Top 100 income tax assurance program

Overall levels of assurance

As of 30 June 2023, over half (52%) of top 100 taxpayers have attained overall high assurance (justified trust). This means that we have obtained assurance that these taxpayers have paid the right amount of Australian income tax for the year reviewed.

The overall level of assurance is based on an objective view (having regard to objective evidence) of whether the taxpayer is considered to have paid the right amount of tax.

Ratings

We apply consistent rating categories when considering our overall level of assurance.

Rating categories

Colour indicator	Rating	Category description
	High	We obtained assurance that you paid the right amount of Australian income tax or reported the right Australian income tax outcomes for the income year reviewed. You can therefore rely on a high assurance rating to mean that we will not initiate any review (including assurance) or audit activity for the income year reviewed in relation to the relevant issues in the return reviewed (other than any issues listed in the future assurance plan or similar work plan, as requiring further review) unless in exceptional circumstances.
	Medium	We obtained assurance in relation to some but not all areas reviewed. For those areas not yet assured, further evidence or analysis will be required before we obtain assurance that you paid the right amount of Australian income tax for the income year reviewed.
	Low	We have specific concerns around your compliance with the Australian income tax laws and the amount of Australian income tax paid for the income year reviewed.

The reviews completed to the end of June 2023 resulted in the following ratings.

Graph 1 – Overall assurance ratings for the last income tax reviews completed as of 30 June 2023

Note: All outcomes data used in this report in relation to income tax is based on the last review completed, which can include:

• a standard justified trust review
• monitoring and maintenance review
• Annual Compliance Arrangement (ACA) review
• refresh year review.

Not rated is applied to taxpayers who are yet to complete a full Justified Trust review across all 4 focus areas.

Graph 2 – Overall assurance ratings for the last income tax reviews completed by industry as of 30 June 2020, 30 June 2021, 30 June 2022 and 30 June 2023

Note:

• These groupings align with the industry segments we use as part of the Corporate Tax Transparency Reporting except where we have amalgamated the Banking, Finance and Investment (BFI), Insurance (ISR) and Superannuation (SUP) segments into a Financial Services (FS) segment. The groupings are:  
  • Banking, Finance and Investment, Superfunds and Insurance (FS)
  • Manufacturing, Construction and Agriculture (MCA)
  • Mining, Energy and Water (MEW)
  • Wholesale, Retail and Services (WRS).
   
• The population depicted in Graph 2 comprises taxpayers in the current top 100 population during the 2021, 2022 and 2023 income years and does not include those that have exited the population as of 30 June 2023. The data for the 2020 income year however includes all top 100 reviews completed during those years, including reviews relating to taxpayers who have exited the population as of 30 June 2023.

Observations

For top 100 taxpayers who have had more than one TAR issued, over 59% have increased their overall assurance rating between the first and last TAR issued.

We have seen a marked increase in the number of taxpayers achieving overall high assurance with a shift from 6% in 2019 to 51% in 2022. During 2023 the number of overall high assurance taxpayers increased incrementally to 52% with 83% of top 100 taxpayers reviewed up to 30 June 2023 having obtained either an overall high assurance rating or an overall medium assurance rating.

The number of taxpayers at overall low assurance has continued to decrease in 2023 to 13%.

Taxpayers continued to pro-actively engage with us during the year to progress and finalise the assurance reviews. Taxpayers have also developed a better understanding of the justified trust principles (particularly those relating to governance) and continued to make efforts to provide objective evidence to support a higher rating.

We have also been much more deliberate in setting out our assurance findings succinctly in the TAR. We clearly set out the areas of concern, governance gaps and enhancements and how taxpayers can practically improve their assurance ratings. These reports are complemented by the annual ADF letters where we highlight to senior executives any areas of concern requiring resolution. We also work with taxpayers to prioritise issues that can improve their overall assurance rating.

High assurance taxpayers

We have again seen a small increase in 2023 in the number of top 100 taxpayers achieving overall high assurance with a shift from 51% to 52%. This reflects improved assurance ratings from taxpayers in the following sectors: Mining, Energy and Water (MEW), Banking, Finance and Investment and Wholesale, Retail and Services (WRS) industries.

In limited circumstances, we may give an overall provisional high assurance rating. Such circumstances may include where the taxpayer has provided an undertaking and is actively working on addressing a specific design gap in their tax governance framework, or there is ongoing compliance activity.

There were 12 taxpayers in the current top 100 population who had a provisional high assurance rating as of 30 June 2023. A main reason for a provisional rating is because the taxpayer had not yet developed a periodic tax control testing plan in relation to their governance framework at the time of the rating. This is because the testing plan is usually developed closer to the time of the testing which may occur after the issuance of the TAR depending on the organisation’s internal review cycle. Another main reason is because of ongoing compliance activity.

Some taxpayers who had provisional high assurance have been able to complete the required work and improve their assurance rating to unqualified high assurance. To date, there are no taxpayers who have dropped from an overall provisional high assurance rating to a lower overall assurance rating.

Acknowledging the complexities of tax law, taxpayers may still achieve overall high assurance notwithstanding they are in dispute with us about a particular matter. For example, a difference in technical interpretation as to the correct tax treatment of a transaction entered in the ordinary course of their business. This assumes that all other areas have achieved an appropriate assurance rating (see ‘Obtaining high assurance’ below). However, if the matter being disputed relates to a material systemic issue or features elements of profit shifting or tax avoidance, or we have concerns about behaviour, the taxpayer will rarely achieve overall high assurance.

During 2023, we completed 15 monitoring and maintenance reviews bringing the total to 55 monitoring and maintenance reviews for taxpayers in the current population. We also completed 3 Annual Compliance Arrangement (ACA) reviews during 2023 bringing the total to 7 ACA reviews for taxpayers who have attained overall high assurance. These reviews resulted in all the taxpayers maintaining their justified trust ratings.

During 2023, we completed 11 refresh reviews for taxpayers in the current population. These reviews enabled us to refresh our understanding and evidence base and reaffirmed our confidence that these taxpayers continue to pay the right amount of tax.

We expect that we will continue to have more taxpayers attain overall high assurance in time. This assumes that these top 100 taxpayers provide the required objective evidence to support the high assurance outcome, and we do not identify any new or further issues in the reviews. However, we do not expect that the entire population will achieve high assurance due to ongoing concerns about systemic tax risk of a small number of entities in the group.

This improvement will primarily come from the cooperation of the ATO and taxpayers in achieving timely completion of the planned assurance reviews for the year, and taxpayers actively addressing the areas of concern set out in the future assurance plans contained in the TARs. This is also dependent on potential movements in the composition of the top 100 population (which is moderated each year), and taxpayers continuing to maintain their overall high assurance ratings in the refresh reviews.

Medium assurance taxpayers

In 2023 31% of top 100 taxpayers attained an overall medium level of assurance. This means that we obtained assurance in most areas reviewed. This reflects, to some degree, the complexity of large businesses and signals there is still more to do in some cases. Further work can include actions by taxpayers to address areas of concern or information gaps identified. It can also include actions by us to conduct further assurance activities on specific issues or on a greater proportion of the taxpayer’s economic activities.

In practice, the main blocker to taxpayers achieving overall high assurance is demonstrating design effectiveness of their governance framework. Other key blockers include:

• the display of what we perceive to be non-cooperative behaviours
• non-assured matters relating to tax risks flagged to market
• significant transactions that require further information to be provided to us
• analysis to be conducted by us.

Low assurance taxpayers

In 2023 the percentage of top 100 taxpayers at overall low assurance continued to decrease to 13%. We consider most of these taxpayers to have a higher risk profile and to be typically involved in complex and numerous tax disputes. We generally have significant concerns around their compliance with the Australian income tax laws. A small number of overall low assurance taxpayers are new entrants to the top 100 population and received their first year TAR in 2023.

We will comprehensively and intensively review overall low assurance taxpayers and are more likely to use audits to progress the resolution of issues.

We were able to work with a small number of top 100 taxpayers to improve their overall assurance rating from low to medium assurance in 2023. This was a positive outcome for the taxpayers and the justified trust program. It demonstrates that where the ATO and taxpayers are fully engaged and transparent, it can lead to the efficient resolution of even the most complex issues or disputes to the benefit of both the taxpayer and the administrator.

Overall, low assurance taxpayers typically have a combination of low and red flag assurance ratings across the 4 justified trust focus areas that prevent them from attaining a higher level of overall assurance. Resolving the higher risk tax issues (such as those which go the heart of their tax infrastructure), as well as making improvements to the design effectiveness of their tax risk management and governance frameworks, will likely see these taxpayers increase their overall assurance ratings.

Tax governance framework

Tax governance is a key focus area under the justified trust methodology for large public and multinational businesses.

We consider the existence, design and operation of a tax control framework for income tax and GST focusing on the 8 controls set out in the Tax risk management and governance review guide and the GST Governance, Data testing and Transaction Testing Guide (collectively, the Guides).

1. Board-level control 1: Formalised tax control framework
2. Board-level control 3: The board is appropriately informed
3. Board-level control 4: Periodic internal control testing
4. Managerial-level control 1: Roles and responsibilities are clearly understood
5. Managerial-level control 3: Significant transactions are identified
6. Managerial-level control 4: Controls in place for data
7. Managerial-level control 6: Documented control frameworks
8. Managerial-level control 7: Procedures to explain significant differences

The Guides:

• set out principles for board-level and managerial-level responsibilities, with examples of evidence that demonstrate the design and operational effectiveness of tax control frameworks
• focus on the processes and controls in place and may not necessarily reflect the tax risk appetite or capabilities and experience of the tax or finance team, or their advisers.

Ratings

We apply the following staged rating system when reviewing and assessing tax governance. For practical guidance about how we rate tax governance, see Reviewing tax governance for large public and multinational businesses.

Staged rating system

Colour indicator	Rating	System description
	Stage 3	You provided evidence to demonstrate that a tax control framework exists, has been designed effectively and is operating effectively in practice.
	Stage 2	You provided evidence to demonstrate that a tax control framework exists and has been designed effectively.
	Stage 1	You provided evidence to demonstrate a tax control framework exists.
	Not evidenced or concerns	You have not provided sufficient evidence to demonstrate a tax control framework exists or we have significant concerns with your tax risk management and governance.

The reviews completed to the end of June 2023 resulted in the following ratings which have been grouped by industry.

Graph 3 – Overall governance ratings for the last income tax reviews completed as of 30 June 2023

Graph 4 – Overall governance ratings for the last income tax reviews completed by industry as of 30 June 2020, 30 June 2021, 30 June 2022 and 30 June 2023

Observations

During 2023 we observed continued improvement in governance reflecting the efforts of many taxpayers to enhance their tax control frameworks, provide objective evidence in support of their governance policies and processes, and undertake testing of their tax control frameworks.

A notable shift in 2023 is in the number of taxpayers attaining the highest rating for tax governance (Stage 3) from 12% to 20%. This means that 72% of the top 100 population have at least a well-designed and effective tax governance framework because they have obtained a Stage 2 or Stage 3 rating. We expect that this will result in less incorrect reporting of income tax, and a greater alignment between an organisation’s tax risk appetite and their risk framework.

Stage 1

A Stage 1 rating recognises that a tax control framework exists but reflects that further work is needed to demonstrate that the framework is designed effectively. Most top 100 taxpayers have provided objective evidence that a tax control framework for income tax exists.

For income tax, 26% of taxpayers were assigned a Stage 1 rating for the year ended 30 June 2023 compared to 29% for the year ended 30 June 2022. The decrease in the number of taxpayers at Stage 1 can be attributed to taxpayers providing us with objective evidence addressing their design gaps.

We continue to work with those top 100 taxpayers with a Stage 1 rating to progress to a Stage 2 rating as part of current and future reviews. In this regard, tax return preparation procedures, tax provision procedures (relevant to procedures to explain significant differences between accounting and tax), and the periodic internal controls testing program continue to be the common areas with limited formal documentation.

In particular, we note that although some taxpayers have documented their income tax controls, they have not documented a plan as to when and how frequently, their income tax controls will be tested by an independent tester (rather than the control owner), will undertake income tax control testing. This remains a key blocker to taxpayers achieving a Stage 2 rating.

Stage 2

A minimum Stage 2 rating is required to achieve an overall high assurance rating or justified trust. This means taxpayers have provided objective evidence to demonstrate that a tax control framework exists for income tax and has been designed effectively.

For income tax, 52% of taxpayers were assigned a Stage 2 rating for the year ended 30 June 2023.

When reviewing governance for Stage 2, we will leverage existing processes or identify compensating controls where the better practice elements are either not present or only partially present.

An increasing number of top 100 taxpayers at Stage 2 are working with us to demonstrate that their tax control framework is not only designed effectively but also operating effectively, to proceed to the next rating (Stage 3). Some taxpayers choose to maintain a Stage 2 rating, which is a satisfactory rating.

Stage 3

To obtain the highest rating (Stage 3), we look for evidence that the documented tax control framework is both designed and operating effectively in practice. This stage requires evidence in the form of a detailed report of findings that demonstrates taxpayers have independently tested the operation of their framework in practice and should conclude that the documented tax control framework is operating effectively.

Where the report of findings recommends improvements or enhancements, we will seek to understand whether these have been (or will be) implemented before assigning a Stage 3 rating.

We have seen a noticeable increase from 12% in 2022 to 20% in 2023 in taxpayers being assigned an overall Stage 3 rating this year. Their boards, shareholders and other stakeholders can be confident that there is an independent assessment on the operating effectiveness of their tax control frameworks.

We note that some taxpayers are testing their income tax controls over a 3 to 5 year period and are not expected to be assigned an overall Stage 3 rating until testing has been completed and the results have been provided to us at the conclusion of the 3 to 5 year period, to support the operating effectiveness of their frameworks.

Red flag

A red flag rating is only applied after careful consideration if we have:

• no evidence demonstrating that a tax control framework exists
• significant concerns with the taxpayer’s tax control framework as evidenced by the high level of errors identified
• fundamental concerns about the robustness of existing tax controls.

There remains a small percentage (2% in 2023) of top 100 taxpayers that have been assigned a red flag rating for income tax governance.

Not rated

This rating is only applied in the top 100 program in limited circumstances for income tax governance. The reasons for this vary but include large scale mergers and acquisitions, and where the tax control framework was being substantially redesigned and the changes were so significant that it was appropriate to defer our assessment to the following review. In these circumstances, we typically review the governance framework in the following year.

No taxpayers were assigned this rating in 2023.

Tax risks flagged to market/Significant or new transactions/Specific tax risks

We seek to understand, and review, the income tax treatment of the taxpayer’s business activities, particularly significant and new transactions. We also look for, and review, risks or concerns communicated to the market, and determine if they are present.

Ratings

We apply a consistent rating system when reviewing and assessing the income tax treatment of a taxpayer’s business activities, including significant and new transactions and tax risks communicated to the market.

Staged rating system

Colour indicator	Rating	System description
	High	With respect to this issue, we obtained a high level of assurance that the right Australian income tax outcomes were reported in your income tax return. You can therefore rely on a high assurance rating to mean that we will not initiate any review (including assurance) or audit activity for the income year(s) reviewed in relation to this issue in the return reviewed (other than any issues listed in the future assurance plan or similar work plan, as requiring further review) unless in exceptional circumstances.
	Medium	More evidence and or analysis is required to establish a reasonable basis to obtain a high level of assurance.
	Low	More evidence and or analysis is required to determine whether a tax risk is present.
	Red flag	Likely non-compliance with the income tax law.
–	Out of scope	We have not evaluated this item and not expressed a rating.

Observations

The assurance areas covered in the analysis for tax risks flagged to market, and significant and new transactions often have material tax consequences if they have been incorrectly treated or calculated for tax. Typically, other than governance, this is where most of our time during the review is spent to obtain higher levels of assurance. This also has a significant impact on the overall assurance ratings.

Many top 100 taxpayers have arrangements that are covered by a public advice and guidance product (such as a Practical Compliance Guideline, Taxpayer Alert or Public Ruling). Where a public advice and guidance product may be applicable, our approach is to seek to understand the arrangement to determine the presence of risk, and to work with the taxpayer to mitigate or address any risk. We expect the ratings for these areas to improve over time as the assurance review is completed or, if there is a dispute underway, when that dispute is resolved.

The largest public and multinational companies are required to disclose in the Reportable Tax Position (RTP) Schedule information on uncertain tax positions and arrangements that are considered to pose a systemic risk to the corporate tax base. These arrangements often involve tax avoidance or profit shifting (or both).

The latest Findings report Reportable tax position schedule Category C disclosures provides the aggregated disclosures made by companies for the 2021–22 income year. The report provides insights to the types of arrangements large companies are entering, including arrangements in addition to those outlined below. In 2020–21, arrangements which were not subject to a risk assessment or tax impact calculation in accordance with the relevant Practical Compliance Guideline were separated from the high risk category and captured under a new category, ‘PCG not applied’ that has continued in the 2021-22 year.

The following Reportable tax position schedule Category C disclosures have been made by top 100 taxpayers in the 2021-22 year.

2022 Top 100 disclosures

RTP PCG related questions	High risk	High risk – PCG not applied	Medium risk	Low risk	White zone	Not disclosed	Not low risk	Total
Marketing hubs (question 9)	3	2	5	24	8	1	–	43
Non-core procurement hubs (question 9)	–	1	–	13	56	–	–	70
Related party financing (question 14)	22	2	26	93	13	2	–	158
Related party financing derivatives (question 23)	–	–	6	9	1	–	–	16
Inbound distributions (question 24)	7	3	2	5	–	1	–	18
Maximum allowable debt (question 37)	2	–	4	1	2	–	–	9
Hybrids (question 22)	–	–	–	–	–	–	1	1
Hybrid mismatch (question 39)	10	–	–	112	–	–	–	122

As part of our top 100 assurance reviews, we check on an annual basis, the accuracy and completeness of disclosures made by top 100 taxpayers in tax returns, accompanying schedules (including the RTP Schedules), country-by-country (CBC) reporting statements and financial statements. We also follow up on disclosures in the RTP Schedules relating to unamended mistakes or omissions in tax returns.

The following sections outline specific areas of concern and items that attract our attention. We do not see these in all cases.

We have also included, where applicable, information on the RTP Schedule disclosures made by top 100 taxpayers for the 2021–22 income year under Category C in relation to these areas of concern or items that attract our attention.

We have further observed that many taxpayers who have previously entered into multiple new high risk arrangements that require resolution via audits, now either have no new tax risks flagged to market or, if there is a potential application of a public advice and guidance product, the new tax risks flagged to market either fall in the low risk zone or have been given high assurance. This is consistent with our observations about taxpayers committing to long term behavioural change. We expect that as more of our population reaches overall high assurance or overall medium assurance, the number of new tax risks flagged to market that are characterised as high risk arrangements and require resolution via audits will also decrease.

Transfer mispricing

Transfer pricing is a natural feature of the international tax system, requiring entities to deal with related parties on arm's length terms. Our concern is transfer mispricing, which is where transactions are mispriced, resulting in the tax base being shifted from Australia. This is a particular risk in a country like Australia, with large cross-border capital and transactional flows. As such, the validity of transfer pricing is a common assurance area with approximately 88% of top 100 taxpayers reporting related party dealings in the 2021-22 income year. This area encompasses a substantially large number of dealings, the nature of which can range from simple to very complex.

The following is a breakdown of the typical transfer pricing areas reviewed across a range of dealings.

• International related party financing transactions including arm’s length conditions, related party derivatives, interest free loans (outbound and inbound), cash pooling arrangements and guarantee fees.  
  • Related party loans continue to be a key focus area and represent the highest proportion of unassured items that attract a red flag rating for the top 100 population. Over 11% of the related party financing transactions reviewed attracted a red flag rating, with a further 13% attracting a low assurance rating. Despite this, we have observed that over time about 20% of the related party financing transactions reviewed have resulted in improved assurance ratings.
  • Category C RTP Schedule disclosures by all public and multinational businesses from 2017–18 to 2020–22 on related party financing arm’s length conditions show a positive trend that taxpayers are entering into fewer arrangements or transitioning from high risk to low risk arrangements. Similarly, the number of high risk arrangements pertaining to related party financing derivatives has decreased since 2018–19.
  • From 2019–20 to 2021–22, the number of high risk and medium risk Category C RTP Schedule disclosures for related party financing transactions as self-assessed by top 100 taxpayers has reduced, with the majority of transactions rated as low risk (about 59%). While overall there is a reduction in medium risk transactions there was a small increase in the 2021-22 year. About 8% fell within the white zone. There were no high risk disclosures relating to derivatives in 2021–22 by top 100 taxpayers. The majority of disclosures by top 100 taxpayers were medium risk (38%) and low risk (56%) for derivatives transactions in 2021–22. Where taxpayers need to self-assess their risk rating against Practical Compliance Guideline PCG 2017/4 and they are unable to (or choose not to) self-assess, they can expect us to closely review their related party financing arrangements.
   
• Offshore hubs (marketing or procurement) or service centres  
  • Most of the offshore centralised operating models that were reviewed (hubs covering marketing and non-core procurement activities) attracted a high assurance rating or medium rating. We have observed that over time an increasing number (about 29%) of the marketing hubs and non-core procurement transactions reviewed have resulted in improved assurance ratings.
  • Category C RTP Schedule disclosures by all public and multinational businesses from 2017–18 to 2021–22 relating to marketing hubs show that the proportion of self-assessed risk ratings has remained relatively stable for the low risk category. The medium risk disclosures had increased with a corresponding reduction in high risk disclosures from 2018-19 to 2021-22 but have decreased slightly in 2021-22. In 2021-22 high risk and PCG not applied categories have increased slightly (noting that in 2020–21 high risk disclosures halved due to the introduction of the new category, ‘PCG not applied’ and this has also carried on in the 2021-22 year). Where a taxpayer indicates 'PCG not applied' their hub will generally be rated as being in the red zone, meaning it will be rated as being 'high risk' requiring ATO investigation.
  • Category C RTP Schedule disclosures for 2020–21 and 2021–22 by top 100 taxpayers relating to marketing hubs have remained relatively consistent over the 2 years, with a high proportion (56%) disclosing low risk ratings pursuant to Practical Compliance Guideline PCG 2017/1 in 2021-22. About 19% fell within the white zone.
  • There were no high risk disclosures for non-core procurement transactions by top 100 taxpayers in 2021-22, with most disclosures in the white zone (80%) and low risk (19%).
  • The high proportion of disclosures of low risk ratings for marketing hub arrangements reflects the efforts that have been made by us and top 100 taxpayers (who are responsible for the majority of Australian exports sold through marketing hub arrangements) to resolve our concerns through Advance Pricing Arrangements (APAs) or settlements. A small number of material arrangements are subject to ongoing compliance action.
   
• Inbound distribution arrangements  
  • Category C RTP Schedule disclosures by all public and multinational businesses from 2019–20 to 2021–22 relating to inbound distribution arrangements show a decrease in high risk arrangements (20% in 2022). However, the number of arrangements where the PCG has not been applied has increased over this period (13% in 2022). Where the risk framework in Practical Compliance Guideline PCG 2019/1 applies to a taxpayer's inbound distribution arrangement and they are unable to (or choose not to) self-assess, they can expect us to closely review their arrangement. Medium and low risk arrangements remain stable and make up most of the disclosures (at 33% each).
  • In 2021-22 there was a slight increase in Category C RTP Schedule disclosures for high risk inbound distribution arrangements as self-assessed by top 100 taxpayers under Practical Compliance Guideline PCG 2019/1 from the prior year, but the overall trend indicated a decrease since 2019-20. Disclosures relating to medium and low risk transactions have remained relatively consistent. 17% of disclosures were for the PCG not applied category.
   
• Intangible assets and non-arm’s length arrangements  
  • We continue to observe that the performance of the development, enhancement, maintenance, protection and/or exploitation (DEMPE) activities is not well documented or evidenced.
  • There was one Category C RTP Schedule disclosures by a top 100 taxpayer in 2021–22 relating to deductions for expenses incurred under an arrangement with offshore parties using intangible assets held by an offshore party as described in Taxpayer Alert TA 2018/2.
  • There was one top 100 disclosures for non-recognition or mismatch of activities connected with the DEMPE of intangible assets as described in Taxpayer Alert TA 2020/1.
   
• Inbound and outbound supplies of goods and services  
  • Related party sales is a focus area for us and represents the second highest proportion of unassured items that attracted a red flag rating for the top 100 population in 2022.
   
• Management, administrative and technical services  
  • We continue to observe that the beneficial nature of services and the appropriateness of allocation keys are not well documented or evidenced.
   
• Insurance or reinsurance
  • Where we identify related party dealings in reinsurance, we review the arm's length nature of these.
   
• Research and development (R&D) performed on behalf of overseas related party.

Common issues which continue to arise in relation to transfer pricing matters include the following.

• The inadequacy of information available to support transfer pricing positions.
• The size and complexity of the global value chain in the top 100 population – top 100 taxpayers often have very complex businesses and Australia can be a significant part of the value chain. We are finding it takes time to source relevant information to support the transfer pricing analysis.
• Changes in transfer pricing policy or methodologies without an underlying change to the functional profile of a taxpayer, and inappropriate methodologies being selected given the taxpayer functional profile.
• Transactions that are covered by an APA or Bilateral Advance Pricing Arrangement (BAPA) – we will review the arrangements and the annual compliance report that is required to be submitted for APAs and BAPAs to ensure that taxpayers are continuing to follow the terms of the arrangements. Where transactions are subject to settlement agreements or private rulings, we also review these to confirm that taxpayers are adhering to the terms of the settlement agreement or implementing the relevant transactions in accordance with the ruling.

Structured arrangements designed to reduce Australian tax

In some cases, we see arrangements that are structured to reduce or avoid Australian tax. In those cases, the low assurance ratings and red flags are generally associated with related party transactions or other structured transactions (including third party back-to-back transactions) promoted or designed to achieve Australian tax savings, such as the following:

• Contrived related party financing arrangements, including the use of financing transactions with special terms designed to    
  • artificially defer or avoid interest withholding tax while obtaining annual Australian income tax deductions
  • avoid or reduce dividend withholding tax upon repayment/redemption of contrived related party financing arrangements
  • otherwise obtain deductions or avoid assessable income using arrangements designed to circumvent specific anti-avoidance rules such as thin capitalisation and the hybrid mismatch integrity rule, and debt/equity classification rules.
   
• Intangibles arrangements designed to reduce or avoid Australian taxable income or reduce or avoid royalty withholding tax.
• Arrangements or variation of arrangements of the kind described in Taxpayer Alert 2020/4 – these arrangements broadly involve the transfer of assets to an Eligible Tier 1 (ET-1) and an ET-1 company leaving or anticipating leaving, the multiple entry consolidated (MEC) group.
• Arrangements designed to avoid income being attributable to an Australian permanent establishment.
• ‘Inversion’ or ‘top-hatting’ arrangements, or the interposition of partnerships or other entities, designed to    
  • shift recognition of income and/or change or mischaracterise the nature of income
  • facilitate related party transactions to obtain Australian tax deductions
  • reduce or eliminate withholding tax
  • avoid the application of targeted or general anti-avoidance measures.
   

Common areas attracting our attention

Areas that continue to commonly arise in reviews that attract our attention.

Uniform capital allowances

This area represents the highest proportion of unassured items that continues to attract a low assurance rating for the top 100 population. This reflects that most case teams will assure these claims later in the justified trust review. Typically, uniform capital allowances do not present material tax risks and differences of view are more likely to be effectively resolved.

When assuring capital allowances claims, we consider the systems and governance processes adopted, as well as the supporting evidence provided (including working papers).

Common areas of focus include the use of project pools, balancing adjustment calculations, self-assessed effective lives and asset classification (particularly for composite assets and leasehold improvements). Where automated software tools are used to prepare claims, we also evaluate the level of ‘human intervention’ that confirmed revised claims satisfied the law.

When taxpayers review past claims, we expect a ‘two-way’ analysis – identifying capital items which could have been expensed and where expensed items might be more appropriately capitalised. About 41% of our reviews relating to capital allowances claims have resulted in high assurance. About 38% of ratings relating to capital allowances have improved over time.

Research and development (R&D) expenditure

This area represents a high proportion of unassured items that continues to attract low assurance and red flag ratings for the top 100 population. We have concerns about whether notional deductions claimed by taxpayers are actually incurred on R&D activities and whether expenses (such as overheads and fixed costs) are appropriately apportioned between eligible and non-eligible R&D activities.

In some cases, we have referred activities for review to AusIndustry where concerns have been identified. We have observed in some cases significant delays in R&D amendments being made after the end of the income year which may indicate that there are issues with sufficient contemporaneous documentation being available as required by law, to properly identify eligible activities and the expenditure incurred on those activities.

About 12% of top 100 taxpayers did not receive an assurance rating for R&D as these taxpayers did not claim the R&D tax incentive for the year reviewed but had indicated that they will claim the incentive later via an amendment or in a subsequent income year. About 21% of ratings relating to R&D expenditure have improved over time.

Thin capitalisation

This area remains an ongoing focus area for us. Most of our reviews of the thin capitalisation provisions attracted a high assurance or a medium assurance rating. About 24% of ratings relating to thin capitalisation have improved over time. Some of the issues we are seeing are asset revaluations and not including some arrangements as debt (such as preference shares and notes).

In 2021–22, one top 100 taxpayer made a Category C RTP Schedule disclosure covered by Taxpayer Alert TA 2016/9 and Taxation Determination TD 2020/2. There has been an increase in disclosures for the application of the arm’s length debt test and self-assessment of disclosures on Practical Compliance Guideline PCG 2020/7 in 2021-22. Most of these disclosures are in the high or medium risk categories. Where taxpayers are unable to (or choose not to) self-assess their risk rating against Practical Compliance Guideline PCG 2020/7, they can expect us to closely review their arm's length debt amount.

Deductions

Most of the general deductibility issues we are seeing relate to revenue or capital classification and the subsequent tax treatment of the expense. This includes capitalised labour, exploration expenses and repairs and maintenance. About 86% of reviews relating to deductions have been rated as high or medium assurance.

Consolidation

Consolidation areas reviewed include the allocable cost amount process including some instances where the allocable cost amount has not been prepared at the time of the assurance review, asset recognition, valuation, reconsolidation events and MEC groups. Nearly 59% of reviews relating to consolidation issues have been rated as high assurance. About 9% of ratings relating to consolidation have improved over time.

Losses

We holistically focus on generation, carry forward, transfer and utilisation, of any losses. Our reviews consider not only the tax analysis, but we also look to understand the origin of the losses and the commercial environment of the business at the time the losses were incurred. We also seek to understand when top 100 taxpayers will utilise any carry forward losses and move into a tax payable position. Over 39% of reviews relating to losses have been rated as high assurance. About 29% of ratings relating to losses have improved over time.

Revenue

In some cases we are seeing a need for more evidence and/or analysis of sales revenue and other material revenue amounts to establish a reasonable basis to obtain a high level of assurance, where we have been unable to reconcile revenue figures reported in the tax return with audited financial accounts. About 76% of reviews relating to the derivation of revenue have been rated as high assurance.

Controlled foreign companies and Permanent establishments

These are areas that commonly arise in our justified trust reviews. About 60% of reviews relating to Controlled foreign companies (CFC) have been rated as high assurance and nearly 53% of reviews relating to Permanent establishment (PE) issues have been rated as high assurance.

Hybrid mismatch

We have identified and reviewed circumstances where the hybrid mismatch rules apply, having regard to Law Companion Ruling LCR 2019/3 and accompanying Practical Compliance Guideline PCG 2019/6 and Practical Compliance Guideline PCG 2018/7. Several taxpayers have made Category C RTP Schedule disclosures with regards to hybrid arrangements in the 2021–22 income year. Consistent with this guidance, we expect top 100 taxpayers to engage with us if, having applied our risk assessment framework against their arrangement, they conclude that there is a potential tax risk associated with the arrangement.

Diverted Profits Tax (DPT)

During our assurance reviews, we may consider the application of the DPT concurrently with other provisions of the income tax law, including the transfer pricing rules in Division 815 of the Income Tax Assessment Act 1997. We have considered, or are considering, the potential application of DPT in a small number of top 100 cases.

Ratings and engagement

For some issues or transactions, we require more evidence and/or analysis to obtain high assurance. We are working with top 100 taxpayers to identify the areas that require further evidence or analysis. In some cases, medium assurance ratings on specific transactions may be satisfactory and, depending on the area and the significance of the transaction, it may still be possible to achieve overall high assurance.

High quality information, relevant supporting documentation, and an open and transparent relationship with us are expected from taxpayers to be able to achieve high assurance.

Alignment of tax and accounting outcomes

We analyse the differences between the accounting and tax results. This includes understanding the effective tax rates and ETB. We seek to understand, and be able to explain, any variances between tax and accounting outcomes. This provides an objective basis to obtain greater assurance.

Ratings

We apply a consistent rating system when reviewing and assessing the alignment of tax and accounting outcomes, which is outlined below.

Staged rating system

Colour indicator	Rating	System description
	High	We understand and can explain the various streams of economic activity and why the accounting and income tax results vary.
	Medium	Further analysis and explanation are required to understand the various streams of economic activity and/or why the accounting and tax results vary.
	Low	We identified concerns from our analysis of the various streams of economic activity and/or why accounting and tax results vary.
	Red flag	We do not understand and cannot explain the various streams of economic activity and/or why accounting and tax results vary.

The reviews completed to the end of June 2023 resulted in the following ratings.

Graph 5 – Alignment of tax and accounting ratings for the last income tax reviews completed as of 30 June 2023

 

Graph 6 – Alignment of tax and accounting ratings for the last income tax reviews completed as of 30 June 2020, 30 June 2021, 30 June 2022 and 30 June 2023

 

Observations

Most (96%) of the top 100 taxpayers have obtained a medium or high assurance rating with respect to the alignment of tax and accounting outcomes, with the proportion at high assurance increasing from 44% as of 30 June 2020 to 61% as of 30 June 2023.

We are generally able to obtain assurance over a significant proportion of reported income and expenses as most taxpayers have audited financial statements, supported by a book-to-tax reconciliation between net profit or loss reported in the financial statements and the total profit or loss disclosed in the relevant tax return. This can be more challenging for taxpayers with MEC groups, foreign branches or stapled groups. However, in many cases, we have been able to overcome these challenges through active collaboration with top 100 taxpayers with these structures to deepen our understanding of these taxpayers’ various streams of economic activity and why the accounting and income tax results vary.

We are also generally being provided with detailed book-to-tax reconciliations which allow us to obtain assurance over the key adjustments from the accounting results to calculate the taxable income (and tax payable) figures.

The number of medium ratings (35%) for this focus area had decreased but demonstrates that further analysis is required and underway, to understand the various streams of economic activity where the accounting and tax results vary for the top 100 population. It is also reflective of the significance and complexity of the transactions that are still being reviewed and have not yet been rated as high assurance.

The number of low ratings for this focus area has reduced to 2% in 2023 from 11% in 2020. We have observed that where taxpayers do not have effectively designed tax provision procedures in their governance framework, these taxpayers are also attaining a low or medium rating in relation to their alignment of tax and accounting outcomes.

Another component of this focus area is the ETB calculation, which we use to analyse the tax and economic performance of corporate groups. Boards and tax representatives of corporate groups should understand their ETB calculation and discuss the results with us (including underlying proxies and assumptions). We particularly encourage taxpayers to provide information around their global value chains and foreign taxes paid on Australian-linked activities and continue to work with us to refine and enhance their ETB analysis.

We have observed that the ETB analysis provides a good cross-check or confirmation in relation to our analysis and assurance over related party dealings. By identifying the economic group’s worldwide profit from Australian-linked business activities and the Australian and offshore tax paid on that profit, the ETB offers a useful sense check on any transfer prices and whether they are giving plausible, common-sense outcomes, or conversely if they are having the effect of skewing profits to low tax jurisdictions.