The ATO is focusing on transfer pricing compliance by taxpayers with related-party cross-border financing arrangements. It has followed up a win in the Chevron transfer pricing case (Chevron Australia Holdings Pty Ltd v FC of T 2017 ATC 20-615) by issuing Draft Practical Compliance Guideline PCG 2017/D4. Under the draft PCG, taxpayers will be expected to self-assess the transfer pricing risks of their financing arrangements with non-resident related parties.
In the Chevron case, the Australian subsidiary of the oil and gas giant was denied tax deductions, under the transfer pricing provisions, for interest paid to a related US company. The court found that the interest Chevron had paid under the in-house lending arrangements was more than would have been paid under a similar arrangement between independent parties dealing at arm’s length. It is no coincidence that the example in the draft PCG illustrates the risk assessment process for an Australian subsidiary of a US oil and gas company.
The ATO states that its draft risk assessment framework has been developed with the expectation that the cost of related party cross-border debt should “align with the costs that could be achieved, on an arm’s length basis, by the parent of the global group to which the borrower and lender both belong”.
Risk assessment checklist
The ATO has devised what practically is a checklist which when applied to the taxpayer’s related party financing arrangement(s) produces a score that places the arrangement in one of six risk categories or “zones”. The checklist applies to both inbound and outbound loans.
Taxpayers required to complete a Reportable Tax Position (RTP) Schedule will report whether they have completed the self-assessment process, if so, to disclose the self-assessed risk rating.
The ATO will use the score to tailor its approach to compliance with Div 815 or a relevant double tax treaty. For example, a taxpayer in the green zone will be treated as being at a lower risk of not complying with transfer pricing rules and the ATO generally will not scrutinize the arrangements, other than to confirm certain facts and to check eligibility for that rating. Red zone taxpayers will attract the highest level of ATO attention which may include proceeding directly to audit.
Exclusions from risk assessment
Some groups will be exempted from the requirement to self-assess cross-border loan risk, including a financing arrangement entered into by a member of a wholly owned group containing an ADI, an Australian resident securitisation vehicle or a resident eligible for the simplified transfer pricing record keeping options, and an arrangement that is a form of Islamic finance.
Voluntary disclosure offer
The draft PCG contains an offer to remit penalties and interest if, on reviewing risk, taxpayers change their financing arrangements to come within the low risk green zone and make a voluntary disclosure. The offer will apply for 18 months from the date the draft is published.
The finalised PCG will apply from 1 July 2017 to existing and newly created financing arrangements, structures and functions.
If draft PCG 2017/D4 is finalised, taxpayers with related party cross-border debt that is affected will need to consider undertaking the risk assessment process. Doing so will allow them to have a better understanding of the level of tax risk associated with funding arrangements and prepare for the compliance approach which the ATO is likely to adopt.
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