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Beware the Matrix… ATO compliance approach to cross-border transactions

ATO approach to cross-border transactions

Glen Hutchings and Tim Keeling discuss the ATO's guidance on their compliance approach to taxation issues associated with cross-border transactions.


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The Australian Taxation Office (ATO) has released its Practical Compliance Guideline (PCG) 2017/4 : ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions.

This PCG follows on from a draft that the ATO issued for consultation in May 2017, and will have effect from 1 July 2017. It applies to existing and newly created financing arrangements.

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 are relying on to score taxpayers remain unchanged 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.

However, 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 have indicated that arrangements 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 has indicated a willingness to work with taxpayers and resolve areas of difference.

The ATO has provided some concessions relative to the draft PCG; for example, there are now more accommodating interest coverage ratio metrics, and taxpayers won’t 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 PCG, the final PCG generally places taxpayers in higher risk categories where 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 PCG. This intra-group debt cannot receive a rating better than yellow (moderate risk) under the final PCG.

Where you have cross border intra-group loans it is recommended you review the now finalised PCG to understand how the ATO will view your loan arrangements from a risk evaluation perspective. Taxpayers should ensure that the interest rates applied to their intra-group debt, and the PCG 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 PCG is not tailored to account for the different facts and circumstances of taxpayers (such as materiality and industry) and as such, there will be instances where arm’s length debt arrangements could be placed in higher risk categories. In these circumstances in particular, care should be adopted in analysing and benchmarking your cross border loan positions.

Stay tuned for further ATO transfer pricing publications in the financing space with ATO releases relating to the interaction of transfer pricing with debt/equity, guarantees, interest free loans and derivatives expected in the first quarter of 2018.

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