Transfer pricing for an Australian subsidiary: arm's length charges, records and reporting

Transfer pricing is the set of rules that decides whether the prices an Australian subsidiary pays to, or charges, its overseas group are acceptable for Australian tax. The core rule is in Subdivision 815-B of the Income Tax Assessment Act 1997: if the conditions between the subsidiary and a related party differ from what independent parties would have agreed, and that difference reduces Australian tax, the ATO substitutes arm's length conditions. The rules apply to every foreign-owned company, but the paperwork scales with size, from the ATO's simplified record-keeping options for smaller subsidiaries up to country-by-country reporting for groups with A$1 billion or more of global income.

This page explains how the rules apply to a typical subsidiary and what the board, including the resident director, should expect to see. It is general information. Transfer pricing is specialist work, so the pricing itself should come from a tax adviser with cross-border experience.

The arm's length principle in Subdivision 815-B

Subdivision 815-B works in two steps.

1. Is there a transfer pricing benefit? Under section 815-120, an entity gets a transfer pricing benefit if the actual conditions in its commercial or financial dealings with another entity differ from arm's length conditions, the dealings are cross-border, and with arm's length conditions its taxable income would have been greater, its losses or tax offsets smaller, or its interest or royalty withholding tax greater.
2. If so, substitute. Under section 815-115, the actual conditions are taken not to operate and the arm's length conditions are taken to operate instead.

Two further points matter in practice:

• Substance over form. Section 815-130 says arm's length conditions are identified by reference to the actual commercial or financial relations, having regard to both their form and their substance, and the form is disregarded where it is inconsistent with the substance. A contract that calls the subsidiary a "low-risk distributor" will not help if the subsidiary in fact carries the risks.
• OECD guidance. Section 815-135 requires the arm's length conditions to be identified so as best to achieve consistency with the OECD Transfer Pricing Guidelines. Australian practice therefore follows the familiar OECD methods.

The legislation itself is on the Federal Register of Legislation (Income Tax Assessment Act 1997, Division 815).

It is a self-assessment regime. The company is expected to have applied the rules when it lodges its return, not to wait for the ATO to raise it.

Typical intercompany dealings for a subsidiary

Most foreign-owned subsidiaries have some mix of the following. Each needs a price that can be explained.

For loans and capital, see funding an Australian subsidiary.

Management fees and service charges to the parent

Management fees are the dealing that most often appears in a young subsidiary's accounts and that directors are least able to explain. The questions to ask are simple:

• What services did the Australian company actually receive? Can someone list them?
• Would an independent company have paid for them, or are they things the parent does as shareholder (group board costs, investor reporting, the parent's own compliance)?
• How was the charge calculated? On what cost pool, with what allocation key and what mark-up?
• Is there a written intercompany agreement that matches what happens?
• Is the charge consistent with what the parent reports in its own country?

A fee that wipes out the subsidiary's profit every year, or that is set as a round percentage of Australian revenue without a cost basis, is the kind of pattern that invites questions.

Documentation and penalty protection

Australian law does not make transfer pricing documentation compulsory. It makes it the price of penalty protection.

Under Schedule 1 to the Taxation Administration Act 1953, a particular way of applying Subdivision 815-B is not treated as reasonably arguable, for administrative penalty purposes, unless the documentation requirements in section 284-255 are met. The ATO's IDS instructions explain this link. Section 284-255 requires records that, among other things:

• were prepared before the time by which the company lodges its income tax return for the year
• are in English, or readily accessible and convertible into English
• explain the particular way Subdivision 815-B applies (or does not apply) to the dealing
• explain why applying it that way best achieves consistency with the OECD transfer pricing guidance that section 815-135 points to.

Without a reasonably arguable position, any shortfall the ATO finds on a transfer pricing adjustment attracts a higher base penalty. Records must already exist when the return is lodged, so documentation put together later, for example once the ATO starts asking questions, does not meet the timing requirement.

The ATO's view of what the records should cover is in Taxation Ruling TR 2014/8. The IDS instructions summarise its five questions: what the actual conditions are, what comparable circumstances are relevant, what methods were used, what the arm's length conditions are and whether the treatment is appropriate, and whether material changes have been identified and documented.

The ATO's simplified record-keeping options

For smaller and simpler groups, the ATO offers simplified transfer pricing record-keeping options in Practical Compliance Guideline PCG 2017/2. If the company is eligible and elects an option, the ATO says it will generally not review the covered dealings for transfer pricing purposes beyond checking eligibility. The current version applies to income years starting on or after 1 July 2018.

There are 7 options. In outline:

Most options also require that the company has not made sustained losses (the distributors option has no sustained-loss test; it uses the 3% profit ratio instead), has not restructured in the year and has assessed its compliance with the transfer pricing rules. The loan rates are updated for each income year, so check PCG 2017/2 for the year you are in.

Electing an option does not switch the rules off. The ATO's guidance says the rules apply whether or not you are eligible or choose an option, and you still need ordinary records under section 262A of the Income Tax Assessment Act 1936. You elect by entering documentation code 7 against the relevant dealings in the international dealings schedule.

A common mistake is treating the management fee as covered by the low value-adding services option without checking the mark-up and the 15% tests, or overlooking that royalties above $500,000 knock out the small taxpayer option for everything else.

The international dealings schedule

A company with more than $2 million of international related-party dealings in a year must lodge an international dealings schedule (IDS) with its tax return. It reports dealings by type and amount, the methods used and how much is documented. See company tax obligations for foreign-owned companies for how it fits with the rest of the return.

Significant global entities

The significant global entity (SGE) concept decides which groups face Australia's larger-multinational rules. From income years starting on or after 1 July 2019, an entity is an SGE if it is a global parent entity with annual global income of A$1 billion or more, or a member of a group (consolidated for accounting purposes, or a notional listed company group) headed by such a parent. The ATO notes that exceptions to consolidation and materiality rules are disregarded for this purpose.

The test is group-wide. A three-person sales office of an A$1 billion group is an SGE. SGEs may be subject to:

• the multinational anti-avoidance law
• the diverted profits tax
• increased administrative and other penalties.

Country-by-country reporting

Separate from SGE status, a CBC reporting entity (Subdivision 815-E) has country-by-country reporting obligations. Broadly, that is a parent with annual global income of A$1 billion or more, or a member of a group with such a parent. For income years starting on or after 1 July 2019, the obligations depend on whether the entity was a CBC reporting entity for the whole or part of the previous income year.

The ATO's CBC page sets out three statements:

• CBC report: the group's revenues, profits and taxes by jurisdiction
• Master file: the group's operations and activities
• Local file: the Australian entity's international related-party dealings.

All three must be lodged within 12 months of the end of the reporting period, as XML files. The local file and master file use an ATO schema and can be lodged together; the CBC report is lodged separately. In practice the parent often supplies the CBC report and master file, and the Australian company is responsible for the local file. Some CBC reporting entities may also need to give the Commissioner a general purpose financial statement; see financial reporting for foreign-controlled companies.

Public country-by-country reporting

Australia now also requires certain large groups to publish selected tax information. According to the ATO, a Public CBC reporting parent is, in summary, the top entity of a CBC reporting group with annual global income of $1 billion or more, that was a CBC reporting parent for the preceding period, is (or has trustees or partners that are) a constitutional corporation, has an Australian resident group member or an Australian permanent establishment, and has $10 million or more of Australian-sourced aggregated turnover, unless exempted.

Key points for a foreign-owned subsidiary:

• The obligation rests with the global parent, whether located in Australia or overseas. An Australian subsidiary of a foreign entity does not generally have its own Public CBC obligation, unless it is left out of the group's consolidated accounts and qualifies as a parent in its own right.
• The report is given to the ATO in an approved XML form within 12 months after the end of the reporting period, and the ATO publishes it on data.gov.au.
• The first reports, for periods ending 30 June 2025, were due by 30 June 2026. For reporting periods of 1 January 2025 to 31 December 2025, the ATO has extended the deadline to 29 January 2027.
• The ATO describes the penalties for late lodgment as significant and aligned with other SGE penalties.

What the resident director should see and approve

A resident director does not price intercompany dealings, but the board is responsible for the company's tax position and its accounts. Reasonable things to ask for each year:

1. A list of all related-party dealings with amounts, matching the accounts and the IDS.
2. Signed intercompany agreements for each recurring dealing, approved by the board, that describe what actually happens.
3. The documentation position: full documentation meeting section 284-255, or a simplified option under PCG 2017/2 with the eligibility working, prepared before the return is lodged.
4. The SGE and CBC status of the group, confirmed in writing by the group tax team, and who is preparing the local file.
5. An explanation of any management fee or royalty that materially reduces Australian profit.
6. Board minutes recording that these were reviewed. See company record keeping.

Directors should be cautious about signing off accounts or a tax return that relies on intercompany charges nobody in Australia can explain. Our director duties guide covers why. If the group directs pricing from overseas without board involvement, that also bears on where the company is managed; see central management and control.

Where we fit

AG Resident Directorship provides resident directors and company secretarial support. We don't prepare transfer pricing analysis, but we do ask for the items above, keep the board record, and flag dealings that need an adviser's attention. See pricing or start here.

General information about Australian law and practice, not legal or tax advice for your circumstances. Check the official sources, or ask your adviser, before you act.