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Australia’s New Risk Framework and Its Effects on the Resources Industry

Posted on September 14, 2017 by Milla Ivanova

Table of Contents

  1. Background
  2. The Risk Assessment Framework
  3. Singapore as a Commodity Trading Hub
  4. Challenges
  5. Implications
  6. Conclusion

On January 1 the Australian Taxation Office (ATO) finalized its Practical Compliance Guideline (PCG) 2017/1. The guide provides a framework to self-assess the transfer pricing risk of hubs, with the intention of setting clear boundaries around a low-risk zone where taxpayers are encouraged to operate.

The development of PCG 2017/1 arose as a result of concerns about aggressive tax planning in the resource industry. The ATO identified a growing trend of multinational mining companies establishing marketing hubs in Singapore to sell to customers in Asia. With Australia set to become the world’s largest liquefied natural gas (LNG) exporter by 2020,1the ATO now has a powerful tool in its arsenal to use on oil and LNG giants that will be operating in Australia.

This article will examine the application of the guide’s risk framework to Australia’s resources sector, with a focus on operations in Singapore. By examining the commercial benefits of establishing marketing operations in Singapore, this article hopes to show that the framework is not reflective of the industry standard and thereby contradicts the arm’s-length principle in its purest form.


Although PCG 2017/1 was introduced in January, the use of centralized operating models is not new. In fact, the rising concern regarding marketing hubs was highlighted in a 2011 Treasury Department consultation paper that cited the ATO Compliance Plan for 2010-2011, referencing a concern about the creation of marketing hubs to shift or shelter profits. The 2013-2014 federal budget showed that AUD 109.1 million was dedicated to increasing ATO compliance checks on offshore marketing hubs, highlighting increasing interest and support from the government to detect and restrict the use of those hubs to minimize taxes.2 The ATO issued Taxpayer Alert 2015/5 in December 2015, indicating a stronger focus on arrangements involving offshore procurement hubs.

Perhaps the biggest push for a compliance guide came after a 2015 Australian Senate inquiry into corporate tax avoidance and aggressive minimization highlighted BHP Billiton’s and Rio Tinto’s Singapore dealings, for which they were being audited by the ATO.3 Further, BHP Billiton’s deflection of most of the committee’s questions prompted a denial of public-interest immunity for tax rate disclosure.4 Consequently, BHP Billiton had to reply to the committee’s additional questions on notice and revealed substantial revenues earned in Singapore with comparatively negligible expenditures.5

The government responded swiftly, issuing numerous ATO documents.6 An interim report from the Parliament Economics References Committee recommended that the Australian government “work with governments of countries with significant marketing hub activity to improve the transparency of information regarding taxation, monetary flows and inter-related party dealings.”7

Emboldened by its win in Chevron Australia Holdings Pty. Ltd. v. Commissioner[2015] FCA 1092, the ATO released a draft discussion paper on offshore marketing hubs that outlined its intended approach for bringing hub profits back home.

In 2017 the Australian public’s level of trust toward business and government hit the lowest recorded level since 2012.8 Along with that came a demand for “greater scrutiny, regulation and taxation of business.”9

The ATO’s response to the public outrage that followed the Senate inquiry — that is, PCG 2017/1 — was successfully timed to stimulate public support against mining giants hiding billions of dollars in Singapore. Further, with Australia set to become the world’s largest LNG exporter, the guide’s application to mining companies will warn energy giants that the ATO will seek to benefit from their lucrative LNG exports.

The Risk Assessment Framework

The guide’s risk assessment framework provides six different risk zones for offshore marketing hubs. The white zone is the safest risk area, and a hub will be in that zone if it has an advance pricing agreement or a settlement agreement with the ATO, or if the ATO has reviewed the hub and given it a low-risk rating in the last two years.

Hubs that do not meet those criteria can still be low risk if they fall within the green zone, which indicates that hub profits are less than or equal to a 100 percent markup of hub costs, or are fully attributed. That allows the marketing hub to be eligible for simplified recordkeeping and means that compliance resources will not be applied by the ATO.

If hub profits exceed a 100 percent markup of hub costs, the taxpayer will move into one of four zones that specify the level of risk based on the hub’s tax impact. The tax impact is calculated using the following formula:

tax impact = [hub profit less 100% markup above costs] * nonattributed income ratio * Australian company tax rate

The blue zone is at the lower end of the scale, and the red zone is the highest priority for review as high risk. However, even if the taxpayer is in the intermediary yellow or amber zone, it will automatically move to the red zone if it does not have transfer pricing documentation that meets the requirements in Taxation Ruling 2014/8. PCG 2017/1 considers those documents “critical to the assessment of risk related to hubs that are outside the green zone.” The level of detail expected is extensive and includes primary evidence of legal arrangements, financial outcomes, job descriptions, key performance indicators, and cost-benefit analyses. That places a high compliance burden on taxpayers and thereby increases their chances of inadvertently falling into the red zone. Although the ATO has said the degree of documentation detail required will depend on the level of complexity and materiality of the risk, PwC has found the expectation to extend well beyond the level of detail typically included in transfer pricing matters.10

In testing and evidencing the marketing hubs, the required documentation will be critical in supporting the hub’s functions, risks assumed, and commerciality/arm’s-length nature of pricing arrangements, according to PCG 2017/1. The level of economic substance and commerciality of the hubs will be a key focus of the ATO’s testing. Given the precedent set by Chevron, the ATO is likely to scrutinize the validity of economic analysis for comparability. BDO Australia has said that companies will have to invest more time in functional analysis to support a hub’s economic substance. The problem is that many groups have not prepared the functional analyses required by the ATO, leaving them potentially exposed and at risk of falling into the red zone.11

Singapore as a Commodity Trading Hub

The term “marketing hub” has become closely associated with Singapore, particularly in the resources sector, and the association has grown stronger with the release of PCG 2017/1. Singapore has emerged as Asia’s most important commodities trading hub because of its strategic location; strong financial and trading infrastructure; and reliable regulatory, legal, and tax regimes.12

Alongside its rapid economic growth, Asia’s share of global commodity consumption is also rising.13 Singapore’s geographic location at the center of Asian trade routes is a key advantage that has attracted a participant network of major global commodity producers, consumers, and traders, including Australia’s BHP Billiton and Rio Tinto.

Asian sales make up 65 percent and 68 percent of sales for BHP Billiton and Rio Tinto, respectively.14 It is therefore essential for those companies to tap into Singapore’s talent pool, which has the knowledge and cultural awareness to facilitate trading with Asia and the world’s largest growing markets.

Emerging economies such as China, India, and the Association of Southeast Asian Nations play an important role in driving global growth and demand for commodities provided by companies such as BHP Billiton and Rio Tinto.15 Consequently, setting up commodity trading hubs in Singapore allows those companies to tap into the Asian sector by understanding the supply and demand of each market.16

PCG 2017/1 operates on the flawed premise that those marketing hubs were established as tax-minimization tools, despite their evident commercial benefits.


There is an inherent problem with applying PCG 2017/1 to marketing hubs. First, it is important to understand that a marketing hub performs the role of a full-fledged distributor that is highly active in the market, has access to the right consumer base, and builds demand for products through marketing and sales activities.17 Hubs conduct quality control of inventory, are responsible for warehousing and logistics, take title to goods until sale and delivery, and perform marketing activities and post-sales services to customers.

Hubs must be distinguished from the classic buy-sell distributor, which usually holds title to goods sold only briefly to reduce the distributor’s exposure to risk.18 Marketing and advertising is typically outsourced, and the distributor does not add substantial value to the product. Consequently, the buy-sell distributor has limited responsibility and risk, leading to decreased remuneration.19

BHP Billiton’s and Rio Tinto’s Singapore hubs contribute significantly to the value of the companies’ products. They build relationships with clients by understanding their needs, gather intelligence to structure deals to meet client needs, manage commodity movements to ensure timely delivery, arrange legal documentation, and monitor those activities to ensure risk levels do not exceed specified limits.20 That allows the risk exposure of commodity trading to be isolated and controlled, and ensures that time-sensitive commodity transactions are swiftly processed. As such, the marketing unit exposes itself to risk by being active in the market, building consumer demand, and taking responsibility for the goods.

A full-fledged distributor is remunerated using the comparable uncontrolled price or resale price method.21 Both methods rely on sales to determine an arm’s-length price.22

The problem with applying PCG 2017/1 is that the outcome of the risk framework is tied to costs rather than sales. To remain in the green zone, the marketing hub’s results must be below the cost-plus indicator (the hub’s profit is less than or equal to a 100 percent markup of costs). That means the hub’s remuneration, which is derived from the resale price margin, will be measured according to costs rather than sales — and will ultimately determine whether the hub remains in the green zone. That kind of approach does not reflect industry norms and thereby runs contrary to the arm’s-length principle.

The concept of independent party transactions is the cornerstone of the arm’s-length principle. Independent parties acting as a manufacturer (the parent) and a full-fledged distributor (the marketing hub) would contract to derive remuneration as a percentage of the unit price, which is how the hub makes its profit and reflects the risks assumed and the value added. PCG 2017/1 applies a cost-based approach to deals that are inherently sales-based. The logic behind tying marketing remuneration to sales is to encourage an increase in sales and a decrease in operating costs. The cost-plus indicator works in the hub’s favor only if costs are higher than profit, which goes against a hub’s business model.


For companies in the resource sector, applying PCG 2017/1 could result in their falling immediately into the amber zone. For instance, BHP Billiton’s response to questions on notice at the Senate inquiry included a summary of international related-party transactions, with Singapore revenues of AUD 31.2 billion and expenditures of AUD 645 million.23 Those numbers are unsurprising, given the large volume of sales that pass through Singapore into Asia, and they highlight that it is impossible for a company like BHP Billiton to maintain a 100 percent markup of hub profits relative to cost. From an economic perspective, it defeats the purpose of giving incentives to marketing teams to minimize costs. It also does not reflect the commercial purpose behind establishing a marketing hub to enhance sales into Asia.

Once a marketing hub is assessed as being in the amber zone, PCG 2017/1 allows the ATO to monitor, risk-review, and even audit the hub. Parent companies will be expected to provide primary documentation to support the transfer pricing treatment and analysis of transactions with the hub. If they are unable or unwilling to do so, the hub will automatically be moved to the red zone.

In theory, one of the preferred consequences of the assessment would be to encourage filing APAs with the ATO to move the hub into the white zone. Rio Tinto reported in 2016 that it had entered into an APA with the ATO regarding its activities in Singapore,24 which technically places it in the white zone under PCG 2017/1. Even so, it has since been audited, and in April the ATO issued an AUD 379 million amended tax assessment plus interest of AUD 68 million for those very activities.25

That kind of outcome does not reassure other multinational enterprises in the resources industry about the certainty and safety of APAs. In fact, what it suggests is that despite the supposed safety provided by its white zone, PCG 2017/1 is yet another tool that could be used as a gateway to an audit.

PCG 2017/1 is inconsistent on the use of APAs to decrease a risk rating. It suggests that hubs apply for an APA to engage with the ATO and reduce their risk rating but also states that if the information provided does not meet the complexity of the arrangement, the hubs will not be allowed into the APA program. That, combined with the precedent set by the Rio Tinto APA, does not boost an MNE’s confidence in PCG 2017/1. It also does little to encourage companies to work with the ATO to be placed in the white zone.

Being outside the green zone opens a marketing hub to an audit, which can open a gateway to the application of the diverted profits tax (DPT). The DPT is meant to ensure that the tax paid by large global entities reflects the economic substance of their activities in Australia and to prevent the diversion of profits offshore through contrived arrangements.26 If the ATO determines that the transactions give rise to an effective tax mismatch and have insufficient economic substance,27 a DPT liability will be imposed at a rate of 40 percent.

Once an audit places a resource company with an offshore marketing hub in the DPT’s scope, the ATO’s powers are far-reaching. Broadly, a multinational like BHP Billiton could be subject to the DPT by being a major global entity operating in a jurisdiction with a corporate tax rate below 24 percent and doing so to obtain a tax benefit.28

The DPT is a unilateral instrument that overrides Australia’s tax treaties and frees the ATO of the obligation to apply the OECD transfer pricing guidelines.29 Consequently, although the OECD guidelines recommend that a full-fledged distributor be remunerated based on the resale price method,30 the ATO is not obligated to adopt that approach. It can rely on a cost-based method to evaluate a marketing hub’s remuneration and conclude that the hub was set up to obtain a tax benefit. The company has the burden of disproving the assessment but cannot do so by relying on its current pricing methods because the ATO does not have to take them into account. Thus, PCG 2017/1 could play an instrumental role in the DPT’s application to resource companies with operations in Singapore.

PCG 2017/1 states that its framework should be used to “work with the ATO to mitigate transfer pricing risk . . . and be confident that you have reduced your risk exposure.” However, that outcome can be achieved only if there is a meeting of the minds between the ATO and the multinational. There is a disconnect between the approaches of MNEs and the ATO, as the outcome of the Rio Tinto APA suggests. Thus, it is unclear how a meeting of the minds can occur or how the guide can give MNEs confidence about their risk exposure.


PCG 2017/1 introduces uncertainty for Australia’s resource industry. Despite the commercial benefits of creating a centralized marketing unit in Singapore, measuring remuneration relative to sales instead of costs places multinationals at a high risk of falling in the red zone. The guide’s risk framework is not aligned with the arm’s-length principle because it does not consider industry norms. Concluding an APA to be moved to the white zone still does not provide a company with absolute certainty and illustrates a dichotomy between the approaches of the ATO and the mining companies, with the companies penalized as a result.


1 The Australian Petroleum Production & Exploration Association, “Benefits of LNG” (2017).

2 Australia, “Portfolio Budget Statements 2013-14,” Budget Related Paper No 1.18, at 182 (2013).

3 Sue Lannin, “Rio Tinto, BHP Billiton Audited by ATO Over Singapore Operations,” ABC News (Apr. 10, 2015).

4 Neil Chenoweth, “BHP Billiton, Rio Tinto Under Fire at Tax Inquiry,” Australian Fin. Rev. (Apr. 15, 2015).

5 BHP Billiton, “Responses to Additional Questions on Notice to the Australian Senate,” at 6 (Apr. 24, 2015).

6 See ATO, “In Focus: Offshore Marketing Hubs” (July 8, 2015); and “In Focus: Procurement Hubs of Australian Multinational Enterprises” (Aug. 5, 2016).

7 Australian Parliament Economics References Committee, “Corporate Tax Avoidance Part 1 — You Cannot Tax What You Cannot See,” at 8 (2015).

8 Steven Spurr, “Trust Free-Falls in the Land Down Under,” Edelman blog (Feb. 21, 2017).

9 Id.

10 PwC, “Australia: Final Guidance Released on Assessing the Transfer Pricing Risk of Hubs and Centralised Operating Models” (2017).

11 BDO Australia, “Marketing Hubs and Offshore Holding Companies Under the ATO Spotlight” (2016).

12 International Enterprise Singapore, “Commodity Trading Hubs: Singapore’s Role and Proposition” (2015).

13 Id.

14 BHP Billiton’s responses to additional questions during the Senate inquiry, at 1 (Apr. 24, 2015); and Rio Tinto PLC, “Rio Tinto 2016 Annual Report” (2016).

15 International Enterprise Singapore, supra note 12, at 14.

16 Id. at 7.

17 Anuschka Bakker, Transfer Pricing and Business Restructurings 30 (2009).

18 Id.

19 Id.

20 International Enterprise Singapore, supra note 12, at 7.

21 Bakker, supra note 17.

22 The 2010 OECD transfer pricing guidelines state that for the resale method, the resale margin can be increased if it is shown that the reseller has special expertise in marketing the goods, bears special risks, or contributes substantially to the creation or maintenance of intangible property associated with the product. Commercially, that method makes sense because it provides incentives for the marketing team to obtain the most optimal contract price and reduce operating costs to increase profits. Tying remuneration to the sales of the commodities is an effective way to ensure the objectives of the marketing team are aligned with those of the parent company, ultimately boosting sales and overall profits. It also reflects the risks assumed and the value created by using the marketing team as a full-fledged distributor.

23 BHP Billiton responses, supra note 14, at 6.

24 Rio Tinto, “Taxes Paid in 2016” (2017).

25 Joanna Mather and Fleur Anderson, “Rio Tinto Hit With $450M Tax Bill; Multinational Crackdown to Raise $3B,” Australian Fin. Rev. (Apr. 6, 2017).

26 ATO, “Diverted Profits Tax” (Feb. 10, 2017).

27 Australian Treasury, “Implementing a Diverted Profits Tax,” at 4 (May 2016).

28 Revised Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, Diverted Profits Tax Bill 2017 (Cth) 27-30.

29 December 2016 email from David Watkins and Claudio Cimetta of Deloitte Touche Tohmatsu in Sydney, to Brendan McKenna of the Australian Treasury.

30 OECD 2010 transfer pricing guidelines.