Explanatory Memorandum
(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)Chapter 6 - Record keeping requirements and penalties
Subdivision 284-E of Schedule 1 and other amendments to the Taxation Administration Act 1953
Link between record keeping and penalties
6.1 A taxpayer is liable to an administrative penalty under the Taxation Administration Act 1953 (TAA 1953) where the Commissioner of Taxation (Commissioner) takes certain actions to give effect to Subdivisions 815-B or 815-C.
6.2 Whether or not a taxpayer has a reasonably arguable position in respect of the way they had self-assessed their position under Subdivision 815-B or 815-C prior to the Commissioner determining that additional tax is payable by the taxpayer impacts upon the amount of the administrative penalty. Where an entity is able to demonstrate that its position was reasonably arguable, the entity is entitled to a reduced penalty amount.
6.3 Subdivision 284-E of Schedule 1 to the TAA 1953 sets out the records that an entity or the agent of the entity may prepare and maintain in order to demonstrate that they have correctly applied Subdivisions 815-B or 815-C. Records that are kept in accordance with Subdivision 284-E are required (but not sufficient) to establish a reasonably arguable position about the application of those Subdivisions.
6.4 In the event that an entity is liable for a scheme shortfall amount due to the application of Subdivision 815-B or 815-C, the entity is only able to establish it has a reasonably arguable position if it has prepared and maintained documentation in respect of the matter that gives rise to the shortfall amount. To the extent that it has not kept documentation in respect of such conditions, it is unable to establish that it has a reasonably arguable position about how the Subdivisions apply and is therefore unable to access the lower scheme penalty amount should it be liable to a shortfall penalty.
6.5 Although establishing a reasonably arguable position is one avenue through which an entity can lower the applicable penalty amount, the requirement that a taxpayer keep records under Subdivision 284-E has no impact upon the Commissioner's general ability to exercise a discretion to remit administrative penalties.
Interaction with section 262A of the ITAA 1936
6.6 Section 262A of the Income Tax Assessment Act 1936 (ITAA 1936) imposes a general requirement that a person who is carrying on a business keep records that explain all transactions and other acts engaged in by the person that are relevant for any purposes of the ITAA 1936 and the Income Tax Assessment Act 1997 . It would be expected that to the extent that documents prepared in accordance with Subdivision 284-E relate to transactions or acts that would otherwise need to be recorded under section 262A, the documents prepared in accordance with Subdivision 284-E would satisfy the more general record keeping requirement under section 262A. However where this is not the case, section 262A continues to apply in respect of any relevant transactions and acts.
Penalties for adjustments made under Subdivision 815-B or 815-C
When will penalties apply?
6.7 Subdivision 284-C in Schedule 1 to the TAA 1953 imposes a liability to an administrative penalty where the Commissioner takes certain actions to give effect to Subdivision 815-B or 815-C that result in a liability to an additional amount of income tax or withholding tax. [Schedule 2, item 3, subsection 284-145(2B) in Schedule 1 to the TAA 1953]
6.8 The relevant actions of the Commissioner are the amendment of an assessment in an income year in respect of a liability to additional income tax, or the serving of one or more notices that additional withholding tax is payable. [Schedule 2, item 3, subparagraphs 284-145(2B)(a)(i) and (ii) in Schedule 1 to the TAA 1953]
6.9 As such, if the Commissioner determines that a taxpayer has not correctly self-assessed their tax position under Subdivision 815-B or 815-C and amends an assessment or issues a notice in respect of withholding tax, the taxpayer is liable to an administrative penalty.
What is the amount of the penalty?
6.10 Administrative penalties under Subdivision 284-C in Schedule 1 to the TAA 1953 are determined by the scheme shortfall amount to which the relevant adjustment relates. In the context of adjustments made under Subdivision 815-B or 815-C, the scheme shortfall amount is the amount of the additional income tax or withholding tax payable as the result of the Commissioner taking action against the taxpayer. [Schedule 2, item 4, subsection 284-150(4) in Schedule 1 to the TAA 1953]
6.11 In most cases, the administrative penalty for transfer pricing related scheme shortfall amounts is the sum of:
- •
- 25 per cent of the scheme shortfall amount; and
- •
- 10 per cent of the scheme shortfall amount to the extent it is attributable to the taxpayer (or their agent) having treated the transfer pricing rules as applying or not applying to a matter in a way that was reasonably arguable.
[Schedule 2, item 5, table item 2 in subsection 284-160(3) in Schedule 1 to the TAA 1953]
6.12 However, where it is reasonable to conclude that the entity entered into the scheme with the sole or dominant purpose of obtaining a transfer pricing benefit (for themselves or another entity), the base penalty amount is the sum of:
- •
- 50 per cent of the scheme shortfall amount; and
- •
- 25 per cent of the scheme shortfall amount to the extent it is attributable to the taxpayer (or their agent) having treated the transfer pricing rules as applying or not applying to a matter in a way that was reasonably arguable.
[Schedule 2, item 5, table item 1 in subsection 284-160(3) in Schedule 1 to the TAA 1953]
6.13 Increased penalties in respect of schemes that were entered into for the sole or dominant purpose of obtaining a transfer pricing benefit are consistent with the former penalty provisions that applied in relation to Division 13 of the ITAA 1936 (Division 13). Penalties in relation to adjustments under Division 13 only applied where penalties for the sole or dominant purpose of obtaining a scheme benefit did not apply.
6.14 The base penalty rule for Subdivisions 815-B and 815-C includes higher penalties in relation to sole or dominant purposes. Accordingly, to the extent that a scheme shortfall amount is attributable to the Commissioner giving effect to Subdivision 815-B or 815-C, that amount is not included in a scheme shortfall amount covered by subsection 284-145(1) (which applies to schemes entered into for the sole or dominant purpose of obtaining a scheme benefit). This carve-out ensures that taxpayers are not subject to administrative penalties under both provisions in relation to the same scheme. [Schedule 2, item 4, subsection 284-150(5) in Schedule 1 to the TAA 1953]
6.15 In addition to rules for transfer pricing related adjustments under Subdivisions 815-B and 815-C, the base penalty rules for schemes with the sole or dominant purpose of obtaining a scheme benefit and for transfer pricing adjustments under Subdivision 815-A have been rewritten into new subsections but have not been modified in substance. [Schedule 2, item 3, subsections 284-160(1) and (2) in Schedule 1 to the TAA 1953]
Scheme shortfall amounts that are less than the reasonably arguable threshold
6.16 Administrative penalties do not apply in respect of Subdivisions 815-B or 815-C where the scheme shortfall amount is equal to or less than an entity's reasonably arguable threshold. [Schedule 2, item 6, subsection 284-165(1) in Schedule 1 to the TAA 1953]
6.17 Special rules also apply for partnerships and trusts to ensure that administrative penalties in respect of Subdivision 815-B or 815-C do not apply to scheme shortfall amounts that result in a trust having a greater amount of net income or a lesser amount of a tax loss, or a partnership having a greater amount of net income or a lesser amount of a partnership loss than the trust or partnerships' reasonably arguable threshold. [Schedule 2, item 6, subsections 284-165(2) and (3) in Schedule 1 to the TAA 1953]
6.18 In instances where a trust or partnership has no net income, a trust has no tax loss, or a partnership has no partnership loss, it is not correct to say that the entity has a nil amount (rather they have no amount at all). To ensure that the necessary calculation can still be performed in such instances, a rule is included to deem the trust or partnership to have net income, a tax loss, or a partnership loss equal to an amount of nil (as appropriate) in the income year. This allows the relevant amount to be compared with the nil amount (or amounts). [Schedule 2, item 6, subsection 284-165(4 ) in Schedule 1 to the TAA 1953]
What is the reasonably arguable threshold?
6.19 Amendments made to the TAA 1953 in relation to administrative penalties remove the threshold references from items 4 to 6 of the table to subsection 284-90(1) and insert them in the definition of 'reasonably arguable threshold'.
6.20 The relevant thresholds are the greater of:
- •
- $10,000 or 1 per cent of income tax payable, or minerals resource rent tax (MRRT) payable by an entity for the income year; and
- •
- $20,000 or 2 per cent of an entity's net income for an income year, where the entity is a trust or partnership.
[Schedule 2, items 45 to 48]
6.21 The definition of reasonably arguable threshold allows any future changes to the general thresholds under section 284-90 of Schedule 1 to the TAA 1953 to apply automatically for the purposes of determining administrative penalties in relation to transfer pricing adjustments.
Records for Subdivision 815-B and 815-C
6.22 Subdivision 284-E of Schedule 1 to the TAA 1953 sets out requirements in respect of documents related to the application of Subdivisions 815-B and 815-C.
6.23 Where an entity has treated Subdivision 815-B or 815-C as applying or not applying to a matter in a certain way (or made a statement about the way those Subdivisions apply to a matter), and the entity does not have records that meet the requirements of Subdivision 284-E, the entity cannot have a reasonably arguable position in respect of that matter. [Schedule 2, item 7, section 284-250 in Schedule 1 to the TAA 1953]
6.24 In order to meet the documentation requirements of Subdivision 284-E, the records must be prepared before the time the entity lodges its income tax return for the income year, and either be in English or be readily accessible and convertible into English. [Schedule 2, item 7, paragraphs 284-255(1)(a) and (b) in Schedule 1 to the TAA 1953]
6.25 It is intended that an entity only maintain and prepare documentation in respect of those conditions that are both material and relevant to the application of Subdivision 815-B and 815-C to them. In this regard, a condition is material if it impacts upon the entity's Australian tax position, and is ultimately relevant where it is subject to an adjustment by the Commissioner.
6.26 Because compliance with the documentation rules is not mandatory, it is expected that in determining whether certain conditions are material or relevant an entity will undertake a risk assessment of its cross-border dealings and prepare and maintain transfer pricing documentation in respect of those matters which could be the subject of dispute with the Commissioner.
6.27 Where an entity has prepared and maintained transfer pricing documentation in respect of a matter that is the subject of a scheme shortfall amount, the entity is entitled to establish that it had a reasonably arguable position in respect of that matter (and therefore is eligible for a lower administrative penalty). Conversely, in the event that an entity does not have any documentation in respect of the matter which is ultimately disputed by the Commissioner and results in a scheme shortfall amount, the entity is unable to claim a reasonably arguable position in respect of that matter.
6.28 To the extent that an entity considers that transfer pricing documentation should be prepared and maintained in respect of certain matters, the documentation must explain the way in which the relevant Subdivision was applied to the matter, and why the application in that way best achieved consistency with the relevant guidance material. [Schedule 2, item 7, paragraphs 284-255(1)(c) and (d) in Schedule 1 to the TAA 1953]
6.29 The records must also contain information in respect of the relevant arm's length conditions, as well as particulars about the method selected and the comparable circumstances relevant in identifying the arm's length conditions. [Schedule 2, item 7, paragraphs 284-255(2)(a) and (b) in Schedule 1 to the TAA 1953]
6.30 As such, transfer pricing documentation should also contain an explanation of all the steps that are undertaken in identifying which method should be selected, and the comparable conditions used in that process.
6.31 In cases where the records explain the application of the transfer pricing rules to a matter (as opposed to the non-application of the rules), the records must also explain the result of the application of the relevant Subdivision and contrast this result with the outcome that would have been achieved in the absence of the Subdivision being applied (for example, the entity's tax result under arm's length conditions relative to actual conditions). [Schedule 2, item 7, paragraph 284-255(2)(c) in Schedule 1 to the TAA 1953]
6.32 In cases where the records relate to the application of Subdivision 815-B, the records must also explain the actual conditions that are relevant to the matter in question. [Schedule 2, item 7, paragraph 284-255(2)(d) in Schedule 1 to the TAA 1953]
6.33 In cases where the records relate to the application of Subdivision 815-C, the records must also explain the actual profits and arm's length profits attributed to the permanent establishment that are relevant to the matter, as well as the particulars of the activities and circumstances of the permanent establishment that were assumed as the result of the entity being deemed to be a separate and distinct entity. [Schedule 2, item 7, paragraph 284 255(2)(e) in Schedule 1 to the TAA 1953]