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PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999
11.15.2 The Commissioner’s appraisal of a taxpayer’s transfer prices will, as a starting point, focus on the conditions under which the taxpayer was operating at the time the relevant transaction occurred. An examination of relative pro ts from a controlled transaction over a period of time will, in itself, not form the basis for a transfer pricing adjustment, but may, however, form the basis for the Commissioner to identify cases for potential investigation.
11.15.3 The appropriate use of data from periods subsequent to a transaction being examined is discussed in the OECD Guidelines at paragraph 1.51:
‘Data from years following the year of the transaction may also be relevant to the analysis of transfer prices, but care must be taken by tax administrations to avoid the use of hindsight. For example, data from later years may be useful in comparing product life cycles of controlled and uncontrolled transactions, for the purpose of determining whether the uncontrolled transaction is an appropriate comparable to use in applying a particular method. Subsequent conduct by the parties will also be relevant in ascertaining the actual terms and conditions that operate between the parties.’.
11.15.4 Hindsight may therefore be valuable for appraising the reliability of comparables used by a taxpayer in its transfer pricing analysis. However, this does not only bene t the Commissioner. It may be that a taxpayer’s transfer pricing policy is more persuasive if data of actual transactions supports the taxpayer’s comparables. Hindsight is also a valuable tool in the periodic review of the continuing applicability of methods used to determine arm’s length prices.
11.15.5 The availability and use of contemporaneous documentation in a taxpayer’s transfer pricing analysis will also reduce the likelihood of the Commissioner using hindsight in an appraisal of the taxpayer’s transfer prices.
11.16 ‘Safe harbours’
11.16.1 It may be argued that the dif culties in applying the arm’s length principle would be alleviated by providing circumstances in which taxpayers could follow a simple set of rules under which transfer prices would be automatically accepted by the Commissioner. Such provisions would constitute safe harbours.
11.16.2 In this context, taxpayers may also erroneously be of the opinion that the adoption of an arm’s length principle implies that members of groups need only cover their variable costs and make some contribution to xed costs, or return a pro t (however marginal) from their activities to avoid transfer pricing challenges from the Commissioner.
11.16.3 Various factors such as administrative simplicity, certainty and compliance relief support the use of safe harbours. However, there are various disadvantages to the setting of safe harbours. Most importantly, the introduction of safe harbours can produce results that may be inconsistent with the arm’s length principle.
11.16.4 In paragraph 4.123 the OECD Guidelines warn against the use of safe harbours. The Commissioner supports this view.
11.17 The effect of government policies
11.17.1 As a general rule, government interventions such as price control, interest control and exchange control should be treated as conditions of the market in a particular country. Government policies should be taken into account in evaluating a transfer price in a particular market, to the extent that the policies affect the manner in which prices are determined by comparable independent enterprises.
11.18 Four-step approach
11.18.1 Practical transfer pricing generally involves following a process to determine arm’s length transfer prices.
11.18.2 The Australian Taxation Of ce (Taxation Ruling 98/11, Chapter 5) has designed a four-step approach as a useful tool for taxpayers to develop the methodology and documentation needed to support the evaluation of their
transfer prices. The Commissioner endorses the four-step process as a useful tool.
11.18.3 The process will be especially useful if the nature of the international dealings is fairly extensive and necessitates
a thorough analysis.
11.18.4 A summary of this approach is set out in Annexure B. Taxpayers are, however, not obliged to use it in determining
their transfer prices. This methodology is as follows:
(a) Step1:Understandingthecross-borderdealingsbetweenconnectedpersonsinthecontextofthetaxpayer’s
business and assessing the risk
(b) Step 2: Selecting the appropriate transfer pricing method
(c) Step 3: Applying the transfer pricing method
(d) Step 4: Calculating the arm’s length price in accordance with the selected method.
12 The Commissioner’s Approach to Transfer Pricing Reviews, Audits and Investigations
12.1 Introduction
12.1.1 Depending on the facts applicable to each individual case, the Commissioner intends to follow the general guidelines set out in this Practice Note. The discussion below focuses on various practical issues that have not yet been addressed above:
12.2 The Commissioner’s access to and use of information
12.2.1 There are various sources from which the Commissioner can obtain information. The rst is from the taxpayer, by way of enquiries into its transfer pricing practices. Alternatively, information may be sought from sources external to the taxpayer, such as:
(a) other taxpayers within the same or similar industry;
(b) nancial databases, publicly available industry information, the Internet, etc. This includes information on comparable foreign entities;
(c) other jurisdictions (through the exchange of information provisions contained in tax treaties).
12.3 Use of publicly undisclosed information
12.3.1 In the context of a review of a taxpayer’s voluntary compliance with the transfer pricing rules, the Commissioner’s
primary source for obtaining information will be from the taxpayer itself. However, it should be remembered that the Commissioner, when applying any method, may have more information available than a taxpayer has, or
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