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Australia: ATO guideline on cross-border related-party financing arrangements, transactions

Australia: ATO guideline on transactions

The Australian Taxation Office (ATO) released a “practical compliance guideline” on its approach to tax issues associated with cross-border related-party financing arrangements and related transactions.

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The Practical Compliance Guideline (PCG) 2017/4 : ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions follows on from a draft that the ATO issued for consultation in May 2017, and the effective date is 1 July 2017, and it applies to existing and newly created financing arrangements.

Tax risk spectrum

The ATO has modified its colour-coded tax risk spectrum (White, Green, Blue, Yellow, Amber & Red-zone) following the consultation on the draft. The relevant factors that the ATO will rely on to score taxpayers—such as the spread relative to third-party debt or global cost of funds (“external debt funding costs”), interest-cover ratios, security, subordination, and the existence ‘high risk’ factors including the use of use of hybrids—remain unchanged.

The risk rating is now derived from the intersection of the taxpayer’s scores on two axes of a matrix, being “Pricing” and “Motivational”—rather than from a one-dimensional aggregate points score. 

  • The matrix has 15 boxes, of which only one is for the Green “low risk” rating, and nine are for the Amber and Red “high” and “very high” ratings. 
  • The ATO indicated that arrangements rated as high risk or above would be subject to review as a matter of priority. 
  • Moderate risk ratings would still be subject to review, albeit the ATO indicated a willingness to work with taxpayers and resolve areas of difference.

Changes from draft guideline

The ATO provided some concessions relative to the draft guideline; for example, there are now more accommodating interest coverage ratio metrics, and taxpayers will not be penalised for the tax jurisdiction of the lender provided it is the location of the head office or treasury department. However, compared to the draft guidelines, the final version generally places taxpayers in higher risk categories when the pricing of their debt differs from external debt funding costs. For example, an intra-group debt which was subordinated, priced between 51-100bps above external debt funding costs, and received no other points from relevant factors, would be scored as Green (low risk) under the draft guideline. This intra-group debt cannot receive a rating better than Yellow (moderate risk) under the final guideline.

KPMG observation

When there are cross-border intra-group loans, taxpayers need to consider reviewing the final guideline to understand how the ATO will view the loan arrangements from a risk-evaluation perspective. Taxpayers need to determine that the interest rates applied to their intra-group debt, and the guideline colour category determined for their intra-group debt are supported by appropriate evidence—such as transfer pricing documentation, intercompany legal agreements and policy documents. The guideline is not tailored to account for different facts and circumstances of taxpayers (such as materiality and industry) and as such, there will be instances when arm’s length debt arrangements could be placed in higher risk categories. In these circumstances in particular, care needs to be used in analysing and benchmarking such cross-border loan positions.

Further ATO transfer pricing publications with respect to financing arrangements can be expected relating to the interaction of transfer pricing with debt/equity, guarantees, interest-free loans, and derivatives in the first quarter of 2018. 

 

Read a January 2018 report prepared by the KPMG member firm in Australia

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