Intangibles migration arrangements – PCG 2024/1

The Australian Taxation Office (ATO) finalised its Practical Compliance Guideline (PCG) 2024/1 – intangibles migration arrangements on 17 January 2024. 

This follows earlier drafts released in 2021 and 2023, including most recently of PCG 2023/D2 as analysed in our previous Insight.

With PCG 2024/1, the ATO has finalised its guidance for structuring issues and tax risks associated with 'Intangibles Migration Arrangements', i.e., cross-border arrangements involving the migration of intangible assets.

This PCG is intended to assist taxpayers in understanding how the ATO perceives risks in this space, and we believe that the PCG largely reflects reasonable views on most matters it discusses. This document will be particularly important for larger groups that fall under the Reportable Tax Position (RTP) regime, as they will need to disclose their risk-rating outcome within the RTP schedule. If no analysis is performed, a 'High Risk' rating must be disclosed.

It is important to note that this ruling includes arrangements that relate to Australian Development, Enhancement, Maintenance, Protection and Exploitation (DEMPE) activities in connection with intangible assets held offshore. The ruling is primarily focused on activities that involve Development, Enhancement, Maintenance, and Protection (DEMP). However, the "exploitation" of software is subject to other considerations, including royalty withholding tax. The ATO's most recent views on this matter can be found in draft ruling TR 2024/D1. While the content of PCG 2024/1 is largely reflective of reasonable and orthodox views, the ATO's position in draft ruling TR 2024/D1 is controversial due to its purported expansion of Australia's taxing rights.

Overview of Intangible Assets in Australia

During business operations, entities in Australia may enter into Intangible Migration Arrangements for a variety of commercial reasons. For example, an Australian entity may lack the resources to sustain the risks of owning Intangible Assets in the long term or it may have foreign entities capable of performing relevant DEMP activities related to the enhancement and development of said Intangible Assets.

Common examples of Intangible Migration Arrangements include an Australian entity selling software, or any other intellectual property they have developed, to a related entity overseas.  Another example is proprietary information developed in Australia that is then purchased by a related overseas entity to further develop an intangible asset for commercialisation.

From an Australian tax perspective, the primary tax issues arising from Intangible Migration Arrangements include:

• Transferring Intangible Assets from Australia would result in the derivation of profits in another tax jurisdiction, ultimately reducing the entity’s tax payable in Australia presently or in the future. It is the view of the ATO that since the ideation and development of intellectual property have taken place in Australia, the relevant taxes on the derived profit for these activities should also be paid to the ATO.
• An Australian entity may continue to perform intensive DEMP functions for an intangible asset held by a foreign company. Still, it may not be renumerated according to the proportion of their contribution, thereby also reducing the potential profit earned and potential assessable income the Australian entity may derive.

Key elements of PCG 2024/1

In the above context, the ATO sets out its view in evaluating the risk profile of such arrangements under PCG 2024/1.

The risk profile for such arrangements is determined through a self-assessment process, which involves evaluating whether the applicable arrangements meet the prescribed criteria, each of which is assigned a specific number of points. The total of these points will determine the risk profile of the arrangement, with ‘green’ indicating the lowest risk rating and ‘red’ indicating the highest risk rating.

The key elements in the ATO’s view that would typically attract a high number of points and consequently have a higher-risk rating are as follows:

• Circumstances of the Relevant Entity – Relevant entities or recipients of the intangible property will be allocated a high number of points if they are newly established overseas or in the initial stages of establishing operations. These entities generally have limited or no staff with the necessary expertise to perform DEMP activities in relation to the Intangible Asset. Consequently, they may rely on persons located in Australia to conduct DEMP activities or outsource these activities due to their lack of in-house capabilities.
• Tax Outcomes – the ATO is also conscious of the tax outcomes that the relevant entity may realise, particularly the benefits resulting from the arrangement. These may include being subject to a preferential tax regime in relation to the relevant entity or intangible property, the anticipation of benefits from a tax holiday or concession, the use of R&D tax offsets or credits, significant tax losses that would shelter the entity’s income and reduce tax payable. The ATO also considers whether the jurisdiction of the relevant entity is a specified jurisdiction and whether hybrid arrangements arise, where an acquisition is recognised in the foreign jurisdiction, but a disposal is not recognised in Australia.
• Undocumented or Unrecognised Dealings – Two criteria must be met, the relevant entities will be substantially using or directly benefitting from the use of the Australian entity’s intangible asset and, the Australian entity or group have not identified intangible assets related to the arrangement or evidences the processes and activities associated with the intangible asset.

ATO example of a high-risk rating under PCG2024/1

The following is an example of a high-risk arrangement and how ruling PCG2024/1 applies. An Australian company, AusCo, owns and controls the DEMPE activities associated with an existing intangible asset and receives royalty payments from its international related parties for the use of this asset under licence agreements. The group decides to centralise its intangible assets in a new entity, NewCo, in a foreign jurisdiction to benefit from a tax concession. To do this, AusCo enters into an Intangible Migration Agreement to sell its existing intangible asset to NewCo, terminates its licences and stops receiving royalties. NewCo then enters into licensing agreements with AusCo and all other international-related parties and receives all royalty payments. AusCo also enters into a contract R&D service agreement to perform DEMP functions on behalf of NewCo for a mark-up on costs incurred for the provision of R&D services. NewCo will own any new intangibles developed.

Applying the risk assessment outlined in PCG 2024/1, we must first examine whether a restructuring or change has occurred. AusCo has transferred its intangible asset to NewCo and performs DEMPE activities with respect to existing and future intangibles, thus a change has occurred. AusCo’s functional profile changes from an entrepreneur to a service provider, earning 5 points.

Examining the circumstances of the relevant entity, we can see that NewCo is a newly established entity with few employees and relies on AusCo to perform and control DEMPE activities related to all intangible assets. Therefore, 15 points would be allocated.

Next, we consider the tax outcomes that arise from the arrangement. NewCo is expected to qualify for concessional taxation on the income from the new intangibles, and AusCo would have continued to derive income from royalty payments if the arrangement had not occurred. Since there are two benefits, they would be allocated 10 points each, for a total of 20 points.

The aggregate of all the points would be 40 points, which would mean this type of arrangement would be considered a high-risk rating (red zone).

Of course, a range of other fact patterns will exist, with subtle changes potentially having a significant impact on the overall outcome. The colour-coded risk scores and adjustments as set out in our earlier summary may again be helpful in this context, though careful analysis will be required.

Considerations for Australian Taxpayers

Following its finalisation, PCG 2024/1 is expected to have the following considerations for Australian taxpayers:

• Additional risk rating disclosure in the income tax return form: taxpayers who are required to prepare and lodge a RTP Schedule will have to self-assess against this PCG and disclose their risk rating (or otherwise disclose a 'High Risk' rating). This is expected to lead to an increase in review activity relating to taxpayers who disclose a high risk rating.
• Intangible asset sale occurred in previous financial years: Companies who have previously undertaken an intangible asset sale or have previously undertaken development, enhancement or maintenance activities relating to intangible assets should also consider this ruling carefully, as it applies to both existing and new arrangements.
• Planning to transfer intangible assets, please evaluate before completion: Companies also considering undertaking intangible asset migration should also consider this ruling carefully to understand the risk profile of their arrangements.
• Are there legal agreements in place: Companies should also ensure that legal agreements have been put in place to substantiate these types of arrangements as the ATO lists this as one of its primary sources of evidence it will require when reviewing these arrangements.

FOR MORE INFORMATION

If you would like to learn more about the topics discussed in this article, please contact your local RSM office.