Australia: ATO focus on cross-border financing arrangements
Australia: Cross-border financing arrangements
Traditional sources of debt capital are becoming more difficult to source, and one consequence has been an increase in lending activity from debt funds and institutional investors.
Historically the focus of the Australian Taxation Office (ATO) has been on related-party debt, transfer pricing, and thin capitalisation of cross-border financing arrangements. While continuing its focus in these areas, the ATO recently has focused its attention on alternative debt financing and how those arrangements are structured.
Specifically, the ATO published two taxpayer alerts in 2020 outlining its concerns in relation to cross-border financing arrangements.
- The first taxpayer alert (TA) 2020/2 relates to cross-border arrangements that involve foreign investors investing directly into Australia through debt that is “non-vanilla.” While the ATO has not targeted any one industry, arrangements more likely to attract ATO scrutiny include situations when a lender has participation or control rights that extend beyond those of ordinary debt holders, or arrangements when the lender has exposure to equity-like returns. The ATO stated that it will review the tax characterisation of such arrangements to determine that they are being appropriately treated under a number of different provisions in the tax legislation—including transfer pricing, the general anti-avoidance provisions, the debt-equity rules, and withholding tax provisions.
- In TA 2020/3, the ATO noted its concerns with arrangements that involve interposed offshore entities that facilitate the avoidance of interest withholding tax—such as when companies obtain financing offshore and incur debt deductions against Australian assessable income (usually trust distributions) without incurring a liability to Australian interest withholding tax. Arrangements attracting the ATO’s attention include those with features that reduce the effective tax rate on Australian-sourced income to a minimal or nil amount, when related-party debt is priced at a significant premium to comparable third-party debt, or when the arrangement falls outside the “green zone” (as referred to by the ATO’s transfer pricing guidance). In TA 2020/3, the ATO signaled that the outcomes of these structures may be subject to challenge under the debt-equity, thin capitalisation, transfer pricing or general anti-avoidance provisions. Features that will attract ATO attention include when entities are residents in lower tax jurisdictions, non-application of thin capitalisation measures, financing at a significant premium to relevant third-party debt, gearing levels substantially above that of the group or debt that is economically more akin to equity. However, to the extent the capital structure of the taxpayer is within ordinary and commercially observed levels, and the applicable thin capitalisation limits and transfer pricing requirements are met, the risk of an ATO challenge may be reduced.
As debt markets and products continue to evolve, the tax treatment of new products and instruments will need to be continually assessed. The ATO has already flagged its concerns in relation to structured arrangements in the two taxpayer alerts, and the ATO will continue to monitor the features of future arrangements through compliance activities. In addition, taxpayers need to be aware of the ATO’s ongoing focus on transfer pricing with regard to related-party transactions and the Australian anti-hybrid laws, among other items.
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