Global tax authorities and multinationals in the US, Australia, and Canada are facing off in legal challenges next year over their pricing methods with millions at stake for both sides, and the potential to alter the landscape for laws governing methods for valuing transactions.
The outcome of the cases could hand companies new tools to lower their tax bills or empower tax authorities with new approaches to raise taxes owed on transfer pricing transactions, including in a closely-watched case in Australia involving PepsiCo Inc.
Multinationals will also be testing out new ways to fight transfer pricing adjustments in 2024 by taking disputes to forums where transfer pricing hasn’t traditionally been litigated like state courts, Anna Soubbotina, principal at Charles River Associates in New York, said.
“What we’re seeing more of is more and diverse applications of transfer pricing and those tend to be less in the public eye,” Soubbotina said.
Transfer pricing refers to prices in transactions between two companies in the same corporate group. Tax authorities require those prices to be similar to those found in a transaction between arm’s length firms to keep companies from artificially lowering their tax bills.
Here’s what tax professional are watching next year.
PepsiCo
In Australia, tax lawyers will be closely watching whether PepsiCo Inc. appeals the Australia Tax Office’s victory in the new year despite the fact the case isn’t, strictly speaking, a transfer pricing case, Anthony Sloan, a tax partner at BDO in Sydney, said.
Australia’s Federal Court ruled Nov. 30 inPepsiCo Inc. v. Commissioner of Taxation,that the beverage giant was wrong to call trademarks it provided to third-party bottler Schweppes Australia “royalty free.” The ruling makes PepsiCo liable for royalty withholding tax, according to the ATO.
If the judgment stands, it will give the office a powerful new way to raise company’s tax bills on intra-company transactions without necessarily using transfer pricing provisions, Sloan said.
“If you think of transfer pricing in terms of recharacterizing transactions between related parties so that they reflect an arm’s length principle, this case lets the ATO do that and do it without direct reference to transfer pricing rules,” Sloan said. “There’s no need to rely on the transfer pricing provisions. It’s huge.”
The case also holds major consequences for any line of business involving a valuable brand, Sloan said.
The federal court ruling includes an analysis that splits the value of the brand from the physical value of the product. Taken to its logical extreme, this could mean greater transparency over how much the price of a product stems from the brand alone, a trend that could deeply complicate business practices, Sloan said.
“No one wants this,” he said.
A likely outcome to avoid disruption for companies could be for the ATO to clarify the application of the decision, Sloan said.
The ATO could say the analysis only applies in cases where an Australian company puts a multinational’s trademark on a product manufactured in Australia, but not when a company imports a fully formed product, he said.
Medtronic
In Medtronic Inc. v. Commissioner, the IRS is appealing a US Tax Court’s decision in its dispute with the medical device manufacturer, which favored the company’s use of so-called “unspecific method” for calculating intra-company prices, Steve Dixon, partner at Steptoe LLP, said.
Medtronic and the IRS are at odds over what method to use to price transactions between the firm and an affiliated manufacturer in Puerto Rico for tax years 2005 and 2006. The IRS filed its brief to the 8th Circuit Dec. 18, but an oral hearing hasn’t been scheduled.
An unspoken hierarchy exists in transfer pricing law among different pricing methods that puts unspecific methods at the bottom, Dixon said. An 8th Circuit ruling backing the tax court would make unspecified methods more attractive, he said.
“If the 8th Circuit were to bless an unspecified method, you would find taxpayers likelier to embrace them,” Dixon said. “You would also find the IRS trying to find creative ways to use unspecified methods to get the results that they think are the right arm’s length price.”
Alternatively, the IRS sees its interpretation of the comparable pricing method—which would be less rigorous than the unspecified method the Tax Court ordered—as providing it with more leverage in tax disputes, Dixon said. A decision in its favor would lead to changes in its approach in other transfer pricing cases, he said.
The comparable profits method looks at the profitability of a transaction by comparing it with to a similar exchange between arm’s length entities. A less rigorous application of the method, as the IRS wants, would allow the agency to apply the method more often in cases involving intangibles that are hard to value, Dixon said.
“The IRS would like to use the CPM in more of those cases and has thus far been largely unable to do that,” he said.
ConocoPhillips
The Louisiana Department of Revenue’s $700 million suit against ConocoPhillips Co.’s alleges a pattern of transactions that sought to shift profits out of the state.
Richard v. ConocoPhillips Co. is noteworthy because it’s part of a trend of transfer pricing cases moving away from federal courts and towards other forums, like state courts and international arbitration, Soubbotina said.
ConocoPhillips filed its brief in the suit in the state’s 19th Judicial District Court in late November. A hearing is scheduled Feb. 26 to examine exemptions to the state’s petition, according to court administration.
The oil company is challenging Louisiana’s preferred pricing method, the comparable pricing method, as part of its suit, which could impact cases outside the case, Soubbotina said.
“To the extent that this case involves discussions of the best or most applicable method in transfer pricing, that’s going to have broad implications,” she said.
Dow Chemical, Bank of Nova Scotia
Canada’s Supreme Court will likely release a decision in 2024 in a dispute between that country’s tax authority and Dow Chemical Canada ULC after holding an oral hearing on the matter in November.
The judges will decide which lower court should hear Dow’s lawsuit over a C$3.36 million ($2.54 million) downward adjustment the Canada Revenue Agency made during a transfer pricing audit.
In another case—The Bank of Nova Scotia v. Her Majesty the Queen —Canada’s Federal Court of Appeal is scheduled to hear a dispute between the agency and the Bank of Nova Scotia, one of the country’s largest banks, on Oct. 30.
The Toronto-based bank is appealing an October 2021 decision by Canada’s Tax Court that denied the company’s preferred method for calculating interest as part of a transfer pricing settlement.
To contact the reporter on this story: James Munson in Toronto at correspondents@bloomberglaw.com
To contact the editors responsible for this story:
Global minimum tax on multinationals goes live to raise up to $220bn
Why 2023 was a year of living taxingly
In the first of a two-part series, Robyn Jacobson looks at some of the sweeping changes and landmark decisions.
The end of another working year provides an opportunity to relax over the festive break, reflect on the events of the year and regroup ahead of embarking on goals and objectives for 2024 with renewed vigour.
Ongoing economic uncertainty created by global events continued into 2023, fuelled by persistently high inflation, repeated interest rate hikes, tight labour markets and geopolitical shocks. These and other factors have compounded cost of living pressures
From a tax policy perspective, 2023 was yet another significant year with sweeping tax changes including landmark case decisions. In this first part of a two-part series, some of the key developments that marked the tax landscape are discussed below.
Note that not all the government’s proposed legislative measures completed their passage through parliament by the last sitting day on 7 December, so the government will resume its progression of these measures when the 2024 Parliamentary sittings commence on 6 February.
Small and medium enterprises
Following years of tweaks (and changes of a more substantial nature) to the full expensing measures for depreciating assets of SMEs, the next variant remains to be legislated. The standard instant asset write-off threshold is proposed to be temporarily increased from $1,000 to $20,000 (for eligible depreciating assets costing less than $20,000) for small business entities (aggregated turnover of less than $10 million) where those assets are first used or installed ready for use in 2023–24.
Eligible business entities (aggregated turnover of less than $50 million) will be allowed to claim an additional 20 per cent deduction on spending that supports electrification and more efficient use of energy. Eligible assets or upgrades need to be first used or installed ready for use in 2023-24.
These measures are contained in Schedules 1 and 2, respectively, to the Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Bill 2023, which remains before Parliament.
On the case law front, the focus of SME advisers will be firmly on the appeal to the Federal Court of the Administrative Appeals Tribunal’s decision in Bendel v Commissioner of Taxation [2023] AATA 3074. In that case, an unpaid present entitlement (UPE) arising from an entitlement to income (or capital) of a trust was held not to be a loan under Division 7A of Part III of the Income Tax Assessment Act 1936. This decision has generated widespread interest because it departs from the Commissioner’s long-held views in TR 2010/3 (withdrawn), PS LA 2010/4 (withdrawn), PCG 2017/3 and TD 2022/11. In response, the Commissioner released an interim decision impact statement on 15 November 2023. We keenly await the Federal Court’s take on the vexing question of whether a UPE constitutes a loan for Division 7A purposes.
Superannuation
Division 296 tax
In a major change for those with substantial superannuation balances, the Treasury Laws Amendment (Better Targeted Superannuation Concessions Bill) 2023 proposes to introduce new Division 296 into the ITAA 1997 to levy an additional tax on individuals at the rate of 15 per cent on earnings on total superannuation balances above $3 million. The measure is proposed to start on 1 July 2025. On 7 December 2023, the Senate referred the Bill to the Senate Economics and Legislation Committee for inquiry and report by 19 April 2024.
Unquestionably, the primary concern of stakeholders, including the Tax Institute (see our submission to the Treasury) is the establishment of a new precedent of taxing unrealised gains. Historically, taxing unrealised gains has been used only in the context of anti-avoidance provisions and it should not be a feature in the design of this, or future, general taxation measures.
The inability to carry back unrealised losses, the non-indexation of the $3 million threshold and liquidity issues relating to the payment of the new tax are among the other concerns stakeholders have with the new measure.
Payday super
In October 2023, Treasury released a consultation paper on payday super which will require employers from 1 July 2026 to pay their employees’ superannuation guarantee contributions at the same time they pay salary and wages. The measure is to be applauded for its objective to better secure the superannuation entitlements of millions of workers. However, a range of design and implementation issues must be considered, as set out in the joint submission on the consultation paper lodged with the Treasury by the Tax Institute and other professional associations.
Pleasingly, Treasury and the ATO have engaged in numerous targeted consultations with key stakeholders this year. Through this collaboration, bright minds have come together to identity and work through the optimum design of the regime, so it has the best chance of success when it comes to its implementation. Further announcements regarding the policy are expected in the federal budget in May 2024, with legislation to follow later in the year.
The proposed regime presents a golden opportunity to redesign the archaic, draconian and disproportionate SG charge penalty to make it fairer, proportional and more streamlined. This should reduce complexity for all stakeholders and increase compliance, which advances the overarching objective of securing Australians’ superannuation entitlements.
According to the ATO’s tax gap figures for 2020-21, the net SG gap is 5.1 per cent. While this may be interpreted as a positive outcome that nearly 95 per cent of employers are complying with their SG obligations, it also means that $3.619 billion of superannuation entitlements were not paid in that period (being the difference between the estimated theoretical SG liability and what is collected). This gap is the impetus for the payday super reform.
NALI and NALE
The well-trodden path of amending the non-arm’s length income (NALI) and non-arm’s length expense (NALE) provisions continued in 2023. Schedule 7 to the Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Bill 2023 proposes to amend the NALE provisions by limiting the amount of NALI arising from a general NALE for self-managed superannuation funds and small APRA-regulated funds to twice the level of a general expense.
These changes are proposed to apply retrospectively from 1 July 2018. This bill was referred by the Senate to the Senate Committee for inquiry and report and, on 24 November, the Senate Committee released its report. Concerns regarding these proposed amendments are set out in the joint submission lodged by the Tax Institute and other professional associations.
Multinationals
As part of its election commitments, the government announced a Multinational Tax Integrity and Tax Transparency Package, proposed to apply from 1 July 2023, aimed at:
• Strengthening thin capitalisation rules to address risks to the corporate tax base arising from the use of excessive debt deductions.
• Introducing reporting requirements for certain companies to enhance the tax information they disclose to the public.
• Introducing an anti-avoidance rule to deny deductions for payments made to related parties in relation to intangible assets connected with low or no tax jurisdictions.
The tax transparency measures and thin cap measures are contained in the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share Integrity and Transparency) Bill 2023, which is yet to be enacted, despite almost six months having passed since its proposed start date. The intangibles measure has not yet been introduced into Parliament. It is not clear at this stage whether the proposed intangibles measure will proceed and if so, whether it will be subject to further consultation.
Also, as part of the federal budget 2023-24, the government announced the implementation of the OECD’s Pillar 2 rules, effective for income years starting on or after 1 January 2024. Exposure draft legislation for the implementation of Pillar 2 in Australia has not yet been released for consultation, despite the looming start date.
On the case law front, significantly, the decision of the Federal Court in PepsiCo, Inc. v Commissioner of Taxation [2023] FCA 1490 is the first diverted profits tax case considered by the court. The decision was made in favour of the Commissioner.
Dispute resolution
The proposed reform and replacement of the AAT with the new Administrative Review Tribunal (ART) will be given effect by the Administrative Review Tribunal Bill 2023 and Administrative Review Tribunal (Consequential and Transitional Provisions No. 1) Bill 2023 which were recently introduced into parliament. The bills have been referred to the House of Representatives Standing Committee on Social Policy and Legal Affairs. Arrangements will be made to transition existing matters from AAT to ART.
On reflection
Reflecting on the measures introduced and consulted on during 2023, and those that were not consulted on, it will be important for stewards of the tax system like the Tax Institute and other professional associations to continue to work with government to direct greater attention to improving consultation processes — including the time provided to stakeholders — and reducing the government’s use of retrospective legislation as a priority for an effective taxation system.
The second and final part of this series will be published next Friday, 5 January, and focuses on changes to the regulation of the tax profession, the key measures announced as part of the Mid-Year Economic and Fiscal Outlook 2023-24 and some state tax issues.
Robyn Jacobson is the senior advocate at the Tax Institute.
