The Australian Taxation Office (ATO) has added yet another acronym to the Australian tax lexicon in issuing Taxpayer Alert 2020/1 (Taxpayer Alert), which addresses international non-arm’s length arrangements that mischaracterise Australian activities connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets. The ATO’s alert is broad and may cover a number of arrangements but, based on the examples identified, it seems to be targeted at arrangements that ‘cherry-pick’ a particular characterisation based on their taxation outcomes.
The Taxpayer Alert highlights the ATO’s concerns involving the transfer of intangible assets that are developed or co-created in Australia, such as intellectual property (IP), to foreign jurisdictions.
What are the ATO’s concerns?
The ATO’s concerns are twofold – firstly, the selection of a particular type of payment (for example, services payment or royalty) to arrive at a particular tax outcome and secondly, the remuneration Australian entities receive in connection with the DEMPE of intangible assets (in accordance with transfer pricing principles of considering functions, assets and risks). As a subset of these issues, the ATO is also concerned with arrangements where intangible assets are migrated to international related parties as part of non-arm’s length arrangements. This means that the ATO will, therefore, be considering these arrangements under first principles (that is, whether the payments are royalties or simple use), under transfer pricing principles and under the General Anti-Avoidance Rule.
The ATO has identified arrangements of concern, which include, but are not limited to, the following arrangements involving the:
- bifurcation of intangible assets and mischaracterisation of Australian DEMPE activities; and
- non-recognition of Australian DEMPE activities.
The ATO has provided specific examples to illustrate the nature of the concerns. Interestingly, both examples involve research & development (R&D) arrangements being contracted to foreign related companies.
Example Arrangement 1
The first example is in relation to the bifurcation of intangible assets and mischaracterisation of Australian DEMPE activities. It involves an Australian company (AusCo), which enters into a contract R&D arrangement to provide services to an international related party (ForCo) associated with the DEMPE of new intangible assets that are intrinsically linked to existing intangible assets. ForCo owns all new intangible assets produced under the arrangement and derives all income generated from the exploitation of the new intangibles. AusCo continues to employ the same specialised staff and use its expertise and assets associated with the existing intangibles to manage, perform and control DEMPE activities associated with the new intangibles. AusCo continues to receive income derived from the exploitation of the existing intangibles but the value of the existing intangibles and income derived by AusCo from their exploitation declines due to the use of the new intangibles while reducing or ceasing DEMPE activities in connection with the existing intangibles.
AusCo’s remuneration under the contract R&D arrangement with ForCo is not reflective of the extent or character of functions performed, assets used and risks assumed by AusCo in connection with the new intangibles.
Example Arrangement 2
The second example is in relation to arrangements that involve the non-recognition of Australian DEMPE activities. It involves an Australian company (AusCo), which is party to a cost contribution arrangement (CCA) with a number of related foreign companies (ForCo). The CCA agreements (CCA Agreement) provide that the participants will contribute resources and perform activities associated with the DEMPE of intangible assets for the mutual benefit of all participants.
In substance, AusCo undertakes and manages extensive R&D activities relative to the other participants in the CCA, assumes associated risks, and develops and commercialises new intangible assets. AusCo uses assets, employs specialised staff, applies its specialist expertise to manage risks, and is subject to minimal direction and oversight from ForCo. ForCo employs limited staff and contributes limited funds and/or assets under the CCA. Limited contributions are also made by the other related foreign companies to the DEMPE of intangible assets under the CCA.
AusCo develops and enhances the valuable intangible assets, which are exploited by ForCo and the other related foreign companies party to the CCA Agreement to derive income. The benefits received by AusCo under the CCA Agreement do not reflect the value of AusCo’s contributions to the CCA including the extent or character of functions performed, assets used and risks assumed by AusCo in connection with the intangible assets covered by the CCA.
What is the ATO doing?
The ATO is reviewing these arrangements and engaging taxpayers who have entered into, or are considering entering into, these arrangements.
It is understood that the ATO is developing a Practical Compliance Guideline outlining its compliance approach in respect of cross-border arrangements involving intangible assets.
What should you do?
Taxpayers are encouraged to proactively analyse and review their cross-border arrangements that involve the development and exploitation of intangible assets and ensure they fall within the circumstances described in the Taxpayer Alert. Taxpayers that are considering entering into any new arrangements involving intangible assets should structure those arrangements with the ATO’s concerns in mind.