Pharmaceuticals caught in the ATO net

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This article was written by Jerome Tse & Dioni Perera.

The Australian Tax Office has made it clear that pharmaceutical companies operating in Australia continue to be a strategically significant focus for them, especially given the size of the industry. 

Whilst resource companies and the technology industry have understandably been a key focus area, the ATO continues to target the transfer pricing practices of multinational pharmaceutical companies.  This includes not only whether pharmaceutical companies are being remunerated on arm's length terms but also whether the Australian operations have failed to withhold an amount in respect of interest or royalties allegedly paid by those operations. 

Transfer pricing in focus

The application of transfer pricing rules in Australia is in a state of great uncertainty. After three decades of the operation of Division 13 to what was considered to be a transaction-based comparability analysis, taxpayers now find themselves having to self-assess their compliance to transfer pricing laws having regard to untested concepts of "arm's length conditions" and reconstruction provisions that differ significantly to the OECD Guidelines.  For those taxpayers whose global group's turnover is AU$1 billion or more, the stakes are higher given the harsher penalties that apply to "significant global entities".

In the pharmaceutical sector, the key pressure points or questions to ask include:

  • What are the Australian operation's roles and responsibilities in the value chain; what value does Australia add? Are the activities consistent with what has been previously been agreed?
  • What assets are employed in the Australian business? Who is responsible for protecting the various forms of IP used in the business?  How was the IP developed?
  • Are related parties correctly characterising payments between related parties for withholding tax purposes?
  • Who is responsible for quality control, licensing and discussions with the TGA? Who is responsible for product liability, currency risks etc.?
  • Does the accounting and tax treatment align? Are there reasons for any misalignment?
  • Is existing transfer pricing documentation adequate to address the more complex Australian documentation requirements? The Australian requirements are vastly different to the OECD's country-by-country reporting (CbCR) regime and involve substantially more analysis than considering benchmarking outputs.
  • What tax profile is disclosed in the group's CbCR, reportable tax positions schedule and other tax transparency related documents?

ATO investigations of pharmaceuticals

The ATO is utilising its formal and informal powers to investigate pharmaceuticals operating in Australia. Their focus is on cross-border taxation issues, with transfer pricing investigations being at the forefront but thin capitalisation, intellectual property, consolidation and R&D tax issues are also under scrutiny.  We are also seeing increased activity relating to the purported existence of permanent establishments.  Overall, the ATO's ongoing reviews are "to gain a detailed understanding of the pharmaceuticals industry and ensure the industry pays the right amount of tax."  Pharmaceutical companies, in protracted audits or otherwise, are being asked by the ATO to provide information and documents and, in some instances, make persons available for interviews.  

The outcome in Chevron shows that even the most difficult of tax disputes can be capable of settlement.  The King & Wood Mallesons tax team is uniquely experienced to assist pharmaceutical companies resolve their tax disputes, especially in cases where the disputes have become difficult and protracted and a fresh approach and team is needed to break the stalemate.   

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