CorssBorder Solutions’ Chief Economist Mimi Song sits down with Geoff Morris, a veteran of Australia’s ATO, who shares a revealing look into one of the world’s most aggressive tax authorities and how to remain in compliance with it.
Matthew DeMello: Australia, the land down under and home to perhaps the most aggressive tax authority on the planet in three letters that strike fear in the hearts of every multinational tax director, the ATO or Australian Tax Office. Aggressive of course, is an understatement. Nearly 200 multinationals have been hit with $2.5 billion in adjustments in fiscal year 2020 alone, with $1.5 billion of that amount being disputed by 26 different taxpayers.
It seems not even a global pandemic can slow this jurisdiction down, which would be one thing if the country’s transfer pricing rules better reflected OECD Guidelines. But perhaps what best exemplifies how Australia sticks out like a sore thumb in global transfer pricing is trying to find another country that requires as many as five years in the inter-quartile range of their economic analysis requirement.
So the short of it, this jurisdiction does not play around and they do not make it easy on anyone but themselves. It helps to have someone on the inside who can tell you how the Australian Tax Office looks at transfer pricing, and today we may just have that knight in shining armor. Today’s guest, Geoff Morris, is not just any veteran of the ATO. He led the Economist Practice at the agency for 10 years between 2010 and 2020, and he joins us today to share the wealth of that knowledge.
Mimi Song: Let’s dive right into it. I think your background is fascinating. You’ve been working with the ATO a long time, and being a founding member for transfer pricing within the ATO. You’ve had a long history there, but in your opinion, what makes working with the ATO on transfer pricing different than working with other tax authorities?
Geoff Morris: Bit of a loaded question. I could give all the dirt on the ATO and dirt on the other authorities I’ve seen, other tax jurisdictions I’ve seen as well, and I’ll add it over the course of this conversation. But I’d like to think that the ATO is more TP-aware, pragmatic and practical, possibly even commercial in resolving TP issues than some other jurisdictions. The ATO has been assisted by what is now a large economist team. They’ve got senior people with some depth of transfer pricing experience. They’re focused on the technical merits of a case, understanding function versus risk and choosing the right method and the right comparables and making the right adjustments.
But I think the ATO does also bear in mind the legal tests. You mentioned the attorney lens. Your view of the world is an important one that the teams do have to apply the tax law, but they also need to have an eye on what’s commercially realistic. Even though the law has to be met and there’s the TP technical analysis, the outcomes and the agreements and the resolutions to the audit still have to make commercial sense. I’d like to think the ATO takes those things into account, not all the time, because I know that that’s not the case, but hopefully I think they will take all of those three things into account more often than some other jurisdictions.
Mimi Song: But I would have to admit, I think Australia at this moment has a little bit of a reputation for being one of the more challenging tax authorities. Where do you think that reputation comes from?
Geoff Morris: That’s a good question. The approach I would take as part of my role in the economist practice and working with the auditors themselves is you’re better off asking for more, so ‘go-er’ adjustment than you can wholly justify, than asking only for what you think you can prove. Because part of the challenge here is that the TP analysis, even if it’s based on OECD Guidelines, it’s very hard to find the legal standard of proof or evidence to justify a position. And if it does come down to a commercial pragmatic view of a reasonable profit outcome in Australia, you’re better off asking for more and giving ground than not asking for enough and, as some of our early advisors would say, leaving money on the table.
The other thing I think that’s changed probably in the last 10 years or so is, the ATO made almost a conscious decision to move away from just pricing the arrangement as we found it. As we know, an agreement between related parties can say anything that the related parties want it to say. And if one just priced the arrangement as it was found, you possibly end up with arm’s length pricing of a non-arm’s length arrangement. They had to spend quite a bit of time up to 2010 looking at how the law worked, looking at how obviously the guidelines worked in this space, and they actually had lost a case that gave them some impetus to change the law. And back in 2010 they changed the law to allow the ATO to have much more scope to restructure the arrangements that the taxpayers had put on the table.
Because there’s been a large economist practice, when I left there was 80 economists. That’s quite a team. Not as big as the U.S. team I don’t think, but still quite significant. We spent a fair bit of time, not just doing the work, doing the risk reviews and doing the audits, but also spending a bit of time with the program managers thinking about how do we “solve” transfer pricing? What guidance can we give taxpayers? What tax alerts could the ATO issue? What practical compliance guidelines could we issue? What benchmarks could we make more plain? And as we say here in Australia, swim between the flags. If you’re a surfer, swimming between the flags will keep you from being sucked out to sea. It’s a safe place to swim. The ATO has spent a lot of time thinking about how to provide guidance to taxpayers on swimming between the flags.
And I think probably a final point here is that the ATO is seeing transfer pricing risk as something of a landscape. At one end, there’s fairly simple or straightforward inter-group services, senior admin services, and other evaluating services. And there’s distributors and there’s- … manufacturers of different sizes and types and so on. They’ve asked themselves a question, do we see all the transfer pricing risk in this landscape?
Mimi Song: How did the BEPS initiative play into the ATO’s viewpoint on transfer pricing? I think ATO was an early adopter of BEPS. There’s a question of how did it change, if anything, the ATO’s perception of transfer pricing and the potential commercial benefits of transfer pricing?
Geoff Morris: Maybe a little bit of a secret here. The ATO, because they had to spend a lot of time thinking about transfer pricing as a problem to solve and thought about the types of arrangements that the poor old economists, as it were, were forced to price, even though they thought some of those arrangements didn’t necessarily reflect what an arm’s length partner would do. One of their keys had already been along the lines of the BEPS action items 8 to 10 and other action items as well, so those items 8 to 10 didn’t really come as any surprise, I would say. And actually the ATO does spend a lot of time with the OECD on Working Party 6 and so on to make those initiatives be at least consistent with what the ATO is trying to do.
So those action items didn’t come in any surprise. In fact, they confirmed the kind of approach that the ATO was starting to adopt. And because those things were now written into the OECD Guidelines, the ATO saw merit in changing their law to refer to the 8 to 10 action items, which included some authority to restructure arrangements, for example. The landscape here, the political landscape, was the government needed revenue at that time. There was a lot of debate in the media about how much tax multinationals were paying. There was journalists working through multinationals’ Australian accounts to work out how much profit they made and how much tax they paid.
Mimi Song: It was like a witch hunt, right?
Geoff Morris: And it went on for years, quite a long time. As part of that, the government had felt it important to mention the 8 to 10 action items as part of their law, but also introduced a few other parts of law as well, one of which is the diverted profits tax, not necessarily a part of the regular income tax law but a part of the anti-avoidance provisions. So if a taxpayer entered into an arrangement with the object of reducing their tax liability, then the diverted profits tax would apply and the penalties were more significant, 40% of the tax. But it had actually a transfer pricing or an arm’s length component, so the taxpayer could demonstrate that the results were arm’s length so the diverted profits tax wouldn’t apply. But it wouldn’t necessarily mean that the OECD Guidelines were taken into account. It would just be a commercial realism analysis.
In addition to the DPT, the diverted profits tax, there was the MAAL as well, the multinational anti-avoidance legislation, which was really a set of laws or set of rules to encourage taxpayers to restructure payees so that they are recognized in Australia. They convert them to full subsidiary status, because what the ATO had seen before that was sales booked offshore and no local presence recorded at all.
Mimi Song: I was actually going to ask you whether or not there were other initiatives launched by the ATO for the purpose of identifying tax avoidance? What did you call it, the MAAL?
Geoff Morris: The MAAL, M-A-A-L, yeah. That was part of the broader program over a number of years, and it had different names but I think the last name when I left was the Tax Avoidance Task Force. We shared a couple of things. It actually founded the ATO, essentially doubled the number of auditors and economists able to do transfer pricing work, and also part of the larger program was the law change and the bringing in the updated OECD Guidelines into our law, ensuring that they were applied properly.
As part of that Tax Avoidance Task Force, there was a program of work around risk reviews and audits, where I think the top 100 largest taxpayers were reviewed every year, the next 1,000 taxpayers were reviewed every three years, and then taxpayers below that, of which there are about 500 or so, would be reviewed by the ATO’s risk algorithms, which relied on data from all the different sources, saying whether there was potential TP risk or not.
Mimi Song: What about the documentation? Is that a requirement in Australia? This has been an area that I think needs a little clarification.
Geoff Morris: Documentation per se is not mandated, but there are strong incentives to have contemporaneous documentation. If there was an audit started, and the ATO proposed an assessment, an adjustment to the tax return, then if there was no or inadequate TP documentation, then the rules would mean that the taxpayer would not be able to argue that they had a reasonably arguable position. It’s trying to ensure that the taxpayer makes an honest, a decent attempt to try and get an arm’s length transfer pricing price for whatever transactions is under review.
Mimi Song: And while it might not be compulsory, let’s look at it from the point of how it aligns with the OECD’s three-tiered approach, or differs. Can you tell us a little bit about the alignment or the differences with the OECD’s guidance?
Geoff Morris: Yeah. Obviously, the country-by-country report is required. The master file is required, and the local file is required. There are actually little differences with the Australian approach to the local file, because we’ve had an international dealing schedule, which is a schedule of all the related party dealings that the taxpayer has had over the last year with the significant jurisdictions. So for a long time, the ATO has had something slightly better than the local file anyway. There’s a little bit of coordination between the local file and the international dealings schedule there.
In addition to that, taxpayers who’ve got revenues in Australia of more than $250 million also have to complete the report of all tax position schedule as well. But the third part of that schedule is important. It’s actually a list of 26 questions, where the taxpayers have to disclose how they come up against some of the risk ratings from the practical compliance guides. For example, if the taxpayer is a distributor of goods purchased from a related party, then they need to disclose self-assessed what their risk rating is based on the practical compliance guide around the inbound distributor metrics. And that’s an important way for the ATO to decide whether the taxpayer is in the red zone, per those practical compliance guides. Obviously, no taxpayer really wants to put themselves in a red zone.
Mimi Song: Well, I was going to say, have you seen taxpayers perhaps change their internal policy so that they don’t have to indicate that they would fall in the red zone? But why would they do that to themselves?
Geoff Morris: It’s interesting, isn’t it? Because this is where transfer pricing gets more complicated, is Australia is a small country, 25 million people, not a big market in the scheme of things. Parents’ transfer pricing policies that apply for the rest of the world may not change just for the ATO. If a parent has got a transfer pricing policy, and they may have signed up APAs with other jurisdictions consistent with that policy in different countries around the world, but when it comes to Australia, they don’t want to change it. They might choose to disclose they’re in the red zone but have good documentation, or propose an APA or a bilateral APA, or a MAP even, that would allow them to get some kind of coverage or explain why their red zone result is still an arm’s length one. It’s an interesting leverage point the ATO is trying to push there. The traffic light says don’t do it. If you do do it, there will be consequences.
Mimi Song: I agree. I think it seems like it’s a pretty clever move by the ATO, because you’re essentially putting the onus on the taxpayer to indicate whether or not there is something to be evaluated. And then the ATO doesn’t have to necessarily invest any time and resources until they evaluate that risk assessment and they can target taxpayers accordingly.
Geoff Morris: Exactly. They can allocate their resources, and the compliance guide says if you’re in the red zone, we’re going to come and talk to you. There’s a big incentive for taxpayers to be prepared.
Mimi Song: The ATO has you do the work for them, right?
Geoff Morris: Yeah.
Mimi Song: It’s a great system. I’d like to bring it back full circle really quickly, in terms of documentation not being compulsory. But with all these additional requirements and the risk assessments and things of that nature that are compulsory, that require filing, in a lot of ways, you can’t get those forms completed without having the documentation. Am I right?
Geoff Morris: That’s right. They ask questions about what method have you used and so on, and to include the agreements. I’ve seen companies go without it and forget transactions, but it’s not a pretty outcome.
Mimi Song: No, definitely not. Why doesn’t the ATO just make the documentation mandatory if you really need it to be able to address all those forms, the tax forms?
Geoff Morris: That’s a good question, and it’s one that does come up occasionally, because it would make taxpayers’ lives just a little bit easier because they would actually know what the standard was and what boxes that they would need to tick, in a much more easy to understand. But the tax law in Australia is on a self-assessment basis. The onus is on the taxpayer to assess for themselves what their tax obligation is. And it’s the role of the Tax Office to collect the tax, as well as to check whether the law has been applied appropriately. It’s that after the fact, after the lodgement of the tax return, checking is what the ATO is focused on. To try to address that issue, why doesn’t the ATO be more explicit or transparent around the documentation requirements? The Practical Compliance Guides and the reportable tax position schedule, the idea is we’ll encourage the taxpayer to know that they have to do a fair bit to get their self-assessment to be really robust, yeah.
Mimi Song: Now let’s talk a little bit about benchmarking, because in this current post-BEPS environment, a lot of jurisdictions are requiring local benchmarks. And even before the BEPS initiative, I think Australia has always been a country that has preferred local benchmarks. Is that a preference or is that a mandate?
Geoff Morris: Definitely not mandated. It’s definitely preferred. Being a small country, there’s not a lot of independent operations. Thinking about distributors, there’s probably 10 or so independent distributors at any point in time that could be a viable company’s comparables qualitative screening to be included in a benchmark. The number is quite small, even on some of those basic activities other countries might take for granted. So the ATO will consider overseas comparable sets, but gee, they need to be on point. They need to be better than a rough standard applied just to Australia.
Mimi Song: Is there a tax authority preference of, and this might be on a case-by-case basis, but public versus private companies? Would you rather have private companies operating in Australia, or public company data operating in similar geographic markets?
Geoff Morris: Well, I think the ATO would prefer public companies. That’s almost the gold standard in independent benchmarks. But because the pool of comparables runs a bit shallow, the ATO will consider private companies as well if there is sufficient information knowable about those operations that make them at least as good as comparables as the public companies are. The economist practice made in the last few years, for a long time they preferred only public companies, because they weren’t confident in using the private company data. Often, information around those private companies was often insufficient to make a call on, but they’ve loosened this thing up a bit now, I think, and private companies can be included.
But having said that, you’d need to have a similar jurisdiction, you’d need to have a similar market, you would need to consider the differences in the markets the private company was used in, and one would need to have sufficient information around that private company to make a call on whether it was functionally-
Mimi Song: Sufficiently comparable.
Geoff Morris: … similar, yeah, especially around the risks. But some business models adopted by multinationals may be reasonably common offshore, but some of them are not common at all in an Australian setting. There can be the scope to include offshore comparables if they’re closer business models then what the Australian.
Mimi Song: I see this a lot when companies extend to regional comparables for purposes of benchmarking the Australian as a party. The consensus or the norm seems to be to expand it to the Asia-Pacific Region. You have a lot of Asian comparables that were considered to be similar in geographic markets. But personally, I think I can make an argument to say the Australian economy is more akin to North America.
Geoff Morris: The Asian markets can be quite a bit different from the Australian market. European and North American comparables, or companies I should say, often operate in a much more similar way to the Australian market. For example, in Japan, distributors, there might be three or four layers of distributors sometimes in some of the value chains. And depending on what distributor you talk about, what level of the value chain, the results could lead you down a path that wasn’t as sound as we’d prefer. Even if you have U.S. and European distributors, I think it’s better to give them less weight than Australian comparables.
Mimi Song: The ATO likes to see a multiyear analysis, and I think they’ve ultimately accepted or prefer five years, as opposed to a standard three. Any thoughts about why five versus three versus-
Geoff Morris: Well, it’s an interesting one, isn’t it? Because for a long time, the ATO did accept three or five-year multiyear averages. So in thinking about the multiyear analysis, I think the ATO likes to hedge its bets, put it that way, and do it a number of ways. We’ll do a three or five-year average for multiyear analysis, but we’ll look at extreme outcomes, so losses would attract attention.
But also in the ATO’s context, if they were to make an assessment, they would have to calculate the adjustment on an annual basis, so the ATO would need then to calculate what the adjustment is, not based on a three-year average but on what each individual year would need for it to become arm’s length. In the past, the good old days, in the early 2000s, the ATO would often negotiate a $100 million adjustment, and they’d just apportion it over the three years, whatever the audit period was. It made a bit of sense commercially and allowed the taxpayer to agree.
No one was really was fussed about how the numbers were allocated, as long as the end result was the same. Recently there’s been much more of a legal approach to the analysis, with the question, why is the result in that year not announced in the result, given what the comparables say, this is what the company’s commercial context is or was and so on? I think the three to five years might be much more common as a risk review tool, but certainly extreme results one way or another would attract a bit of attention. I’m just trying to understand why those things were the way they were.
Mimi Song: The ATO, I think we talked about this before, basically says that a taxpayer needs to show a reasonably arguable position. What is your advice for taxpayers on how to ensure that they’ve taken a reasonably arguable position?
Geoff Morris: Having a RAP is important, because the penalties can change quite quickly. But generally the taxpayer will need to set out what the actual conditions are relevant to the transaction, so what actually happened? what are the comparable circumstances? Identify the arm’s length conditions. Methods were used to identify the arm’s length conditions, so price is an arm’s length condition, but the taxpayer should also consider whether the other parts of the intercompany agreement are also arm’s length. They need to work out whether their transfer pricing position is appropriate, so they may need to make a judgment around whether the outcomes are consistent with how the law applies. And they also need to consider any changes or updates to both the transactions, to the circumstances, and to how the law works as well.
For most taxpayers, if they’re following the OECD Guidelines, then they’ll get there. But if they try to do it non-contemporaneous, then it could be doubtful whether they have a RAP. If they’ve just applied a number without a basis for it, without a comparables data, or that’s insulated from what third parties do, arm’s length parties do, then it can get a bit doubtful whether they have a RAP or not.
Mimi Song: Essentially, based in all those requirements, Geoff, I feel like the recommendation should be, “Don’t have any shortfalls in your documentation. Create robust documentation.”
Geoff Morris: That’s right. Make sure your documentation is absolutely perfect.
Mimi Song: That’s right. So Geoff, this is all extremely insightful, and I’m curious. Based on what you were saying before, what’s been the focus of the ATO these days during an audit?
Geoff Morris: What I need to explain to taxpayers is that in a way, the audit starts at the ATO’s risk assessment stage. The ATO would spend six to nine months working through all of the taxpayer’s TP documentation and trying to get an understanding of their business, and looking at the costs of goods sold, the cost of debt, the way intangibles are being treated, the cost allocations coming from headquarters and so on.
During the risk assessment stage for a top 1000 company, the ATO will get fairly detailed into what they like and what they don’t like. They point to individual transactions. But in trying to answer that question, I would say calendar year ’20, there’s been, I think, 14 developments around TP in the market.
There’s been two taxpayer alerts, for example. One of those has been on transfer pricing treatment of Australian-developed intangibles. Anything that the ATO announces like that, a taxpayer alert, a compliance guide, the treatment of some of the government’s subsidies resulting from the COVID crisis, anything the ATO has done that year, that’s what they will focus on in particular.
Mimi Song: So it’s a rolling challenge?
Geoff Morris: It’s a rolling challenge, but the ATO recently gave an update on its compliance program, and they’ve said in the year 2020, more than 180 companies have received assessments of A $2.5 billion, and there’s 26 of those that got assessments around A $60 million dollars or more, so there’s a lot of smaller adjustments in that total number as well. Most of those assessments have involved Singapore.
They’ve involved resource companies, so Australian minerals and gas and liquids being exported offshore through Swiss or Singapore trading arrangements. E-commerce, and there’s only a few of those companies, they’re in the spotlight. Pharmaceutical, health and science companies as well. Australian intangibles not being recognized as part of the profit outcome, which makes it challenging when one is looking at comparables, how to recognize Australian intangibles. Related party finance. Court cases, there’s two of those ongoing, which are important. The ATO would probably say that they wrote half the chapter X for their STD on finance arrangements.
Mimi Song: I think the Chevron case was a huge win for the ATO, and we can talk about that during a whole nother podcast.
Geoff Morris: Yeah. And that’s under appeal. It will be heard early next year. That’s an exciting time, with lots of new experts and lots of arguments. The other court case is SingTel-Optus, which is one of our two largest phone carriers here, owned by a Singapore company, and their related party finance arrangements is being challenged in the courts. Oil and gas, as I mentioned, is part of the Oracle marketing hub arrangements. The Glencore issue is a marketing hub arrangement, for instance. Royalties, where the royalty is embedded in payment for products. And still, the ATO is pursuing MAAL and TPT cases, so they’re still actively considering whether both the MAAL and the TPT could apply to some of the arrangements that they’re seeing.
Mimi Song: And do you think the ATO is going to continue to invest in resources and expand its team of economists or field editors or things of that nature?
Geoff Morris: Well, the Tax Avoidance Task Force provided significant funding for the ATO. Essentially, they doubled the staffing levels in this area. But that was a finite program, and if they have achieved results and if the risk is still there, then the government will have incentive, both politically and from a budget revenue perspective, to roll that funding over and continue to invest.
But I would say, the ATO sees in a way risk reviews and audits as a bit of a transactional approach. It lacks a broader strategic context, how to run a compliance program or how to manage the risk landscape, so they will still to continue to invest, I think, in practical compliance guides, taxpayer alerts that point to issues that they see around risky arrangements. And they’ll certainly build up their air quotes “body of knowledge.” As you were pointing out before, Mimi, corral taxpayers into doing the ATO’s work for them and over time manage down the level of risk from transfer pricing. So I think that’s the broader strategy there.
Mimi Song: And I think you had touched on this before. Given the current environment, with the global pandemic, I think the ATO had offered some guidance as it relates to transfer pricing. What are some of those recommendations?
Geoff Morris: Yeah, it’s an interesting one. The ATO released a couple of things, one of which was thinking about the pull of MAAL if we’re in the middle of a COVID crisis. Comparables won’t show their results from the COVID crisis for another year or two when their accounts are publicly available. But the taxpayers are doing their analysis now, trying to meet their tax obligations now. How should they adapt their transfer pricing policies for the current environment?
For some companies, the ATO has recommended that taxpayers undertake what’s described as a but for analysis. If the taxpayer can show but for the economic impacts of the crisis, they would’ve achieved arm’s length outcomes, then the ATO for this year would accept that those results were arm’s length.
To understand how to do that but for analysis, one has to think about what the revenue implications were, what the cost implications were, what kind of business planning was underway in the early part of the year, and so on, so it will be a little bit of an exercise for taxpayers to work out but for COVID-19 they would have had an arm’s length outcome.
Mimi Song: And then last but not least, can you tell us anything about the ATO’s JobKeeper Program?
Geoff Morris: The JobKeeper Program was a government subsidy for wages. They kicked in around March, and it was to last for, I think it was five months, six months. And they’ve just this week reduced the rate of the subsidy. It was $1,500 a fortnight for each employee, regardless of whether they were part time or full time, to keep the company afloat. But the subsidy was contingent on the business suffering a 30% decline in turnover, and they couldn’t be a billion dollar revenue business for example, and they couldn’t be a bank either to get the subsidy. But for a lot of companies, it was March, April period, it was what kept them afloat and kept them in business.
The government JobKeeper Program does raise some interesting transfer pricing questions around how should the transfer price take into account a government subsidy for wages? The government has released some guidance on this point. Specifically, they say that for services from Australia being charged offshore, then essentially the subsidy should be ignored, so the cost base would be the same, and the markup would be the same, and so the charge to the offshore affiliate would be the same as pre-COVID.
And that would not be problematic, I don’t think, for most taxpayers who were just providing headquarter services. But it might raise some issues for some taxpayers who have an Australian affiliate providing marketing or similar services to an affiliate, who would be reporting or recording sales from Australia. So in that sense, some of the e-commerce businesses might find that approach a little bit unusual, if they’ve suffered revenue impacts of their own and they couldn’t take into account, according to the ATO suggestion, the government wage subsidy.