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 {"PCG_Number": "PCG 2018/5", "Document_Type": "Final PCG", "Title": "Diverted profits tax", "Status": "Current", "Date_of_Issue": "26 September 2018", "Date_of_Effect": "1 July 2017", "Date_of_Withdrawal": "", "Replaces": "", "Related_Rulings_and_Determinations": "LCR 2015/2 | LCR 2018/6 | PS LA 2007/8 | PS LA 2015/4 | PS LA 2017/2", "Legislative_References": "ITAA 1936 ITAA 1936 Pt IVA ITAA 1936 6(1) ITAA 1936 177C(1)(a) ITAA 1936 177C(1)(b) ITAA 1936 177C(1)(ba) ITAA 1936 177C(1)(bb) ITAA 1936 177C(1)(bba) ITAA 1936 177C(1)(bbaa) ITAA 1936 177C(1)(bc) ITAA 1936 177DA ITAA 1936 177F ITAA 1936 177J(1)(a) ITAA 1936 177J(1)(b) ITAA 1936 177J(1)(c) ITAA 1936 177J(1)(d) ITAA 1936 177J(1)(e) ITAA 1936 177J(1)(f) ITAA 1936 177J(1)(g) ITAA 1936 177J(2) ITAA 1936 177K ITAA 1936 177L ITAA 1936 177M ITAA 1997 ITAA 1997 Div 815 ITAA 1997 815-135 Diverted Profits Tax Act 2017 Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act 2017", "Other_References": "PCG 2017/1 PCG 2017/2 PCG 2017/4 PS LA 2007/8 PS LA 2015/4 PS LA 2017/2 2010 OECD Transfer Pricing Guidelines 2015 OECD Report", "Summary": "1. This Guideline sets out our risk assessment and client engagement frameworks for the diverted profits tax (DPT). It also outlines our compliance approach when the DPT is identified as an area of concern. 2. You can use this Guideline to: Structure of this Guideline 3. This Guideline is structured as follows:", "Purpose_and_Scope": "", "Background": "4. The DPT is designed to ensure that significant global entities (SGEs) pay tax in Australia that properly reflects the economic substance of their activities in Australia and that they do not reduce the amount of tax they pay by diverting profits offshore through contrived arrangements with related parties. The measure is also intended to encourage taxpayers to provide information to the Commissioner of Taxation to allow for the more timely resolution of tax disputes. 5. The DPT applies to DPT tax benefits obtained in income years commencing on or after 1 July 2017, even if the scheme was entered into or commenced before that time. Where the DPT applies, the Commissioner may make a DPT assessment imposing tax at a rate of 40% on the diverted profit. 6. For the DPT to apply, the following criteria must be satisfied: 7. An outline of our views on the law is set out in Law Companion Ruling LCR 2018/6 Diverted profits tax. This Guideline should be read in conjunction with LCR 2018/6. 8. Due to the seriousness of making a DPT assessment, Law Administration Practice Statement PS LA 2017/2 Diverted profits tax assessments provides direction to our staff on the steps that must be followed in order to make a DPT assessment, and after a DPT assessment is made. The process outlined in PS LA 2017/2 is rigorous and includes several layers of endorsement and oversight. 9. All further legislative references in this Guideline are to the of the ITAA 1936, unless otherwise indicated.", "Compliance_Approach": "General compliance activity: 11. We expect that a DPT risk will usually be identified in the course of our ordinary compliance activity. 12. Once a DPT risk is identified, our compliance approach may include ongoing monitoring of the risk or active consideration. Our decision-making process in relation to compliance activity is guided by the circumstances of the particular case. We will generally prioritise our resources to address arrangements that we consider pose the highest risk. 13. We will generally tell you if we intend to commence an examination of a DPT risk. As part of our examination, we will consider information available to us and may request further information from you as outlined in paragraphs 62 to 72 of this Guideline. 14. We will seek to communicate our findings to you once we have concluded our examination and will outline our proposed compliance approach going forward. This may include further compliance activity or no further action. If we consider your arrangement to be low risk, we may continue to monitor your arrangement having regard to any additional information that becomes available. 15. In some cases, we may identify other treatment strategies where there is an identified DPT risk. This may include a recommendation to seek greater certainty through an advance pricing arrangement (APA) or a private ruling. 16. It is important to note that in the course of our compliance activity we may consider the application of the DPT concurrently with other provisions of the income tax law, including the transfer pricing rules in Division 815 of the Income Tax Assessment Act 1997 (ITAA 1997). In order for the DPT to apply, the criteria set out in paragraph 6 of this Guideline must be satisfied. These criteria include the principal purpose test in paragraph 177J(1)(b) which is the central provision around which the DPT operates. [1] Consequently, while the DPT provisions are not provisions of last resort, consistent with the operation of Part IVA generally, it is expected that the DPT will be applied in limited circumstances. | Advance pricing arrangements: 17. The extent to which an APA provides assurance in relation to the potential application of the DPT will depend upon the date that the APA application or renewal is or was entered into, and whether the APA contains a DPT clause. The DPT clause is explained at paragraphs 54 to 56 of this Guideline. Advance pricing arrangement applications and renewals entered into prior to 4 April 2017 18. For APA applications and renewals entered into prior to 4 April 2017 [2] ,assurance relating to the DPT will generally not be provided to a taxpayer. Advance pricing arrangement applications and renewals entered into on or after 4 April 2017 19. For APA applications and renewals entered into on or after 4 April 2017, the covered transactions will generally be considered low risk for the purposes of the DPT for the period of the APA. The relevance of a low-risk rating is explained at paragraph 19 of this Guideline. Monitoring compliance stage 20. In reviewing a lodged Annual Compliance Report, where the covered transactions are considered to be low risk for the purposes of the DPT, we will generally not apply compliance resources to review the potential application of the DPT. This however, does not afford the same protection as an APA that includes a DPT clause. 21. If the APA includes a DPT clause, we will only consider the application of the DPT in relation to the covered transactions where the taxpayer has not complied with the terms of the APA or where there has been a breach of an APA critical assumption. 22. Where there has been a breach of an APA critical assumption, we will consider our treatment of the breach in accordance with Law Administration Practice Statement PS LA 2015/4 Advance Pricing Arrangements. For instance, if there is a material change in the facts about the taxpayer or its affiliates that constitutes a breach, we may consider whether the change in circumstances results in a potential risk of the DPT applying to the covered transactions. | Settlements: 23. If there is a risk that the DPT may apply to an arrangement covered by a proposed settlement, we will generally seek to resolve the matter before proceeding with the settlement. 24. Taxpayers may request the insertion of a DPT clause in their settlement deeds. We will consider the insertion of such a clause on a case-by-case basis. Taxpayers engaged in settlement negotiations with us who would like such a clause are encouraged to make a request during the early stages of the settlement negotiations. | Our risk assessment framework: 25. This section is designed to assist you in assessing the risk of your arrangement. This section contains: 26. You should consider this section in conjunction with the DPT risk assessment process at Appendix 1 to this Guideline. | Our framing questions for assessing risk: 27. You can assess the risk of your arrangement having regard to the framing questions outlined in paragraphs 27 to 31 of this Guideline. The framing questions are indicative of the matters we are likely to consider when assessing the risk that the DPT applies to an arrangement. The framing questions are separated into a number of categories although there may in a particular case be significant overlap in relation to these categories. Preliminary framing questions 28. In conducting a preliminary assessment of risk we will generally consider the following questions: 29. If any of these questions are answered in the negative then we are unlikely to consider the potential application of the DPT further (other than to test or confirm the conclusion reached and monitor any future arrangements). Transaction-specific framing questions 30. In assessing the risk of a particular arrangement we may consider a number of transaction-specific framing questions if the taxpayer is otherwise within the scope of the DPT. These questions are likely to focus on whether the arrangement involves: Framing questions relevant to the principal purpose test 31. The following questions may be relevant to the application of the principal purpose test. The questions outlined in paragraph 32 of this Guideline may also be relevant when considering this test: Framing questions relevant to the sufficient economic substance test 32. In assessing whether an arrangement satisfies the SES test, we are likely to consider the following kinds of questions. Affirmative answers to the following questions indicate a greater likelihood of satisfying the SES test: | Matters relevant to the application of the sufficient economic substance test: 33. The SES test is an exception to the application of the DPT. The SES test will apply (that is, the exception will be satisfied) where it is reasonable to conclude that the profit made as a result of a scheme by each relevant entity reasonably reflects the economic substance of the entity's activities in connection with the scheme. 34. The scenarios at Appendix 2 to this Guideline are provided to illustrate some of the matters we will consider in assessing risk in relation to the SES test. 35. The scenarios at Appendix 2 to this Guideline include both high and low-risk scenarios. The high-risk scenarios highlight the circumstances in which we consider it unlikely that the SES test will apply. The low-risk scenarios highlight the circumstances in which we consider it likely that the SES test will apply. 36. Under the SES test, to the extent relevant, regard is to be had to the 2010 OECD Transfer Pricing Guidelines (OECD Guidelines) and other documents covered by section 815-135 of the ITAA 1997 [3] in determining whether the profit made by an entity reasonably reflects the economic substance of the entity's activities in connection with the scheme. 37. When we are determining whether the profit made by an entity reasonably reflects the economic substance of the entity's activities in connection with the scheme, to the extent relevant, we will have regard to the OECD Guidelines [4] in relation to the use of transfer pricing methods including both the traditional transaction methods and the transactional profit methods. The appropriate method will depend on the circumstances of the particular case. 38. Generally, we will accept, based on an assessment of sufficient information and documentation, a profit that falls within a range of acceptable results, provided that the profit made by each entity reasonably reflects the relative significance of the functions performed by the entity and the entity's relative contribution within the context of the overall value chain. 39. In addition, in considering the 'profit' made by each entity as a result of the scheme, we will generally determine 'profit' in a general commercial sense, having regard to accounting measures as a guide. | Other relevant guidance products: 40. We consider the following guidance products relevant to determining the level of engagement we expect from you: 41. If your arrangement is in the green zone under PCG 2017/1 or PCG 2017/4 [5] , there is no expectation that you will separately engage with us in relation to the DPT. Practically, this means we will generally only dedicate compliance resources to review your arrangement in accordance with the relevant Guideline. 42. Similarly, if your arrangement is in the white zone under PCG 2017/1 or PCG 2017/4, we will generally only undertake compliance activity to the extent stipulated in the relevant Guideline. 43. If you are eligible to apply any of the following simplified transfer pricing record-keeping options under PCG 2017/2, there is no expectation that you will separately engage with us in relation to the DPT for covered transactions: 44. Practically, this means we will generally only undertake compliance activity to the extent stipulated in the Guideline. 45. Our approach to assessing risk in such cases is limited to the types of arrangements outlined in the specified Guidelines. Guidance products – insurance arrangements 46. When considering the application of the DPT in the context of insurance arrangements, we will have regard, among other relevant matters, to existing ATO advice and guidance on these arrangements. Specifically, we will have regard to the guidance contained in Taxation Ruling TR 96/2 Income tax: taxation implications of arrangements known as financial insurance and financial reinsurance and Law Administration Practice Statement PS LA 2007/8 Treatment of non-resident captive insurance arrangements. 47. Refer to SES Scenario 12 in Appendix 2 to this Guideline for an example of an insurance arrangement that would be considered low risk for the SES test. | Our client engagement framework: 48. We expect you to engage with us if, having considered the risk of your arrangement taking into account our risk assessment framework, you conclude that there is a potential DPT risk associated with your arrangement. 49. If your arrangement requires further engagement with the ATO to obtain greater certainty, the main avenues of engagement are: 50. As early as possible during the APA or private ruling process, we will advise you if an alternative product is better suited to your circumstances. | Advance pricing arrangement program: 51. The APA program can provide certainty with respect to the application of the DPT to covered transactions for an agreed period. For certain DPT tax benefits [6] , the APA program is our preferred product when we need to consider the substance of a group's overall value chain. 52. In most cases, we do not expect the DPT to be a risk that will potentially affect the outcome of an APA. However, where it does represent such a risk, where practicable, we will seek to deal with the DPT as a collateral issue in parallel with the development of the APA. 53. Where it is not practicable to resolve a DPT risk during the APA process, it is unlikely that we will proceed with the APA and the matter may be referred internally for further consideration. Diverted profits tax clause 54. If you wish to obtain further assurance in relation to the DPT, you can request that a DPT clause be inserted into an APA. The standard DPT clause provides written assurance to you that, in relation to the covered transactions under an APA, we will not seek to issue a DPT assessment for the income years covered by the APA. However, this is subject to: 55. At your request, we will consider extending the standard DPT clause to include a DPT tax benefit that arises from a tax benefit referred to in paragraphs 177C(1)(bb), (bbaa), (bba) or (bc). Taxpayers may be required to provide further information to enable us to make a decision in relation to any such request. 56. If you would like a DPT clause included in an APA, we ask that you make note of it in your APA submission or as early as possible in the APA process. | Private rulings: 57. You may lodge a request for a private ruling on the application of the DPT in relation to a particular arrangement. A private ruling may be appropriate where you require a greater level of certainty in relation to the application of the law. 58. However, it should be noted that you will only obtain a greater level of certainty if the arrangement ruled upon reflects the arrangement actually carried out, and all relevant matters are disclosed. | Relevant documentation: 59. There are no specific record-keeping requirements for the DPT. Taxpayers will need to keep appropriate records of their arrangements and transactions in the normal way. 60. We have, however, sought to outline in paragraphs 62 to 72 of this Guideline the kinds of documentation we may consider relevant should your arrangement require engagement (for example, during the APA process). The documentation may also be relevant when we are assessing risk during compliance activity. 61. The documentation outlined in this Guideline is intended as a general guide and should not be treated as an exhaustive or mandatory list of the kinds of documentation we may take into account. The relevance of particular documentation will turn on the circumstances of the arrangement in question. | General: 62. In considering the application of the DPT, we will have regard to information in our possession, including but not limited to: 63. To further assist us in considering the application of the DPT, you may provide the following information: 64. Where you have chosen to use a simplified transfer pricing record-keeping option, we will have regard to the record-keeping obligations outlined in PCG 2017/2.", "Examples": "", "Appendices": "Appendix 1: – Diverted profits tax risk assessment process 73. Diagram 1 of this Guideline outlines the risk assessment process. Diagram 1: Diverted profits tax risk assessment process | Appendix 2: – Low-risk and high-risk scenarios for the sufficient economic substance test Sufficient economic substance Scenario 1: lease in lease out arrangement – high risk Diagram 2: lease in lease out arrangement – high risk Background 74. Australia Co is a wholly owned subsidiary of a global parent entity engaged in the operation of oil drilling rigs. Asset Co and Sub-lessor Co are also members of the global group. 75. Asset Co is the legal owner of a drilling rig and provides the requisite finance and insurance for the asset. Asset Co is a resident of a country that does not have a tax treaty with Australia. Sub-lessor Co is resident of a country that has a tax treaty with Australia. 76. Asset Co leases the rig to Sub-lessor Co under the Master Lease for $300 million per annum. 77. Sub-lessor Co sub-leases the rig to Australia Co on substantially the same terms for the same period for $350 million per annum under a sub-lease arrangement. 78. Australia Co utilises the rig in the conduct of its business. As part of the conduct of its business, Australia Co is responsible for identifying and liaising with third-party customers, the marketing and scheduling of the rig, managing its outsourced contractors, and managing operational, environmental and utilisation risks associated with the rig. 79. The sub-lease contract between Sub-lessor Co and Australia Co mirrors the terms of the Master Lease agreement and there are no inherent risks borne by Sub-lessor Co. Accordingly, risks are shared between Asset Co and Australia Co. 80. After taking into account the costs associated with the running of its business, Australia Co makes a return commensurate with its functional profile. 81. Service Co is a foreign related party of Australia Co and undertakes various technical, crewing and other services related to the operation of the rig on behalf of Australia Co. Service Co employs staff with the requisite skills to perform the obligations under the contracts. 82. The interposition of Sub-lessor Co results in a reduction or exclusion from Asset Co's liability to pay royalty withholding tax on the lease payment. This is a consequence of the Double Tax Agreement in force between Australia and the foreign country in which Sub-lessor Co is a tax resident. 83. There is a substantial equipment permanent establishment (PE) of Sub-lessor Co in Australia. However, Sub-lessor Co does not perform any additional functions that would result in Sub-lessor Co being considered to be carrying on a business through a PE in Australia (pursuant to subsection 6(1)) and the relevant treaty does not deem the PE to be carrying on a business. As such, no Australian royalty withholding tax could apply between the lease payments made by Sub-lessor Co to Asset Co. Sufficient economic substance analysis 84. Based on the information available to us, the profit made as a result of the scheme by Australia Co and Service Co appears to reasonably reflect the economic substance of the entity's activities in connection with the scheme. 85. Notwithstanding Sub-lessor Co being party to the sub-lease agreement with Australia Co, it does not undertake any active functions in respect of the sub-lease. No independent consideration or negotiation is undertaken by Sub-lessor Co to determine the relevant terms and conditions of the sub-lease nor does Sub-lessor Co actively engage in managing any inherent risks from the underlying agreement (for example, defaulting payments). 86. Based on the information available to us, the profit made as a result of the scheme by Sub-lessor Co ($50 million) does not appear to reasonably reflect the economic substance of Sub-lessor Co's activities in connection with the scheme. 87. Asset Co, as the Master Lease holder, is responsible for the acquisition and financing of the rig, and the ongoing insurance of the rig with external providers. A functional analysis determines that Asset Co should have received $350 million for its economic activities in connection with the scheme. 88. Based on the information available to us, the profit made by Asset Co as a result of the scheme does not appear to reasonably reflect the economic substance of Asset Co's activities in connection with the scheme. We would consider this to be high risk in the context of the SES test. Sufficient economic substance Scenario 2: lease in lease out arrangement – low risk 89. Assume the following modifications to the facts of Scenario 1 of this Guideline. 90. Sub-lessor Co is the central leasing entity for the global group and is responsible for the sub-lease of rigs to related party operating entities in various regions of the world (including the Mediterranean, Africa and South America). Sub-lessor Co is responsible for global marketing and scheduling of the rigs, managing outsourced contractors, and adhering to local government reporting and compliance obligations in the country of Sub-lessor Co. Sub-lessor Co also bears utilisation risk in relation to the vessel and its financial performance is a function of its ability to optimise utilisation of the asset during the period of the head lease. 91. Sub-lessor Co enters into a Master Lease agreement with Asset Co under arm's length terms. Sub-lessor Co then sub-leases the rig to Australia Co after negotiating the terms and conditions of the lease for $350 million per annum under a sub-lease arrangement. Australia Co utilises the asset in the conduct of its oil drilling business. 92. In this modified scenario, Sub-lessor Co is able to demonstrate that it carries out significant functions and bears actual risk in its role as sub-lessor. After taking into account the costs associated with the running of its business, Australia Co makes a return commensurate with its functional profile and Asset Co is remunerated in accordance with the financial and economic risks borne by it in respect of the rig. 93. Based on the information available to us, the profits made by Australia Co, Asset Co and Sub-lessor Co as a result of the scheme appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be low risk in the context of the SES test. Sufficient economic substance Scenario 3: intangibles migration (pharmaceutical) – high risk Diagram 3: intangibles migration (pharmaceutical) – high risk Background 94. Australia Co is part of a global pharmaceutical group. The group's core business is the development and commercialisation of pharmaceutical products. The group derives the bulk of its income from the sale of medicinal drugs. The development and manufacture of the drugs requires the group to exploit a range of IP assets. 95. On 1 July 2017, the group restructured. Prior to the restructure, Australia Co was the legal and beneficial owner of the IP associated with medicinal drug #16 (MD16) including registered trademarks, patents, know-how and processes. Australia Co performed all functions associated with developing, enhancing, maintaining, protecting and exploiting MD16. This involved funding and managing the development of the drug over a 10-year period, including: 96. On 1 July 2017, at the final stage of clinical trials and prior to commercialisation, Australia Co and Foreign Co entered into an agreement which legally transferred the ownership of all the existing registered IP relating to MD16 to Foreign Co. This included exclusive rights to utilise the registered IP for the manufacturing, distribution, marketing and commercialisation process. The trademarks for the product were also permanently assigned to Foreign Co. Foreign Co is the legal owner of the IP for MD16 post 1 July 2017. 97. At the time the registered IP was transferred, Foreign Co employed a small number of staff with limited experience in the development and commercialisation of pharmaceutical products. 98. Following the disposal, a manufacturing contract was entered into between Foreign Co and a third-party manufacturer to produce MD16 for the purpose of global sales. Evidence available to us indicates that Australia Co undertakes functions related to the manufacture and commercialisation of MD16 for the global market, including: 99. Australia Co also continues to perform functions associated with developing, enhancing, maintaining, protecting and exploiting MD16, including: 100. Australia Co is remunerated on a cost plus basis for the services provided to Foreign Co. Foreign Co is responsible for payment to the third-party manufacturer for the production of the drug and receives all income from global sales of the drug. 101. The effect of the arrangement is to move ownership of the IP offshore and the subsequent profits arising from the global sales of the drug. Sufficient economic substance analysis 102. We take the view that an independent entity in circumstances comparable to Australia Co would not have entered into the arrangement as it involves Australia Co disposing of valuable IP while continuing to undertake the main functions in connection with the commercialisation of the IP. If the transfer of the IP had not taken place, Australia Co would have derived the income from global sales of the drug. 103. At the time of the disposal of the IP, the drug was fully developed and ready for commercialisation. Following its disposal, Foreign Co enjoys legal and beneficial ownership of the IP and derives a majority of the profits from its exploitation. 104. The form of the transaction allocates all risks that come with owning the IP to Foreign Co, as the purchaser. However, Australia Co continues to bear economically significant risks associated with the exploitation of the IP. The functions required to exploit the drug, including the legal protection of the IP, management of the third-party manufacturing contract and distribution of the drug, continue to be performed by Australia Co. 105. Based on the information available to us, the profits made by Foreign Co and Australia Co as a result of the scheme do not appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be high risk in the context of the SES test. Sufficient economic substance Scenario 4: intangibles migration (pharmaceutical) – low risk 106. Assume the following modifications to the facts of Scenario 3 of this Guideline. 107. Australia Co determines that it does not have the requisite skills and resources to successfully commercialise MD16. In addition to the transfer of the registered IP rights in respect of MD16 to Foreign Co, the following are also transferred to Foreign Co from Australia Co: 108. Further, a number of key employees of Australia Co involved in the decision-making and management of the MD16 project were also relocated to Foreign Co. Foreign Co also employed additional personnel locally who are qualified and skilled in the development and commercialisation of pharmaceutical products. 109. Foreign Co provided market value [8] compensation to Australia Co in relation to the transfer of the registered IP, as well as associated business assets and other intangibles. 110. Australia Co made a gain on the disposal on the registered IP which it included in its assessable income. The R&D integrity rules applied to the relevant parts of this gain. 111. After the transfer of the MD16 business, Australia Co continued to perform various functions to develop, enhance and protect the MD16 IP under an agreement with Foreign Co to provide contract R&D and other support services. These functions were only performed for a short transitional period following the transfer of the business to Foreign Co and were performed under the direction of Foreign Co staff. Australia Co was remunerated by Foreign Co for these services in accordance with arm's length principles. 112. After the transition period, Australia Co provided limited contract R&D services in relation to the MD16 at the direction of Foreign Co and was remunerated accordingly. 113. Foreign Co employees are responsible for the planning and design of the manufacturing process for MD16. Foreign Co also bears the relevant risks associated with the exploitation of the IP, including risks associated with the manufacture and distribution of the MD16 product. Furthermore, Foreign Co has the financial capacity to bear the costs of managing and mitigating these risks as well as assuming any potential losses. 114. Foreign Co is entitled to the profits from the global sales of the MD16 products as a result of the functions and risks assumed by Foreign Co. 115. Based on the information available to us, the profits made by Foreign Co and Australia Co as a result of the scheme appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be low risk in the context of the SES test. Sufficient economic substance Scenario 5: distributor – high risk Diagram 4: distributor – high risk Background 116. Parent Co, Australia Co, Singapore Co and China Co are members of a global group which designs, manufactures and markets electrical appliances. 117. China Co owns the group's manufacturing facilities and is responsible for: 118. Singapore Co is the initial purchaser of the finished goods and distributes the goods in the Asia-Pacific region. Singapore Co buys the goods from China Co at a percentage mark up on cost. Singapore Co further subcontracts to Australia Co for distribution to Australian customers. Singapore Co does not take physical possession of or make any changes to the products. 119. There are 2,000 employees in Singapore Co who perform centralised ordering and invoicing, human resources, logistics and sales and distribution functions for various countries in the Asia-Pacific region. Information available to us suggests that Singapore Co performs ordering functions for Australian sales based on instructions from Australia Co. We do not have any evidence that Singapore Co employees undertake any relevant functions in relation to the generation of Australian sales. 120. The terms of the contractual agreement between Australia Co and Singapore Co provide that Australia Co is a limited risk distributor and that Australia Co's purchase price is set in order to achieve a particular targeted adjusted operating margin of 2%. As set out in the distribution agreement between Australia Co and Singapore Co, Australia Co's main responsibilities as a distributor are the provision of routine sales and marketing support functions, and the delivery of administrative services. Pursuant to this agreement, Australia Co is the contracting party in all agreements entered into with Australian customers and these customers only have recourse to Australia Co. 121. Available evidence suggests that Australia Co assumes the relevant risks including inventory risk, market risk, customer credit risk, and warranty and product liability risk. 122. Australia Co employs over 500 personnel who perform a variety of functions, including: 123. In examining the arrangement between Singapore Co and Australia Co, we review information provided by the taxpayer as well as publicly available information, Country-by-country reports and information obtained under exchange of information processes. 124. To further understand the arrangement, we seek to conduct functional analyses of Australia Co and Singapore Co and issue a number of requests for information to obtain additional information about their roles and functions. Australia Co is not forthcoming in engaging with us, consistently requests lengthy extensions of time to respond and provides incomplete responses to our requests for information. 125. As a result, we rely on available information to complete our review. This information suggests that over the years, Australia Co has undertaken market development activities which enhanced the value of the global group's brand name, with the strategy of building the group's market share in Australia. Sufficient economic substance analysis 126. Based on the information available to us, we take the view that the profits made by Australia Co and Singapore Co do not appear to reasonably reflect the economic substance of their activities in connection with the scheme. Australia Co is the contracting party in all agreements entered into in the Australian market and it has an obligation to provide the products to customers. Australia Co's staff perform, significant functions including developing and implementing local marketing and promotional strategies, which are a crucial driver for the group's success in the Australian market. Australia Co's activities capture market share and generate value creation in Australia, and contribute to the strengthening of the global brand. 127. Furthermore, Australia Co bears market, inventory, warranty and customer credit risk. Australia Co undertakes functions and assumes risks that are consistent with the functional characterisation of a fully-fledged distributor. Australia Co's characterisation as a limited risk distributor does not align with its actual roles and responsibilities. On this basis, the profit made by Australia Co as a result of the scheme does not appear to reasonably reflect the economic substance of its activities in connection with the scheme. 128. Although there are a large number of employees in Singapore Co who are performing sales, marketing and distribution functions, these activities relate to sales made in the Asia-Pacific region excluding Australia. It is the activities performed by Singapore Co that relate directly to Australian sales that are relevant when considering the appropriate level of profit derived by Singapore Co for the purposes of the SES test. Available evidence demonstrates that Singapore Co has a limited, non-value adding role in relation to the sales made to Australian customers. 129. Singapore Co purchases products from China Co but does not take physical possession of the products. The purchases and delivery are based on Australia Co's instructions. Singapore Co relies heavily on Australia Co to perform key functions and Singapore Co's functions add value only to sales made in regions other than Australia. 130. Based on the information available to us, the profit made by Singapore Co as a result of the scheme does not appear to reasonably reflect the economic substance of its activities in connection with the scheme. We would consider this to be high risk in the context of the SES test. Sufficient economic substance Scenario 6: distributor – low risk Diagram 5: distributor – low risk Background 131. Assume the following modifications to the facts of Scenario 5 of this Guideline. 132. Singapore Co takes physical possession of the products from China Co in order to perform quality checks on the products to ensure they adhere to the relevant industry safety standards and regulations. As the group's distributor for the Asia-Pacific region, Singapore Co is also responsible for all significant decision-making activities referable to the sales of the product to Australian customers. 133. Australia Co has a separate agreement with Singapore Co which provides that Singapore Co is responsible for and assumes the economically significant risks that relate to the sale of goods to Australian customers. These risks include inventory risk, customer credit risk, and warranty and product liability risk. Singapore Co has exercised control over these risks through the performance of functions such as quality control and inventory management. Singapore Co also has the financial capacity to assume these risks. In the past it has been required to pay for warranty and product liability claims and to bear the cost of customer bad debts. 134. Of the 2,000 plus employees in Singapore Co, over 500 employees undertake significant functions in relation to the generation of Australian sales, including: 135. The taxpayer is able to demonstrate that the distribution agreement between Australia Co and Singapore Co is an accurate representation of Australia Co's main responsibilities, that is, the provision of routine sales and limited marketing support functions, as well as the delivery of routine administrative services. Australia Co employs 50 personnel in carrying out these functions. Australia Co's purchase price is set in order to achieve a targeted adjusted operating margin that appropriately reflects its significant economic contribution to the transaction. Based on the functional and comparability analysis the margin is higher than the return in Scenario 5 of this Guideline. 136. Further to the functional analyses of Australia Co and Singapore Co, evidence available to us confirms that Singapore Co's role in directing and managing sales and market development activities in Australia has enhanced the value of the global group's brand name and increased the group's market share. Sufficient economic substance analysis 137. While Australia Co maintains its role in providing routine sales, limited marketing support functions and routine administrative services, Singapore Co's staff perform significant functions in generating Australian sales. This includes developing and implementing local marketing and promotional strategies which are a crucial driver for the global group's success in all relevant markets. Singapore Co's activities capture market share, generate value creation in Australia and contribute to the building of the global brand. Singapore Co also assumes the relevant risks associated with the distribution of the products in Australia. 138. Importantly, in considering the activities performed by Singapore Co in relation to the generation of Australian sales, it is clear that Singapore Co possesses actual decision-making responsibilities in directing sales and marketing strategies as well as managing and controlling the implementation of market development activities. With its product development and client management functions also reflected by the capability of its staff, it is evident that Singapore Co performs key functions in adding value specifically to the generation of sales in Australia. Based on the information available to us, the profit made by Singapore Co as a result of the scheme appears to reasonably reflect the economic substance of its activities in connection with the scheme. 139. China Co owns the group's manufacturing facilities and is appropriately rewarded for the goods supplied to Singapore with a mark-up on cost. 140. Based on the information available to us, it also appears that the profits made by Australia Co and China Co as a result of the scheme reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be low risk in the context of the SES test. Sufficient economic substance Scenario 7: intangibles migration – high risk Diagram 6: intangibles migration – high risk Background 141. Foreign Co is the parent company of a global group. Australia Co is a wholly owned subsidiary of Foreign Co and the holding company for the group's Australian operations. The group derives income from the sale of goods and associated services. The distribution of goods and the provision of associated services require the group to exploit IP assets including copyrights, patents and trademarks. 142. On 1 July 2017, the group restructures. Prior to the restructure, Australia Co was the legal and beneficial owner of group IP (old IP) and performed all functions associated with developing, enhancing, maintaining, protecting and exploiting the old IP. Australia Co received income from global customer sales on behalf of the group. From 1 July 2017, Australia Co licences the old IP to Foreign Co to allow Foreign Co to produce future versions of goods using the old IP. After entering into this agreement, Australia Co becomes a sales agent of Foreign Co in relation to the sale of the goods to Australian customers. Under the licensing agreement, Foreign Co also becomes the legal owner of group IP developed post 1 July 2017 (new IP). 143. The evidence available to us suggests that the development of the new IP is wholly reliant on the enhancement and exploitation of the old IP so that the old IP forms the platform upon which the new IP is developed. Australia Co has a central role in the development of the new IP during the period following entry into the licensing arrangement, but is only engaged by Foreign Co on a contract R&D basis in respect of this work. Foreign Co pays licence fees to Australia Co on arm's length terms for the use of the old IP and remunerates Australia Co on a cost plus basis for providing contract R&D services associated with new IP. The amount of licence fees paid by Foreign Co to Australia Co declines over a short timeframe as the new IP is developed. Licence fees are no longer payable after the goods associated with the new IP are released to market. 144. Following this, key personnel are relocated offshore and Australia Co starts to provide limited R&D support to Foreign Co. Australia Co distributes goods to Australian customers only and is remunerated by Foreign Co on a cost plus basis. Foreign Co employs the key personnel and starts to perform the majority of functions associated with developing, enhancing, maintaining, protecting and exploiting the new IP. For example, Foreign Co: 145. These functions are a key aspect of the group's business model and vital to the success of the business globally. Foreign Co also sells and distributes the goods to offshore customers and receives income from global group sales. Foreign Co enters into new global agreements with third parties as the existing agreements with Australia Co expire. 146. The effect of these arrangements is to move ownership and development of group IP offshore. Sufficient economic substance analysis 147. On the available evidence, we take the view that the profits made by Foreign Co and Australia Co do not appear to reasonably reflect the economic substance of their activities in connection with the scheme. 148. Foreign Co enjoys legal and beneficial ownership of the new IP and derives a majority of group profits from the exploitation of the new IP, either through royalties from the use of the new IP by other group companies or directly through the manufacture and sale of products incorporating the new IP. This is mainly achieved via the modification and exploitation of the old IP, despite the absence of a legal form disposal of the old IP by Australia Co to Foreign Co. 149. Based on the evidence available, it is also considered that in the period following entry into the licensing agreement, Foreign Co did not have the capacity to undertake these further R&D activities as it did not have the expertise, know-how or qualified staff to do so and only paid Australia Co for the provision of 'limited R&D' services. While key personnel are eventually transferred to Foreign Co, it is considered that the activities undertaken by these employees after the transfer did not significantly contribute to the development of the new IP. 150. Additionally, the level of profit made by Australia Co is indicative of a sales agent with no responsibility for long-term product or market development and this does not reflect Australia Co's contribution towards the development, enhancement, maintenance and protection of the new IP during the period following entry into the licensing arrangement. As the key R&D specialists and know-how in relation to the old IP remained in Australia during this period, Australia Co's role was not merely of a contract R&D provider but rather Australia Co played a key role in the development of the new IP, including the making of key decisions during the R&D process. 151. Based on the information available to us, the profits made by Foreign Co and Australia Co as a result of the scheme do not appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be high risk in the context of the SES test. Sufficient economic substance Scenario 8: intangible migration – low risk 152. Assume the following modifications to the facts of Scenario 7 of this Guideline. 153. Foreign Co is the primary R&D entity of the global group and accordingly has staff with the necessary skills, experience and capability to provide the relevant R&D services to further develop and enhance group IP. 154. The strategic decision was made for Australia Co to sell the IP to Foreign Co. 155. Under this alternative arrangement, Australia Co received market value [9] consideration for the disposal of the IP from Foreign Co in accordance with arm's length principles. Australia Co made a gain on the disposal of the registered IP which is included in its assessable income. The R&D integrity rules applied to the relevant parts of this gain. 156. Going forward, Foreign Co is entitled to the profits from the global sales of goods associated with the old and new IP as a result of the functions and risks assumed by Foreign Co. 157. Based on the information available to us, the profits made by Foreign Co and Australia Co as a result of the scheme appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be low risk in the context of the SES test. Sufficient economic substance Scenario 9: marketing hub – high risk Diagram 7: marketing hub – high risk Background 158. Australia Co, Hub Co, Argentina Co and Canada Co are all members of a global group. The global group generates income primarily through selling commodities both in the Asia Pacific and Atlantic markets. 159. Australia Co, Argentina Co and Canada Co carry out mining, processing, inland transport and port activities for commodities in their respective jurisdictions. Australia Co, Argentina Co and Canada Co also undertake exploration activity to provide long-term reliable supply and to maintain the product brand. 160. Australia Co provides commodities for the Asia-Pacific market whereas the Atlantic market commodities are sourced from Canada Co and Argentina Co. 161. Under the group's arrangements, Australia Co, Argentina Co and Canada Co exclusively sell all their production (on Free on Board terms) to Hub Co, which then on-sells the commodities immediately to third-party customers (on Free on Board terms) in the 2 regional markets. 162. Due to Hub Co's participation in the sales market, it collects 'sales-side' market intelligence for the 2 distinct markets to assist in the identification of, and marketing to, potential customers (such as, technical specification to price sensitivity, volume to price sensitivity, the customer's stockpile levels, demand cycles, sales by competitors). 163. Under the arrangement, Australia Co, Argentina Co and Canada Co use the 'sales-side' market intelligence to assist them in their production planning. In addition, in order to secure sales, Hub Co is also dependent on the technical and production information gathered by Australia Co, Argentina Co and Canada Co in relation to their commodities as customers utilise this information to inform their purchase decisions. Accordingly, Hub Co is highly dependent on Australia Co, Argentina Co and Canada Co to provide technical marketing assistance to allow it to secure the sale of the commodities to third parties. 164. Australia Co, Argentina Co and Canada Co provide Hub Co with ongoing 'production-side' market intelligence (such as, forecast production schedules, port loading delays, changes in product quality, production or quality of competitors) and a feedback channel to their operating assets to allow Hub Co to most effectively sell its commodities. 165. Hub Co also receives information from group personnel located in the jurisdictions of the customers, who provide real-time information of market conditions and customer contact in those regions. 166. Physically, Australia Co, Argentina Co and Canada Co hold the commodities in port stockpiles until sold. Hub Co does not alter the commodities, or take physical possession. 167. Australia Co, Canada Co and Argentina Co sell commodities to Hub Co at a discount relative to their respective regional index price which allows Hub Co to generate profits on the sale of the commodities to third-party customers. 168. Australia Co employs staff who perform the following activities: 169. Canada Co and Argentina Co undertake similar functions in relation to their local markets. 170. The taxpayer has provided documentation that stipulates that Hub Co assumes the following risks: 171. Hub Co employs staff who undertake the following activities: Sufficient economic substance analysis 172. On the available evidence, we take the view that the profits made by Australia Co and Hub Co do not appear to reasonably reflect the economic substance of their activities in connection with the scheme. 173. While Hub Co performs marketing activities and other administrative functions, we do not consider that these activities reasonably reflect the level of profits that it is receiving given that Australia Co, Canada Co and Argentina Co (as well as the personnel located in the local jurisdictions of the customers) provide key functions to Hub Co to allow it to secure its third-party contracts. 174. Based on the functional analyses undertaken by us, Australia Co staff are responsible for ensuring planning, production and technical marketing of the commodities as well as collating local market intelligence. Australia Co undertakes significant activities in relation to the production, scheduling and specifications of the commodities which are important to the group's third-party customers. Key value chain decisions and management functions are undertaken by Australia Co in relation to the Asia-Pacific sales and Hub Co does not undertake the activities required to obtain its third-party contracts or to satisfy its contractual obligations, and relies on the functions and decision-making activities of its related parties in order to fulfil its obligations. 175. Further, as inventory is mined and transported to stockpiles at port and held until requested by customers, most of the market risk is still held by Australia Co. Hub Co bears limited market risk as the commodities are not sold to Hub Co unless the commodities are needed to fulfil a sales agreement with a customer. Hub Co does not have full control over the sales in relation to the supply, delivery or scheduling of the commodities as these are all dependent on Australia Co's functions. As such, Hub Co does not have a real exposure to losses based on the price or volume of the transaction. 176. Although Hub Co legally assumes accounts receivable late payment risk, based on the information available to us, Hub Co does not have the ability to manage and control any of its exposure to this risk and does not have the financial capacity to bear the risks apart from the ability to call on the financial resources of its parent. 177. Based on the information available to us, the profits made by Australia Co and Hub Co as a result of the scheme do not appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be high risk in the context of the SES test. Sufficient economic substance Scenario 10: marketing hub – low risk Diagram 8: marketing hub – low risk Background 178. Australia Co, Hub Co and a number of foreign companies (Foreign Cos) are all members of a global group. The global group generates income primarily through the sale of oil and gas in various regional markets around the globe. 179. The global group acquires a percentage interest in the rights to develop a prospective natural gas field in Australia. This field holds proven reserves of natural gas that are able to be commercialised into liquefied natural gas (LNG). Australia Co is incorporated to carry out the front-end engineering design, the subsequent extraction of the natural gas and its conversion to LNG. The Foreign Cos undertake similar activities in their local jurisdictions. 180. Hub Co is a global hub for the group and carries out marketing, storage (as required), shipping and other related services in the LNG markets. The role of Hub Co as a global hub pre-dates the LNG sales agreement with Australia Co. 181. Australia Co and the Foreign Cos enter into long-term sales agreements with Hub Co to sell 100% of their production to Hub Co, including any excess production volumes. Hub Co also purchases a diverse portfolio of liquid natural gas (LNG) from third-party producers, using a mixture of medium to long-term supply contracts and spot purchases. Hub Co also owns and leases seaborne freight capacity. 182. Hub Co has a number of long-term third-party sales contracts that are fulfilled using both related party and third-party supplies. 183. Hub Co identified the small number of foundation buyers (that were the basis for the group's Final Investment Decision (FID) in the Australian LNG project). LNG produced by Australia Co is on-sold by Hub Co to the foundation buyers, as well as other third-party customers. 184. Hub Co is responsible for ensuring that the orders are most optimally scheduled and fulfilled. For example, this could address situations where there are urgent customer orders to be met or where there is port congestion requiring diversion of the affected ship to another port. 185. Hub Co takes legal title of the LNG from Australia Co and the Foreign Cos upon loading of the LNG onto the vessel. While Australia Co and the Foreign Cos are responsible for ensuring liquefaction of the natural gas and piping of the LNG at the load ports, Hub Co is responsible for the shipping of the LNG to the customers from the load port until delivered. 186. Hub Co develops business strategies for the sale of LNG to third-party customers. Australia Co and the Foreign Cos provide Hub Co with on-going production information (such as, forecast production schedules, transportation delays, changes in LNG specifications); Hub Co is not solely reliant on this information to inform its marketing and trading strategies. Hub Co has third-party providers and in-house employees responsible for obtaining third-party market information to assist in its decision-making and price negotiations. 187. Australia Co, as the operator of the Australian LNG project for the global group, employs staff or contractors to perform the following activities: 188. The Foreign Cos undertake similar functions in their local markets. 189. Hub Co employs staff who are located in the same jurisdiction as Hub Co to undertake the following activities: 190. There are no staff in Australia that have the ability or capacity to undertake the activities performed by Hub Co. 191. The taxpayer has provided documentation which demonstrates that Australia Co and Hub Co assume various entrepreneurial risks. Australia Co takes on entrepreneurial risks related to the construction, financing and operation of the LNG project and management of the joint venture parties. Australia Co assumes production volume and production cost risk and, to an extent, also bears price risk in relation to the sales to Hub Co. 192. Hub Co assumes further entrepreneurial risks related to the marketing, sourcing, sales and delivery of the LNG, such as: Sufficient economic substance analysis 193. Based on functional analyses and the evidence provided, Australia Co's staff are responsible for exploration, construction, operations, project financing, extraction of the natural gas, and loading of the LNG. Further, as a result of the long-term sales and purchase agreement with Hub Co, Australia Co receives the market index price (with market based (or similar) adjustments for specification) and has a relatively certain income stream for its production volumes to allow it to focus its resources on production rather than marketing and portfolio management. 194. Hub Co undertakes key sales, marketing decisions and management functions. In this regard, Hub Co is responsible for securing sales, arranging shipping and delivery to third-party customers. It is also responsible for portfolio optimisation and, in some instances, a degree of storage. Hub Co therefore also takes on entrepreneurial risks, including some degree of market price risk, being the difference between the price it pays to Australia Co and receives from third-party customers. 195. In addition, the documents provided by the taxpayer support a conclusion that Hub Co has assumed customer non-performance risk, which primarily arises from spot contracts with new customers negotiated by Hub Co. The evidence supports the conclusion that Hub Co possesses the ability to manage and control its exposure to these risks (such as having the authority within the group to blacklist these customers) and possesses the financial capacity to bear the risks. 196. Based on the information available to us, the profits made by Australia Co, Hub Co and Foreign Co as a result of the scheme appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be low risk in the context of the SES test. Sufficient economic substance Scenario 11: financing arrangement – high risk Diagram 9: financing arrangement – high risk Background 197. Australia Co is a wholly owned subsidiary of Foreign Parent Co. Australia Co is engaged in the production, marketing and distribution of packaged food and beverages. Australia Co has an Australian dollar functional currency for Australian accounting and tax purposes. 198. Fin Co 1 is the treasury company for the global group. It is responsible for entering into financial transactions with external parties for the purposes of group debt funding, hedging and other cash management activities. Fin Co 1 has 40 full-time employees and performs various treasury functions, including: 199. Fin Co 1 is funded by equity from Foreign Parent Co and sources debt funding for the global group from third-party borrowings. The traceable debt cost of US dollar (USD) funds for Foreign Parent Co is 3%. 200. On 1 July 2017, Australia Co refinances its Australian Dollar (AUD) AUD500 million loan from Fin Co 1 into an equivalent USD loan. The repayment terms are interest only. The refinancing of the loan from AUD to USD results in an actual reduction in interest rate. The interest rate on the AUD loan was fixed at 5% and the interest rate on the USD loan is fixed at 3%. Fin Co 1 is subject to Australian interest withholding tax on the payment of interest. 201. The multinational group's decision to refinance the related party loan creates an exposure for Australia Co to exchange rate movements (that is, USD to AUD). This is said to result in commercially significant volatility in Australia Co's standalone cash flow, financial accounts and tax performance which results in the group deciding to have a member of the Australian tax consolidated group enter into a foreign currency derivative with another overseas member of the group to reverse the foreign currency exposure created under the related party borrowing. This newly created risk (that is now having to be managed), results in Fin Co 1 incorporating a subsidiary in the Cayman Islands, Fin Co 2. 202. Fin Co 2 enters into a cross currency interest rate swap with Australia Co. At this time the AUD and USD currencies are at parity. Under the terms of the swap agreement Australia Co notionally exchanges USD500 million for AUD500 million (there is no physical exchange of principal). At maturity, Australia Co will notionally pay AUD500 million and notionally receive USD500 million. In addition, Australia Co incurs annual periodic payments being the net of a payment of AUD interest (at 5% calculated by reference to the AUD500 million) and a receipt of USD interest (at 3% calculated by reference to the USD500 million). The periodic payments under the swap are net settled in USD (this does not eliminate the cash flow risk for Australia Co on the USD borrowings). Fin Co 2 does not enter into an arrangement to hedge the exposure it has assumed. The group does not enter into an arrangement with a third party to hedge the exposure at a group level. Sufficient economic substance analysis 203. The effect of the swap arrangement is that the cost of the loan to Australia Co is the same as before the refinancing however, after the refinancing, the interest cost is less and the balance is for the periodic swap payments. For Australian tax purposes, the periodic swap payments are deductible under the Taxation of Financial Arrangements provisions and are not subject to Australian interest withholding tax. 204. Fin Co 2 has one part-time employee, is capitalised with nominal equity, and does not undertake any other treasury functions. The sole purpose of incorporating Fin Co 2 was for it to act as a counterparty under the swap arrangement. All but one of the directors of Fin Co 2 are on the board of Fin Co 1 and the directors usually reside in the United States of America. The role of the Fin Co 2 directors was essentially limited to entering into the swap arrangement. Fin Co 2 pays an annual dividend to Fin Co 1. This payment corresponds to its net periodic receipts from Australia Co. 205. The terms of the swap agreement, and the economic environment prevailing at the time the swap was entered into, meant that Fin Co 2 was a net receiver of periodic payments over the life of the swap arrangement. At maturity, Fin Co 2 made a net loss in relation to its notional right to receive AUD500 million and its notional obligation to pay USD500 million. It received a contribution of equity from Fin Co 1 to finance this net loss. Australia Co uses the proceeds of the net gain at maturity to, in part, meet its obligation to repay the USD loan to Fin Co 1. As the terms of the swap arrangement do not provide for an exchange of physical cash flows with respect to the notional principal and periodic interest payments, the swap does not manage the cash flow risk for Australia Co (that is, Australia Co does not receive USD to meet its periodic loan and principal repayments). 206. The information provided indicates that Fin Co 1's employees are actively engaged in performing the relevant functions and managing the relevant risks in respect of the refinanced loan. The Commissioner considers the profit made by Fin Co 1 appears to reasonably reflect the economic substance of its activities in connection with the scheme. 207. The information provided indicates that Fin Co 2 does not actively manage the foreign currency exposure arising from the swap arrangement. In addition, Fin Co 2 is not capable of meeting its obligations under the arrangement without contributions of equity from its parent, Fin Co 1. As a result, the Commissioner considers that Fin Co 2's profit does not appear to reasonably reflect the economic substance of its activities in connection with the scheme. We would consider this to be high risk in the context of the SES test. Sufficient economic substance Scenario 12: insurance arrangement – low risk Diagram 10: insurance arrangement – low risk [10] 208. Insurance Co is the reinsurer of a global group and is a resident in Bermuda. Insurance Co is authorised and registered to conduct an insurance business in Bermuda. 209. Insurance Co enters into reinsurance arrangements with Australia Co who provides insurance services to third parties in Australia. There is a genuine transfer of significant insurance risk to Insurance Co from Australia Co, with Insurance Co assuming the insurance risks under the reinsurance cover provided. Insurance Co is an associate of Australia Co. 210. Insurance Co employs staff located in Bermuda, who carry out underwriting, manage and control Insurance Co's arrangements with Australia Co, and manage Insurance Co's assets and investments. These employees have the requisite skills to undertake these activities. 211. Australia Co undertakes any reinsurance of its insurance risk exposure on arm's length terms and in a way which reflects its commercial risk appetite. 212. An insurance premium (net of commission) that is struck on arm's length terms is paid by Australia Co to Insurance Co. 213. Insurance Co has the capacity to pay and indeed does pay out any insurance claims made by Australia Co. 214. Costs incurred by Insurance Co are priced on arm's length terms, and there is no evidence of biased allocation of costs between the relevant insured risks and its other business. 215. Insurance Co undertakes any retrocession [11] of the reinsured risk to other reinsurers on arm's length terms and in a way which reflects its commercial risk appetite. 216. Insurance Co holds a level of capital in its investment portfolio which corresponds to the liability that it manages. Capital reserve levels and measurement of accounting liabilities in Insurance Co reflect the commercial nature of the relevant risks. [12] 217. Based on the information available to us, the profits made by Australia Co and Insurance Co as a result of the scheme appear to reasonably reflect the economic substance of their activities in connection with the scheme. We would consider this to be low risk in the context of the SES test.", "Other_Sections": "Diverted profits tax: This Practical Compliance Guideline sets out a practical administration approach to assist taxpayers in complying with relevant tax laws. Provided you follow this Guideline in good faith, the Commissioner will administer the law in accordance with this approach.", "Compendium_Reference": "/law/view/document?LocID=%22COG%2FPCG20185EC%2FNAT%2FATO%2F00001%22&PiT=99991231235958", "Is_Archived": false, "Is_Draft": false, "Source_URL": "https://www.ato.gov.au/law/view/document?docid=COG/PCG20185/NAT/ATO/00001", "Unmatched_Content": "This Practical Compliance Guideline is being updated and moderated for consistency with the APA Review recommendations. During the interim period where current ATO public guidance materials are being updated, any inconsistencies will be disregarded and the APA Review recommendations will be applied (available at Findings report APA program review ). Further guidance can be obtained by emailing internationalsgatekeeper@ato.gov.au , if required. This document incorporates revisions made since original publication. View its history and amending notices, if applicable. There is a Compendium for this document: PCG 2018/5EC . | What this Guideline is about | Background to the diverted profits tax | Sufficient foreign tax test | Related party financing arrangements | Procurement, marketing, sales and distribution hubs | Intellectual property arrangements | Date of effect: 10. This Guideline has effect from 1 July 2017 and applies to existing and new arrangements. | 65. In considering the application of the principal purpose test, we may have regard to the following kinds of source documents, where they are relevant to the matters listed in subsection 177J(2): | Sufficient foreign tax test: 66. In considering the application of the sufficient foreign tax test, we may have regard to the following kinds of documents: | 67. In considering the application of the SES test, we may have regard to the following kinds of documents: | 68. The documents that will be relevant in a particular case will depend on the circumstances of the case including the nature of the arrangement and the relevant industry sector. We provide some further guidance in relation to specific kinds of arrangements in paragraphs 69 to 72 of this Guideline. | Related party financing arrangements: 69. In the context of related party financing arrangements and related transactions, paragraph 57 of PCG 2017/4 provides examples of the kind of documentation that may be relevant in relation to the relevant risk indicators. | Procurement, marketing, sales and distribution hubs: 70. The framing questions listed at paragraphs 111 to 113 of PCG 2017/1 may assist taxpayers in identifying and preparing relevant documents in relation to procurement, marketing, sales and distribution hubs. | Intellectual property arrangements: 71. For intellectual property (IP) arrangements, we will pay close attention to intercompany agreements and company policies relating to the development, enhancement, maintenance, protection and exploitation of the relevant intangible assets. Source documents evidencing that the relevant entities are operating in accordance with intercompany agreements, company policies, transfer pricing documentation and other information supplied for the relevant period are likely to assist us in considering the application of the SES test. | 72. We may also have regard to the following kinds of documents: | Commissioner of Taxation 26 September 2018 | Previous paragraph 48 and previous paragraph 58 | Updates reflect closure of DPT specialist team. | Updated reference document and links. | Updated to align with amended style and formatting requirements. | Previously issued in draft form as PCG 2018/D2 | Related Rulings/Determinations: LCR 2015/2 LCR 2018/6 TR 96/2"}
 {"PCG_Number": "PCG 2026/D3", "Document_Type": "Draft PCG", "Title": "Draft Practical Compliance Guideline", "Status": "Draft", "Date_of_Issue": "24 June 2026", "Date_of_Effect": "1 July 2026", "Date_of_Withdrawal": "", "Replaces": "", "Related_Rulings_and_Determinations": "", "Legislative_References": "TAA 1953 Sch 1 45-5 TAA 1953 Sch 1 45-112 TAA 1953 Sch 1 45-112(1)(b) TAA 1953 Sch 1 45-205 TAA 1953 Sch 1 45-320 TAA 1953 Sch 1 45-320(3) TAA 1953 Sch 1 Subdiv 45-C TAA 1953 Sch 1 Subdiv 45-F TAA 1953 Sch 1 Subdiv 45-G TAA 1953 Sch 1 Subdiv 45-K TAA 1953 Sch 1 Subdiv 45-P ITAA 1936 262A", "Other_References": "How to vary your PAYG instalments Personal crisis or financial hardship Explanatory Memorandum to the A New Tax System (Pay As You Go) Bill 1999", "Summary": "3. This Guideline outlines the Commissioner's practical compliance approach to the application of the general interest charge (GIC) on excessive variations of PAYG instalments under Subdivision 45-G. 4. The purpose of the PAYG instalments regime is to ensure the efficient collection of income tax, the Medicare levy and other liabilities. [2] 5. PAYG instalments are a distinct and separate liability from your income tax liability at the end of the income year. Entities with business or investment income must pay instalments that either reflect current trading and investment conditions, or instalments based on the last year's income tax and a gross domestic product (GDP) adjustment. [3] 6. The underlying intent of the dynamic PAYG instalment method is to better align instalment amounts or rates to current financial performance. 7. Generally, the Commissioner issues you with either an instalment rate (instalment rate method) [4] or an instalment amount (instalment amount method). [5] This is based on the latest assessment for your most recent income year, or where the Commissioner is satisfied that a later income year has no taxable income, the latest return for that later year from which an assessment would have been made. [6] 8. You have the option to choose to vary your PAYG instalment rate or amount [7] , where, for example, your instalments (worked out by applying the instalment rate method or instalment amount method) will not be an adequate reflection of your expected tax liability for that income year. [8] Broadly, there is no prescribed method to vary your PAYG instalment rate or amount. [9] 9. Where you choose to vary your PAYG instalment rate or amount to calculate your PAYG instalments for a period [10] , the Commissioner may work out your benchmark instalment rate (Commissioner's benchmark instalment rate) or benchmark tax (Commissioner's benchmark instalment tax) for the income year under Subdivision 45-K. The Commissioner's benchmark instalment rate or benchmark instalment tax is based on historical data. 10. If you vary your PAYG instalment rate or amount, and the amount worked out is less than 85% of the Commissioner's benchmark instalment rate or benchmark tax, GIC may apply under Subdivision 45-G. If you are liable to GIC, the Commissioner may issue you with a notice of the amount, and you must pay it within 14 days after the notice is given to you. 11. The dynamic PAYG instalment method will assist you to vary your PAYG instalment amount so that the calculated dynamic PAYG instalments better reflect the underlying financial performance of your business for a period. Using real-time information from your business accounting software will reduce the potential for tax debts at the end of the year or overpaying instalments which reduces your working capital during the year. 12. To support the use of the dynamic PAYG instalment method, this Guideline provides a safe harbour from GIC being imposed and collected under Subdivision 45-G if the requirements set out within this Guideline are met, specifically when you are risk rated as falling in the white or green zones as described in Table 1 of this Guideline. 13. This Guideline does not consider the imposition of administrative penalties pursuant to Division 284.", "Purpose_and_Scope": "Scope: 17. This Guideline applies to you if you are using the dynamic PAYG instalment method provided by the Commissioner to work out your dynamic PAYG instalments. When you can rely on this Guideline 18. You must comply with the following requirements to obtain the benefit of this Guideline: Requirement to take reasonable care 19. The dynamic PAYG instalment method is designed to allow you to leverage your business accounting software to more accurately vary your PAYG instalments as a reflection of your financial performance for the relevant period. This design relies on and requires you to ensure that the information used in the dynamic PAYG instalment method properly reflects your financial position. 20. The compliance approach outlined in this Guideline is therefore also contingent on you taking reasonable care in relation to your inputs (values or data you use in the dynamic PAYG instalment method) and your broad use of the dynamic PAYG instalment method, including as to acts or omissions that might affect the accuracy or completeness of those inputs. 21. We will accept that you have exercised reasonable care for the purposes of this Guideline if, having regard to all relevant facts and circumstances, you have exercised the care that a reasonable person would be likely to exercise in your circumstances (this will include consideration of your knowledge, education, experience and skill) when meeting your tax obligations. The standard of reasonable care is determined objectively. 22. The following is a non-exhaustive list of indicators that reasonable care has been taken: 23. If you carry on a business, you have an obligation to keep records to explain all transactions and other acts you engage in that are relevant for any purpose of relevant taxation laws. [14] You must keep records that evidence your inputs, your use, and the outputs of the dynamic PAYG instalment method. Populating your activity statement 24. Guidance on how to vary your PAYG instalments in applying the dynamic PAYG instalment method is available on our website [15] or other materials authorised by us that set out how to apply the dynamic PAYG instalment method.", "Background": "14. The dynamic PAYG instalment method helps you use data obtained from your business accounting software to calculate PAYG instalments that reflect current financial performance, for the purpose of varying PAYG instalments under the law. 15. The dynamic PAYG instalment method operates within existing law and provides a way for taxpayers to work out appropriate varied instalment amounts.", "Compliance_Approach": "Intro: 25. Generally, you may be subject to review in relation to PAYG instalments under the Commissioner's compliance program. 26. The program will generally prioritise the application of our compliance resources to the areas of highest risk. 27. If you are subject to compliance action, the risk zones in Table 1 of this Guideline will assist you in understanding whether the Commissioner will have cause to apply compliance resources to impose and collect GIC under Subdivision 45-G in relation to your PAYG instalment variations. 28. It is important to note that the ATO offers tailored support for taxpayers experiencing challenging life circumstances. If you are finding it difficult to manage your tax obligations, the ATO can help with flexible options and supportive guidance. [16] 29. Table 2 of this Guideline explains how the Commissioner determines which risk zone you are in. For example, to reduce your PAYG instalment: You will also be in the red risk zone where your conduct raises questions about the possible application of general or specific anti-avoidance rules [18] , or you have engaged in fraud or evasion. This may include circumstances, whether in a single income year or across multiple income years, where: More generally, we will look closely at PAYG instalment variations that produce outcomes that are consistently or materially lower than what would be expected having regard to your underlying income tax liabilities.", "Examples": "Example s: 30. The following examples illustrate how the principles outlined in this Guideline may apply in practice. They are provided for illustrative purposes only and do not limit the circumstances in which this Guideline may apply. | Example 1: – using the dynamic PAYG instalment method and taking reasonable care 31. Little Co is a small business that has experienced a reduction in sales in the current income year due to circumstances which were not present in the previous financial year. They use the dynamic PAYG instalment method to work out their PAYG instalments. 32. Little Co's varied rate is less than 85% of the Commissioner's benchmark instalment rate for that income year. 33. Little Co uses the dynamic PAYG instalment method and takes reasonable care when calculating its PAYG instalment rate. In doing so, it relies on up-to-date financial information and incorporates the impact of the downturn in its current sales into those calculations. 34. Little Co is in the green risk zone. The Commissioner will not have cause to apply compliance resources to impose GIC in respect of the variation for the instalment period. | Example 2: – using the dynamic PAYG instalment method and making an inadvertent error 35. This scenario follows on from Example 1 of this Guideline. When preparing the September 2026 instalment, Little Co's head of accounts, Joanne, inadvertently enters incorrect financial data. She enters a fortnightly figure into the digital service provider (DSP) software where a monthly figure is required, resulting in a computational error. 36. The incorrect data causes the dynamic PAYG instalment method to produce a varied PAYG instalment rate less than 85% of the Commissioner's benchmark instalment rate for the income year. Without the mistake, the PAYG instalment rate would have remained at or above the benchmark. Joanne later identifies the error and corrects it when she calculates the PAYG instalment for the following month. 37. Little Co used the dynamic PAYG instalment method and otherwise took reasonable care when calculating its PAYG instalment rate. The outcome (PAYG instalment rate less than 85% of the Commissioner's benchmark instalment rate) arose from an inadvertent honest mistake that Joanne corrected for future periods. 38. Little Co is in the green risk zone. The Commissioner will not have cause to apply compliance resources to impose GIC in respect of the September 2026 instalment. | Example 3: – using the dynamic PAYG instalment method with a software error 39. This scenario follows on from Example 1 of this Guideline. When preparing the December 2026 instalment, Little Co's DSP software experiences a mapping error, where a, later confirmed, software bug includes an invoice that it shouldn't have. 40. The software error causes the dynamic PAYG instalment method to produce a varied PAYG instalment rate less than 85% of the Commissioner's benchmark instalment rate for the income year. Without the software error, the PAYG instalment rate would have remained at or above the benchmark. 41. Little Co used the dynamic PAYG instalment method and otherwise took reasonable care when calculating its PAYG instalment rate. The outcome (PAYG instalment rate less than 85% of the Commissioner's benchmark instalment rate) arose from a software error that could not be rectified by the DSP. 42. Little Co is in the green risk zone. The Commissioner will not have cause to apply compliance resources to impose GIC in respect of the December 2026 instalment. | Example 4: – using the dynamic PAYG instalment method without taking reasonable care 43. ABC Holdings Co uses the dynamic PAYG instalment method. 44. When preparing the July 2027 instalment, ABC Holdings Co's financial controller, John Doe, does not take reasonable care. ABC Holdings Co has poor record-keeping practices and weak internal controls. The failure to take reasonable care could include, but is not limited to, any one or more of the following: 45. The inaccurate data produces a materially lower PAYG instalment rate. The PAYG instalment rate is less than 85% of the Commissioner's benchmark instalment rate and reduces ABC Holdings Co's immediate PAYG instalment liability. 46. ABC Holdings Co is in the yellow risk zone. ABC Holdings Co has not complied with the requirements in paragraph 18 of this Guideline, and reasonable care was not taken when calculating its PAYG instalment rate. In these circumstances, the Commissioner may have cause to apply compliance resources to impose and collect GIC under Subdivision 45-G. | Example 5: – varying PAYG instalment variations in a way that undermines the intended collection of income tax 47. ABC Holdings Co uses the dynamic PAYG instalment method. However, they disregard the output calculated by the dynamic PAYG instalment method and instead vary their instalment to nil. 48. As a result, the financial information used does not reflect ABC Holdings Co underlying financial position at the time. The resulting varied instalment rate is significantly less than 85% of the Commissioner's benchmark instalment rate for the income year, and what it should have been based on ABC Holdings Co's true financial position. 49. ABC Holdings Co seeks to justify the variation based on 'market conditions', and uncertainty. However, this justification is expressed in vague and general terms and is inconsistent with its business records, which demonstrate ABC Holdings Co has made considerable profits throughout the income year. 50. The Commissioner concludes that ABC Holdings Co is approaching its tax responsibilities in a way that is inconsistent with the purposes and objects of the PAYG instalment regime. 51. ABC Holdings Co is in the red risk zone. In these circumstances, the Commissioner can be expected to apply compliance resources to impose and collect GIC under Subdivision 45-G. The Commissioner may also investigate the possible application of anti-avoidance rules.", "Appendices": "", "Other_Sections": "Your comments: 52. You are invited to provide comments on this draft Guideline, including the proposed date of effect. Forward your comments to the contact officer by the due date. 53. A compendium of comments is prepared as part of finalisation of this Guideline. An edited version of this compendium (names and identifying information removed) may be published on ato.gov.au. 54. Advise the contact officer if you do not want your comments included in the edited version of the compendium. | AUSTRALIAN TAXATION OFFICE FOR THE COMMONWEALTH OF AUSTRALIA: © You are free to copy, adapt, modify, transmit and distribute this material as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products). Not previously issued as a draft.", "Compendium_Reference": "", "Is_Archived": false, "Is_Draft": true, "Source_URL": "https://www.ato.gov.au/law/view/document?docid=DPC/PCG2026D3/NAT/ATO/00001", "Unmatched_Content": "Dynamic pay as you go instalments and general interest charge on excessive variation - ATO compliance approach: For information about the status of this draft Practical Compliance Guideline, see item 4270 on our Advice under development program . | Terms used in this draft Guideline | What this Guideline is about | Who this Guideline applies to | This Practical Compliance Guideline is a draft for consultation purposes only. When the final Guideline issues, it will have the following preamble: | This Practical Compliance Guideline sets out a practical administration approach to assist taxpayers in complying with relevant tax laws. Provided you follow this Guideline in good faith, the Commissioner will administer the law in accordance with this approach. | Terms used in this draft Guideline: 1. For this draft Guideline [1] , and for ease of expression: | 2. All legislative references in this Guideline are to Schedule 1 of the Taxation Administration Act 1953, unless otherwise indicated. | 16. When finalised, it is proposed that this draft Guideline will apply from 1 July 2026. | The Commissioner will not have cause to apply compliance resources to impose and collect GIC under Subdivision 45-G. | The Commissioner will not have cause to apply compliance resources to impose and collect GIC under Subdivision 45-G. The Commissioner may make enquiries to understand why that outcome occurred, as it will help support the ongoing administration and improvement of the dynamic PAYG instalment method. | The Commissioner can be expected to apply compliance resources to determine whether to impose and collect GIC under Subdivision 45-G. | Commissioner of Taxation 24 June 2026"}
 {"PCG_Number": "PCG 2025/5EC", "Document_Type": "Compendium", "Title": "Compendium", "Status": "Draft", "Date_of_Issue": "", "Date_of_Effect": "", "Date_of_Withdrawal": "", "Replaces": "", "Related_Rulings_and_Determinations": "PS LA 2005/24 | TD 2005/29 | TR 2001/8 | TR 2022/3", "Legislative_References": "", "Other_References": "", "Summary": "It is recommended that the final Guideline addresses genuine partnership situations and 'husband and wife' partnerships. The final Guideline should be applied prospectively rather than retrospectively. We have a long-standing view on the treatment of personal services income (PSI) and the potential application of Part IVA of the Income Tax Assessment Act 1936 (Part IVA). Existing judicial decisions and guidance such as Taxation Rulings TR 2001 /8 Income tax: what is a personal services business (now withdrawn) and TR 2022/3 Income tax: personal services income and personal services businesses has made clear that Part IVA can apply to alienation arrangements including income splitting and profit retention. How will companies save for future assets or bring in new employees if they are taxed in the hands of the individual? Start-up businesses cannot always pay an employee straight away and need time to save money in the company to build the business. Retention of profit arrangements are indicative of low risk if the intention is to temporarily retain some profit for a clear commercial purpose and that intention is carried out. This includes situations, for example, where an amount of net PSI is retained in a personal services business (PSB) with the intention to purchase equipment or cover expenses that the individual needs to perform their services. If the purchase of the assets is to enable the individual to charge more for services, take on more clients and increase future profits – this temporary retention of profits is for a clear commercial purpose. Importantly, the intention is carried out and the amount temporarily retained should only be enough to cover the anticipated expenses. In paragraph 7 of the draft Guideline, it is unclear which provision 'it' is referring to in the sentence, '… because where it applies no tax benefit is obtained …'. '[I]t' refers to the preceding mention of either the PSI rules of Part IVA, but it becomes apparent only later that it's referring to the PSI rules, disrupting the flow of the sentence. We recommend changing the part of the sentence quoted above to: '… because, where the PSI rules apply, no tax benefit is obtained …'. Some companies will only contract with another company (interposed entity) for commercial purposes, which makes attributing PSI more complex. The final Guideline addresses situations where a PSE is utilised to alienate PSI through profit retention arrangements or income splitting with associates, resulting in a lower overall tax rate and providing a tax benefit to the individual whose PSI is involved. Record keeping is a challenge for PSBs which are micro or family businesses, where a number of family members perform services, or where they perform a mix of work (supplying goods and providing personal services). A practical or informal family business approach should be taken to record keeping. Such businesses should consider whether to seek record-keeping assistance from an appropriately qualified person. Further examples should be provided in the final Guideline that demonstrate a taxpayer's need to retain profits – for example, to meet ongoing costs. This is especially so in the case of entities that need to retain profits as part of cashflow management if they are unable to generate income for certain periods of time and need to meet ongoing costs, to fund working capital, purchase trading stock, trade debtors and loans used in the business. Example 6 of the draft Guideline deals with a situation where a superannuation benefit is provided to the individual undertaking principal work. It would be helpful if the final Guideline could include one or more examples dealing with situations where superannuation contributions are made for the benefit of a related individual who only performs administrative work in the business. Those expenses are allowable deductions when calculating net PSI – just as they are for superannuation paid on behalf of the individual engaged as an employee by the PSB to provide the principal personal services. Taxation Determination TD 2005/29 Income tax: will Part IVA of the Income Tax Assessment Act 1936 always apply if a taxpayer who carries on a business (including a personal services business) pays superannuation contributions that do not exceed the age-based limits but are considerably in excess of the value of the services provided by the employee? sets out our position on the application of Part IVA where a PSB employs a related individual and makes superannuation benefits for that individual that are in excess of the value of the services they have provided. Example 4 of the draft Guideline is unclear on certain matters, and anomalies arise irrespective of how those uncertain matters might be clarified. It is recommended that the example be amended to remove anomalies and achieve appropriate tax and commercial outcomes. Example 4 of the draft Guideline indicates that, in the ATO's view, calculating profit and bonus figures prior to 30 June should be the norm and that undertaking the calculations after year-end is only acceptable in one-off special circumstances. This does not reflect commercial reality. It is suggested that the final Guideline include a low-risk example which has a PSB finalising their accounts within a reasonable time after year-end or that a sensible time lag be permitted. The timing of the calculations is simply used to establish the taxpayer's normal pattern of behaviour and thereby identify abnormal behaviours of a kind that fall outside that pattern. Example 6 of the draft Guideline does not address a number of outcomes and consequences that will arise. The applicable company tax rate is 25% and profit is equal to taxable income. There are double taxation issues and anomalies that arise and GST implications for funds retained for purchase. We have also changed the type of payment in this Example from a bonus to a franked dividend, to prevent double taxation of the $2,000. Example 9 of the draft Guideline suggests that investing retained profits in a passive investment such as a share portfolio will automatically trigger a higher risk rating. It would be interesting for the final Guideline to have an example where the passive investment was a modest and highly liquid investment such as a term deposit or cash holdings in high interest accounts, to determine whether it would be considered a low-risk arrangement by the ATO. The final Guideline should provide clarity and examples of how the ATO would apply the PSI rules and Part IVA on a non-white collar professional business such as a tradesperson or a heavy machinery operator. The final Guideline should clarify and include an example of how the ATO would apply the PSI rules and Part IVA where a husband and wife employ an apprentice or an employee. Is the scale of the business activity being carried out such that it amounts to a 'business structure' and thus would not be caught in the realm of the PSI and Part IVA rules? Paragraph 16 of the final Guideline makes clear that the Guideline does not apply to alienation arrangements where the income generated is not PSI – such as income from a business structure. Paragraph 16, through footnote 11, outlines where to find further guidance on when income is being generated from a business structure. The final Guideline should provide an example of how the ATO would apply the PSI rules and Part IVA where one partner of the business, that is, a silent partner, such as a retired parent or relative, contributes the funds, and the other partner provides the know-how to starting a business. Will the ATO allow apportionment of income derived by the business between the partners or will the income be solely attributed to the individual who provides the know-how and generates the income? In the final Guideline, an alternative outcome should be added into Example 13, outlining the outcome if Tom conducted both his civil engineering consulting and the other business selling goods in his personal name. This will allow Tom to be entitled to all allowable deductions – the losses from other business operations would be deductible against the civil engineering consulting income. There is no Part IVA risk. TR 2022/3 provides guidance relevant to individuals who earn PSI but do not work through a PSE (that is, sole traders). Given that BLD is in losses from its other business operation, the payment of a bonus or salary by BLD to Tom, equal to the net PSI, could have serious risk and cause BLD difficulties in paying its creditors and run the risk of insolvent trading. In this example (now Example 17 in the final Guideline), the fact that the PSI is retained to offset significant losses from another business activity, may not be for a relevant or appropriate commercial purpose and may require further review. The final Guideline should confirm that paying an employee higher than award wages will not, in itself, trigger a higher risk rating. We also note that awards do not apply in many industries. Accordingly, we suggest that in the final Guideline the wording be amended to simply reflect that the employees are being paid commercial, market value wages and salary. It would be helpful if footnote 7 in paragraph 6 of the draft Guideline explicitly referenced the details of existing guidance and judicial decisions that have 'made clear that Part IVA can apply to alienation arrangements involving income splitting and retention of profits where the dominant purpose of a participant in the scheme was to obtain a tax benefit'. It is acknowledged that there are references to ATO guidance and judicial decisions in the footnotes, with the exception of TR 2022/3, these references appear to refer to guidance and judicial decisions that were published prior to the introduction of PSI regime and therefore prior to the introduction of the concept of PSB. The final Guideline includes a reference (at footnote 3) to TR 2001/8 (now withdrawn) which was released shortly after the PSI rules were introduced. TR 2001/8 remained in force until replaced by TR 2022/3. The introduction of the PSI rules had the practical effect of narrowing the scope for Part IVA to apply to alienation arrangements (because where the PSI rules apply, no tax benefit is obtained), but it did not otherwise affect the continued operation of Part IVA. The case law provided in the draft Guideline relates to business and work conditions in the early 1980s. The facts and outcome of Commissioner of Taxation v Mochkin [2003] FCAFC 15 (Mochkin) were not highly dependent on the time period involved and unlikely to change the need to consider modern business conditions in assessing the appropriate flexible approach to income splitting or retention by the many PSBs which are modern businesses. Judicial precedent is adaptable to new facts and circumstances. Courts revisit older case law and interpret it in light of changes in business practices and technology. In reference to Mochkin at [39], paragraph 27 of the draft Guideline states 'However, Sackville J indicated that it was arguable we could have been successful in the application of Part IVA had the narrower scheme have been argued.' Respectfully, Mochkin at [39] does not support the draft Guideline's assertion that Sackville J indicated it was arguable the Commissioner could have been successful in the application of Part IVA had the narrower scheme been argued. Instead, it only pointed out that it was arguable for the Commissioner to apply Part IVA on a narrower scheme and that the Commissioner had to show the scheme defined was not so narrow as to deprive it of all practical meaning. The final Guideline should more accurately reflect Mochkin at [39]. Mochkin does, however, emphasise the point made, in paragraph 32 of the final Guideline, that the facts and circumstances of particular arrangements can result in 2 different schemes. We have included this case as a reference in that paragraph. Small businesses are met with demands to operate through a corporate entity as imposed by their clients. It is arguable that this crucial precondition for getting work means there was no sole purpose of obtaining a tax benefit from any subsequent income splitting by the test individual. The draft Guideline addresses this issue at paragraph 26 by suggesting that the Commissioner might choose to identify the relevant scheme narrowly rather than widely. The effectiveness of such an approach is open to question in light of the decision of the Full Federal Court in Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28. Even if a small business owner is required to operate through a company, Part IVA may still apply where that company has been used to facilitate an income splitting arrangement or a retention of profits arrangement, or both. If taxpayers and advisers need to reconsider any higher risk arrangements where there is an element of income splitting or profit retention, what are the indicators of red flags to identify a higher risk? Will there be a dollar value or a percentage? Or a moderate level of income splitting where net PSI allocated to lower associates remains below a threshold for a year of income? In the final Guideline, Table 2 provides an overview of the higher risk indicators where PSI is alienated through a PSE conducting a PSB. An alternative approach is to apply risk assessment factors (1) and (2) in Table 1 of Practical Compliance Guideline PCG 2021/4 Allocation of professional firm profits - ATO compliance approach to the net PSI of the PSB. The risk assessment framework in PCG 2021/4 was designed to encourage individual profession practitioners to self-assess. In Example 7 of the draft Guideline, the entity passes the PSB tests and has a commercial purpose, however Part IVA is still applied because the distribution is done 'without regard to the value of her personal services which generated income'. The term 'value of her personal services' is not clearly defined. It is unclear whether 100% of net profit after expenses must be distributed to the individual who generated the PSI or whether there are other parameters that determine the correct 'value' of the personal services. The examples indicate the types of arrangements in which any deviation away from distributing 100% of the net profits to the individual may attract the application of compliance resources. Taxpayers and their advisers are not in a position where they can apply Part IVA on behalf of the Commissioner. The Guideline explains when we will be more likely to have cause to apply compliance resources to consider the potential application of Part IVA to an alienation arrangement where PSI of an individual is derived through a PSE that is conducting a PSB. The administration and application of Part IVA is available in Law Administration Practice Statement PS LA 2005/24 Application of General Anti- Avoidance Rules. The ATO views expressed in the Guideline fail to take into account the commercial reality that net PSI derived by a PSE is the culmination of a number of inputs of which only one is the individual's personal efforts or skills. The PSE should be entitled to attribute part of the net PSI to the other components that generate the PSI and thereby be permitted to direct the value of those components away from the individual to which that income would, according to ATO views, otherwise be attributed. When a contract involves a number of components, the entity needs to determine if the income derived from that contract is mainly a reward for the personal efforts or skills of the individual. If it is not, then the whole amount received under the contract is not PSI and the Guideline is not relevant to that income. See paragraphs 46 to 49 of TR 2022/3 for further guidance. Fees charged represent substantially more than payment for the work done. The fees necessarily include components attributable to covering other business costs that are otherwise unrewarded including marketing, tendering, canvassing, engagement letters, billing and collection debt. These tasks distinguish a PSE business from an employee who simply turns up for work, does the work and goes home again without concern for these additional requirements of carrying on business. A PSE will need to consider what the client is actually paying for and whether it is mainly for the reward for the individual's personal efforts or skills. If it is, the entire amount received under the contract is PSI and the character of the income is not changed by a notional allocation to other components for accounting purposes, such as business costs which determines the rate charged to clients. For example, if a plumber has a charge-out rate of $100 per hour and it is generated from them expending their personal effort as a plumber, that is $100 of PSI, despite it being notionally allocated to labour, business costs or profit for accounting purposes. It does not make sense that different deliverables are taxed differently. For example, if a lawyer provides verbal or written legal advice, it is labelled as personal exertion income. However, if a lawyer comes out with an app or writes a book, it is labelled as sale of goods and not personal exertion income subject to the Guideline. Refer to paragraphs 38 to 39 of TR 2022/3 for detailed guidance. The unique nature of many businesses is problematic if seeking to apply a 'one size fits all' approach for income splitting purposes. It is suggested the strict 'one size fits all' low or zero tolerance to income splitting for every PSB which passes the PSI rules should be reconsidered. The type of scheme to which Part IVA may apply will depend on the particular facts and circumstances of the arrangement. © AUSTRALIAN TAXATION OFFICE FOR THE COMMONWEALTH OF AUSTRALIA You are free to copy, adapt, modify, transmit and distribute this material as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).", "Purpose_and_Scope": "", "Background": "", "Compliance_Approach": "", "Examples": "", "Appendices": "", "Other_Sections": "Compendium: This Compendium of comments provides responses to comments received on Draft Practical Compliance Guideline PCG 2024/D2 Personal services business and Part IVA of the Income Tax Assessment Act 1936. It is not a publication that has been approved to allow you to rely on it for any purpose and is not intended to provide you with advice or guidance, nor does it set out the ATO's general administrative practice. Therefore, this Compendium does not provide protection from primary tax, penalties or interest for any taxpayer that purports to rely on any views expressed in it.", "Compendium_Reference": "/law/view/pdf?DocId=COG%2FPCG20255EC%2FNAT%2FATO%2F00001&filename=law%2Fview%2Fpdf%2Fcog%2Fpcg2025-cp005.pdf&PiT=99991231235958", "Is_Archived": false, "Is_Draft": true, "Source_URL": "https://www.ato.gov.au/law/view/document?docid=COG/PCG20255EC/NAT/ATO/00001", "Unmatched_Content": "Partnerships are not a focus of the Guideline. However, paragraphs 16 and 17 of the final Guideline describe the Commissioner's long-standing compliance approach to spousal partnerships. | In the final Guideline, this sentence (now in paragraph 8) has been clarified to reflect the intended reference to when the PSI rules apply. | The final Guideline includes further low-risk arrangement examples that demonstrate retention of profit arrangements that have a clear commercial purpose and are carried out as intended. | In the final Guideline, Example 4 now clarifies the tax and commercial outcomes. | In our view, it would make no difference if the retained profits were invested in a modest and highly liquid investment rather than a share portfolio. The circumstances set out in this example (now Example 13 in the final Guideline) would remain as higher risk because there are profits retained in a lower-taxed entity. | The final Guideline includes examples reflecting a broader range of professions. | The final Guideline includes an example (Example 9) that has, as part of the arrangement, a relative who is a silent investor in a new business. | The final Guideline reflects that employees are being paid an amount of wages or a salary that is commensurate with the work they have performed."}
+{"PCG_Number": "PCG 2026/D4", "Document_Type": "Draft PCG", "Title": "Draft Practical Compliance Guideline", "Status": "Draft", "Date_of_Issue": "4 September 2026", "Date_of_Effect": "", "Date_of_Withdrawal": "", "Replaces": "", "Related_Rulings_and_Determinations": "TR 2026/2", "Legislative_References": "Case References: Commissioner of Taxation v PepsiCo Inc & Anor [2025] HCA 30 2025 ATC 20-969 124 ATR 1 (2025) 99 ALJR 1211", "Other_References": "", "Summary": "", "Purpose_and_Scope": "Scope: 26. This Schedule relates to payments made in relation to software and should be read together with TR 2026/2, which sets out our interpretative position on when an amount paid under a software intermediation arrangement is subject to royalty withholding tax. [3] If we review your arrangement to consider whether an amount should have been withheld from a payment, our position will be in accordance with our views set out in TR 2026/2. 27. This Schedule applies to software intermediation arrangements under which an intermediary makes a payment or payments directly or indirectly to the owner or licensee (offshore supplier) of the software IP rights for the right to be in a position to earn income relating to the use of, or right to use, software IP rights. Table 2 of this Guideline summarises the risk zones for software intermediation arrangements. 28. Payments may be royalties not only because they are for the use of or right to use software IP rights, but also because they are for related IP (for example, trademarks, patents or confidential information) or services which are ancillary to the use or enjoyment of the relevant IP. 29. The character of payments under a software intermediation arrangement depends upon the facts and circumstances of the particular case. This includes the express and implied terms of any agreements between the parties and can include the conduct of the parties. Valuation evidence and the identification of the various monetary and non-monetary undertakings passing under the agreements can also be relevant. Where a royalty is recognised Where no royalty is recognised Where your operating margin exceeds a certain amount However, where the Australian operating margin exceeds 10% or is within 10 percentage points of the global group's operating margin, the arrangement will not be in the amber zone. OR You have not undertaken a self-assessment of the residual risk assessment calculation. 30. Diagram 1 of this Guideline provides an overview of the risk assessment framework. Diagram 1: Roadmap for the risk assessment framework White zone 31. Your arrangement falls within the white zone if any of the following apply to you for an income year: 32. This is provided there has not been a material change in the available facts and evidence in relation to the arrangement since the time of the settlement agreement, APA, court decision, review or audit. Where information previously provided to us or a court was materially different or incomplete, this condition will not be satisfied. 33. If your arrangement falls within the white zone, you do not need to consider the other zones. Green zone 34. If your arrangement falls within the green zone, you do not need to consider the other zones. Where no royalty is recognised 35. Where no royalty is recognised, your arrangement falls within the green zone if your undissected payment is paid solely for the acquisition of: 36. Where no royalty is recognised, your arrangement also falls within the green zone if your undissected payment is paid solely for the acquisition of copies of software in circumstances where: Where a royalty is recognised 37. Where a royalty is recognised in relation to the instrument under which you purchase software (including software licences or access to software) from an offshore supplier, your arrangement will fall within the green zone if: Yellow zone Where a royalty is recognised 38. Where a royalty is recognised in relation to the instrument under which you purchase software (including software licences or access to software) from an offshore supplier, your arrangement will fall within the yellow zone if: 39. If your arrangement falls within the yellow zone, we may review the quantum of your royalty depending on the tax at risk. Where no royalty is recognised 40. Where no royalty is recognised, your arrangement falls within the yellow zone if it is not in the amber or red zones. 41. An arrangement that would otherwise fall within the amber zone or red zone may qualify for the operating margin exception and instead fall within the yellow zone. Operating margin exception 42. Your arrangement will fall within the yellow zone where the Australian operating margin for a relevant income year: Amber zone 43. Your arrangement will fall within the amber zone where: 44. Your arrangement also falls within the amber zone where you have not self-assessed your risk zone or are unable to provide evidence to explain your self-assessment against our risk assessment framework. 45. An arrangement that would otherwise be in the amber zone will be categorised in the red zone if your arrangement meets the additional red zone criteria at paragraph 46 of this Guideline. An undissected payment that falls within the amber zone is considered medium to high risk. We may engage with you to understand the royalty risk. Red zone 46. An arrangement in the amber zone will fall within the red zone if under the arrangement: 47. If your arrangement falls within the red zone and we select you for an audit or other review, you can expect that we will require you to provide detailed and comprehensive information and documentation to examine your royalty risk including details of the costs incurred by the offshore supplier in relation to the software. Residual risk assessment calculation 48. The following residual risk assessment calculation will be used for the purposes of a quantitative risk assessment of your royalty apportionment: Residual amount = payment − offshore supplier costs 49. Offshore supplier costs are the total of the costs in relation to the manufacturing, intermediation services or distribution of software and related goods and services incurred by the offshore supplier in relation to sales to you – for example, infrastructure costs, sales and marketing costs, third-party royalty expenses and direct labour costs plus a mark-up of 5%. 50. Where the offshore supplier is an intermediary supplying goods or services produced by a related party, include the relevant costs incurred by the related party when determining the costs incurred by the offshore supplier (but separately identify and exclude any mark-up on the costs between the related party and the offshore supplier). 51. Exclude the following from the costs incurred by the offshore supplier of the goods or services: 52. We recognise that the offshore supplier may sell products or services to numerous entities in addition to you, and therefore it may be necessary to conduct a cost allocation for the products or services sold to Australia. In these circumstances, you should make a considered and reasonable allocation of costs to your sales-related transactions and retain the evidence to substantiate the approach you adopted. 53. Consistent with this being a risk assessment framework, provided that your cost base calculation is conducted on a reasonable and 'best efforts' basis, we accept that your calculation may not be precise. 54. To complete the residual risk assessment calculation, subtract the offshore supplier costs from the payment to determine the residual amount. A threshold percentage of the residual amount is used to determine your risk rating. These thresholds relate part of the residual amount to the value of intangible assets used in the value chain while recognising that part of the residual amount may instead relate to mark-ups earned on offshore supplier costs or other profit elements.", "Background": "2. Taxation Ruling TR 2026/2 Income tax: royalties – character of payments in respect of software and intellectual property rights published on 4 September 2026 and sets out our interpretative position on when an amount paid under a software intermediation arrangement is a royalty and subject to royalty withholding tax. This Guideline should be read together with TR 2026/2. 3. Following the High Court's decision in Commissioner of Taxation v PepsiCo Inc & Anor [2025] HCA 30, we issued a Decision impact statement on 19 March 2026 outlining the Commissioner's response to the decision. We have updated this Guideline [2] and published TR 2026/2 consistent with the view expressed in the Decision impact statement that the economic fundamentals of an arrangement may be relevant to the identification of unrecognised royalties.", "Compliance_Approach": "Intro: 7. This framework allows you to self-assess the compliance risk relating to whether a cross-border payment you make to a non-resident relating to software is a royalty subject to Australian tax. 8. Where no portion of a cross-border payment is expressly stated to be a royalty by the instrument under which it is paid (or if there is no instrument), that payment is referred to as an 'undissected payment' for the purposes of this Guideline. 9. We will concentrate our efforts to examine arrangements that pose the highest risk of non-compliance with Australian tax obligations. We will have regard to the factors in the risk assessment framework in reviewing the royalty risk associated with your arrangements. 10. We may also consider the application of the general anti-avoidance rules (including the diverted profits tax and the multinational anti-avoidance law), particularly in circumstances where an arrangement lacks substance or where there is insufficient evidence for the commercial rationale for the arrangement. 11. Our compliance approach to your royalty risk will vary depending on the applicable risk zone. The 'risk zones' and 'risk ratings' in this Guideline relate to the relative likelihood of us having cause to prioritise the application of compliance resources to review a royalty risk rather than the risk that you have not correctly applied the law to your arrangement. 12. You do not need our input or sign off on your self-assessed risk rating. However, you may be asked to tell us if you have self-assessed your risk rating and what your risk rating is. We will not review your arrangement other than to verify that you meet the requirements of the green zone. We are less likely to review your arrangement, other than to verify that you meet the requirements of the yellow zone. We will prioritise review of arrangements in higher risk zones. Your arrangements will be prioritised for review. Your arrangements will be our highest priority for review. 13. If your arrangement falls within the white zone or green zone, we are unlikely to have cause to apply our resources to further review your arrangement with respect to royalty risk, other than to verify your self-assessment under this Guideline. Where you recognise a royalty, we may ask you to provide evidence supporting how you have arrived at the amount of the royalty recognised and to provide us with a quantitative risk assessment of your payment under the residual risk assessment calculation at paragraph 48 of this Guideline. We will use this to consider whether the royalty you have recognised is reasonable. 14. If your arrangement falls within the yellow zone, we are less likely to have cause to review the royalty risk, other than to verify that you meet the requirements of the yellow zone. We will prioritise higher risk zones. Where you recognise a royalty, we may ask you to provide evidence supporting how you have arrived at the amount of the royalty recognised and to provide us with a quantitative risk assessment of your payment under the residual risk assessment calculation at paragraph 48 of this Guideline. We will use this to consider whether the royalty you have recognised is reasonable. 15. If your arrangement falls within the amber zone, we may engage with you to review the royalty risk. Your arrangement also falls within the amber zone where you have not self-assessed your risk zone or are unable to provide evidence to explain your self-assessment against our risk assessment framework. 16. If your arrangement falls within the red zone, we will prioritise our resources to review the royalty risk. This may involve commencing an audit or other review. While arrangements in the red zone have features we consider indicate higher risk, there is no presumption that you have not complied with Australian tax law because your arrangement is in the red zone. 17. You should ensure that your self-assessed risk profile of your arrangement is supported by appropriate documentation and evidence. 18. We will review the use and application of this Guideline over time and may update it to reflect changes to our risk tolerance or add further schedules relating to other kinds of arrangements. | Apportionment: 19. TR 2026/2 states that where a payment is made partly in consideration for items that fall within the definition of a royalty, the payment may need to be apportioned. 20. In essence, a reasonable royalty rate reflects the sharing of the economic benefit derived from the licensed property between the licensor and the licensee. Determining the appropriate apportionment methodology to ascertain a reasonable royalty will depend on the particular facts and circumstances of the arrangement. 21. It is not within the scope of this Guideline to prescribe any particular approach. Instead, this Guideline sets out, under the green and yellow zones, our risk assessment approach as to when we will further examine the quantum of your royalty. | Restructures: 22. Regardless of the outcome under the risk assessment framework, if there has been a change to or restructure of your agreements resulting in a reduction or avoidance of Australian royalty withholding tax, we may have cause to apply compliance resources to review your arrangement. 23. Other provisions (including but not limited to Subdivisions 815-B and 815-C of the Income Tax Assessment Act 1997 and the general anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936)) may also be relevant. For example, a restructure by a multinational group so that Australian customers contract with an offshore subsidiary (even though activities in connection with the sale continue to be undertaken by an Australian subsidiary) may be a scheme to which Part IVA, including by way of section 177DA of the ITAA 1936, applies. | Our risk assessment approach: 24. Our risk assessment framework includes an assessment of your royalty risk based on the risk indicators set out in the Schedule to this Guideline. | Glossary: 25. In this Guideline:", "Examples": "Example s: Green zone examples | Example 1: – royalty recognised – downloadable and cloud-based software 55. An agreement between AusCo and its foreign parent ForeignCo sets out the following key terms: 56. Customers in Australia enter into a standardised contract which states that AusCo is the entity with which they contract for the purchase of the products and customers in Australia pay AusCo for the products. 57. Upon a customer in Australia contracting with AusCo and paying the subscription fee for the purchase of the products to AusCo, ForeignCo grants a limited IP licence to the customer directly (for no further payment from the customer) and grants the customer relevant access to the computer software from a computer server it controls. 58. ForeignCo owns or has rights to all the IP in the products and also provides AusCo access to confidential information and know-how regarding the products. ForeignCo is not a party to the sales contract with customers in Australia for the products. However, ForeignCo is a party to the IP licensing agreement with the customer which accompanies AusCo's contract with the Australian customers. 59. As part of their agreement, ForeignCo and AusCo agree that a portion of the payments made by AusCo to ForeignCo under the agreement are royalties. How they arrived at the royalty rate and the self-assessment of the residual risk assessment calculation in this Guideline is documented. Under the residual risk assessment calculation, AusCo has calculated that the royalty payment is a proportion greater than 75% of the residual amount. AusCo withholds an amount from the royalty it pays to ForeignCo and pays the withheld amount to us. 60. ForeignCo and AusCo have also not restructured their related party dealings to lower the amount of royalties recognised prior to any restructure. Risk assessment 61. AusCo is recognising a portion of the payments to ForeignCo as royalties for Australian tax purposes (including by withholding an amount from the royalty it pays to ForeignCo and paying the withheld amount to us), with such an amount not being the result of a reduced royalty rate due to a change in related party arrangements. Further, AusCo's supporting documentation for the royalty amount includes a self-assessment of the residual risk assessment calculation and has calculated that the royalty is greater than or equal to 75% of the residual amount. 62. As a result, AusCo's arrangement is categorised as being in the green zone, and we will not prioritise the allocation of resources to review the royalty risk. If AusCo is selected for review, we will seek AusCo's supporting documentation regarding how they arrived at the royalty rate as well as their self-assessment of the residual risk assessment calculation. | Example 2: – internet security software solely acquired for private or domestic use 63. Sarah wants to enhance her online security and, after researching various internet security software options, decides that she wants a subscription for internet security software from AntiVirus Co. 64. AntiVirus Co is a provider based in a foreign country and specialises in developing internet security software to detect and neutralise computer viruses. 65. Sarah selects a one-year subscription plan on AntiVirus Co's website, enters her payment details, downloads a copy of the software and follows the easy setup instructions to install the internet security software onto her personal computer. 66. For the purposes of this Guideline, the arrangement under which Sarah made payments to AntiVirus Co is categorised in the green zone as the copy of the software acquired is solely for her private or domestic use. | Example 3: – general administrative software acquired solely for business use 67. EducationCo Australia provides education services to Australian customers. 68. EducationCo Australia has an agreement with EducationForCo to obtain access to a comprehensive suite of cloud-based productivity applications which are licensed by EducationForCo from an unrelated offshore global software provider which develops software that is made generally available to the public. 69. These applications include: 70. EducationCo Australia cannot modify the source code in the software but is permitted by the global software vendor to configure and customise certain features of the cloud applications to fit its unique business needs, within certain constraints. For instance, EducationCo Australia customises the reporting and dashboards within the customer relationship management to display key performance indicators. EducationCo Australia also configures the security roles and access permissions across staff to vary levels of access based on an employee's role. 71. EducationCo Australia may work closely with the Software as a Service (SaaS) provider or approved third-party vendors to ensure these configurations align with both their operational needs and the cloud provider's software limitations. 72. EducationCo Australia provides access to these cloud-based applications to all staff across its Australian subsidiaries. 73. The cloud services agreement places a number of restrictions on EducationCo Australia's use of the software applications. EducationCo Australia is not permitted to disclose its account credentials to third parties or allow the applications to be used by more than 300 devices. EducationCo Australia can pay an additional amount to add more devices to the user base. 74. For the purposes of this Guideline, the arrangement is categorised in the green zone as the software is used in the course of EducationCo Australia's own business (productivity applications for EducationCo Australia staff use), is generally available to the public, is not substantially customised, and is not further sold, licensed or otherwise exploited as a primary object of its business. 75. The categorisation of EducationCo Australia's arrangement as low risk does not preclude further investigation of the unrelated global software provider's arrangements in Australia. | Example 4: – software copies embodied on physical media acquired by a retailer 76. Electronics Retail Co is a large Australian retail company that resells consumer electronics and white goods at stores located throughout Australia. 77. Electronics Retail Co also resells software such as productivity programs on physical media (for example, CD-ROMs). Electronics Retail Co has wholesale agreements with offshore software companies which enables Electronics Retail Co to purchase the software on physical media at reduced prices. 78. Under the wholesale agreements, Electronic Retail Co has no rights to reproduce, modify or sublicense, nor has any other rights to use the software IP rights of the offshore companies. 79. Further, Electronic Retail Co does not provide to customers any presale or implementation services, or post-sale services connected with use of the software. 80. The arrangement under which Electronics Retail Co makes payments to the offshore software providers under the wholesale agreements is categorised in the green zone as the facts satisfy the criteria in paragraph 36 of this Guideline. The software copies embodied on physical media are acquired for mere resale, Electronics Retail Co does not reproduce, adapt, nor provide value-added services, and the software is embodied on physical media. | Example 5: – washing machines with embedded software 81. White Goods Co manufactures washing machines with smart technology and sells the products to Australian customers through its subsidiary distributor, AusCo. AusCo makes payments to White Goods Co for the washing machines under a distribution agreement. 82. The smart washing machines AusCo purchases from White Goods Co have pre-installed software that allows consumers to remotely control and monitor their washing machine through an application on a smart phone. The software embedded in the washing machine also supports the sensor functions that automatically dispense detergent, monitor energy consumption during wash cycles, and run diagnostic tests and troubleshoot problems. 83. AusCo does not have any rights to modify, or sublicense the rights to modify, the software installed onto the smart washing machines. 84. The arrangement under which AusCo makes payments to White Goods Co is categorised in the green zone as the payments are for finished tangible goods of which software is an inherent and practically inseparable part, and the software is to enable the tangible goods to perform their intended function and the goods are acquired for resale to retail customers. | Example 6: – smartphones with embedded software 85. Tech Co manufactures smartphones with embedded software and sells the products to Australian customers through its subsidiary distributor AusCo. AusCo makes payments to Tech Co for the smartphones under a distribution agreement. 86. The smartphones AusCo purchases from Tech Co have pre-installed software and an operating system that among its functions allows customers to make and receive calls, browse the web, install applications, take photos and video, play media and connect to Wi-Fi and Bluetooth. 87. AusCo does not have any rights to modify, or sublicense the rights to modify, the software installed onto the smartphones. 88. The arrangement under which AusCo makes payments to Tech Co is categorised in the green zone as they are for finished tangible goods of which software is an inherent and practically inseparable part, and the software is to enable the tangible goods to perform their intended function. | Example 7: – simple distribution – video games 89. Software Co, a foreign resident, develops video games for computers and gaming consoles. AusCo, an Australian resident subsidiary of Software Co, markets and distributes the group's software products to customers in Australia. 90. AusCo pays Software Co to acquire electronic copies of the video games for sale in the Australian market. AusCo has no right to, and does not, make additional copies of the video games available as part of the distribution process. 91. Customers make a one-off payment to AusCo, which allows them to download a copy of the video game that AusCo makes available via the internet, install it and play the game. Customers are not required to pay ongoing subscription fees to AusCo to continue playing the game. 92. The facts in this Example satisfy the criteria in paragraph 36 of this Guideline. The arrangement under which AusCo makes payments to Software Co is therefore categorised in the green zone. Amber and red zone examples | Example 8: – amber zone – agreement to market and distribute software 93. IT Software Co, a foreign resident, develops enterprise resource planning (ERP) software. IT Software Co owns all the IP relating to the software. IT Software Co enters into an arrangement with its Australian wholly owned subsidiary AU Software Co to distribute the software to Australian customers. 94. The agreement grants AU Software Co an exclusive right to market and distribute the ERP software to Australian customers. However, the agreement does not grant AU Software Co the right to make copies or modify the ERP software. 95. Australian customers enter into agreements with both AU Software Co and IT Software Co to obtain an access code to the ERP software. Customers pay a subscription fee to AU Software Co which AU Software Co remits to IT Software Co which it describes as a fee for distribution rights after retaining a small margin for distribution services. Risk assessment 96. Under the agreement, the undissected payment is described as being for AU Software Co's right to market and distribute software licences to Australian customers – with no consideration for the use of, or the right to use, IP. 97. AU Software Co's arrangement does not satisfy the criteria for the green or red zones and will be categorised in the amber zone because of the following: | Example 9: – red zone – agreement to market, promote, distribute, copy and sell software licences 98. International Corporation (International) is a worldwide provider of software (Programs). It is a foreign resident and parent company of the International Group. 99. Intangible Enterprises (IE) is a tax resident in a specified jurisdiction and member of the International Group. Operational Business Australia Co (OBA) is an Australian company and head company of the group. 100. OBA became the principal distributor of the Programs in Australia by entering into a licence agreement (Agreement) with IE. The key terms of the Agreement are: 101. End-users obtain use of the Programs through one of 3 ways: electronic download, via cloud content hosted on servers controlled by IE, or through physical copies shipped to them by IE. In each situation, end-users are required to first enter into a EULA with OBA. After entering into a EULA, OBA will invoice the end-user and receive payment from them. Risk assessment 102. Under the agreement, the undissected payment is for OBA's right to market, promote, distribute, copy and sell licences for the Programs to end-users – with no part of the undissected payment for the use of, or the right to use, IP. 103. The agreement between OBA and IE contains clauses where customers are required to enter into a contract with OBA as a precondition to receiving a licence to access the computer software (albeit described as limited or restricted), where that licence specifies the terms upon which the software is made available to the end-user. 104. Further, Clause 3 permits end-users to make copies of the Programs. 105. Accordingly, OBA's arrangement satisfies the amber zone criteria and is not a green zone arrangement: 106. However, based on the following characteristics, OBA's arrangement is characterised in the red zone since it also meets the criteria of the red zone:", "Appendices": "", "Other_Sections": "Your comments: 107. You are invited to provide comment on this draft Guideline. Forward your comments to the email address below by the due date. 108. A compendium of comments is prepared as part of the finalisation of this Guideline. An edited version of the compendium (with names and identifying information removed) may be published to the ATO Legal database on ato.gov.au. 109. Advise if you do not wish for your comments to be included in the edited compendium. | AUSTRALIAN TAXATION OFFICE FOR THE COMMONWEALTH OF AUSTRALIA: © You are free to copy, adapt, modify, transmit and distribute this material as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products). Previously issued as PCG 2025/D4", "Compendium_Reference": "", "Is_Archived": false, "Is_Draft": true, "Source_URL": "https://www.ato.gov.au/law/view/document?docid=DPC/PCG2026D4/NAT/ATO/00001", "Unmatched_Content": "Royalty characterisation of payments relating to intermediation or distribution arrangements - ATO compliance approach: For information about the status of this draft Guideline, see item 4168 on our Advice under development program . | What this draft Guideline is about | Structure of this Guideline | SCHEDULE 1 – software intermediation arrangements | This Practical Compliance Guideline is a draft for consultation purposes only. When the final Guideline issues, it will have the following preamble: | This Practical Compliance Guideline sets out a practical administration approach to assist taxpayers in complying with relevant tax laws. Provided you follow this Guideline in good faith, the Commissioner will administer the law in accordance with this approach. | What this draft Guideline is about: 1. This draft Guideline [1] outlines our compliance approach to identifying whether any part of a cross-border payment made to a non-resident is a royalty and subject to withholding tax (royalty risk). This includes providing clarity on arrangements that will not attract our attention, thereby providing confidence to, and avoiding unnecessary compliance costs for, in-scope businesses. | Date of effect: 4. When finalised, this draft Guideline is proposed to apply to arrangements entered into both before and after its date of issue. | Structure of this Guideline: 5. This Guideline is structured as follows: | 6. Additional schedules may be added to this Guideline in the future. | Further risk assessment not required. | Commissioner of Taxation 4 September 2026 | Arrangements that meet any of the criteria at paragraph 31 of this Guideline. | IntangiblesArrangements@ato.gov.au | Legislative References: ITAA 1936 6(1) ITAA 1936 Pt IVA ITAA 1936 177DA ITAA 1997 Subdiv 815-B ITAA 1997 Subdiv 815-C"}