ATO Releases Final Guidance on Transfer Pricing Rules and Debt/Equity Tests

On July 3, 2019, the Australian Taxation Office (“ATO”) published final Taxation Determination TD 2019/10 (“Determination”) which deals with the interaction between the Australian debt and equity rules in Division 974 and the transfer pricing rules in Subdivision 815-B of the Income Tax Assessment Act 1997 (ITAA 1997). 

This Determination was previously released in draft as TD 2018/D6 and was discussed in the December 2018 issue of Duff & Phelps’ Transfer Pricing Times. The ATO also released a compendium of responses to the issues raised by external parties to the draft Determination.

Despite the numerous issues raised, TD 2019/10 is substantially unchanged from the draft Determination and provides the same three examples (with some slight modifications) to illustrate the effect of the transfer pricing rules on the debt equity rules.

One notable change is in Example 2 concerning an interest withholding tax benefit received by the foreign company on an inbound discretionary, non-cumulative interest loan to an Australian company which would satisfy the equity test based on the actual terms but not the debt test under the arm’s length conditions. In the draft Determination, the ATO indicated at paragraph 16 that it may exercise its discretion to make a consequential adjustment under section 815-145 by way of a deemed deduction for interest to the Australian-company. However, this paragraph has been omitted from the final Determination. The reason provided in the compendium is that the payer’s entitlement to a consequential adjustment under section 815-145 is beyond the scope of the Determination. Of equal concern to taxpayers would be that the operation of section 815-145 does not extend to provide a consequential adjustment for dividend withholding tax paid that may have been paid. In such circumstances, the compendium indicates that the ATO will consider refunding any dividend withholding tax incorrectly paid.

Although outside the scope of the Determination, the compendium also clarifies that with the exception of the thin capitalization rules, other parts of the income tax law used in working out the relevant entity's taxable income, etc. are to be applied to the arm's length conditions, rather than to the actual conditions, where Subdivision 815-B reclassifies an instrument from debt to equity and vice versa, for example. The consequence of this is that taxpayers will need to consider the impact of the terms of any cross-border related party financing arrangement in Australia aside from just the interest rate.

Read Transfer Pricing Times – July 2019