Australia: Arm’s length consideration and related-party loan
20 January 2015
Posted by: Author: KPMG Australia
Author: KPMG Australia
A clear illustration of the focus on base erosion and profit shifting (BEPS) is an appeal filed by a major oil company against a tax assessment, pending before Australia’s Federal Court.
At issue is whether an interest rate of 9% on an advance of U.S. $2.5 billion to an Australian taxpayer from its U.S. subsidiary exceeded what would be arm’s length consideration.
The Australian Tax Commissioner has challenged the commerciality of the loan, contending that the interest rate applied was higher than ordinary terms and that it would be unsustainable for a borrower to uphold a loan at that rate and unreasonable for a lender to provide a loan when the terms offer no actual security or covenants.
Possible thin cap implications
If the Commissioner’s arguments are successful, arm’s length consideration under the transfer pricing rules could become more difficult for taxpayers to satisfy. There would be uncertainties for taxpayers as a result of the tightening of these rules—particularly when precedent is created for essentially allowing related-party transactions to be priced based on hypothetical scenarios.
Also, there may be effects on other tax law provisions. For example, the reduction to the safe harbour debt amount under the thin capitalisation rules means that greater reliance would be placed on the "arm’s length debt test.”
Although the concept and application of the "arm’s length debt test” for thin capitalisation purposes is distinct from the transfer pricing rules, it has historically been recommended that these rules be more closely aligned. If the court were to accept the Commissioner’s position, so that there would be a tightening of the arm’s length transfer pricing rules, this would signify a departure from this recommendation—particularly in light of the work currently being undertaken to ease taxpayers’ compliance costs in applying the thin capitalisation "arm’s length debt test.”
This article first appeared on kpmg.com.