On Wed 31 Oct 2018, the ATO issued Draft Tax Determination TD 2018/D6, which considers the interaction between the debt/equity rules and Australia’s transfer pricing rules.
The Commissioner’s approach is that the debt/equity rules (in Div 974 of the ITAA97) cannot limit the operation of the transfer pricing rules( in Subdiv 815-B) – which appears correct in view of the express requirement in s815-110 of the ITAA97.
The transfer pricing rules operate when a taxpayer gets a ‘transfer pricing benefit’, which is measured against the situation that would have applied, if the ‘arm’s length conditions’ had applied (s815-120).
- The thrust of the ‘transfer pricing’ provisions is to neutralise ‘transfer pricing benefits’, by (where appropriate) increasing the taxpayer’s taxable income, by the amount of that benefit (s815-145).
- A ‘tax benefit’ is measured by comparing the actual conditions, to the defined ‘arm’s length conditions’ (s815-115).
- As part of this process, the Act says that Subdiv 815-B is not limited by any other provision in the Act (s815-110).
- And the ‘debt/equity’ provisions (in Div 974) are part of those other provisions.
This might sound right, in theory, but give you no idea what this means in practice. Fortunately, the Commissioner gives some examples in the ruling, which demonstrate how such a principle might apply in practice. I will refer (below) to ‘Example 1’ [in para 5 of the Ruling, and following].
- A foreign subsidiary might owe, its Australian parent, money, on terms that interest would not start to accrue, until the Australian lender/parent, had an accounting profit (so as to not ‘eat up profits’).
- However, the ‘debt/equity’ effect of the interest obligation contingent, in this way, turns the ‘debt’ instrument into an ‘equity interest’, under Div 974’s ‘bright line’ test, namely that the borrower must have ‘effectively non-contingent obligation’ to repay amounts that have a ‘present value’ at least equal to the amount borrowed (which it does not, as the lender parent might never have a profit and the loan becomes interest free).
- However, under ‘arm’s length conditions’ interest would not be contingent and would have accrued from the outset.
- When the ‘debt/equity’ provisions apply to the arm’s length conditions, they treat the loan as a ‘debt interest’ producing fully taxable income.
- If the parent has less than the 9% amount of assessable interest, then a ‘transfer pricing benefit’ would arise.
COMMENTS on the draft are due by 30 November 2018.
PROPOSED DATE OF EFFECT: income years starting on or after 29 June 2013 (the date on which Subdiv 815-B began to operate).
Previous ruling withdrawn
Taxation Determination TD 2008/20, which considered the interaction between Div 974 and the previous transfer pricing provisions (in the former Div 13 of Pt III of the ITAA36), was withdrawn on and with effect from Wed 31.10.2018.
CPD questions (answers available)
- Is a ‘transfer pricing benefit’ exist where (amongst other things) the taxable income of the taxpayer, based on the actual conditions, is less than it would be under certain defined ‘arm’s length conditions’?
- Do the transfer pricing provisions (in Div 974) say that, for these purposes, the rest of the Act should apply to those ‘arm’s length conditions’?
- Does that mean that the ‘debt/equity’ provisions apply to the taxpayers affairs as if the ‘arm’s length conditions’ were in existence?
- What provision says that?
- Does the Commissioner give an example (in this draft Determination) where loan that was an ‘equity interest’ on the actual conditions, became a ‘debt interest’ on the ‘arm’s length conditions)?