of scrutiny influenced by transaction size and other relevant factors.

‘High risk’ or ‘very high risk’ arrangements are expected to attract ATO review or audit. Further detail on the risk assessment process is provided in Schedule 1, while Schedule 2 offers specific guidance relating to royalty arrangements and beneficial ownership.

Royalty withholding tax interaction

The ATO’s position, as reinforced by PCG 2024/1, considers that royalty withholding tax may apply to payments that are not strictly characterised as royalties. This follows the *PepsiCo v Commissioner of Taxation* decision. Section 128B of the Income Tax Assessment Act 1936 imposes withholding tax on royalty payments made to non-residents, typically at a general rate of 30%, although this rate may be reduced by treaty arrangements.

The application of withholding tax is separate from, but can interact with, transfer pricing considerations. Payments structured to avoid withholding tax may still be subject to the transfer pricing rules in Subdivision 815-B of the Income Tax Assessment Act 1997, requiring cross-border intangibles arrangements to be priced at arm’s length.

Furthermore, arrangements designed to avoid withholding tax may also attract the Diverted Profits Tax (DPT) under Part IVA of the Income Tax Assessment Act 1936, at a penalty rate of 40%, if they lack economic substance or were entered into for a principal purpose of obtaining a tax benefit. The General Anti-Avoidance Rule in Part IVA may also be relevant.

Practical implications

Taxpayers operating cross-border arrangements involving intangibles are expected to evaluate their position against the risk ratings outlined in PCG 2024/1. Arrangements assessed as high or very high risk should be reviewed with a view to voluntary disclosure or restructuring, to mitigate potential compliance issues.

Robust documentation is essential. This documentation must clearly demonstrate the substance of the arrangement, the specific Development, Enhancement, Maintenance, Protection, and Exploitation (DEMPE) functions performed, and that pricing applied is at arm’s length.

Large multinationals classified as Significant Global Entities (SGEs) should be particularly aware of their obligations. Failure to lodge required transfer pricing documentation can result in penalties of up to $782,500. SGEs are also subject to the Country-by-Country reporting regime outlined in Subdivision 815-E of the ITAA 1997.