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ATO releases draft compliance approach to Arm’s Length Debt Test

Arm’s Length Debt Test draft compliance guideline

Tim Keeling, Frank Putrino and Jay Mankad provide an overview of the ATO’s compliance approach to the Arm’s Length Debt Test.

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The Australian Taxation Office (ATO) released its long-awaited draft practical compliance guidance PCG 2019/D3 (the PCG)on 28 August, which sets out a risk assessment framework that outlines the ATOs compliance approach to applying the Arm’s Length Debt Test (ALDT) as well as instances where the application of the ALDT will be considered ‘Low Risk’. The PCG follows and builds on TR 2019/D2, which provides an update and refreshes the ATO’s views regarding key technical issues pertaining to the ALDT.

In the PCG, which will be effective from 1 July 2019, the ATO outlines a vastly different and more detailed approach to applying the ALDT than what was previously outlined in TR 2003/1 (the previously ALDT ruling). The ATO makes it clear in the PCG that it sees ‘limited circumstances’ where entities would gear in excess of 60 percent of net assets and as such, it will generally view the ALDT as posing a ‘Moderate’ to ‘High Risk’ of non-compliance with the requirements of the thin Capitalisation rules. For this reason, it considers a much more rigorous analysis is required when applying the ALDT as compared to the other thin capitalisation tests. The approach outlined in the PCG represents the level of analysis expected by the ATO when applying the ALDT when the facts and circumstances don’t fall within a Low Risk category.

The Low Risk scenarios put forward by the ATO are relatively limited and although some degree of evidence and analysis is still required, it will allow eligible taxpayers a ‘short-cut’ in supporting a low risk outcome under the PCG.

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