CCH Networks and the Corporate Tax Association recently hosted an interactive webinar where Assistant Commissioner Shahzeb Panhwar of the ATO provided insights into cross-border related party financing arrangements.
The session covered:
- three aspects of the Chevron decision that inform taxpayers on evaluating the transfer pricing risks with cross-border financing
- changes to Practical Compliance Guideline PCG 2017/4 from the draft to final ruling
- the various options available to taxpayers under PCG 2017/4 in relation to their related party cross-border financing arrangements e.g. availability of transitional arrangements, eligibility for the “white zone” and how taxpayers can defend their position by preparing the right documentation
- a series of practical case studies illustrating the ATO’s approach to reviewing cross-border arrangements, and
- other ATO guidance products in the pipeline.
This article outlines some of the key areas discussed. Further details can be accessed via the webcast link provided below.
Three key takeaways from the Chevron decision
- There is no mandate in Australia’s transfer pricing rules to divorce, in a transfer pricing analysis, the relationship between the Australian entity and the rest of the group.
- Legacy arrangements that were created to satisfy the tax legislation but have a limited connection to market conditions in terms of commerciality and pricing, will be difficult to defend.
- Evidence to support the commerciality of an arrangement is crucial.
Key changes to PCG 2017/4 from the draft ruling
The most material change is that the final ruling contains two tables that look separately at motivational and pricing factors. The scores in these tables are combined to place the taxpayer in a particular risk zone. The ATO views the bifurcation of the table as placing a ceiling on how a high a taxpayer can be rated where they are conservatively priced.
Certain criteria in the draft ruling were relaxed in the final ruling. For example, the interest coverage ratio is more generous than the draft ruling to accommodate thin capitalisation policy. In relation to the tax rate of the lender’s jurisdiction certain arrangements will be viewed as low risk including if an entity is borrowing from its parent entity, a group treasury hub (meeting certain requirements) or a subsidiary in the same jurisdiction of the parent.
Options available to taxpayers and what they need to know
After self-assessing pursuant to PCG 2017/4, if a taxpayer falls into a zone other than the green zone they have three options. The taxpayer may choose to transition from a high to low risk arrangement (“de-risking”), consider their eligibility to access the white zone or defend their position. Taxpayers who choose not to have regard to the PCG will need to prepare documentation to support their arrangements.
PCG 2017/4 outlines an 18-month transition period which represents an acknowledgment from the ATO that a taxpayer’s arrangements may inadvertently not be in compliance with the law post Chevron. For taxpayers that engage with the ATO, the ATO will use discretion in the back years for penalties and interest and focus on prospective arrangements to arrive at a level of risk that the ATO and taxpayer are comfortable with. This will give taxpayers certainty in relation to prior years and options are available to memorialise that agreement.
The white zone
The “white zone” is a recognition by the ATO that PCG 2017/4 was developed for a population and there may be individual taxpayers within population where the outlined risk filter does not make sense. The white zone may be appropriate if there are factors that cause the taxpayer to fall outside the low risk zone, however the taxpayer believes the risk zone rating does not accurately reflect their underlying risk and the arrangement makes commercial risk. Engagement with the ATO may result in a scenario where the taxpayer will effectively receive a similar risk approach to the green zone and can elect the “white zone” where they need to file a reportable tax position schedule. To further discuss the white zone, taxpayers can contact their dedicated ATO relationship team or email PGIFinancing@ato.gov.au .
The ATO have advanced data analytics to identify high risk taxpayers and in most circumstances where taxpayers are in the amber or red zones, the ATO will dedicate resources to engage with these taxpayers.
ATO approach to reviewing arrangements
When reviewing an arrangement, the ATO’s primary question is if the entity under consideration were to raise funds from the market how would the lending be priced? In analysing this question, the entity is not to be treated as an orphan but viewed as part of a global group (as confirmed by Chevron). Post Chevron the question is what arm’s length conditions should be featured in the financing arrangement and how should it be priced.
What’s coming up next?
The ATO intends to release more guidance products related to this issue on derivatives, interest free loans and thin capitalisation.
Mr Shahzeb Panhwar is the Assistant Commissioner in the Law, Advice & Resolution Area within the Public Groups & International business line of the ATO.
Click here for the CCH Networks webinar “ATO Insights on Cross Border Financing”, 20 March 2018.
Read a summary of the Full Federal Court’s decision in Chevron on CCH iKnow.