The ATO’s Top 1000 CAR Program: an insight into transfer pricing assurance

The Australian Taxation Office (ATO) recently released its sixth findings report, providing key insights into its Top 1000 Combined Assurance Review (CAR) program, particularly focusing on transfer pricing and related areas. Introduced in 2020, the CAR program targets the top 1,000 Australian taxpayers to ensure compliance with taxation laws across four core Justified Trust pillars: governance, tax risks, significant transactions, and variations in accounting versus tax results.

The ATO’s findings report from September 2024 addresses reviews finalised in the 12 months ended 30 June 2024, and presents significant trends and emerging areas of concern regarding transfer pricing, hybrid mismatch, and other cross-border tax issues.

1. What is the CAR program?

The CAR program is part of the ATO's ongoing efforts to engage with large businesses and ensure their tax practices align with Australia’s tax laws and international standards. The program assesses the tax practices of these businesses, focusing on:

• Tax governance frameworks: Ensuring robust tax management and compliance.
• Tax risks flagged to the market: Identifying high-risk areas of concern.
• Significant transactions: Reviewing major business deals to ensure proper tax reporting.
• Discrepancies between accounting and tax results: Understanding why these differences arise.

The goal is to provide the ATO with greater visibility and assurance that the taxpayers are complying with their obligations, identifying areas of non-compliance or risk, and guiding businesses on potential improvements.

2. Key findings from the ATO's report on transfer pricing and related issues

Transfer pricing

Transfer pricing remains a central area of focus in the CAR program, with 66% of reviewed taxpayers having non-financing related transfer pricing arrangements scrutinised. Common findings in transfer pricing reviews include:

• Inadequate transfer pricing documentation: Many taxpayers failed to provide contemporaneous and adequate documentation to support their transfer pricing positions, a key requirement for demonstrating arm's length transactions.
• Material policy changes without justification: Changes to transfer pricing policies were often found to lack alignment with the taxpayer's functional profile or the economic reality of the business.
• Inconsistent transfer pricing methodologies: Changes in transfer pricing methodologies that were not based on an actual change in the taxpayer's functional profile were flagged as a red flag.

Specific arrangements that continued to raise concerns include:

• License fees and royalties: Issues related to the ability to substantiate the economic benefits received from licensed assets, particularly concerning the Australian DEMPE (Development, Enhancement, Maintenance, Protection, and Exploitation) activities related to intangibles.
• Financing arrangements: Areas like interest-bearing loans, cash pooling, and interest-free loans attracted lower assurance ratings, with particular concerns over pricing and terms not matching third-party market conditions.

The ATO also highlighted that 40% of its escalated audits involved transfer pricing issues, excluding financing arrangements, which were often rated poorly in terms of compliance.

Hybrid mismatch rules

Hybrid mismatch rules, designed to address tax avoidance through cross-border hybrid instruments, were another area under scrutiny. About 25% of taxpayers received a low assurance rating for these rules. The ATO’s findings emphasised that taxpayers often lacked evidence showing substantial efforts to comply with the hybrid mismatch rules, especially in relation to the imported mismatch rule.

The ATO's hybrid mismatch letter campaign reflects the importance of addressing these rules, with taxpayers advised to keep detailed records of their compliance processes to avoid low assurance ratings.

Thin capitalisation

The thin capitalisation area has historically seen high assurance ratings, with 75% of taxpayers achieving high ratings in the latest review. Recent changes to thin capitalisation rules suggest a shift towards lower assurance ratings in future reviews. Contributing factors include:

• Lack of evidence for safe harbour calculations: Inaccurate or insufficient documentation for safe harbour calculations has led to concerns.
• Arm’s length debt test: The application of this test will become even more important following the introduction of new rules in 2023, particularly for taxpayers involved in cross-border financing arrangements.

Loss utilisation and structured arrangements

The ATO has also focused on how businesses handle capital and revenue losses, especially regarding compliance with continuity of ownership tests and business continuity tests. In some cases, businesses were found lacking adequate documentation to support the transfer and utilisation of losses, or their strategies for dealing with complex group structures.

Further scrutiny was placed on structured arrangements designed to reduce or avoid Australian tax. These arrangements, especially those involving related-party financing or mischaracterisation of intangible assets, led to low assurance ratings, with several escalated for further compliance action.

3. Key takeaways

The 2024 findings report presents several key takeaways for businesses subject to the ATO’s CAR program:

• Enhanced scrutiny on transfer pricing: Transfer pricing continues to be a primary area of focus. Companies should ensure they have robust, contemporaneous documentation to support their transfer pricing arrangements. Changes in policies must be backed by solid economic justification.
• Hybrid mismatch and thin capitalisation: Businesses should pay close attention to the hybrid mismatch rules and thin capitalisation adjustments. Inadequate compliance or documentation in these areas is likely to lead to lower assurance ratings.
• Documentation is critical: The importance of comprehensive documentation cannot be overstated. Businesses need to maintain detailed records, especially concerning losses, cross-border financing arrangements, and significant transactions.
• Proactive engagement: Taxpayers should prepare for CAR reviews well in advance. This includes ensuring governance documentation is up-to-date, understanding and complying with Practical Compliance Guidelines (PCGs), and reviewing transfer pricing policies and methodologies.
• A shift in ATO’s approach: With the introduction of a differentiated approach to assurance reviews, businesses with previously high assurance ratings may still face increased scrutiny due to new rules and regulations. Companies should proactively reassess their tax compliance to align with new ATO expectations.

Conclusion

The ATO's Top 1000 CAR program plays a crucial role in maintaining high standards of tax compliance among Australia's largest businesses. With transfer pricing, hybrid mismatch rules, and thin capitalisation at the forefront of this year's findings, businesses are encouraged to review their tax practices, ensure appropriate documentation is in place, and be prepared for heightened scrutiny in future reviews.

If you would like to further discuss this alert, reach out to our team or your PKF adviser.