Top 5 trends in 2023 ATO disputes: the musical

We have taken the liberty of pairing the themes with songs, featuring Miley Cyrus, Eminem, Ed Sheeran, Queen, Harry Styles and Fleetwood Mac. The Spotify playlist link is at the end of the article.

1. Taxpayers revisiting the virtue of attaining high assurance in Justified Trust reviews: "I can buy myself flowers"

Watching the trends in the assurance ratings given by the ATO to the Top 1,000 taxpayers, the large majority are obtaining medium assurance ratings (refer chart below). In fact, the only notable movement in recent years has been some taxpayers moving from high to medium assurance. Between FY22 and FY23 there was almost no movement whatsoever.

So why are taxpayers not improving their assurance ratings over time? This may reflect the cost to taxpayers of achieving high assurance, particularly given the short space of time available during a combined assurance review (CAR) to convince the ATO of the correctness of complex and difficult positions. The upshot is that without being across the underlying facts and able to quickly address any ATO concerns, matters are likely to be pushed through to a Next Action Review (see trend 4 below).

In the October 2022 Federal Budget, the ATO received a further $1.1 billion of funding towards the Tax Avoidance Taskforce, which conducts the CARs (amongst other things). The funding applies from FY23 to FY26, meaning that there are at least a few more years of CARs locked in.

2. ATO Focus Areas: "Guess who's back, back again"

The ATO's focus areas in 2023 have been more of the same, with some tweaks around the edges. Transfer pricing (TP) continues to be the ATO's number one issue for multinationals.

• Financing: The ATO has been strongly focused on the financing aspect of TP for many years following the Chevron decision in 2017, and then the ATO's guidance in Practical Compliance Guideline 2017/4. Beyond the TP elements of financing, it is also interested in withholding tax avoidance and the withholding tax exemption criteria not being met. Financing issues (including TP) have the lowest assurance rating in the ATO's most recent publication about CARs for the Top 1,000 taxpayers, being 27% low assurance.
• Non-financing: A heightened TP focus on non-financing issues appears to be emerging, such as the pricing of goods or services between related parties. These are receiving 22% low assurance in CARs. The ATO has specifically called out licence fees and royalties. In its separate report on Reportable Tax Position disclosures, 20% of inbound distributors rated themselves as high risk for FY22 under the ATO's guidance. The ATO's position on some of these issues will also be strengthened by the proposed legislation on intangibles. The recent Federal Court judgment of Pepsi's appeal against the Commissioner's position on diverted profits tax (DPT) and withholding tax also provides some judicial guidance.

A prediction – the ATO's focus on financing matters will certainly continue. With the increase in interest rates globally, the amount of interest expenses paid from Australia to offshore related parties will jump drastically. We have modelled this for FY22 onwards using the ATO's published data from FY17 to FY21, assuming the amount of debt into Australia remains constant and the interest rates move upward with the RBA cash rate (refer chart below). The consequence is related party interest expenses of almost $30 billion for FY24, as compared to less than $20 billion from FY17 to FY21.

3. Penalties: "It's true, my bad habits lead to you"

Since 1 July 2017, multinationals which are a "significant global entity" (SGE) have generally been subject to automatic doubling of penalties. For example, a SGE which fails to take reasonable care is subject to a penalty of 50% of the tax shortfall, whereas the penalty rate for non-SGEs is 25%. A SGE is, broadly an entity in a group with AU$1 billion of annual group revenue.

Prior to this 2017 change, Australia already had relatively high penalty rates before the doubling. Multinationals need to be aware of the relativities between the Australian penalties regime and those in other jurisdictions, as it is clearly an important and costly factor relevant to how they manage tax risk and disputes in Australia. The graph below shows the more common penalty rates for tax shortfalls in some comparable jurisdictions.

When combined with the ATO more readily considering the potential application of Part IVA, and the prevalence of TP disputes, the graph shows that multinationals can very quickly come under pressure, particularly as some of the penalty rates can reach 100% of the tax shortfall. To avoid distorting the comparison, we have not shown the 150% penalty for SGEs for intentional disregard, nor the four-fold penalties for SGEs under the proposed intangibles law (i.e. a 100% penalty for a careless position, and 200% for a reckless position).

The practical implications are that taxpayers should:

• be very considered when undertaking transactions that may attract the operation of Part IVA or the TP rules, ensuring that their positions are at least reasonably arguable, and that reasonable care is taken;
• know that even if they take reasonable care and have a reasonably arguable position, penalties may still apply automatically under the scheme penalty provisions for Part IVA and TP (unlike in some of the comparable jurisdictions); and
• appreciate that Part IVA and the TP legislation do bring a high degree of uncertainty. There has only been 2 Part IVA cases concerning the significant changes which were introduced in 2013 (Guardian this year and Minerva last year but on appeal), and there have not yet been any TP cases about the fundamental TP changes in Subdivision 815-B which were also introduced in 2013.

4. More intensity, sooner "Pressure, pushing down on me"

With the maturity of the ATO's Justified Trust review program, multinationals no longer have the luxury of waiting until an audit commences to formulate a tax disputes strategy. The large amount of information exchanged during CARs, combined with taxpayers knowing what questions they will be asked, means that preparation needs to commence much earlier.

13% of CARs in 2023 have progressed to review or audit. A consequence of the detailed CARs is that issues which are progressed for further investigation by the ATO post-CAR face very close scrutiny, much sooner. This does not necessarily involve the protracted information gathering phase where the ATO requires significant time to understand the information provided and formulate its position.

Streamlined reviews or audits can involve the issuance of detailed statutory notices, compelling production of information. The ATO's historical approach might have involved formal notices being issued at a later stage of audits, whereas we are more commonly seeing these issued during early engagement processes or risk reviews, and with intense detail. This is particularly the case where anti-avoidance provisions might be applied, or for TP matters, where the ATO is keen to ensure they have a fulsome picture of the factual scenario. The possibility of having to deal with formal notices issued both onshore and offshore is also something that should be proactively managed insofar as possible.

Multinationals should make sure that they spend enough time with their head above water, preparing their own case and not simply responding to ATO notices whereby the ATO can focus on building its case.

5. The forthcoming avalanche of judgments and legislation: "You know it's not the same as it was"

In parallel with the above trends focused on interactions with the ATO, the courts and Parliament are also providing regular contributions to the Australian tax landscape which multinationals need to keep in touch with. Some highly relevant cases which are awaiting judgment, or have just received judgment, include:

• the Singtel transfer pricing appeal about related party financing;
• the Pepsi case, the first court decision on Australia's DPT; and
• the Mylan financing case concerning the general anti-avoidance rule (GAAR) in Part IVA.

There is also forthcoming legislation on key topics including Pillar Two, intangibles and thin capitalisation, much of which may be enacted with retrospective effect by the time it is enacted.

Taxpayers need to be across the implications from these cases and legislation, particularly when resolving disputes with the ATO where a future tax treatment is being agreed. The decisions in the pending cases will impact taxpayers' substantive risk, as well the ATO's likely compliance approach more generally. From a legislative perspective, Australia's continual tightening of specific anti-avoidance rules means that multinationals need to plan enough lead time for transactions and monitor existing structures for ongoing compliance.