Introduction

The Australian Taxation Office (ATO) has recently released the final version of the Practical Compliance Guideline 2024/1 (PCG 2024/1), which details the ATO's approach to assessing the tax risks associated with the migration of intangible assets. This guidance document is relevant for companies who have entered into, or are contemplating entering into, arrangements that involve the transfer or licensing of intangible assets to offshore related parties.

The main objective of PCG 2024/1 is to provide companies with certainty and transparency on how the ATO will apply the transfer pricing rules and the general anti-avoidance rule (GAAR) to intangibles migration arrangements. The guidance document also aims to encourage companies to self-assess and disclose their tax risks, and to engage with the ATO early and cooperatively.

The purpose of this article is to summarise the key features and implications of PCG 2024/1, and to provide some observations and insights on how companies can manage their tax risks and optimise their tax outcomes in relation to their intangibles arrangements. 

Summary of the guidance document

PCG 2024/1 provides a risk assessment framework that the ATO uses to evaluate the tax risks associated with intangibles migration arrangements. This assessment follows similar guidance issued by the ATO, such as PCG 2019/1, with respect to inbound distributors. The framework consists of four risk zones: white, green, amber, and red. The risk zones reflect the likelihood and consequences of the ATO's compliance action on an arrangement.

These risk zones are determined by two main factors: the transfer pricing outcomes and the integrity of the arrangement. The transfer pricing outcomes are measured by the alignment of the profits allocated to the intangible assets and the economic substance of the activities performed by the parties involved in the arrangement. The integrity of the arrangement is assessed by the presence or absence of features that indicate tax avoidance or profit shifting motives, such as artificial or contrived structures, lack of commercial rationale, or inconsistency with the arm's length principleAiming for practical application, the guidance document provides a table that summarises the key indicators and expected outcomes for each risk zone. The table also indicates thelevel of evidence and documentation that the company needs to provide to support their arrangement, and the type and extent of the ATO's engagement and review.

The guidance document also provides some examples of how the risk assessment framework can be applied to different scenarios involving the migration of intangible assets, such as patents, trademarks, software, customer lists and goodwill. The forthcoming examplesillustrate how the ATO considers the various factors and indicators to determine the risk zone of an arrangement, and the potential consequences and outcomes of the ATO's compliance action.

Observations and insights

PCG 2024/1 has significant implications for companies who are involved in intangibles migration arrangements. Some initial observations and insights on how companies can manage their tax risks and optimise their tax outcomes in relation to their intangibles arrangements include:

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This PCG continues the ATO approach of guiding companies to its view of what an appropriate outcome should be in various circumstances, minimising the need for audits or other review activities. For many companies it may well be the right approach to follow the PCG however a PCG only represents the ATO's views, and it is still open to companies to take a different view based on their own circumstances, provided they have considered the law and have appropriately evidenced and documented their position.

Examples of low risk and high risk scenarios

To illustrate how the risk assessment framework works in practice, two examples, one of a low risk scenario and one of a high risk scenario, both based on the guidance document, are provided below. These examples are not exhaustive and are only intended to demonstrate the general principles and factors that the ATO considers when evaluating the tax risks of intangibles migration arrangements.

Low risk scenario: Transfer of a patent to a related party in Singapore 

In this scenario, an Australian company (AusCo) transfers a patent to its wholly-owned subsidiary in Singapore (SingCo) for $100 million. The patent relates to a new technology that AusCo developed and patented in Australia. SingCo is responsible for the manufacturing and distribution of the products that use the patent in the Asia-Pacific region. SingCo also performs significant research and development (R&D) activities in Singapore to improve and enhance the patent.

The ATO considers this arrangement to be low risk for the following reasons:

  • The transfer price of $100 million is supported by a comprehensive and independent valuation report that uses appropriate valuation methods and comparables.
  • The transfer price reflects the fair market value of the patent and the expected future income streams that it will generate.
  • The transfer of the patent is consistent with the business strategy and commercial objectives of AusCo and SingCo, and is not driven by tax considerations.
  • The transfer of the patent does not result in a significant reduction of the Australian tax base, as SingCo pays an arm's length royalty to AusCo for the use of the patent, and AusCo continues to receive income from its other intangible assets and activities in Australia.
  • The transfer of the patent does not involve any artificial or contrived structures or arrangements, such as the use of intermediaries, conduits, or low-function entities.
  • The transfer of the patent is aligned with the economic substance of the activities performed by AusCo and SingCo, as SingCo contributes to the creation and enhancement of the value of the patent through its manufacturing, distribution, and R&D functions.

The ATO assigns this arrangement to the white zone, which means that the ATO will not allocate any compliance resources to review or audit this arrangement, unless there is a material change in the facts and circumstances.

High risk scenario: Licensing of a trademark to a related party in Bermuda

In this scenario, an Australian company (AusCo) licenses a trademark to its wholly-owned subsidiary in Bermuda (BermCo) for $10 million per year. The trademark is a well-known and valuable brand name that AusCo created and registered in Australia. BermCo is a shell company that has no employees, assets, or operations in Bermuda, except for holding the license agreement. BermCo sublicenses the trademark to other related parties in various countries, including Australia, for a total of $200 million per year.

The ATO considers this arrangement to be high risk for the following reasons:

  • The license fee of $10 million per year is not supported by any valuation report or analysis, and is significantly lower than the arm's length price that an independent party would pay for the use of the trademark.
  • The license fee does not reflect the fair market value of the trademark or the expected future income streams that it will generate.
  • The licensing of the trademark is not consistent with the business strategy and commercial objectives of AusCo and BermCo, and is mainly driven by tax considerations.
  • The licensing of the trademark results in a significant erosion of the Australian tax base, as BermCo pays no tax in Bermuda on the income that it receives from the sublicensing of the trademark, and AusCo pays minimal tax in Australia on the license fee that it receives from BermCo.
  • The licensing of the trademark involves an artificial and contrived structure or arrangement, as BermCo is a low-function entity that has no economic substance or commercial rationale in Bermuda, and acts as a conduit or intermediary to divert the income from the trademark to a low-tax jurisdiction.
  • The licensing of the trademark is not aligned with the economic substance of the activities performed by AusCo and BermCo, as AusCo is the sole creator and owner of the value of the trademark, and BermCo does not perform any functions, use any assets, or assume any risks in relation to the trademark.

The ATO assigns this arrangement to the red zone, which means that the ATO will allocate significant compliance resources to review or audit this arrangement, and will apply the transfer pricing rules and the GAAR to adjust the tax outcomes and impose penalties and interest.

Conclusion

PCG 2024/1 is a significant and comprehensive guidance document that reflects the ATO's increased focus and scrutiny on intangibles transactions. The guidance document provides companies with a clear and transparent framework to assess and document their tax positions, to identify risks and to engage with the ATO proactively and cooperatively. The guidance document also emphasises the importance of aligning the profits allocated to the intangibles assets with the economic substance of the activities performed by the parties involved in the arrangement, and of having a sound and genuine commercial rationale for the arrangement.

Companies who are involved in intangibles migration arrangements need to be aware of the implications and impacts of PCG 2024/1 for their current or planned intangibles transactions. Companies need to ensure that they have robust and consistent transfer pricing policies and documentation to support their intangibles arrangements, and that they comply with the relevant tax laws and international standards. Companies also need to manage their tax risks and optimise their tax outcomes in relation to their intangibles arrangements, having regard for the framework and its indicators, and by carefully considering any features that may indicate tax avoidance or profit shifting motives.

We note that it is open for companies to form their own view on the technical aspects and commercial merits of their IP migration arrangements, notwithstanding the PCG. However, in doing so, we strongly recommend that these views and positions are evidenced and documented appropriately.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.