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The Australian Taxation Office will be coming after more large companies for their cross-border related-party financing, and the agency explained what businesses can do to avoid penalties.
The ATO issued guidelines May 16 on cross-border related-party financing, which specialists say might result in some taxpayers changing existing arrangements, even when they consider them to be legal.
“Even though an arrangement that is classified as ‘high risk’ under these guidelines may in fact accord with the transfer pricing laws, some taxpayers may still be inclined to modify their arrangements to fit within a low-risk category to avoid the compliance burden associated with increased ATO scrutiny,” according to law firm Greenwoods + Herbert Smith Freehills.
The latest ATO guidance follows a ruling by the Full Federal Court of Australia April 21 that a A$2.5 billion loan ($1.8 billion) between Chevron Australia Holdings Pty. Ltd. and its U.S. subsidiary, ChevronTexaco Funding Corp. (CFC), didn’t meet the arm’s-length standard. CFC had borrowed money in the U.S. at a 1.2 percent rate and lent the funds to Chevron Australia at a 9 percent rate.
The ATO’s latest guideline encourages companies to self-assess their financing arrangements in line with the tax authority’s approach. According to Greenwoods, this would place “a considerable additional compliance load” on companies to regularly collect data for self-assessments.
Zara Ritchie, Melbourne-based leader of BDO’s global transfer pricing practice, told Bloomberg BNA the new guidance overlooks the complexity and multitude of possible arrangements for related party-debt “and will result in puzzling outcomes on application.”
Many of those targeted over high-risk financing arrangements are likely to be in the oil, gas and mining industries, based on an ATO breakdown of related-party loans.
“In the 2014-15 income year, total related-party loans equaled A$420 billion ($311 billion),” an ATO spokesperson told Bloomberg BNA in an emailed statement.
“Almost half (48 percent) of related-party loans were in the energy and resources sector (worth A$202 billion),” the spokesperson said.
“About one quarter (23 percent) of related-party loans were in the oil and gas industry (worth A$97 billion),” according to the statement.
The guideline says the ATO will use a risk framework to classify financing arrangements into various zones, ranging from green (low-risk) through to amber (high-risk) and red (very high-risk).
“Your risk zone for an income year will reflect that of your highest risk financing arrangement,” the guideline says.
The ATO already has a number of large taxpayers on its red zone list and expects to add more.
“We will closely review the arrangements of taxpayers outside the green zone and, over time, expect a significant voluntary shift towards the green zone,” the ATO spokesperson said.
The guideline allows for an 18-month grandfathering period during which the ATO is willing to remit penalties and interest if taxpayers modify their financing arrangements to bring them within the green zone.
However, it will only do so if a taxpayer that moves to the green zone makes a “full and true disclosure” in relation to back years and doesn’t carry forward tax losses to later income years.
BDO’s Ritchie told Bloomberg BNA that numerous taxpayers with loans from the third-party financiers are likely to find themselves outside the low-risk green zone “for commercial reasons alone.”
“It would be unreasonable to expect all taxpayers to structure their arrangements to fall within the green zone as that maybe uncommercial not only in the context of the affairs of the Australian taxpayers but also in the context of the whole multinational group,” Ritchie said in an emailed statement.
However, the combination of the Chevron ruling and the new ATO guideline makes it clear that taxpayers must have sufficient analysis and evidence to support their positions, “as the likelihood of financing arrangements being reviewed by the ATO is now high,” she said.
The draft guideline is likely to trigger a flurry of submissions from advisers and taxpayers, Ritchie added.
Greenwoods managing director Tony Frost and director Julian Pinson noted that from now on the Reportable Tax Position schedule in which large businesses disclose their most contestable and material tax positions will include a question on whether cross-border related-party financing arrangements have been self-assessed.
The heart of the new ATO guideline is a table with 11 quantitative and qualitative risk indicators that are given scores, on a loan-by-loan, year-by-year basis, Frost and Pinson said in a May 16 blog post.
“A key risk indicator assesses the interest rate on the related party debt in comparison to any ‘referable debt,’ being the global cost of group debt, traceable third party debt, and certain other third party debt,” their post said.
“For inbound loans, the ‘safest’ outcome is interest that does not exceed 50 basis points over the cost of the ‘referable debt’,” they said. “The higher the margin over the cost of the ‘referable debt,’ the greater the risk score.”
The other 10 risk indicators relate to factors including collateral, subordinated or mezzanine debt, the headline tax rate of the lender entity jurisdiction and whether the currency of debt is different from the operating currency.
Clayton Utz tax partner Niv Tadmore described the guideline as “a risk management tool” rather than a public ruling.
“It is aimed at assisting taxpayers to arrange their affairs in a way that would gel with the ATO’s own internal risk triggers,” he told Bloomberg BNA in emailed comments.
“If a taxpayer triggers a risk flag it can still have a defensible position, but the ATO will have a very close look at it,” Tadmore said.
The guideline says red zone taxpayers are likely to have their financial arrangements reviewed as a matter of priority, possibly directly through audit.
The ATO is also likely to use formal information-gathering powers for red zone taxpayers and there is “an increased prospect” of litigation, it says.
“It should be noted that the higher the risk zone you fall within, the greater the expectation by the ATO that you will have high quality transfer pricing documentation in place to support your transfer pricing outcomes,” the guideline says.
Comment on the draft guideline closes June 30. Once finalized, it will have effect from July 1.
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