Introduction

1.1 The Australian Taxation Office (ATO) is the principal revenue agency responsible for administering the tax system and aspects of the superannuation system. As part of its duties, the ATO conducts compliance activities to ensure taxpayers are complying with tax requirements. The ATO’s stated purpose is to contribute to the economic and social wellbeing of Australians by fostering willing participation in the tax, superannuation, and registry systems.

1.2 The ATO’s Corporate Plan 2023–24⁹ identifies multinational tax performance as a key focus area, with a number of deliverables, including:

• address key risks to the corporate tax base and close tax loopholes so that the community has confidence that public and multinational businesses are paying the right amount of tax in Australia; and
• support the integrity of the tax system by boosting tax transparency through better public reporting of large business tax information.¹⁰

Transfer pricing

1.3 Multinational groups operate on an international basis, dispersing business units across the globe for a variety of reasons. Transactions between two entities in the same group are called related party transactions. The pricing of these transactions is referred to as transfer pricing. The transactions must be priced as if the entities were independent parties operating wholly independently (at ‘arm’s length’) from one another. The arm’s length principle is outlined in Australian legislation in subdivisions 815-B and 815-C of the Income Tax Assessment Act 1997 (ITAA 1997). The arm’s length principle requires the terms of transactions between related parties to be comparable to transactions between independent and separate entities.

Related party debt

1.4 Interest expense on corporate debt is generally determined to be tax deductible in Australia under section 8-1 of the ITAA 1997. This creates the risk that loans may be made under conditions which are inconsistent with what would be expected when obtaining financing from an independent third party. These conditions may include artificially high interest rates or a lack of security and guarantees which would ordinarily reduce interest payable. Entities involved in mispricing may underpay their Australian tax liability by using related party arrangements. To combat this, the ATO monitors taxpayers’ use of transfer pricing for related party debt to ensure those transactions satisfy Australia’s transfer pricing laws, which are applied to best achieve consistency with the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines 2017. The ATO has identified transfer pricing risk as a key focus for tax avoidance.¹¹ Box 1 describes hypothetical instances of transfer pricing.

Figure 1.1: Hypothetical transfer pricing

Note: Overall group tax benefit is the difference between the total tax paid in non-arm’s length and arm’s length scenarios.

Source: ANAO analysis.

1.6 The ATO’s Client Engagement Group (CEG) focuses on engagement to make it easy for taxpayers (including their representatives) to meet their obligations. CEG tailors engagement activities (such as reviews and audits) according to behaviour and risk level. The current CEG Group Plan has identified maintaining high levels of compliance across the tax systems and the avoidance of deterioration of tax performance as a critical outcome for the ATO. Within CEG, the Public Groups¹² division ensures taxpayers which are members of public groups pay the right amount of tax to meet their Australian obligations. Public Groups division provides oversight of the strategy for transfer pricing, and is responsible for the administration of a range of tax frameworks, including transfer pricing for related party debt.

Previous audits and review

1.7 Auditor-General Report No. 5 of 2014–15 Annual Compliance Arrangements with Large Corporate Taxpayers found that Annual Compliance Agreements¹³, which were viewed positively by participants, had a low take-up rate, with taxpayers preferring Pre-lodgment Compliance Reviews (PCRs). (For more information relating to PCRs see from paragraph 3.79)

1.8 Auditor-General Report No. 18 of 2019–20 Tax Avoidance Taskforce — Meeting Budget Commitments found that there had been a significant increase in compliance revenue over the life of the Tax Avoidance Taskforce, and that it was not clear the extent to which this was as a result of the Budget funding provided. Tax Avoidance Taskforce funding contributes to the ATO’s work managing transfer pricing for related party debt.

Rationale for undertaking the audit

1.9 The latest publicly reported figures indicate that in 2020–21 inbound international related party borrowings in Australia totalled $520 billion, with $13.2 billion in interest expenses paid.¹⁴ The ATO monitors entities belonging to the Top 100 and Top 1,000 populations.¹⁵ Approximately 33 per cent of these inbound related party borrowings were attributed to the Top 100 entities and an additional 40 per cent were reported by the Top 1,000 entities.

1.10 The ATO has identified inbound related party borrowings as a key risk. In the ATO’s 2022 assurance activities for the Top 100 entities, related party financing represented the highest proportion of unassured items receiving a red flag rating¹⁶ to indicate likely non-compliance with income tax laws.¹⁷ Similarly, amongst the Top 1,000 entities, financing assurance activities resulted in a higher amount of low assurance and red flag ratings (27 per cent) than other areas reviewed.¹⁸ Interest bearing loans were the largest category of financing risks reviewed.¹⁹

1.11 This audit will provide assurance to the Parliament that the ATO effectively manages transfer pricing for related party debt, using sound strategies and processes to address risks and to ensure related party debt is appropriately priced. This audit was identified as a priority by the Parliament’s Joint Committee of Public Accounts and Audit in the context of the ANAO’s 2022–23 and 2023–24 Annual Audit Work Program.

Audit approach

Audit objective, criteria and scope

1.12 The objective of the audit was to assess the effectiveness of the ATO’s management of transfer pricing for related party debt.

1.13 The audit focused on the ATO’s management of transfer pricing for related party debt for the Top 100 and Top 1,000 populations from 2019–20 to 2022–23.

1.14 To form a conclusion against the objective, the following criteria were adopted.

• Are the risks relating to transfer pricing for related party debt appropriately managed?
• Does the ATO have a sound strategic framework to manage the use of transfer pricing for related party debt?
• Does the ATO effectively manage transfer pricing for related party debt?

Audit methodology

1.15 The audit methodology included:

• review of ATO documentation such as strategies, plans, risk documents, meeting papers and minutes, reporting and internal briefings;
• meetings with ATO officers; and
• detailed technical walkthroughs of processes and procedures with ATO officers.

1.16 The audit was conducted in accordance with ANAO Auditing Standards at a cost to the ANAO of approximately $592,982.

1.17 The team members for this audit were Shane Armstrong, Ally Cerritelli, Michael Dean, Renae Lowden, Anthony Ditton, Alison Millea, and David Tellis.

2.1 The ATO’s Corporate Plan 2023–24²⁰ identifies multinational tax performance as a key focus area, with a number of deliverables, including:

• address key risks to the corporate tax base and close tax loopholes so that the community has confidence that public and multinational businesses are paying the right amount of tax in Australia; and
• support the integrity of the tax system by boosting tax transparency through better public reporting of large business tax information.²¹

2.2 The Commonwealth Risk Management Policy notes that risk management is ‘fundamental to good governance’²², and that good risk management ‘supports the better delivery of government services through more effective decision-making, greater preparedness for unexpected events and supports innovation.’²³

2.3 This requires the ATO to manage risks relating to transfer pricing for related party debt.

Does the ATO have sound processes for identifying and prioritising risks to transfer pricing for related party debt?

The ATO’s risk management process

2.4 The documents that govern risk management at the ATO are the Enterprise Risk Management Framework (ERMF), the Risk Management Guide, and Risk Management Chief Executive Instructions.

2.5 The ATO’s Risk Management Guide states that the ‘[ERMF] and risk management processes apply to all levels of risk across the ATO.’ The ATO’s risk management process was developed to meet the ATO’s obligations under the Commonwealth Risk Management Policy, and is based on ISO 31000:2018²⁴, outlining the cyclical nature of the process. This is depicted at Figure 2.1.

Figure 2.1: The ATO’s risk management process

Source: ANAO analysis of ATO documentation.

2.6 The ERMF states that the risk methodology is ‘the practical tool that should be used in all planning activities to ensure a positive and proactive approach to risk management is applied.’ Guidance on risk management is made available to staff through internal risk management training courses, and risk management templates are provided on the ATO intranet. The ATO also uses a Chief Executive Instruction (CEI) on risk management, which outlines staff responsibilities for risk management.²⁵

Risks relating to transfer pricing for related party debt

2.7 Transfer pricing for related party debt is considered at both the enterprise and business levels.

Enterprise level risks related to transfer pricing for related party debt

2.8 Enterprise level scrutiny of transfer pricing for related party debt risk has taken two different forms through the period of the audit. Until May 2021, the relevant enterprise level risk was ‘PMB²⁶ — International Risk’, and its short description was ‘Multinational entities use international related party or cross border arrangements to reduce Australian tax payable.’ This risk was endorsed in January 2018, and was closed in February 2022. The ATO advised the ANAO in November 2023 that it rationalised its enterprise level risks in May 2021.

2.9 As a result, the current enterprise level risk is ‘Tax and superannuation performance in accordance with the law’, and is described as:

There is a risk that performance of the tax and superannuation systems move out of tolerance due to our inability to identify and address in a timely manner lodgment and correct reporting issues resulting in reduced community confidence and willing participation and further reduced revenue performance.²⁷

2.10 The ATO describes the management strategy as:

…focused on sustained improvement in tax and superannuation compliance and, in turn, long-term system health. Strategies can be designed to improve correct participation in the system and to address non-compliance thereby improving both gross and net system performance.²⁸

2.11 The ATO’s handling of the risk of transfer pricing at the business level is consistent with this approach, and the ATO maintains a risk assessment and treatment plan for this enterprise level risk.

Business level risks related to transfer pricing for related party debt

2.12 The relevant business level risk is ‘Arm’s Length Conditions’. This business risk is managed by the Arm’s Length Conditions – Related Party Finance Risk Cluster (finance risk cluster) (see from paragraph 2.17). The Arm’s Length Conditions Risk and Issue Treatment Plan (the plan) notes that:

The risk of artificially inflating financing costs exists due to the absence of terms normally seen in a loan negotiated at arm’s length, such as security or guarantees. Alternatively, conditions are present which would not ordinarily exist in arm’s length transactions (e.g. the loan is denominated in a foreign currency, or the loan is deeply subordinated²⁹). The existence of the former, or absence of the latter, would ordinarily reduce the interest payable under the loan.

2.13 The plan notes that ‘the risk is already in existence’, and that the use of related party financing is ‘a common technique used to reduce or eliminate Australian company tax on Australian profits.’ This risk was created in July 2016, and the plan examines how the risk has evolved over time. Table 2.1 illustrates the population and revenue consequence of the risk. The approach to treating this risk is discussed in Chapter 3.

Table 2.1: Population and revenue consequence based on 2020 data

Source: ANAO analysis of ATO documentation.

2.14 The ATO advised the ANAO in November 2023 that it did not ‘track how many [Full Time Equivalent (FTE)] or how much funding’ was attributed to managing the risk, and that the only team fully dedicated to working on the risk was the finance risk cluster, which was five FTE. The ATO further advised the ANAO in November 2023 that the Top 100 Network was 24 FTE and the approximate FTE for case teams from Engagement and Assurance was 160 (see paragraph 3.82). For the Top 1,000 team FTE was 114, and Economist Practice³¹ (see paragraph 3.53) consisted of 100 FTE, with the ATO stating:

Related party financing is one of the focus areas of these programs, however, as they consider all tax risks, the true “cost” is some portion of this. In addition, there are resources that might work on transfer pricing for related party debt in [Economist Practice, Review and Dispute Resolution, Tax Counsel Network], and all of [Engagement and Assurance].’

2.15 The ATO’s Risk Management Guide notes that endorsement of risks by risk owners can be maintained within the business area. Evidence of risk endorsement is indicated through the approval of risk assessment documents. Analysis of risk treatment plans between 2016–17 and 2022–23 indicates that the risk was considered, and largely appropriately endorsed³² by the SMC (see paragraph 2.62).

2.16 The Risk Management Guide states that ‘Enterprise risks should be reviewed every twelve months as a minimum’. It is silent on a review timeframe for business level risks. Analysis of risk treatment plans between 2016 and 2023 indicates that the risk has been reviewed and updated annually.

Risk management

2.17 The focus on potential risks is examined by the ATO at the individual taxpayer level. The ATO manages business level risks through the use of ‘risk clusters’, which are used ‘to treat and manage risks that exhibit common factors, characteristics or behaviours within a population in a consistent manner.’ Table 2.2 outlines the broad functions of the finance risk cluster and provides examples of work done in each of these areas.

Table 2.2: Finance risk cluster functions and examples of activity

Note a: Australian Taxation Office, Practical Compliance Guideline 2017/4, ATO, 2020, available from https://www.ato.gov.au/law/view/document?docid=COG/PCG20174/NAT/ATO/00001 [accessed 19 October 2023].

Source: ANAO analysis of ATO documentation.

2.18 The ATO advised the ANAO in August 2023 that the transfer pricing risk was identified before the finance risk cluster was established. The ATO advised the ANAO in August 2023, that prior to the introduction of the Top 100 Justified Trust Program (see from paragraph 2.41) (and the Top 1,000 Combined Assurance Program, see from paragraph 2.46) there was a risk identification process involving analysis of tax return data, and that the approach could not be targeted.

2.19 The finance risk cluster was established ‘at a similar time’ to the Top 100 Justified Trust Program, to address the risk and test the extent to which it may manifest in the taxpayers using related party financing. The Top 100 Justified Trust Program was then used to obtain assurance as part of managing the risk. If assurance was not obtained, then further compliance activity may be undertaken.

2.20 The Top 100 Justified Trust Program and the Top 1,000 Combined Assurance Program, ‘at a case level, [form] a significant part of the treatment strategy’, and ‘for both the Top 100 and Top 1,000 populations, transfer pricing of related party debt is a significant part of the assurance program.’ The ATO advised the ANAO in August 2023 that individual taxpayer risks were identified and tested via justified trust and this then provided the ‘springboard’ for compliance activities.

2.21 The ATO advised the ANAO in August 2023 that justified trust enabled it to take the next step from risk identification, and that without justified trust, the ATO would not be able to target its work, meaning matters would be escalated to audits or reviews as required and without a clear structure in place. In November 2023 the ATO advised the ANAO that justified trust ‘builds and maintains community confidence that taxpayers are paying the right amount of tax’, and that it enabled the ATO to focus the use of its resources into ‘the right areas.’

2.22 The treatment strategy contains three phases. Phase one, which has been finalised, focused on developing a compliance strategy, internal and external communications, development of a strategy on advisors, developing risk filters³³ and metrics, and internal engagement to ‘attempt to address associated legislative issues.’ Phases two and three are combined in the treatment plan³⁴, with the ATO advising the ANAO in September 2023 that the rollout of these phases is ‘ongoing with a particular focus being continuous improvement’.

2.23 The plan includes a delivery plan that outlines key milestones and months in which work on identified key milestones was scheduled to occur. Aside from providing technical support to internal clients, all delivery plan items are reported on in quarterly SMC reports. The plan contains five key performance indicators (KPIs) that seek to identify ‘indicators of success/key metric[s] for determining effectiveness.’ These, and reporting against these KPIs, are contained in Table 2.3.

Table 2.3: Finance risk cluster KPIs and internal reporting

Note a: International, Support, and Programs division.

Source: ANAO analysis of ATO documentation.

Using monitoring processes to inform risk prioritisation

2.24 The plan notes that the ATO uses information in the RTP and other tax return schedules to ‘recommend appropriate active compliance activities on the higher risk arrangements that require assurance’, and that the growth of self-assessments via PCG 2017/4 (see from paragraph 3.40), provides a greater opportunity for the ATO to monitor trends and detect risks.

2.25 RTP Schedule disclosures (see from paragraph 4.7) collect information on taxpayers’ use of related party debt. Prior to 2021, taxpayers were only required to report the risk zone for their highest self-assessed risk zone arrangement. Since 2021, taxpayers are required to report the three most material arrangements. If the highest risk zone arrangement was not one of the three most material, this is also required to be reported. The ATO advised the ANAO in August 2023: ‘The RTP self-assessments disclosed by the taxpayers may only represent a portion of their related party financing transactions.’ For more information on RTP Schedule disclosures, see Figure 3.3 and Figure 3.4.

2.26 The ATO advised the ANAO in November 2023:

[T]he total number of related party transactions and the respective amount for each such transaction across all taxpayers that might use related party debt is not presently collected by the ATO.

2.27 Further data was acquired through taxpayer disclosures in the IDS.³⁵ Transaction-level information was only required to be provided by taxpayers completing local file³⁶ requirements. Table 2.4 outlines taxpayers who may be required to provide local file reporting and those that have provided it.

Table 2.4: Country-by-Country local file reporting 2019–20 to 2022–23

Note a: 2022–23 data is incomplete as tax returns are lodged throughout the year.

Source: ATO documentation.

2.28 The ATO advised the ANAO in November 2023 that the difference in the number required to lodge and the total count of lodgers was due to a series of possible exemptions. The ATO was unable to provide a further breakdown of the reasons those who may be required to lodge had not lodged: ‘In relation to non-lodgment of the full local file, we do not have a definitive count of [taxpayers] with a reporting obligation that have not complied with lodgment requirements.’³⁷

2.31 The ATO advised the ANAO in August 2023 that transaction-level data on related party financing received through the IDS was unstructured, imperfect, and incomplete. As a result, the ATO focused on assessing the three biggest and highest risk transactions outlined in RTP Schedule disclosures.³⁸ The ATO was unable to verify that the transactions reported by taxpayers were the biggest and highest risk transactions. The ATO used the justified trust methodology to understand how individual taxpayers approached the use of related party debt (see from paragraph 2.35).

Updating strategies to account for new and emerging risks

2.32 The Arm’s Length Conditions Risk and Issue Treatment Plan is updated annually by the finance risk cluster taking into account how the risk has continued to evolve, and how the treatment approach should change.

Are risks to transfer pricing for related party debt managed in accordance with ATO requirements?

Justified trust

2.33 To manage the risk to transfer pricing for related party debt, the ATO uses the broader justified trust concept to engage the members of its Top 100 (see from paragraph 2.41) and Top 1,000 (see from paragraph 2.46) populations³⁹ (see from paragraph 3.73 for details how the Top 100 and Top 1,000 populations are established). The ATO defines the concept of justified trust as:

A reasonable conclusion based on sufficient evidence that the taxpayer is complying with its tax obligations and paying the right amount of tax in relation to its business and economic activities connected or linked to Australia.

2.34 Further, justified trust is:

How we build and maintain community confidence taxpayers are paying the right amount of tax. Justified trust is a concept from the Organisation for Economic Cooperation and Development (OECD).⁴⁰

Justified Trust builds and maintains community confidence that taxpayers are paying the right amount of tax. It also allows us to focus our resources in the right areas.⁴¹

2.35 To achieve justified trust for both the Top 100 and Top 1,000 populations, the ATO focuses on four areas:

• understanding a taxpayer’s tax governance framework;
• identifying tax risks flagged to market;
• understanding significant and new transactions; and
• understanding why the accounting and tax results vary.⁴²

2.36 The ATO’s website describes the intended outcomes from its approach to justified trust:

Justified trust gives the community confidence that large businesses are paying the right amount of tax. This fosters broader willing participation and engagement across the tax and superannuation system.

Our approach helps us focus how we minimise the income tax and Goods and Services Tax (GST) tax gaps through:

• our engagement strategy (for example, identifying and resolving areas of concern at the earliest possible time)
• active compliance (for example, audit cases)
• active prevention across the market (for example, through Taxpayer Alerts, Practical Compliance Guidelines, or Public Rulings).⁴³

2.37 The importance of the justified trust approach to managing risk is noted in the Public Groups SMC charter. It states that the SMC’s objective is to manage ‘risks to the tax system relevant to Public and Multinational Businesses, providing justified trust that the right amount of tax is being paid.’⁴⁴

2.38 The threshold for assurance has been articulated in the Justified Trust Methodology Guide:

Assurance has been achieved where the team confirms that the taxpayer’s tax treatment aligns with the income tax law and the ATO’s view as to its application.

Assurance can be obtained where sufficient analysis has been conducted and/or supporting documentation obtained to confirm that the taxpayer’s tax treatment accords with the income tax law.

Alternatively, assurance can be obtained through escalation (e.g. audit, objection, litigation) where the ATO and the taxpayer have a material difference of opinion in relation to the tax treatment. Once the ultimate outcome of an escalation procedure has been determined and applied (whether favourable or unfavourable to the taxpayer), assurance will have been obtained.

2.39 Three overall assurance ratings can be applied to Top 100 and Top 1,000 taxpayers: high, medium and low (see paragraph 3.80). Obtaining justified trust requires a taxpayer to meet two metrics:

1. a minimum of 90 per cent of its tax activity and economic activity must be correctly reported; and
2. meeting all seven qualifying factors for the income tax period covered by the Tax Assurance Report.⁴⁵

2.40 For both the Top 100 and Top 1,000 populations, of the seven qualifying factors, there is one directly related to transfer pricing for related party debt: ‘International related party dealings and CFCs.’⁴⁶ As part of this qualifying factor, the ATO must have a medium level of assurance⁴⁷ that ‘material or significant’ international related party dealings satisfy the arm’s length principle pursuant to subdivision 815-B of the Income Tax Assessment Act 1997 (ITAA 1997). This includes that no further action is necessary. Top 100 taxpayers achieving justified trust are then subject to a ‘Monitoring and Maintenance’ approach. (See from paragraph 3.83).

Top 100

2.41 Figure 2.2 depicts how the ATO assesses Top 100 taxpayers as part of the Top 100 Justified Trust Program.

Figure 2.2: Top 100 justified trust process

Source: ANAO analysis of ATO documentation.

2.42 The Justified Trust Methodology Guide for the Top 100 population states:

In the Australian context, the concept relates to the level of assurance we have that a taxpayer has paid the right amount of tax on its business and economic activities connected or linked to Australia. Justified trust does not represent absolute certainty that the taxpayer is complying with all their tax obligations and the amount of tax paid is completely accurate, as this level of certainty is not attainable. It reflects a level of confidence that the taxpayer is complying with its Australian tax obligations.

2.43 To obtain justified trust, the ATO conducts a PCR (see paragraph 3.81), which leads to the development of a TAR (see from paragraph 3.82).

2.44 Table 2.5 provides more insight into the total number of Top 100 taxpayers assessed via TARs and also those taxpayers who have achieved justified trust and are now subject to a ‘Monitoring and Maintenance’ approach.

2.45 Even though the ATO aims to complete a TAR for each Top 100 taxpayer annually⁴⁸, it is not possible for this to be achieved, as some taxpayers have obtained justified trust and have moved into Monitoring and Maintenance. Taking into account TARs issued, and taxpayers subject to Monitoring and Maintenance, the ATO has annually scrutinised, on average, 66.25 per cent of Top 100 taxpayers over the last four years, and has therefore not achieved the level of assurance that it has sought. It should be noted that TARs may take more than a year to complete, and the ATO maintains a case coverage plan for the Top 100 population, planning and tracking taxpayer engagement. Further, TARs also examine multiple income years if a TAR was not issued in the year previously.

Top 1,000

2.46 Figure 2.3 depicts how the ATO assesses Top 1,000 taxpayers through CARs.

Figure 2.3: Top 1,000 CAR process

Source: ANAO analysis of ATO documentation.

2.47 Since 2021⁴⁹, the ATO has used CARs to ‘obtain assurance that large public and multinational groups are reporting the right amount of both income tax and GST. CARs also identify and address [income tax] and GST tax risk.’ CAR findings are recorded in Combined Assurance Reports. Transfer pricing for related party debt is a comparatively small part of the CAR process. The ATO identified the Tax Avoidance Taskforce⁵⁰ as a driver for the adoption of justified trust for the Top 1,000 population.

2.48 A CAR seeks to deliver a tailored experience for taxpayers that is influenced by their previous assurance ratings, leading to a trend of faster and more efficient reviews ‘and, in some cases, improved assurance ratings.’ The ATO aims to complete 250 CARs per year. Table 2.6 provides the number of CARs from 2019–20 to 2022–23.

Table 2.6: Combined Assurance Reports issued, 2019–20 to 2022–23

Note a: 2019–20 relates to Streamlined Assurance Reviews (SARs) which were conducted prior to 2020–21.

Note b: There was no annual target for SARs.

Note c: First time reviews and changes to assurance ratings for 2020–21 are calculated from previously issued SARs.

Source: ANAO analysis of ATO documentation.

2.49 Even though the ATO aims to complete 250 CARs every year⁵¹, it has achieved, on average, 61.3 per cent of this target since CARs were developed. The ATO advised the ANAO in January 2024 that no formal process had been undertaken to determine whether 250 CARs provided sufficient assurance prior to the commencement of the program. The ATO advised the ANAO in March 2024 that between 2020–21 and 2022–23, 62 per cent of Top 1,000 taxpayers with High or Medium disclosures received a CAR and a further 10 per cent did not meet the CAR selection criteria based on Total Business Income (TBI) alone. The ATO further advised the ANAO in March 2024 that CARs covered 76 per cent of medium and high risk TBI.

2.50 While the ATO analyses RTP Schedule disclosures (see paragraph 3.41), it then uses this analysis to identify high and medium risk. Top 1,000 taxpayers not subject to CARs may require further scrutiny via a ‘gap analysis program’ (approved by the SMC (see paragraph 2.62) in September 2023) to allow the ATO to gain further assurance over taxpayer use of related party debt (the ‘T1,000 gap population’). This is done by identifying high risk financing arrangements based on the loan quantum and implied interest rate. Prior to this, there was no further methodical analysis of taxpayers, though the ATO advised the ANAO in January 2024 that issues may have been identified in the course of other work.

2.51 The ATO advised the ANAO in February 2024 that the data used by the team responsible for this gap analysis to assess Top 1,000 taxpayers with related party debt is disclosed via the RTP Schedule, the IDS, and [Country-by-Country] local file reporting ‘where available’.

2.52 The ATO was unable to provide how many Top 1,000 taxpayers had been assessed since the introduction of the gap analysis process, with the ATO advising the ANAO in February 2024 that the ‘gap analysis process is currently in its initial phase’.

2.53 The ATO does not have guidance and training material for staff to analyse transactions, as the material is ‘currently under development.’

Amending the justified trust methodology to respond to changes in risks

2.56 The ATO advised the ANAO in December 2023 that no emerging risks had been identified that led to changes to how transfer pricing was assessed by the Top 100 Justified Trust Program, and there had been no formal process applied to review the Justified Trust methodology. The methodology was amended to incorporate GST and income tax in 2019, and changes to the Monitoring and Maintenance approach (see from paragraph 3.83) were made in 2020 and 2022. The ATO advised the ANAO in November 2023 that it ‘typically [sought] feedback where significant modifications are made to the program’ and evidence of consultation processes was provided, but there had been no changes to the Top 1,000 methodology since 2016.

Reporting on risk

2.58 The ATO publicly reports the aggregate findings from its Top 100⁵² and Top 1,000⁵³ programs on an annual basis. These findings reports include reporting on transfer mispricing for both the Top 100 and Top 1,000 populations. The ATO also advises taxpayers of risks for large corporate groups.⁵⁴

Is oversight of the management of risks to transfer pricing for related party debt fit for purpose?

Risk oversight bodies

2.59 Figure 2.4 illustrates the ATO’s governance structure around risk. Oversight of risks occurs at the enterprise and business levels. As the related party debt risk is primarily addressed at the business level, oversight is also focused on the business level.

Figure 2.4: Risk governance structure

Source: ANAO analysis of ATO documentation.

Enterprise level

2.60 Oversight of enterprise level risks is undertaken by the ATO’s Enterprise Risk Management Committee. Its objective is: ‘To positively influence the ATO’s ability to manage priority areas of risk associated with achieving its strategic objectives.’ The Committee seeks to ensure priority risks are being managed consistent with the ERMF, to consider advice provided in relation to effectiveness of the ATO’s risk management regime, and to consider emerging risks in the context of the ATO’s strategic objectives.

2.61 The Enterprise Risk Management Committee’s charter states that the committee will escalate significant risks to the ATO Executive Committee, and provide regular advice to the Audit and Risk Committee via the Chief Risk Officer. The ATO advised the ANAO in September 2023 that the relevant risk ‘has not been rated out of tolerance and so it has not been escalated to the [Client Engagement Group] Executive or the ATO Risk Committee as part of the escalation procedures.’

Business level

2.62 Oversight of the business level risks to transfer pricing for related party debt is the responsibility of the Public Groups SMC. Its objective is to ‘[manage] risks to the tax system relevant to Public and Multinational Businesses, providing justified trust that the right amount of tax is being paid.’ The committee seeks to satisfy itself that a sound approach has been followed to manage risks, that emerging risks are actively identified and managed, that risk management is consistent with the enterprise risk framework, and to set the direction for Public Groups’ strategic approach. The SMC receives reporting on transfer pricing for related party debt on a quarterly basis (see from paragraph 2.23). This reporting does not include information on the number of PCRs or CARs completed against the ATO’s target of annual review of the entire Top 100 population and annual review of 250 Top 1,000 taxpayers.

2.63 The SMC’s charter states that the committee will ‘Provide regular reports to the [Public Groups] Executive, tracking the treatment of the priority risks’, and ‘provide risk investment recommendations to the [Public Groups] Executive to ensure resources are allocated in accordance with risk priorities and treatment strategies.’ The ATO advised the ANAO in November 2023 that as the risk remained within tolerance, there had been no escalation of matters to the Public Groups Executive. The terms of the charter require the committee to ‘provide regular reports’, rather than to report on an as-needs basis. The SMC charter was revised and endorsed by the SMC in October 2023. The requirement to provide regular reporting to the Public Groups Executive was removed from this version of the SMC charter.

3.1 The ATO’s Corporate Plan 2023–24 identifies multinational tax performance as a key focus area, with the following key deliverables:

• address key risks to the corporate tax base and close tax loopholes so that the community has confidence that public and multinational businesses are paying the right amount of tax in Australia;
• support the integrity of the tax system by boosting tax transparency through better public reporting of large business tax information;
• positively influence the behaviours of advisors in the provision of tax advice and their interactions with the ATO; and
• support large business through the timely provision of tailored advice and guidance, and other contemporary services.⁵⁵

3.2 This requires the ATO to develop a strategic framework that has been properly implemented, and is appropriately oversighted, to ensure transfer pricing for related party debt is managed effectively.

Are the principles outlined in OECD guidance reflected in the ATO’s transfer pricing guidelines?

The OECD Transfer Pricing Guidelines

3.3 The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines)⁵⁶ promote a consistent approach to transfer pricing matters for tax administrations and taxpayers across jurisdictions.⁵⁷ OECD member countries periodically provide input to review and revise the Guidelines in response to emerging issues. The ATO advised the ANAO in July 2023 that it is ‘actively involved in OECD work programs’. The OECD Guidelines aim to ensure countries secure an appropriate tax base and avoid double taxation, encouraging international trade and minimising conflict.⁵⁸

3.4 The 2017 edition of the OECD Guidelines is provided as a guidance document in the Income Tax Assessment Act 1997 (ITAA 1997) subdivision 815-B, paragraph 815-135(2)(a). Subsection 815-315(1) of the ITAA 1997 states:

For the purpose of determining the effect this Subdivision has in relation to an entity, identify arm’s length conditions so as best to achieve consistency with the documents covered by this section.

3.5 The OECD Guidelines centre around the arm’s length principle.⁵⁹ This provides that where the conditions of a transaction between related parties are not what would be expected from independent parties, then:

any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.

3.6 Under the OECD Guidelines, the appropriate transfer price is to be determined through comparability analysis. This analysis compares the conditions of a controlled transaction⁶⁰ to the conditions that would be expected in a comparable uncontrolled transaction between independent parties. Figure 3.1 depicts the steps undertaken in comparability analysis to determine the appropriate arm’s length conditions of a transaction.

Figure 3.1: Comparability analysis

Source: ANAO analysis of OECD documentation.

3.7 The initial preliminary analysis requires identifying the commercial or financial relationship between parties to understand the underlying transaction. The OECD Guidelines provide five comparability factors to inform this analysis.⁶¹ This preliminary analysis informs the selection of a transfer pricing method using criteria outlined by the OECD Guidelines. The five comparability factors are also considered when selecting comparable transactions.⁶² Applying the selected transfer pricing method to comparables determines if the transaction is consistent with the arm’s length conditions. When a transaction is inconsistent with the arm’s length conditions, the taxpayer’s profits may be adjusted for tax purposes to correct distortions.

3.8 In addition to the comparability analysis process, the OECD Guidelines cover administrative approaches to avoiding and resolving transfer pricing disputes and transfer pricing documentation.

3.9 In January 2022, the OECD published a new version of the Guidelines, incorporating an additional chapter on Transfer Pricing Aspects of Financial Transactions (Chapter X of the OECD Guidelines).⁶³ This additional guidance has not yet been introduced into Australian law (see from paragraph 3.21). The ITAA 1997 continues to reference the 2017 edition of the OECD Guidelines.

Consistency of ATO guidance with OECD principles

3.10 Justified trust (see paragraph 2.33) applies a tailored engagement policy where the assurance activities undertaken for a taxpayer will differ based on taxpayers’ individual circumstances. The OECD Guidelines state that effective risk identification and assessment are essential in the early stages of transfer pricing enquiries to identify which arrangements warrant an in-depth review and the commitment of resources.

3.11 Subdivision 815-B of the ITAA 1997 establishes the arm’s length principle for cross-border conditions between entities. The definition of arm’s length conditions, comparability factors, considerations for selecting a transfer pricing method and comparable circumstances contained in the legislation are consistent with OECD statements on these concepts. Table 3.1 summarises the consistency of ATO guidance for staff and taxpayers against the principles of the OECD Guidelines.

Table 3.1: Assessment of the consistency of ATO guidance with OECD principles

Key: ◆ Consistent ▲ Partially consistent ■ Inconsistent

Note: There was a minor departure from the OECD’s guidelines in PCG 2017/4, however, it was immaterial to the overall finding.

Source: ANAO analysis of ATO and OECD documentation.

Comparability analysis internal ATO guidance

3.12 Case teams engage Economist Practice to conduct comparability analysis and determine the appropriate arm’s length conditions (see from paragraph 3.53 for more information on Economist Practice). Top 1,000 case teams complete a Standard or Streamlined Toolkit to provide Economist Practice with information to determine the intensity of review required and to conduct analysis.⁶⁴

3.13 The information requested in these Toolkits identifies the relationship between parties and the economically relevant characteristics of the transaction in line with the comparability analysis process in the OECD Guidelines. The Standard Toolkit provides a template for the ATO to complete its own analysis of the taxpayer’s transfer pricing method selection. There is no equivalent documentation completed by Top 100 teams as these cases are ‘a more bespoke product’. The ATO applies a ‘more streamlined approach’ to the Top 1,000 population.

3.14 The ATO’s Guide to Analysing Related Party Debt assists case officers in their examination of related party finance arrangements and identification of arm’s length conditions. This Guide directs staff to three areas of focus — understanding the group’s global and local business funding profiles, understanding the commercial and financial relations between parties and understanding the taxpayer’s approach to determining arm’s length conditions. The first two areas of focus assist with the accurate delineation of the controlled transaction as suggested by the OECD Guidelines. The third area of focus, ‘understanding the taxpayer’s approach to determining arm’s length conditions’, considers evidence provided by the taxpayer supporting their approach to applying transfer pricing methods and determining the arm’s length conditions (see paragraph 3.53).

Comparability analysis public guidance

3.15 The ATO website provides a general explanation of the arm’s length principle and comparability analysis for taxpayers. It states the arm’s length principle:

involves comparing what a business has done and what an independent party would have done in the same or similar circumstances. This principle is supported by all Organisation for Economic Co-operation and Development (OECD) countries.⁶⁵

3.16 The ATO website also reflects the OECD Guidelines in its definition of comparable transactions. The ATO’s public guidance regarding transfer pricing methods⁶⁶ identifies that where comparable transactions are available, the CUP method⁶⁷ ‘is the most direct and reliable way to apply the arm’s length principle’ in line with the OECD Guidelines.⁶⁸

Dispute resolution

3.17 The mutual agreement procedures (MAPs)⁶⁹ Minimum Standards are outlined in the OECD Making Dispute Resolution Mechanisms More Effective Report⁷⁰ (the Minimum Standards) and covered in Chapter IV of the OECD Guidelines. The ATO advised the ANAO in July 2023 that five MAPs have been undertaken in relation to the Top 100 and Top 1,000 populations for related party debt in the years between 2017–18 and 2021–22.

3.18 Australia has published MAP statistics, peer review reports and a MAP country profile in accordance with the Minimum Standards. The published MAP statistics show cases have been on average resolved within the 24-month timeframe provided by the Minimum Standards across 2017–18 to 2021–22. The ATO also provides guidance for taxpayers on its website in accordance with the Minimum Standards requirements.

3.19 The OECD Guidelines provide additional guidance for conducting advance pricing arrangements (APAs)⁷¹ under the MAP article (bilateral and multilateral APAs) in Annexure II to Chapter IV. The ATO advised the ANAO in July 2023 that there are no currently active APAs which apply to transactions involving related party debt.⁷²

Documentation

3.20 Taxation Ruling 2014/8 sets out the Commissioner’s opinion on the transfer pricing documentation requirements in subdivision 284-E of Schedule 1 of the Taxation Administration Act 1953. This is consistent with the OECD Guidelines statement that ‘requirements should balance the tax administration’s need for information and the compliance burdens on taxpayers.’ The OECD Guidelines also state that transfer pricing documentation requirements should be reasonable and focused on material transactions to ensure mindful attention to the most important matters. This should balance the tax administration’s need for information with the compliance burden on taxpayers.

Process for adopting updates to the OECD Guidelines

3.21 The ATO has commenced a Minor and Technical Amendment (MTA) process to update references in the ITAA 1997 to incorporate the 2022 OECD Guidelines, in place of its current reference to the 2017 Guidelines. An MTA process is used to achieve minor law changes, such as updating references in tax law. It involves the ATO submitting an application for the inclusion of an amendment in an MTA schedule in a Treasury omnibus bill. At the time of this audit, the ATO had engaged with Treasury to include minor technical amendments to incorporate the 2022 OECD guidelines in the next available bill.

Country-by-Country reporting obligations

3.22 The OECD’s three-tiered Country-by-Country reporting approach, comprising of a master file, local file and Country-by-Country report, aims to address a lack of quality data in transfer pricing matters.⁷³ Country-by-Country reporting applies in Australia to income years commencing from 1 January 2016, as recommended by the OECD Guidelines.

3.23 Subdivision 815-E of the ITAA 1997 requires ‘CBC reporting entities’⁷⁴ to give statements corresponding to the three tiers in the OECD Guidelines annexures. The OECD Guidelines recommend all multinational enterprise groups should be required to file an annual Country-by-Country report with an exemption for groups with a consolidated group revenue below €750 million. The ITAA 1997 requires entities to file a Country-by-Country report if they are a parent company with an annual global income of at least $1 billion, or a member of a group with such a parent.

3.24 The OECD Guidelines state: ‘no exemptions from filing the Country-by-Country Report should be adopted apart from the exemptions outlined in this section.’ The ATO provides exemptions for all three reporting tiers on the grounds of administrative relief, fast-track exemptions or exemptions on formal request in certain circumstances.⁷⁵ For the period up to 30 June 2023, 11 Top 100, and 28 Top 1,000 taxpayers have been granted an exemption for the Country-by-Country report.

3.25 The ATO provides its own local file form for taxpayers to complete, comprising of a short form, Part A and Part B.⁷⁶ The short form includes questions addressing the local entity information required by the OECD Guidelines. Part A captures some information on the controlled transactions set out in Annexure II of the OECD Guidelines, including a description of the transactions, the amount of payment and receipts and identification of associated enterprises. Part B requires the taxpayer to provide attachments in line with the OECD Guidelines.⁷⁷

3.26 Both Part A and Part B require the taxpayer to identify the transfer pricing methodologies used. The local file does not contain questions requiring a more detailed description of the comparability and functional analysis performed, including assumptions made, comparable uncontrolled transactions used, comparability adjustments required and the use of financial data as suggested by the OECD Guidelines. The ATO advised the ANAO in November 2023: ‘Those aspects of a transfer pricing analysis generally form part of transfer pricing documentation. They can be quite lengthy and detailed therefore not appropriate for a Local File’.

3.27 Australia is one of 100 signatories to the Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports (MCAA).⁷⁸ This convention was based on one of the model Competent Authority Agreements provided in the OECD Guidelines Annexure IV to Chapter V.⁷⁹ The ATO has internal documentation and restrictions on data access to ensure information received under Country-by-Country agreements remains confidential and is used appropriately by staff.⁸⁰ Australia has additional bilateral exchange arrangements⁸¹ and Tax Information Exchange Agreements⁸² in place for jurisdictions not party to the MCAA.

Does the ATO have a sound strategy to engage with taxpayers who use transfer pricing for related party debt?

Engaging with taxpayers using transfer pricing for related party debt

3.28 Engagement with taxpayers using transfer pricing for related party debt primarily occurs through taxpayer application of PCG 2017/4: ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions⁸³ (PCG 2017/4). The purpose of PCG 2017/4 is to enable the ATO to assess risk and tailor its engagement with the taxpayer according to the features of the taxpayer’s related party financing arrangement, the profile of the parties to the related party financing arrangement and taxpayer choices and behaviour.⁸⁴ Figure 3.2 illustrates the development of the ATO’s strategic framework for managing transfer pricing risk.

Figure 3.2: Development of the ATO’s strategic framework

Source: ANAO analysis of ATO documentation.

Chevron

3.29 The legislation regarding transfer pricing was applied by the Full Court of the Federal Court in the Chevron case⁸⁵ in April 2017 (see Appendix 3), which initiated the development of PCG 2017/4.

Development of PCG 2017/4

3.30 In January 2017, the ATO began to design a PCG for transfer pricing for related party debt. The ATO conducted an internal consultation process, considering key principles and risk indicators, leading to the development of a risk assessment framework and a series of risk zones.

3.31 A ‘targeted consultation’ was then conducted with a capital markets consultant and a banking consultant⁸⁶ to ensure the draft PCG, was based on ‘real-world commercial practices’, prior to its public release. The ATO also consulted with Treasury prior to public consultation to ensure there were no concerns from a policy perspective. Following the ‘targeted consultation’ the ATO provided a draft copy of PCG 2017/4 for public comment. The ATO advised the ANAO in May 2023 that it consulted with various stakeholders⁸⁷, via face-to-face meetings, telephone discussions, or via email. The outcomes of the public consultation process led to the development of a consultation compendium.

Guidance governing taxpayer engagement

3.32 On 18 December 2017, the ATO published PCG 2017/4. It consists of a set of general principles relevant to the framework for considering risk and applying compliance resources to related party financing arrangements.

3.33 The ATO’s transfer pricing strategy is primarily focussed on the taxpayer conducting a self-assessment of its risk position. The ATO then applies an assurance or risk-based approach to assess the disclosures of a selection of taxpayers.⁸⁸ (see from paragraph 3.46) Applying the principles contained in PCG 2017/4 allows taxpayers to self-assess their compliance risk of their related party finance arrangements. The PCG is available on the ATO’s website.⁸⁹

3.34 Section 4 of PCG 2017/4 explains how the taxpayer can use the framework to: assess the tax risk of its related party financing arrangement; understand the compliance approach the ATO is likely to adopt; work with the ATO to mitigate the transfer pricing risk; and understand the type of analysis and evidence the ATO requires when assessing the risk outcomes of the taxpayer’s related party financing arrangements.

3.35 Taxpayers assess features of their arrangements against specific criteria. This assessment results in an overall risk score, with scores falling within risk level zones. The risk zone then reflects the likely compliance approach the ATO will take. When a potential risk is identified, details of the arrangement are confirmed via PCRs (see paragraph 3.82) and CARs (see paragraph 3.88), further profiling is undertaken, and an assessment as to whether the risk exists needs to be made before escalating to Next Actions or an audit, where Alternative Dispute Resolution (ADR) processes are used. Table 3.2 illustrates the ATO’s approach.

Table 3.2: PCG 2017/4 risk assessment framework

Source: ANAO analysis of ATO documentation.

3.36 It is not compulsory for taxpayers to apply PCG 2017/4.⁹⁰ Reportable Tax Position (RTP) Schedule instructions⁹¹ require taxpayers who meet the lodgment criteria to disclose any arrangements relating to PCG 2017/4. Taxpayers that make a disclosure for these questions are required to self-assess their risk zone based on PCG 2017/4 guidelines. A non-disclosure is considered red zone or high risk and the ATO will review why the taxpayer has not applied PCG 2017/4. The ATO details these disclosures in the findings report⁹² which is published annually.

3.37 The ATO states that as ‘practical compliance guidelines are intended to outline sensible and efficient approaches to ongoing tax administration, rather than interpretive views of the law, it is considered particularly important that they be subject to periodic review.’⁹³ PCG 2017/4 has been reviewed to ‘improve clarity ‘and to ‘reflect RTP Schedule changes’.⁹⁴ The ATO advised the ANAO in November 2023 there is an APA review underway which may lead to changes in PCG 2017/4. The ATO advised the ANAO in June 2023 that a ‘positive behavioural shift in taxpayer behaviour’ occurred after the release of PCG 2017/4, with some taxpayers engaging early with the finance risk cluster or case teams to review their arrangements.

Support for taxpayers to apply PCG 2017/4

3.38 PCG 2017/4 is not a guide for taxpayers on how to appropriately price related party debt, and ‘does not provide advice or guidance on the technical interpretation or application of Australia’s transfer pricing rules or other taxation provisions’.

3.39 Taxpayers or their advisors are able to contact the ATO for assistance on how to apply PCG 2017/4. In PCG 2017/4, the ATO advises taxpayers that it has a dedicated team responsible for the oversight and management of related party financing arrangement risks.

3.40 The RTP Schedule is a schedule to a company tax return. It gathers information on uncertain tax positions from the largest companies.⁹⁵ RTP Schedule Category C Question 14 requires taxpayers to disclose the outcome of their self-assessment using PCG 2017/4 for cross-border related party finance arrangements. Figure 3.3 and Figure 3.4 show changes in RTP Schedule disclosures from 2017–18 to 2021–22 for the Top 100 and Top 1,000 populations respectively. The ATO advised the ANAO in January 2024 that:

The Full Federal Court’s decision in the Chevron case, guidance provided by PCG 2017/4, PG’s Top 100 and Top 1000 compliance strategies, and increased transparency through RTP disclosures are arguably positively influencing taxpayer behaviour away from high-risk transactions.

Figure 3.3: RTP disclosures for the Top 100 population, 2017–18 to 2021–22

Source: ANAO analysis of ATO documentation.

Figure 3.4: RTP disclosures for the Top 1,000 population, 2017–18 to 2021–22

Source: ANAO analysis of ATO documentation.

3.41 The application of PCG 2017/4 is monitored through RTP Schedule responses provided by taxpayers as part of their tax returns. The ATO advised the ANAO in May 2023 that work was done with the Strategy, Economist Practice, and Engagement and Assurance case teams to gain insights on taxpayer attitudes to known risks and to identify material residual or emerging related party financing issues. RTP Schedule disclosures are used to identify overall trends in taxpayer behaviour. Annual RTP disclosures are examined to select taxpayers who have riskier arrangements that require assurance for referral to Medium/Emerging and Top 1,000 strategy teams for prioritising for further action. The ATO advised the ANAO in April 2023 that taxpayers who do not apply PCG 2017/4 will be reviewed as part of the ATO’s assurance and compliance programs.

3.42 Table 3.3 outlines the number of taxpayers who did not apply PCG 2017/4 between 2020–21 and 2022–23. Of a total of 43 individual taxpayers that did not apply the PCG, eight reviews have been completed, six are in progress, and one was in planning as at February 2024. The ATO did not review 28, or 65 per cent of taxpayers who did not apply PCG 2017/4.

Table 3.3: Taxpayers who did not apply PCG 2017/4

Note a: Data for 2019–20 is not available as this subcategory was introduced in 2020–21. Some taxpayers did not apply PCG 2017/4 in multiple years.

Note b: 2022–23 data is incomplete as tax returns are lodged throughout the year.

Source: ATO documentation.

Taxpayer reporting requirements

3.45 PCG 2017/4 is the primary communication tool in which the ATO provides guidance to taxpayers. The ATO advised the ANAO in November 2023 that PCG 2017/4 ‘communicates the way the ATO views the risk’, and does not ‘collect comprehensive information’. The base level of information is contained in company tax returns, within schedules to the return. Along with the RTP Schedule (see paragraph 3.40), taxpayers with aggregate international related party dealings exceeding $2 million⁹⁶ are also required to complete the International Dealings Schedule (IDS). Some taxpayers (see paragraph 3.23) are also required to provide information through Country-by-Country reports.⁹⁷

Analysing related party debt, staff guidance, and training and development

3.46 Taxpayers provide case teams with documentation as part of the PCR (see paragraph 3.81) and CAR (see paragraph 3.88) processes to understand and analyse related party debt. Process roadmaps provide guidance to staff and provide consistency in the assessment of transactions that include transfer pricing. This roadmap is summarised at Figure 3.5. The Guide to Analysing Related Party Finance, and the Framework of Enquiry to Understand Global and Domestic Treasury Functions provide further detail on both processes. The roadmaps for the Top 100 and Top 1,000 are almost identical, differing only in what happens after a level of assurance has been established.

Figure 3.5: ATO approach to analysing related party finance

Note: This figure does not depict white zone taxpayers (see Table 3.2).

Source: ANAO analysis of ATO documentation.

Analysing related party debt and staff guidance

3.47 The analysis of related party debt is broken down into four steps for case teams. Case teams must verify the taxpayer’s application of PCG 2017/4, understand the taxpayer’s treasury function and funding profile, determine whether the arm’s length principle has been observed, and, if assurance has not yet been obtained, then exercise judgement to determine the level of assurance.

Step 1: Verify the accuracy of taxpayer’s application of the PCG to determine the risk rating

3.48 ATO guidance states that case teams need to have a thorough understanding of the taxpayers’ overall financing structure to evaluate transfer pricing arrangements and arrive at an appropriate assurance rating. ATO staff need to understand PCG 2017/4 and be able to assess the information required to verify the PCG was properly applied by the taxpayer.

3.49 The taxpayer’s risk zone is one of the indicators of the level of risk posed by an arrangement, along with information obtained during the review, to independently verify the risk rating and influence the ATO’s compliance approach.

3.50 Taxpayers’ responses to PCG 2017/4 are reviewed by the ATO in TARs and Combined Assurance Reports for the Top 100 and Top 1,000 populations respectively. Testing outcomes against these matters are discussed further from paragraph 4.22.

Step 2: Staff need an understanding of taxpayer’s treasury and funding profile

3.51 Table 3.4 outlines the matters ATO staff are required to understand and evidence consideration of to demonstrate that they fully understand a taxpayer’s treasury and funding profiles.

Table 3.4: Evidence gathered by the ATO to understand a taxpayer’s profile

Source: ATO documentation.

3.52 Consideration and the evidencing of these matters are the way case teams verify whether or not the taxpayer is properly applying PCG 2017/4 and appropriately pricing related party debt. Testing outcomes against these matters are discussed further from paragraph 4.23.

Step 3: Determining whether arm’s length conditions are reasonable

3.53 At this step, for both PCRs and CARs, case teams engage Economist Practice to determine whether there is evidence which supports the price, terms and instrument type to demonstrate that the arm’s length principle has been observed. Testing outcomes against these matters are discussed further from paragraph 4.31. The ATO provides additional toolkit templates for Top 1,000 case officers engaging Economist Practice (testing outcomes against these matters are discussed further from Paragraph 4.32).

Step 4: Case team and specialist team judgment

3.54 If a taxpayer’s risk profile is in the yellow risk zone or above, and the ATO determines that arm’s length principles have not been observed, case team and specialist team judgement is required. After the evidence has been considered, the case team can determine an assurance rating between medium and red flag, with further action generally considered to be required. The ATO documents this in TARs and Combined Assurance Reports.

3.55 All Top 100 taxpayers who receive a TAR are provided with a Future Assurance Plan which outlines actions required to be taken by the taxpayer to either maintain or increase their assurance ratings (see paragraph 3.86). For taxpayers who have not obtained high assurance, this includes a section on the ‘pathway to justified trust’ outlining areas the taxpayer must address so the ATO can gain assurance.

3.56 From commencement of the Top 1,000 Combined Assurance Program to 30 June 2023, the ATO identified 64 Top 1,000 taxpayers that had a rating of ‘low’ or ‘red flag’, of which 10 of these matters were flagged as requiring escalation to the Next Actions Program (see paragraph 3.104), and the taxpayer was informed in their Combined Assurance Report. The ATO has completed a Combined Assurance Report for 213 taxpayers during this period.⁹⁸

3.57 When a taxpayer is not escalated to the Next Actions Program, the Combined Assurance Report outlines recommended actions to ‘better align with the ATO’s position’⁹⁹ and advises the ATO may follow up to see what steps the taxpayer has taken in future engagement.

Training and development

3.58 Technical training on transfer pricing has been provided to case officers since 2017, initiated by the judgment in the Chevron court case¹⁰⁰ and the release of PCG 2017/4. The ATO developed a training program which was designed to be undertaken between 2019 and 2021. The ATO advised the ANAO in July 2023 that an advanced training course is in development. Formal training capability development packages have included face-to-face presentations, podcasts, guides and self-directed learning packages.

3.59 Staff training is updated in response to the outcomes of significant litigation. For example, staff were made aware of lessons learned from the Chevron court case via a webinar. Further, self-paced e-learning is available for staff in various formats including videos and podcasts. Training is not mandatory for new or existing non-graduate case officers, and refresher courses are not required. The ATO could not provide details of how many times foundation and intermediate levels of training have been delivered since the release of PCG 2017/4.

Arrangements in place to communicate with individual taxpayers and advisors

3.64 The ATO’s Public Groups division provides oversight of the strategy for transfer pricing for related party debt (see from paragraph 1.6). Public Groups is responsible for the administration of a range of taxes and tax frameworks, including transfer pricing.

3.65 Engagement for both taxpayers and advisors, takes place at a population level, via Public Advice and Guidance¹⁰¹, with PCG 2017/4 functioning as the ‘primary communication tool’. Engagement at the case level primarily occurs through PCRs and CARs. While the ATO has a communication strategy to engage with public and multinational businesses, there is no specific communication strategy to engage with advisors who provide advice to taxpayers using related party debt.

3.66 Top 100 taxpayers are assigned a Key Client Manager¹⁰² and can also be assigned a Key Account Manager.¹⁰³ All Top 100 taxpayers subject to ongoing compliance work have a Senior Relationship Manager available for communication. They also function as an escalation point for issues that cannot be resolved between the case team and the taxpayer. Top 100 taxpayers engage continuously with the ATO through a dedicated case team and via an annual PCR. A finalisation meeting is held with the taxpayer to discuss the outcomes of the PCR and the resulting Tax Assurance Report (TAR).

3.67 Top 1,000 taxpayers engage with the ATO through a CAR (see from paragraph 4.9). Top 1,000 taxpayers are not assigned a direct contact in the ATO. Engagement with Top 1,000 taxpayers occurs via a CAR, through the case team responsible for the delivery of the CAR. This relationship does not extend beyond the completion of the CAR. Once a CAR is complete, a case team meets with Top 1,000 taxpayers to discuss their assigned assurance rating and potential improvements. The ATO receives feedback from taxpayers on this process via a Client Feedback Survey. Top 1,000 taxpayers do not have dedicated relationship managers.

Does the ATO have sound implementation and oversight arrangements to support engagement with taxpayers using related party debt?

Action Differentiation Framework

3.68 The ATO’s engagement with the Top 100 and Top 1,000 taxpayers is tailored based on the ADF.¹⁰⁴ This is the ATO’s ‘strategic approach to engaging with public and multinational businesses’. The ATO’s understanding of, and engagement with, a taxpayer is informed by a taxpayer’s size, transparency in its engagement with the ATO, choices and behaviours in its tax affairs, risk, and the level of assurance it has previously obtained. The ATO aims for the ADF to allow the ATO to use its resources efficiently, target priority areas and ‘to focus on the principles of obtaining justified trust’ (see from paragraph 2.33).

3.69 Under the ADF, Public Groups taxpayers are categorised into four populations based on their total business income (TBI).¹⁰⁵ The two relevant to the audit are Top 100 (greater than $5 billion or a ‘market leader’), and Top 1,000 (greater than $250 million to $5 billion).¹⁰⁶ The ATO advised the ANAO in July 2023 that business rules applied by the Business Market Table define the Top 1,000 population (see paragraph 4.5 for more information on the Business Market Table). Testing indicated that there were no quality controls in place to verify the completeness and accuracy of the Top 1,000 population. This is consistent with the finding made in Auditor-General Report No. 26 2022–23, Interim Report on Key Financial Controls of Major Entities.¹⁰⁷

3.70 Table 3.5 outlines the size of the Top 100 and Top 1,000 populations.

Table 3.5: Size of Top 100 and Top 1,000 populations, 2021–22 to 2023–24

Note a: The Top 100 population is not part of the Top 1,000 population. The Top 1,000 population is in addition to the Top 100 population.

Source: ANAO analysis of ATO documentation.

3.71 There are three ADF ‘engagement experiences’. From highest to lowest, these are partnering; encouraging; and influencing.¹⁰⁸ To have a better ADF engagement experience, a taxpayer has less chance of significant tax risks if it possesses one or more of the following qualitative characteristics: transparency and willingness to engage with the ATO, and less complex tax arrangements. ADF engagement experiences have been communicated to Top 100 taxpayers since 2020–21 in an annual ADF letter. The ATO advised the ANAO in November 2023 that Top 1,000 taxpayers are not informed of their ADF engagement experience.

3.72 Table 3.6 outlines the number of Top 100, and Table 3.7 outlines the number of Top 1,000, taxpayers by their ADF engagement experience.

Table 3.6: Number of Top 100 taxpayers by ADF engagement experience 2021–22 to 2023–24

Note a: 2023–24 data has not been finalised as tax returns are lodged throughout the year.

Source: ANAO analysis of ATO documentation.

Table 3.7: Number of Top 1,000 taxpayers by ADF engagement experience, 2021–22 to 2023–24

Note a: 2023–24 data has not been finalised as tax returns are lodged throughout the year.

Source: ANAO analysis of ATO documentation.

Top 100 population and review priority

3.73 A TBI of greater than $5 billion or being a ‘market leader’ is necessary for an economic group¹⁰⁹ to be considered for inclusion in the Top 100 population and consequent PCRs.

Top 1,000 population and review priority

3.75 The Top 1,000 population comprises those economic groups not in the Top 100 with a TBI of greater than $250 million and up to $5 billion. The ATO advised the ANAO in November 2023 that ‘there are some economic groups in the Top 1,000 population with TBI over $5 billion’.¹¹⁰ Regardless of individual TBI, all entities within a Top 1,000 economic group are part of the Top 1,000 population. TBI is determined by a business rule calculated by the ATO’s Business Market Table (see from paragraph 4.5).

3.76 After a case list of Top 1,000 taxpayers to undergo a CAR in a given period is finalised, it is reviewed and endorsed by the Top 1,000 Assistant Commissioner. Endorsed case lists are then allocated to case teams. A reserve case list of ‘generally smaller taxpayers with less complex arrangements’ who can be reviewed when resourcing permits was provided from the 2022 case selection process, though evidence for previous years was not provided.

3.77 CAR case selection principles were finalised in February 2022. The case selection pool is divided into a ‘Strategy Referral Group’ consisting of three industries¹¹¹ and a ‘General Group’ consisting of all other taxpayers. Prioritisation of taxpayers within the Strategy Referral Group is based on the insights of industry-specific strategy teams. General Group selection is based against defined criteria, followed by a triage process for prioritisation. Prior to the finalisation of the CAR case selection principles, a taxpayer’s selection was based on criteria considering the impact of COVID-19, previous Streamlined Assurance Reviews, other ATO activity and taxpayer performance.

3.78 The ATO manages its population via a live document maintained by the Top 1,000 program. In November 2023 the ATO advised the ANAO that ‘data is refreshed regularly for taxpayer lodgments and ADF changes, as well as with [manual] updates containing case selection notes.’ A triage process is conducted and the Top 1,000 Case Selection Principles document is then applied (for more information on CARs see from paragraph 3.88).

Introduction to PCRs and CARs

3.79 The ATO aims to verify taxpayers’ self-assessments under PCG 2017/4 during PCRs (which lead to the issue of a TAR of Top 100 taxpayers) and CARs (which lead to the issue of a Combined Assurance Report) of Top 1,000 taxpayers.¹¹² Transfer pricing for related party debt is assessed by the ATO as part of obtaining assurance over Top 100 and Top 1,000 taxpayers’ income tax within the ATO’s broader assurance program. The ATO aims to conduct a PCR on Top 100 taxpayers annually (see from paragraph 3.81 for further discussion of PCRs). The ATO also aims to complete 250 CARs of Top 1,000 taxpayers annually (see paragraph 2.48). PCRs and CARs are undertaken by case teams from Engagement and Assurance. The Top 100 Justified Trust Program and the Top 1,000 Combined Assurance Program are part of the ATO’s Tax Avoidance Taskforce.¹¹³

3.80 In terms of income tax assurance, three overall assurance ratings can be applied to Top 100 and Top 1,000 taxpayers: high, medium and low (for more information on assurance ratings, see from paragraph 2.39). The ATO does not record data on the total number of related party finance transactions assessed by the ATO for the Top 100 and Top 1,000 populations from 2019 to 2022.

PCR summary

3.81 Undertaken annually, PCRs are the ATO’s ‘primary income tax assurance product’ for managing engagement with the Top 100.¹¹⁴ Top 100 taxpayers receive an annual ADF letter¹¹⁵ advising how the ATO will tailor its engagement with them and offering Key Account Managers (Top 100 taxpayers are assigned a Key Client Manager and can also be assigned a Key Account Manager — see paragraph 3.66).¹¹⁶

3.82 Engagement and Assurance case teams are responsible for the day-to-day management of a PCR and for the final assurance rating. Engagement and Assurance teams record analysis and document supporting evidence in a TAR to capture the results of a PCR.¹¹⁷ A TAR is divided into a Permanent File and an Executive Summary. The Permanent File is the ‘corporate memory/repository’ of the ATO’s engagement with the taxpayer intended for internal use. The Executive Summary is provided to the taxpayer summarising assurance outcomes and includes a Future Assurance Plan on work needed to obtain or maintain high assurance (see from paragraph 3.86 for further discussion of Future Assurance Plans).

Monitoring and Maintenance approach

3.83 Top 100 taxpayers who have achieved overall high assurance (‘justified trust’) are not subject to further PCRs for the following two income years. The ATO monitors their disclosures and tax outcomes for the following two income years via the ‘Monitoring and Maintenance’ approach. During a Monitoring and Maintenance Review, the ATO seeks only to verify the tax outcomes from any significant new transactions or material changes to a taxpayer’s business activities, including the tax treatment of those activities. A Monitoring and Maintenance Review results in a Monitoring and Maintenance Review Assurance Report.¹¹⁸

3.84 Table 3.8 outlines the number of Monitoring and Maintenance reviews undertaken between 2019–20 and 2021–22.

Table 3.8: Number of Monitoring and Maintenance Reviews, 2019–20 to 2022–23

Source: ATO documentation.

3.85 As part of the Monitoring and Maintenance approach, a ‘more comprehensive’ justified trust review (or ‘refresh’ review) is then conducted every third income year. As at 30 June 2023, 13 refresh reviews have been completed. A refresh review ‘generally’ focuses on the current income year and eventuates in a TAR. If the taxpayer maintains overall high assurance at the conclusion of the refresh review, the Monitoring and Maintenance approach recommences.¹¹⁹ The ATO can conduct a refresh review prior to the third income year if there has been a ‘fundamental business change’ or if it considers trust can no longer be maintained with a taxpayer.

PCR escalation

3.86 A Future Assurance Plan is the pathway developed by a case team to increase or maintain the ATO’s assurance level over a taxpayer. This includes areas over which assurance could not be obtained during a PCR due to further evidence and analysis being required.

3.87 A Future Assurance Plan is a ‘visual snapshot’ of actions to be completed in future engagements, such as further work or behavioural changes required to obtain justified trust. It is located within the Executive Summary of a TAR (see paragraph 3.82 for more information on the Executive Summary).

CAR summary

3.88 A CAR assesses whether a Top 1,000 taxpayer is reporting the correct amount of income tax and GST.¹²⁰ CARs commenced in 2021, replacing Streamlined Assurance Reviews.¹²¹ A CAR is conducted jointly by income tax and GST case teams responsible for their respective income tax and GST components. The income tax component of a CAR covers a four-year period. For a Top 1,000 taxpayer to be eligible for a CAR, ATO documentation suggests it will generally have three or more years of income tax not assured with a TBI above $250 million in three of the last four years lodged.¹²² Table 3.9 outlines how many first time and repeat CARs were conducted between 2019–20 and 2022–23.

Table 3.9: First time and repeat CARs, 2019–20 to 2022–23

Note a: 2019–20 relates to Streamlined Assurance Reviews which were conducted prior to 2020–21. As all CARs completed in 2020–21 were first time CARs, there is no data for that year on changes to assurance ratings.

Source: ANAO analysis of ATO documentation.

3.89 A CAR results in two products: an Internal Combined Assurance Report (ICAR) and an External Combined Assurance Report (XCAR). The income tax component of the ICAR is generated by the Public Groups Assurance Profiling Dashboard accessed via the Enterprise Client Profile (ECP) (see Table 4.1). This occurs during the planning stage of a CAR.

3.90 The generated ICAR includes ‘all base level information’, such as the taxpayer’s details, tax performance and profile, alignment between accounting and tax results, and previous engagement history. To complete the Internal Combined Assurance Report, manual intervention and further analysis is required with additional information incorporated as a CAR progresses. In terms of related party financing arrangements, this occurs in line with the Top 1,000 Assurance Roadmap for Related Party Financing Arrangements (see from paragraph 3.46). The XCAR is the product issued to the taxpayer at the completion of a CAR.

Internal engagement

3.91 Multiple branches within Public Groups, as well as Economist Practice within International, Support and Programs, provide support and assistance to the Top 100 Justified Trust Program and the Top 1,000 Combined Assurance Program. This consultation can occur at any stage during a review. When reviewing significant or new transactions or tax risks as a part of a PCR, ATO guidance suggests engaging internal experts to assist and sign off on assurance ratings.¹²³ Internal guidance recommends that Engagement and Assurance case teams hold an initial workshop with an internal stakeholder to discuss the nature of the engagement between them.

3.92 To ensure decision making ‘reflects’ the ATO’s perspective, case teams consult internal stakeholders such as Economist Practice, International Tax Structuring, the Arm’s Length Conditions – Related Party Financing Cluster (‘finance risk cluster’) and the Tax Counsel Network.

• Economist Practice provides advice on arm’s length conditions for related-party debt, including arm’s length interest rates (see from paragraph 3.53 for more information on engagement with Economist Practice).
• International Tax Structuring provides technical advice and practical insight on broader international tax risks, including transfer mispricing.¹²⁴
• The finance risk cluster (within International Tax Structuring) provides a coordinated strategic approach to the management of related party financing risks and works with other areas of the ATO to provide advice (see paragraph 2.17).
• Tax Counsel Network assists with the interpretation or application of tax law provisions, as well as with legal precedents relevant to their current work.¹²⁵

3.93 A case team’s decision making for considering the appropriateness of a taxpayer’s transfer pricing methods and comparability analysis is informed by engaging Economist Practice. The respective assurance roadmaps for related party financing arrangements for both the Top 100 Justified Trust Program and Top 1,000 Combined Assurance Program states case teams are to confirm with Economist Practice that arm’s length conditions are reasonable (see Figure 3.5).

Oversight and sign-off

Top 100

3.94 A TAR and the assurance ratings it contains are reviewed and endorsed at the SES QA Finalisation Panel.¹²⁶ An SES QA Finalisation Panel is required for full and refresh TARs. After the SES QA Finalisation Panel, case teams record and address any action items and feedback.

Top 1,000

3.95 The ICAR and XCAR are reviewed and endorsed at the Finalisation Panel.¹²⁷ The XCAR is sent by the case team to its team or technical leader for final approval.

Reporting

3.96 Guidance on the Top 100 Justified Trust Program states there is a ‘commitment’ to report to internal and external stakeholders. Information from reviews is tracked by the Top 100 network and reported to ‘various stakeholders’, such as the Public Groups Executive and the Tax Avoidance Taskforce reports. The ATO does not produce dedicated reporting on transfer pricing for related party debt. The ATO advised the ANAO in November 2023 that Top 1,000 Combined Assurance Program reporting requirements and guidance are embedded in procedures. The ATO did not stipulate which procedures these were.

3.97 Reporting on the Top 100 Justified Trust Program and the Top 1,000 Combined Assurance Program includes:

• a monthly paper detailing its outcomes to the PG Executive Forum;
• a monthly update with ‘anything of note’ to the Minister’s office for the Tax Avoidance Taskforce; and
• a quarterly update to the Minister’s office on its overall status under the Tax Avoidance Taskforce.¹²⁸

3.98 Aggregated data is reported publicly via annual findings reports (see paragraph 2.58).

External engagement

3.99 The ATO has attended the TP Minds (‘Transfer Pricing Minds’) Australia conference from 2020 to 2023. TP Minds Australia is the local iteration of a global series of annual conferences dedicated to ‘insights and gain[ing] best practice advice on the latest global [transfer pricing] challenges from authoritative experts’. An ATO Deputy Commissioner also attended TP Minds International in London in March 2018 and delivered a speech at the event. The Deputy Commissioner of Public Groups was a keynote speaker at TP Minds Australia in 2020, 2022 and 2023.

Assurance mechanisms and review processes

3.100 The ATO advised the ANAO in August 2023 that it ‘continually’ reviews and adapts its assurance programs. Examples for the Top 100 Justified Trust Program include the following.

• The guide produced for the Top 100 Assurance Approach to Taxation Determination TD 2022/9¹²⁹ is an example of the Top 100 network supporting case teams with the assessment of transactions after new legislation or guidance has been enacted.
• The implementation of the Monitoring and Maintenance approach, which allows for ‘more tailored, less intense’ reviews for high assurance taxpayers (see from paragraph 3.83). At the Large Business Stewardship Group meeting in March 2020 it was agreed that a paper would be prepared outlining options for consideration and consultation. This led to a draft consultation note presented to the Public Groups Executive Forum, then a process of receiving and responding to internal and external feedback over the following two years.

3.101 Examples for the Top 1,000 Combined Assurance Program include the following.

• Responding to feedback that taxpayers would benefit from clarity on governance expectations, a working group was established at the Large Business Stewardship Group¹³⁰ meeting in April 2021. This led to a workshop, published guidance and post-publication feedback.
• Responding to feedback at its May 2022 meeting that the testing requirements for stage three governance ratings would not always enable all taxpayers to align to their broader enterprise testing programs, the Large Business Stewardship Group established a working group to determine whether any changes were required to the testing requirements. A report of the working group’s findings was reported to the Large Business Stewardship Group meeting in August 2022.

Escalation to audit

Top 100

3.102 The endorsement of the Audit Panel is required to progress issues within a PCR to audit in the case of a tax matter dispute. Internal documentation states that Panel membership consists of three Assistant Commissioners (Senior Executive Service Band 1s) from Law Advice and Resolution, International Risk and Domestic Risk. Additional members who can be invited when needed include an Assistant Commissioner from Economist Practice and Directors from International Risk, Domestic Risk and Case Leadership.¹³¹

3.103 Engagement and Assurance case teams complete an audit business case template for submission to the Audit Panel. The Audit Panel convenes monthly to review business cases presented to it and determine if an escalation to audit is necessary. If an escalation to audit has been recommended, a PCR is not closed until a decision has been made by the Audit Panel and this decision is communicated in the TAR cover letter.

Table 3.10: Number of times an issue from a PCR was escalated to audit, 2019–20 to 2022–23

Source: ANAO analysis of ATO documentation.

Top 1,000

3.104 Areas of concern identified in a CAR are escalated to the Next Actions Program.¹³² Taxpayers are notified if they need to undertake further action or if the ATO will undertake further intervention. If the ATO decides a Next Actions Review is necessary, the XCAR will outline to the taxpayer what it needs to do to prepare for this engagement. The matter can then be further escalated to an audit.¹³³ XCARs also include a ‘Future areas attracting our attention and potential engagement’ section which outlines to the taxpayer any areas beyond the review’s period that are likely to be examined in future reviews.

3.105 Tables 3.11 to 3.13 contain data on CARs escalated to the Next Actions Program and to audit. The ATO’s evidence for this data consists of commencement letters and finalisation letters for Next Action reviews, audit business case referrals and communications from the ATO to the relevant taxpayer. As the evidence provided does not consist of completed Next Action reviews or audit reports, this data cannot be assured.

Table 3.11: Number of CARs escalated to the Next Actions Program, 2020–21 to 2022–23

Source: ATO documentation.

Table 3.12: Number of CARs escalated directly to audit, 2020–21 to 2022–23

Source: ATO documentation.

Table 3.13: Number of CARs escalated to the Next Actions Program further escalated to audit, 2020–21 to 2022–23

Source: ATO documentation.

Post-audit escalation processes

3.106 Alternative dispute resolution processes are approaches ‘other than judicial or tribunal determination’ involving an impartial person. They can be used during settlement negotiations with the aim of resolution or at least minimising areas of disagreement.¹³⁴ One of the ATO’s guiding principles when conducting litigation is to ‘attempt to resolve disputes early to avoid unnecessary litigation and related costs’.¹³⁵ In terms of transfer pricing for related party debt, the ATO advised the ANAO in June 2023 the forms of alternative dispute resolution used typically are settlement by direct negotiation¹³⁶ and, to a lesser extent, in-house facilitation.¹³⁷ The ATO advised the ANAO in June 2023 that 12 financing matters were resolved by settlement for the three years ending 30 June 2022.

3.107 The ATO advised the ANAO in November 2023 that penalties ‘may’ apply when an adviser has promoted a tax exploitation scheme (such as transfer mispricing) or made false or misleading statements to the ATO.¹³⁸ Since the current promoter penalties were enacted in 2006¹³⁹, there have been seven Federal Court of Australia cases concerning promoter penalties. None of the seven cases involved transfer mispricing.

4.1 The ATO’s Corporate Plan 2023–24 identifies multinational tax performance as a key focus area, including the following deliverable:

• Address key risks to the corporate tax base and close tax loopholes so that the community has confidence that public and multinational businesses are paying the right amount of tax in Australia.¹⁴⁰

4.2 This requires the ATO to use data and intelligence to monitor taxpayer behaviour, and for the ATO to properly apply its strategic framework to effectively manage transfer pricing for related party debt.

Does the ATO have sound processes to use data and intelligence to monitor the behaviour of taxpayers using related party debt?

4.3 The ATO gathers information formally and informally¹⁴¹, and ‘generally’ seeks to request information on an informal basis. The ATO’s uses its formal powers when necessary, such as when an informal approach is no longer considered ‘productive’ or when requested by a taxpayer. A taxpayer will be advised by the ATO in advance of formal information-gathering powers being used.

Profiling

4.4 Prior to the ATO submitting requests for information (RFIs), a Top 100 case team profiles a taxpayer when commencing a Pre-lodgment Compliance Review (PCR). For a Combined Assurance Review (CAR), a Top 1,000 case team profiles a taxpayer after the first RFI has been issued (see from paragraph 3.79). This process involves the use of multiple ATO systems to better understand the taxpayer. Table 4.1 outlines the internal sources of profiling information and Table 4.2 outlines the external sources of profiling information.¹⁴²

Table 4.1: Internal sources of profiling information for PCRs and CARs

Source: ANAO analysis of ATO documentation.

Table 4.2: External sources of profiling information for PCRs and CARs

Source: ANAO analysis of ATO documentation.

4.5 ASIC data and intelligence is used by the ATO for the Business Market Table. It captures the details of all taxpayers with standardised information to support taxpayer profiling and reporting.¹⁴³ The Business Market Table applies agreed business rules to allocate taxpayers to client experience segments, business market segments and business lines.¹⁴⁴ The ATO advised the ANAO in July 2023 that these business rules define the Top 1,000 population (see from paragraph 3.75 for more information on the Top 1,000 population). The Action Differentiation Framework was designed to align with the Business Market Table (see from paragraph 3.68 for more information on the Action Differentiation Framework).

Data and intelligence sources

4.6 The main sources of ‘initial data’ for related party debt are:

• the International Dealings Schedule (IDS) (see from paragraph 3.45) or the Country-by-Country Australian local file for significant global entities (see from paragraph 3.22);
• loan agreements (provided as part of the Country-by-Country local file for significant global entities);
• disclosures at Category C, Question 14 of the Reportable Tax Position (RTP) Schedule (see from paragraph 2.25); and
• transfer pricing documentation, via RFIs (see paragraph 4.9) during PCRs and CARs.

4.7 RTP Schedule disclosures are used to gather information on ‘uncertain tax positions’ and identify overall trends in Top 100 and Top 1,000 taxpayers’ behaviour.¹⁴⁵ An RTP Schedule is a schedule to a taxpayer’s annual income tax return. These taxpayers are required to disclose their ‘most contestable, material tax positions’ in their RTP Schedule.¹⁴⁶ This includes arm’s length conditions of related party finance arrangements. Category C, Question 14 of the RTP Schedule asks taxpayers to disclose their self-assessment of any cross-border related party finance arrangement under PCG 2017/4 (see paragraph 3.40).

4.8 An IDS is required to be completed by businesses with more than $2 million in international related party dealings.¹⁴⁷ It is lodged with a taxpayer’s annual income tax return (paragraph 3.45).

Requests for information

4.9 The ATO seeks information for PCRs and CARs via written RFIs and discussions with taxpayers or their representatives.¹⁴⁸ Internal guidance for PCRs and CARs provides information for case teams on the conduct of RFIs throughout the review process.

4.10 The ATO has publicly available guidance for Top 100 taxpayers on the stages of the PCR process.¹⁴⁹ The document is a timeline across eight quarters showing multiple potential meeting points with possible meeting subjects and the information sources the taxpayers should have available.¹⁵⁰ ‘Significant related party and third party deals’ is listed as a potential meeting subject in the first four quarters.

4.11 The ATO advised the ANAO in November 2023 that PCR RFIs are not as structured as those for CARs, which have one, two (if required) or three (if required) RFIs. As evidenced by the publicly available guidance, PCRs involve ongoing dialogue and regular meetings between the ATO and the taxpayer. A ‘milestone template’ is used by PCR and CAR case teams to record the points in the review process, including the issuing of RFIs and taxpayers’ responses to them.

Verification of data

4.12 Opportunities to improve the ATO’s data are identified ‘in the course of ongoing data analysis activities’ by the finance risk cluster (see from paragraph 2.17), as well as by International Risk and Projects and the RTP Insights Team. For example, a data quality review was undertaken in July 2023 regarding the RTP Schedule Question 14 responses provided for the 2021 and 2022 years of income. The findings and recommendations of this review were provided to the RTP Team for consideration and further action. The ATO advised the ANAO in March 2024 that action on this matter was still in progress.

Visibility of transactions in non-OECD countries

4.13 The ATO has visibility of international related party dealings by Australian taxpayers in jurisdictions which are not signatories to OECD Country-by-Country reporting requirements via a taxpayer’s IDS and Country-by-Country local file. The ATO advised the ANAO in September 2023 that information might be exchanged between the ATO and foreign tax authorities in OECD member countries in relation to cases or risks (in accordance with relevant treaties). The ATO participates in international exchange of information (EOI) mechanisms, where taxpayer-related information is shared between jurisdictions either by request or under automatic EOI agreements between tax treaty partners.

Are instances of transfer pricing for related party debt being managed as intended?

Selection of taxpayers for testing

4.14 To assess whether the ATO managed transfer pricing for related party debt as intended, ATO reviews of taxpayers from both the Top 100 and Top 1,000 population were examined.

Top 100

4.15 Fourteen individual taxpayers from the 84 members of the Top 100 population from 2018–19 to 2020–21 were selected to assess whether transfer pricing for related party debt was being assessed by case officers as required by ATO guidance.

4.16 The ANAO selected taxpayers for testing, seeking to ensure that all risk ratings and ATO industry segments and Australian and New Zealand Standard Industrial Classification (ANZSIC) divisions¹⁵¹ were included. To ensure a relevant range of risk ratings, industry segments and ANZSIC divisions were included, a selection matrix was developed to ensure full coverage across these areas. Taxpayers were separated by ATO industry segment and ANZSIC division. In some cases, there was only one qualifying taxpayer in an ANZSIC division, so they were automatically selected for testing. Once these taxpayers were selected, ANZSIC divisions containing multiple taxpayers were examined, and taxpayers were selected to ensure all three risk ratings were represented. Through this process, of the fourteen selected taxpayers, four were high assurance, six were medium assurance, and four were low assurance.

Top 1,000

4.17 From the population of Top 1,000 taxpayers with related party debt from 2018–19 to 2020–21, a representative random sample of 75 taxpayers was taken¹⁵² to assess whether transfer pricing for related party debt was being assessed by case officers as required by ATO guidance. Through this process, of the 75 sampled taxpayers, 16 were high assurance, 51 were medium assurance, and eight were low assurance.

Methodology

4.18 As noted from paragraphs 3.46 to 3.57, ATO staff are guided by process roadmaps outlining the approach to analysing related party debt used by Top 100 and Top 1,000 taxpayers. Step 1 of the roadmap is to verify the accuracy of taxpayers’ application of PCG 2017/4 to determine the risk rating. Step 2 of the roadmap outlines the matters case officers are required to understand and evidence consideration of, to demonstrate that they fully understand a taxpayer’s treasury and funding profiles to establish that related party debt is being appropriately priced. The ATO advised the ANAO in November 2023:

We do not reference, or necessarily follow, the stepped instructions in a step-by-step fashion, nor record the outcomes of each step, in the ‘Top 100 Assurance Roadmap for Related Party Financing Arrangements’.

4.19 For both the Top 100 and Top 1,000, these processes are the same, though the documents used to record this work vary in format.

4.20 Step 3 requires case teams to engage Economist Practice to confirm if a taxpayer’s arm’s length conditions are reasonable. The ATO’s application of these steps is analysed in the Findings section below. Step 4 requires case team and specialist team judgment in cases with medium assurance to red flag ratings requiring further action. The ATO documents this in Internal Combined Assurance Reports (ICARs) and Tax Assurance Reports (TARs) as part of the transfer pricing analysis so this could not be separately tested.

Findings

4.21 A sample of 14 TARs and 75 ICARs was examined to assess the ATO’s management of related party debt (see paragraph 4.14). The ATO’s management of the selected instances of transfer pricing for related party debt in the Top 100 and Top 1,000 populations is largely effective.

Step 1: Verify the accuracy of taxpayer’s application of the PCG to determine the risk rating

Table 4.3: Assessment of the ATO’s verification of taxpayers’ PCG 2017/4 responses^a

Note a: Testing is based on the most recent TAR or ICAR completed for each taxpayer, with report issue dates ranging from 2018 to 2023.

Note b: These figures include one Top 100 case and three Top 1,000 cases where the taxpayer did not apply PCG 2017/4 and the ATO made its own assessment.

Source: ANAO analysis of ATO documentation.

4.22 All ICARs and TARs analysed mentioned PCG 2017/4 and its applicability to some extent. ATO verification of the taxpayer’s PCG 2017/4 assessment was clearly articulated in nine (64 per cent) of the sample (14) of Top 100 TARs and 36 (48 per cent) of the sample (75) of Top 1,000 ICARs analysed. A justification for why the taxpayer’s PCG 2017/4 self-assessment was not verified was included in 12 ICARs and two TARs.¹⁵³

Step 2: Staff need an understanding of taxpayer’s treasury and funding profile

4.23 Analysis of the ATO’s application of Step 2 of the roadmap is at Table 4.4.

Table 4.4: Assessment of the ATO’s management of selected instances of transfer pricing for related party debt

Key: ○ Negligible ◔ Partially complete ◑ Half complete ◕ Mostly complete ● Complete

Source: ANAO analysis of ATO documentation.

4.24 The matters outlined for analysis in Step 2 of the roadmap are primarily documented in TARs for Top 100 taxpayers and ICARs for Top 1,000 taxpayers (See from paragraphs 3.82 and 3.89).

4.25 While information required to assess Top 100 and Top 1,000 taxpayers is the same, there are some inconsistencies in how information has been recorded between TARs and ICARs.

4.26 In the tested Top 1,000 population, 31 cases did not include documented consideration of treasury authority manuals, policies, guidelines, procedures or functions. This should be included in consideration of the taxpayer’s global and Australian financial planning and reporting structure and functions. Further, ATO documentation for 27 of the assessed Top 1,000 cases did not identify what is mandated in the taxpayer’s Australian and global funding profiles.

4.27 These two considerations were documented in all analysed Top 100 cases, often in the ‘financing and capital structure’ section of the TAR template. A comparable section of analysis is not present in the Top 1,000 ICARs. The location of financing information in these reports differs between cases.

4.29 Where applicable, exposure identification and management systems were covered in all Top 100 TARs assessed.¹⁵⁴ In the tested Top 1,000 population, 10 of the 21 ICARs where commodity prices were deemed relevant to a taxpayer’s operations did not consider this factor.

4.30 The ATO documents for all tested Top 100 and Top 1,000 cases included a section analysing transfer pricing for related party debt transactions entered into by the taxpayer. However, of those tested, six Top 100 and 29 Top 1,000 cases did not include consideration of the taxpayer’s credit rating assessment. A credit rating assessment should be considered in analysis of the taxpayer’s approach to determining the arm’s length conditions where applicable. In some cases the ATO documented a decision to not consider all factors regarding the taxpayer’s approach to determining arm’s length conditions.¹⁵⁵

Step 3: Determining whether arm’s length conditions are reasonable

4.31 Table 4.5 contains results of testing performed on the ATO’s engagement with Economist Practice for Step 3.

Table 4.5: Assessment of ATO case teams’ engagement with Economist Practice

Source: ANAO analysis of ATO documentation.

4.32 Within the sample of Top 1,000 files, 59 required case teams to complete the Economist Practice Streamlined Toolkit and 16 required a Standard Toolkit (see from paragraph 3.12).¹⁵⁶ The Streamlined Toolkit was completed in 19 cases and the Standard Toolkit was completed in 18 cases, including six cases where a Streamlined Toolkit was required.¹⁵⁷ It is common practice for case teams to engage Economist Practice by emailing a draft ICAR and a summary of the taxpayer’s activities rather than a completed Toolkit template. There is no document equivalent to the toolkits used for the Top 100 Justified Trust Program.

Appendix 1 Australian Taxation Office’s response

Appendix 2 Improvements observed by the ANAO

1. The existence of independent external audit, and the accompanying potential for scrutiny improves performance. Improvements in administrative and management practices usually occur: in anticipation of ANAO audit activity; during an audit engagement; as interim findings are made; and/or after the audit has been completed and formal findings are communicated.

2. The Joint Committee of Public Accounts and Audit (JCPAA) has encouraged the ANAO to consider ways in which the ANAO could capture and describe some of these impacts. The ANAO’s corporate plan states that the ANAO’s annual performance statements will provide a narrative that will consider, amongst other matters, analysis of key improvements made by entities during a performance audit process based on information included in tabled performance audit reports.

3. Performance audits involve close engagement between the ANAO and the audited entity as well as other stakeholders involved in the program or activity being audited. Throughout the audit engagement, the ANAO outlines to the entity the preliminary audit findings, conclusions and potential audit recommendations. This ensures that final recommendations are appropriately targeted and encourages entities to take early remedial action on any identified matters during the course of an audit. Remedial actions entities may take during the audit include:

• strengthening governance arrangements;
• introducing or revising policies, strategies, guidelines or administrative processes; and
• initiating reviews or investigations.

4. In this context, the below actions were observed by the ANAO during the course of the audit. It is not clear whether these actions and/or the timing of these actions were planned in response to proposed or actual audit activity. The ANAO has not sought to obtain assurance over the source of these actions or whether they have been appropriately implemented.

• The ATO advised the ANAO in November 2023 that the Economist Practice Standard Toolkit (see from paragraph 3.12) is now referred to as the Internal Combined Assurance Review Transfer Pricing (ICAR TP) template, with minor changes made to the template including updates to terminology and case team instructions. The Streamlined Toolkit ‘will no longer be used by case teams’. The ATO advised the ANAO in November 2023 the ICAR TP template was finalised and uploaded to the ATO’s intranet on 6 November 2023. The sections requiring case teams to complete a summary of global and domestic operations have been shortened, with only a summary of the taxpayer’s profit and loss and balance sheet required in the new template. Two additional guidance documents dated 25 October 2023 have also been added to the ATO intranet that include references to the ICAR TP template and a ‘Top 1,000 TP specialist’. These are the ‘Top 1,000 – Top 1,000 Case Team and Top 1,000 TP Specialist responsibilities’ and ‘Top 1,000 CAR TP flowchart’.
• The ATO advised the ANAO in October 2023 that the Audit Panel ceased in June 2023. From July 2023, it was replaced by the Audit Authorisation process. Internal guidance on the income tax component of PCRs was updated on 12 October 2023 to reflect this change. Under the Audit Authorisation process, the Case Leadership Assistant Commissioner and the Operational Assistant Commissioner (responsible for the proposed audit) convene to consider and potentially endorse a business case (see from paragraph 3.102).

Appendix 3 Litigation

1. The ATO provided three litigation cases relevant to the management of transfer pricing for related party debt concerning publicly listed companies. Principles from the judgments in these cases have informed the ATO’s approach to managing related party debt matters. The ATO has produced in-house training for staff on the Glencore¹⁵⁸ and Singtel¹⁵⁹ cases. Summaries of the three litigation cases are included below.

Chevron

2. The Court found that Chevron Australia Holdings Pty Ltd gained a greater tax benefit than would otherwise be possible in an ordinary transaction between two unrelated entities.¹⁶⁰ Chevron Australia and a US-based subsidiary, Chevron Funding Corporation, entered into a loan agreement, where the agreed interest rate was higher than that of an arm’s length transaction.

Glencore

3. In this case the court found that Glencore had produced adequate evidence to establish the pricing terms between Glencore international AG and Cobar Management Pty Ltd were reasonably expected between independent parties and were dealings at arm’s length.¹⁶¹ The transaction was an intra-group arrangement to sell copper concentrate that appeared to be unreasonably disadvantageous to Glencore, triggering the arm’s length transaction question. The court upheld the notion that the transaction was sufficiently arm’s length as it had the effect of risk sharing between the two entities.

Singtel

4. In this case, the Commissioner of Taxation argued the effective overall interest rate exceeded arm’s length conditions.¹⁶² Originally the interest rate was to be equal to the Australian Bank Bill Swap Rate (BBSW) plus a margin of 1 per cent, with interest only payable after the lender issued a variation notice. In 2003 the agreement was amended to increase the premium to 4.552 per cent and the borrower was not required to pay interest until a profitability benchmark was met. Singtel argued the increase in premium was to compensate for the interest free period resulting from this benchmark.

5. This premium was later amended to a 6.835 per cent fixed component plus a margin of 1 per cent. The profitability benchmark was met earlier than expected, meaning the borrower paid more interest than would have been required under the original agreement. Singtel’s effective interest rate was 13.26 per cent following the third amendment to the agreement.

6. The Commissioner of Taxation issued notices of amended assessment disallowing interest deduction payments for the final three years of the agreement as the amendments were inconsistent with arm’s length conditions. The taxpayer objected to these assessments and brought an appeal before the Federal Court of Australia which was unsuccessful. A further appeal was made to the Full Court of the Federal Court of Australia and dismissed by a joint judgment on 8 March 2024.¹⁶³