Transfer pricing – all foam and no beer

After the decisions in Roche and SNF (on appeal) the next big thing to jolt the transfer pricing world in Australia was the release of the much anticipated ruling TR 2011/1 this week. This ruling prescribes the steps that need to be taken when undertaking business restructuring, so that one does not get pitted against the tax office.

The most significant aspect of the ruling is the ‘commercial sense’ requirement in order to conform with the transfer pricing rules and not be subjected to profit adjustment by the tax office.

First the taxpayer needs to perform a functional analysis of the business, pre and post restructure, that is, identify the functions, assets used and the risks undertaken before and after the restructure.

If the consideration paid by one entity to the other involved in the restructure makes commercial sense having regard to circumstances of the parties and the options realistically available to them at arm’s length, then there will be no adjustment to the consideration by the tax office. If not, pricing adjustment must be made to ascertain the arm’s length consideration by reference to the restructuring arrangement itself or by using an arrangement that might reasonably be expected to exist between independent parties dealing at arm’s length.

Although taxpayers can avoid going through long and uncertain processes of determining an arm’s length pricing by using the ‘commercial sense’ option, the question whether consideration paid in a restructure makes commercial sense remains contentious. The outcome of the SNF appeal may throw some light on factors that may be considered when deciding whether the parties have acted in a commercial sense.