Australia: ATO focus on “offshore gearing” structures, related-party financing
Australia: ATO focus on “offshore gearing” structures
The Australian Taxation Office (ATO) released guidance outlining concerns that the ATO has in relation to the tax outcomes of “offshore gearing” structures.
According to Taxpayer Alert 2020/3 (14 August 2020), a typical offshore gearing structure is illustrated by the ATO as follows:
Source: Australian Taxation Office
The key tax outcomes of the offshore gearing structure are:
- Income of the Australian Trust is subject to a non-final withholding tax of 30% when distributed to the Interposed Beneficiary Co.
- Interposed Beneficiary Co will be entitled to a deduction for interest arising on the related-party loan, subject to thin capitalisation and transfer pricing limitations—this may give rise to a refund of the withholding applied above.
- As neither Interposed Beneficiary Co nor Investor Co is an Australian resident, no Australian withholding tax is to be imposed on interest payments.
The ATO’s key concerns with offshore gearing structures include:
- The absence of an appropriate commercial rationale for the interposition of a non-resident beneficiary and/or the jurisdiction of that beneficiary
- The absence of an appropriate commercial rationale as to why the debt used for Australian business purposes is to be borne by the non-resident beneficiary
- An effective tax rate on Australian-sourced income that is minimal or zero
- The related-party debt is at a significant premium to referrable third-party debt, or the lending entity's cost of funds
- The beneficiary's capital structure maximises debt deductions under the thin capitalisation rules
- The beneficiary is resident of a low- or no-tax jurisdiction and/or a non-treaty jurisdiction
While not specifically noted in the ATO guidance, it has been the experience of tax professionals that the ATO is also concerned with offshore gearing structures when the offshore gearing level is significantly higher than that of the group—particularly when the group has limited external debt.
Offshore gearing structures have been relatively commonplace for investment in the infrastructure and real estate sectors for over 20 years. During this time, their outcomes have generally not been challenged; however, in a similar vein to the recent experience with stapled structures, the guidance highlights features that the ATO has observed within certain offshore gearing structures that it considers to be more aggressive.
The ATO signaled that the outcomes of those structures may be subject to challenge under the thin capitalisation, transfer pricing, and general anti-avoidance provisions, along with the ongoing focus on the operation of the Division 974 debt/equity provisions. However, the risk of a challenge by the ATO would be expected to be reduced or lower to the extent the taxpayer’s capital structure is within ordinary and commercially observed levels, applicable thin capitalisation limits, transfer pricing requirements, and not treated as economically similar to an equity interest.
Conversely, greater ATO scrutiny may be expected when the arrangement involves entities residing in lower tax jurisdictions, and there is purported non-application of thin capitalisation, with financing at a significant premium to relevant third-party debt and gearing levels substantially above that of the group or economically more akin to equity. Many of these issues go beyond the specific risk of withholding tax avoidance that can arguably arise under offshore gearing structures and are relevant to related-party financing more generally.
Beyond determining that there is appropriate support for the thin capitalisation and transfer pricing outcomes of the taxpayer’s funding structure with regard to expected cashflows, the ATO guidance highlights the importance of appropriate supporting evidence—evidence that documents and supports the commercial rationale for the structure and certain component elements including the location of entities, the sources of funding, and the commercial drivers that preclude the funding being provided to an onshore entity.
Because the identity and outcomes of these structures will already be known to the ATO—through its review activities, annual income tax returns, and future disclosures in the “reportable tax positions” schedule—determining that appropriate support is in place will be paramount. As a practical point, possibly affected taxpayers need to review their transfer pricing analysis, outcomes, and documentation and then they need to consider whether they have appropriate supporting evidence on hand to document the commercial factors that drove the structuring and funding decisions.
For more information, contact a KPMG tax professional in Australia:
Frank Putrino | +61 3 9838 4269 | email@example.com
Scott Farrell | +61 2 9335 7366 | firstname.lastname@example.org
Matt Ervin | +61 3 9288 5933 | email@example.com
© 2022 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. All rights reserved.
For more detail about the structure of the KPMG global organization please visit https://home.kpmg/governance.
The KPMG name and logo are trademarks used under license by the independent member firms of the KPMG global organization. KPMG International Limited is a private English company limited by guarantee and does not provide services to clients. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.