by Julie Martin, MNE Tax
Australia’s debt-equity classification rules do not limit the operation of the transfer pricing rules, which, in a related-party setting, substitute arm’s length conditions for actual conditions to figure an entity’s taxable income, loss, offsets, and withholding, the Australian Taxation Office said in draft tax guidance released today.
The ATO said in draft Tax Determination TD 2018/D6 that Australia’s transfer pricing rules take precedence over Divison 974 debt-equity characterization rules; therefore, the Division 974 rules are meant to classify an interest by reference to the arm’s length conditions, not the actual conditions.
The ATO provided three examples in its draft guidance.
In the case of an outbound loan to a distressed subsidiary which does not begin to accrue interest until the subsidiary turns a profit, the transfer pricing rules would apply to impute interest payments to this non-arms length loan. As such, the loan is not recharacterized as equity.
In an example involving an inbound related-party discretionary interest loan which would fail the test for debt under the debt-equity characterization rules, the ATO applied arm’s length conditions, saying greater interest deductions and thus greater withholding would apply. The ATO said that in this example, the Australian company received transfer pricing benefit equal to the interest withholding tax that would have been payable; the Commissioner may also adjust the Australian company’s income to account for the interest deductions.
In the case of an outbound interest-free loan to a related party that could not otherwise receive debt financing, the ATO said that arm’s length conditions would satisfy the equity test. The ATO said that there was no transfer pricing benefit in this case, though, so the classification of the arrangement is unaffected by the transfer pricing rules.
In its draft guidance, the ATO discusses arguments supporting the contrary position the debt-equity classification rules should take precedence over the transfer pricing rules and provides its counter-arguments.
The ATO is seeking feedback on its draft by November 30
Austraila’s guidance comes as countries are grappling with the task of creating uniform transfer pricing rules for financial transactions to be incorporated in revised OECD transfer pricing guidelines.
Julie Martin
Julie Martin is the founder of MNE Tax. She edits the publication and regularly contributes articles on new developments in cross-border business taxation.
Julie has worked as a tax journalist and editor for more than 13 years. Prior to that, she worked as an in-house tax attorney in New York. She also holds an LLM in taxation from New York University School of Law.
Julie can be reached at [email protected].
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