PCG 2020/1- Transfer Pricing Issues Related to Projects Involving the Use in Australian Waters of Non Resident Owned Mobile Off

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PCG 2020/1 - Transfer Pricing Issues In Australian Waters Of Non-Resident Mobile Offshore Drilling Units (MODUs)

PCG 2020/1 explains the ATO’s compliance approach to transfer pricing risks arising when foreign‑owned mobile offshore drilling units (“MODUs”) operate in Australian waters, typically for oil and gas exploration or drilling projects.

Because these MODUs are owned offshore but generate revenue from Australian projects, the ATO is focused on ensuring:

Profits from Australian activities are appropriately taxed in Australia
The payments made by Australian customers for MODU services reflect arm’s‑length pricing
The overall allocation of income between Australia and the MODU owner is commercial and justifiable

The PCG provides a “traffic‑light” risk assessment framework so taxpayers can self-assess:

Green zone: Low ATO risk
Amber zone: Moderate ATO risk
Red zone: High ATO risk likely to attract ATO review

It also outlines the behaviours, pricing outcomes, and structural arrangements that the ATO sees as higher or lower risk.

Key Issue Addressed by the PCG

The core concern is how much profit should be recognised in Australia when a non-resident MODU is used for drilling activities here.

The ATO believes certain arrangements may understate Australian taxable income, particularly when:

The foreign MODU entity reports very low profits, despite the MODU being essential to the work
Pricing is based on non‑arm’s‑length rates
The MODU owner is in a low‑tax jurisdiction
Contract structures shift profits offshore through management fees, rig leasing structures, or intra‑group mark‑ups

In essence, the ATO is ensuring that Australia receives a fair share of tax for drilling operations carried out in its waters.

How Does It Affect Taxpayers?

This PCG is directly relevant to taxpayers involved in oil and gas projects that utilise foreign‑owned MODUs for work in Australian waters. Taxpayers can assess their compliance risk each year using the ATO’s indicators explained below.

a. Profitability test (first test)

This involves calculating the operating margin of the Australian operations using the following formula:

Operating margin = EBIT / Australian contract revenue

Based on the operating margin, taxpayers can identify the risk zones as classified below:

Operating Margin	Risk Zone
≥ 10.5%	Green (low risk)
5% – 10.5%	Amber (moderate risk)
≤ 5%	Proceed to revenue test to determine Amber or Red

The ATO emphasises these profit markers are not safe harbours but merely guides to show how the ATO assesses.

b. Revenue test (only applies if margin ≤ 5%)

If profitability is low (≤ 5%), taxpayers should check the total Australian contract or project revenue:

Project Revenue	Risk Zone
< AU$20million	Amber zone
≥ AU$20million	Red zone (high risk)

The AU$20million threshold reflects the ATO’s view that small‑scale projects should not automatically be treated as high risk, even if margins are low.

c. What the ATO does with this information

Taxpayer’s risk zone guides the level of ATO scrutiny as summarised below:

Risk Zone	Level of ATO Scrutiny
Green	ATO is unlikely to review
Amber	ATO may make enquiries
Red	Higher chance of review, audit, or adjustment

Next Steps for Taxpayers

To comply and reduce risk, taxpayers should:

1. Self‑assess their MODU arrangement using the PCG risk framework

Determine whether your arrangement falls into:

Green (low ATO risk)
Amber (moderate risk)
Red (high risk)

This should ideally be done before filing the income tax return for the relevant year.

2. Review pricing against arm’s‑length expectations

Check whether the fees payable to the offshore MODU owner:

Reflect market rates
Properly compensate Australia for economic activity
Do not artificially shift profits offshore

3. Strengthen transfer pricing documentation, including:

Benchmarking studies
Economic analyses
Explanation for pricing outcomes
Supporting evidence for downtime, operational risks, and cost structures

4. Consider restructuring high-risk arrangements. If you fall in the red zone, consider:

Pricing adjustments
Revising contracting structures
Increasing transparency of cost and profit allocations
Bringing certain functions onshore (if practical)

5. Engage with the ATO early if necessary, high‑risk arrangements may benefit from:

Pre‑lodgment meetings
Private rulings
Advance Pricing Arrangements (“APA”)

Bottom line

Taxpayers are expected to demonstrate that the price paid for MODU services is at arm’s‑length, i.e.:

Comparable to what unrelated parties would pay
Commercial and market‑based
Reflective of the economic contribution made in Australia

PCG 2020/1

Specialists in PCG 2020/1 transfer pricing issues related to projects involving the use in Australian waters of non‑resident‑owned mobile offshore drilling units (MODUs).