Australian Taxation Office—Banking & Finance industry strategy for 2023-24

Deloitte Australia hosted a Banking Tax roundtable with clients and the Australian Taxation Office (ATO) on 6 September 2023. During the roundtable, the ATO walked through its Banking & Finance (B&F) industry strategy for year 2023-2024, which has been prepared for the purpose of communicating the ATO’s focus areas to the taxpayer community, relevant industry bodies, and tax advisers. The ATO also provided an overview of the latest demographics of the industry based on tax return data and an update on its reviews of taxpayers in this industry, including outlining its expectations on addressing certain risks in upcoming reviews. The ATO acknowledged that the key issues impacting this industry, such as the challenging economic climate, a dynamic regulatory environment, the evolving global and Australian tax policy, and mergers & acquisitions activity (consolidations and divestments), have given rise to complexity for B&F taxpayers.

Overview of taxpayers in the Banking & Finance sector

During the roundtable, the ATO presented an overview of the number and type of taxpayers in the B&F sector, which comprises Australian headquartered banks, foreign banks, credit unions, mutuals, building societies, fintechs, financial asset investors, providers of auxiliary finance and investment services, and other depository financial intermediation or non-depository financiers. The diagram below provides a summary of the ATO’s stratification of taxpayers into Top 100, Top 1000 and Medium and Emerging (M&E), based on data obtained from income tax return lodgements as of 8 July 2023.
 

Most Top 100 taxpayers received a high assurance rating, considering the Top 100 review program is a mature program within the ATO’s Justified Trust framework. As such, while the ATO will undertake a full review every three years on all areas including transfer pricing and branch profit attribution, the ATO is likely to be able to adopt a more light-touch approach in refreshing the reviews for banks that are part of the Top 100, with a continued focus on:

• Having an appropriate tax governance framework
  
• High assurance in relation to tax risks flagged to market
• Tax treatment with regard to significant and new transactions
• Alignment between tax and accounting outcomes

Outcome of Top 1000 reviews

At present, there are 77 companies that falls within the B&F sector in the ATO’s Top 1,000 program, which assures the income tax and Goods and Services Tax (GST) affairs of taxpayers with annual turnover of AUD 250 million or greater. The ATO noted that the outcomes from the Top 1000 review program are mixed, as compared to Top 100. A common issue resulting in Top 1000 B&F taxpayers not achieving overall high assurance is insufficient information and documentation provided with respect to cross-border related party and internal dealings.

1. Local transfer pricing documentation

During the walk-through of the B&F strategy, the ATO referenced its letter to the Australian Financial Markets Association in April 2021, which indicated that while many taxpayers do prepare transfer pricing documentation, the documentation may not be prepared with sufficient detail to explain and justify the use of the transfer pricing methodology and resulting outcome for Australia pursuant to the relevant provisions, for example:

• Global transfer pricing documentation is provided with either no or limited functional analysis of the Australian entity/branch.
• Insufficient contemporaneous information is provided regarding a contribution analysis where this is necessary in the application of the profit split method. This is particularly the case where a foreign bank relies on a global policy without specific reference to the Australian entity/branch and its contribution.
• Limited information is provided to evidence and connect the transfer pricing outcome in relation to specific transactions (that may be sample tested by the ATO) with what would be expected based on the transfer pricing methodology being adopted by the taxpayer. In certain circumstances (e.g., a complex material split of revenues on a global deal), the ATO may expect transaction specific documentation would be expected to justify the transfer pricing outcome.

2. Intra-entity services

The ATO notes that challenges encountered in relation to intra-entity (i.e., between head office and branch, or branch to branch) service charges include:

• Application of cost allocation keys that are inappropriate considering the nature of the activities undertaken, and therefore not producing an outcome commensurate with the benefit to the Australian branch
• Insufficient supporting documentation to validate the nature of costs incurred offshore and to confirm that the activity to which they relate is not duplicated in Australia
• Application of a mark-up on costs incurred offshore with respect to management and general administrative activities in attributing profit to an Australian branch of a non-resident bank, noting that mark-ups on costs allocated for management or general administrative services are not deductible for tax purposes. Australia has not adopted the Authorised OECD Approach (AOA) and, in the context of intra-entity/internal dealings under the Relevant Business Activity (RBA) approach, for certain types of arrangements only accepts an amount for the allocation of actual expenditure (i.e., without a mark-up) in determining the profits attributable to the Australian branch.
  

In further guidance issued to the B&F industry, the ATO states that Australia is not obligated to provide double tax relief under a Mutual Agreement Procedure (MAP) in relation to intra-entity service charges, as the profit attributable to a permanent establishment for the purpose of the Business Profits article in Australia’s tax treaties is properly determined adopting the RBA approach, notwithstanding that this may result in the treaty failing to relieve resulting in juridical double taxation (because the treaty partner country adopts a different approach).

Based on the ATO’s guidance, general management and administrative services for a bank do not include activities directly involved in its core business of supplying financial products and services to customers, such as sales and marketing, trading, treasury, and loan support and monitoring.

Conversely, common examples of general management and administrative services for a banking business includes accounting and auditing, accounts payables and receivables management, human resources activities, monitoring and reporting activities, information technology services, internal and external communication and public relations support, legal services and activities with regards to taxation obligations.

The ATO has not comprehensively addressed all costs incurred by a bank, including the teams responsible for the oversight of credit risk and market risk, for example, the ATO indicated that each individual category of activities needs to be assessed on a case-by-case basis to determine whether it would be considered integral to the profit earning activities of a banking business.

3. Attribution of assets

Casework through the ATO’s Justified Trust program has identified a lack of information and working papers in relation to the decision-making pursuant to the attribution of risk weighted assets (RWAs) to branches. This will determine the appropriate starting point for the thin capitalisation analysis required in Australia’s tax rules and consequently the allocation of deductible interest expense.

However, the ATO acknowledges there is a lack of ATO guidance as to an acceptable approach to evidence such decision-making for asset attribution. As such, the ATO intends to issue a discussion paper for consultation with the industry in relation to the attribution of RWA to branches. The paper will set out various considerations that may be relevant to developing a workable approach for tax purposes including illustrative examples and regulatory considerations. While the ultimate objective is to issue guidance on an acceptable approach to the attribution of RWA for the purposes of Australia’s thin capitalisation rules, the paper will also highlight flow-on considerations in relation to withholding tax on interest.

Medium and Emerging taxpayers

While the ATO’s resources have historically been concentrated on Top 100 and Top 1000 taxpayers, going forward the ATO is looking to increase its engagement with B&F taxpayers in the M&E segment, which comprises of taxpayers with an annual turnover of less than AUD 250 million. In addition to the issues highlighted for Top 1000 taxpayers above, the ATO will also focus on claims for Research & Development (R&D) credits given the heavy use of incentives by B&F players in this segment.

Proactive engagement with the ATO

A key takeaway from the Banking Tax roundtable was that the ATO is open to discussions with taxpayers in the B&F sector to provide greater certainty on tax matters, including issues relating to transfer pricing and branch profit attribution.

There has been an increase in the number of bilateral and multilateral MAPs and Advance Pricing Arrangements (APAs) entered into by the ATO in the B&F sector, covering support service transactions as well as global dealing profit splits.

For larger taxpayers, the ATO is in the process of revamping the Pre-lodgement Compliance Review (PCR) program, which aims to assure the right tax outcomes, and identify and manage material tax risks through early, tailored and transparent engagement. The ATO is open to reviewing transfer pricing issues through an early engagement process, and potentially issue a low risk rating on transfer pricing issues in the right circumstances, which may reduce the burden in case of a subsequent comprehensive review.

If you would like more information or a copy of the ATO’s strategy, please reach out to Geoff Gill or Priscilla Ratilal.