14 March 2022 • 6 minute read

Transfer pricing chat: Paul McNab

Australia is becoming increasingly prominent when it comes to transfer pricing, thanks in part to a huge amount of foreign investment. In recent years the Australian Tax Office, the nation’s tax authority, has taken multinationals to court over transfer pricing disagreements in high-profile cases involving Singtel—a win for the government—and Glencore—a government loss.

Paul McNab spoke with Bloomberg Tax, about the Australian transfer-pricing atmosphere. Before joining DLA Piper, he was a partner at PricewaterhouseCoopers and spent almost eight years working for the ATO.

Bloomberg Tax: Why is transfer pricing in Australia so important from an international perspective and an American perspective?

McNab: The last time someone analyzed it, something like 30% of the top 2000 companies operating in Australia were foreign-owned. 25% of the capital investment into Australia is from the U.S., 20%'s the U.K. So they’ve got this enormous capital inflow into Australia. Our regulator is acutely aware of the fact that if transfer pricing in relation to capital investment into Australia is not properly set, the risk to revenue is significant.

The second reason I think people should be interested is that the regulator in Australia is incredibly well equipped legislatively. It’s got extremely broad, extremely powerful investigative tools. It’s an active participant in cross-border information flows, and it’s a quite assertive, relatively adventurous regulator as well. So you will see some testing of transfer-pricing principles that you might not see elsewhere.

Bloomberg Tax: How would you characterize the transfer pricing atmosphere in Australia now?

McNab: It’s not just about pricing transactions. If you look at the cases and think about what the revenue is doing there, there’s been some change to the company’s affairs in the way that it does business in Australia, and the Tax Office has taken issue with those changes. So it’s not just about pricing exactly what the company’s done; it’s a much more complex examination of why the business model changed or why those aspects changed, and how those are priced. So you can see that the commissioner is not just arguing about pricing, he’s arguing about the broader context of how commercial arrangements are developed and changed.

Bloomberg Tax: Why does the ATO take such an aggressive stance?

McNab: I think aggressive’s a difficult word. I tend to think of them as assertive; they have a clear view as to what they think is the right answer, and they push that view very strongly. The question of whether transactions are properly priced is one of the biggest risk to revenue items in their whole budget for the year, simply because of the volumes of cross border trade that Australia has, the structure of our economy. I think they can’t afford to ignore that and have chosen to extremely diligently pursue it.

I think taxpayers from other jurisdictions are often surprised by the extent of the powers the Tax Office has and the way they exercise them. And I think that may contribute to some of the reputation that Australia acquires. The powers of the Tax Office to gather information are incredibly broad and generally difficult to have reviewed.

Bloomberg Tax: They also don’t seem to be fazed by setbacks. After the Glencore ruling went against them, they issued an impact statement that basically said this is not going to change how we do things.

McNab: I think there’s some evidence that the Tax Office will occasionally run cases where they believe the law is unsatisfactory or needs to be better developed or explored by the legislature—to make the point, with a loss, that the legislation is deficient and needs to be corrected or improved. So I think in a sense, provided the case is carefully chosen, the Tax Office wins, whether they win or lose, in the sense they’re actually wins on the substance of the matter or potentially makes the point that change could be required.

Bloomberg Tax: So what does this all mean from a company’s perspective? How are companies responding? Are they digging in their heels or are they trying to accommodate what the ATO wants?

McNab: I think companies’ behavior in relation to the Australian market is changing. They are paying attention with the benefit of hindsight to the effect of work that they’ve done in prior years. Companies have to think about the context of changes and the justification for it and the evidence that needs to be accumulated at the time that change is put in place. It’s not just: Does the transaction affect pricing? It’s also: How do I explain the decision to make that change?

If you look at the court decisions in Australia, the evidence that the courts are finding most persuasive is commercial evidence from parties with real knowledge and understanding about transactions of this sort in the marketplace. These are not economics analysts, or traditional pricing specialists. These are people with real market experience about these sorts of transactions who could speak to real comparables, and that’s information the courts are finding incredibly persuasive. So for companies, there’s a real need to think about, okay, if I’m going to have this dispute, who are the experts I’m going to turn to, what sort of experience do they have, and what are the comparables or what are the types of activities that I will use as comparables and who do I know that has experience with them in the marketplace?

Bloomberg Tax: With regard to Covid-19, what sorts of uncertainties are you seeing companies facing with regard to transfer pricing in the wake of the pandemic?

McNab: One is the mobility of workforces, and I don’t think that’s something the global tax system deals well with at all at the moment. There is no doubt that in theory, technology permits a significant part of the workforce to operate from almost anywhere. And the workforce has a variety of economic incentives to do that, individually. But the traditional rules around permanent establishment and residents don’t really accommodate those sorts of lifestyles. I think companies that are genuinely concerned about this don’t have good systems enabling them to monitor it at the moment, and probably both companies and tax authorities haven’t really stepped into examining the changes in workforce behavior that have occurred over the last year.

A lot of companies have changed their business model. They’ve perhaps drifted back from B2B, gone more B2C. So you’ve seen a change in the business model with necessary changes in the transfer-pricing outcomes, and the question is why did you change the model. Was it driven by tax? If the change was tax-motivated, then it could be set aside.

And yet here in Covid, we have an opportunity for businesses to be able to explain the change of model is in fact driven by economic circumstances that justify the outcomes. So I think companies are going through a thought process at the moment about, gee, we had to change the model, do we stick with the new model? And if they do, and they believe it was driven by Covid, then this is one of those moments where documenting evidence and thinking through the way that you explain these changes is critical.

Interview was previously published on Bloomberg Tax website and has been edited for length and clarity.