Private ruling: Application of the transfer pricing provisions in Division 13 of Part Ill of the Income Tax Assessment Act 1936 to advances of funds
Published: December 2012
Ruling period: 1 July 2009 to 30 June 2014
Date scheme commenced: July 2009

Ruling: Q1: Should the funds provided interest free by an Australian company, to its wholly owned foreign subsidiary, be characterised as being equivalent to a contribution of equity with the consequence that subsecion136AD (2) of Division 13 of Part Ill of the Income Tax Assessment Act 1936 does not apply to deem any amount of interest income to be the arm's length consideration in relation to the supply of funds? | A1: Yes. The funds provided interest free by Australian company, to its wholly owned foreign subsidiary, should be characterised as being equivalent to a contribution of equity with the consequence that subsection 136AD (2) of Division 13 of Part Ill of the Income Tax Assessment Act 1936 will not apply to deem any amount of interest income to be the arm's length consideration in relation to the supply of funds.


Relevant legislative provisions: Income Tax Assessment Act 1936 Division 13 of Part Ill | Income Tax Assessment Act 1936 Subsection 136AA (1) | Income Tax Assessment Act 1936 Section 136AC | Income Tax Assessment Act 1936 Subsection 136AD | Income Tax Assessment Act 1936 Subsection 136AD (2)

Reasons for decision: Summary: Based on the scheme described, and the financial statements provided, no consideration will be deemed to be received or receivable in respect of the supply of funds under Division 13 of the Income Tax Assessment Act 1936 (ITAA 1936). Detailed reasoning Division 13 of Part III of the ITAA 1936 provides a legislative framework to counter arrangements that result in avoidance of Australian tax through what are commonly referred to as 'transfer pricing' or 'profit shifting' arrangements. Section 136AD specifies the circumstances for application of Division 13. Subsection 136AD(2) deals with the supply of property where no consideration has been received and broadly provides that consideration equal to the arm's length consideration shall be deemed to have been received and receivable by the taxpayer in respect of the supply where: · the taxpayer supplied property under an international agreement; · the Commissioner is satisfied that the parties to the agreement were not dealing with each other at arm's length in relation to the supply; · no consideration was received or receivable by the taxpayer in respect of the supply; and · the Commissioner determines that the subsection should apply in relation to the taxpayer in relation to the supply. If the requirements in the subsection are satisfied, the arm's length consideration is deemed to have been received and receivable by the taxpayer in respect of the supply for all purposes of the application of (inter alia) the ITAA 1936 and ITAA 1997, but the actual terms, conditions or prices agreed to between the parties are not affected. The Commissioner's view of the application of Division 13 to loans is considered in Taxation Ruling TR 92/11 Income tax: application of the Division 13 transfer pricing provisions to loan arrangements and credit balances . Part C of the ruling deals with the issues to be taken into account in determining whether a transaction which is in the legal form of a loan of money is to be treated as equivalent to a contribution of equity. The first step is to establish the legal relationship established by the transaction. A flexible approach is to be adopted in which the special circumstances of each case will be considered. Division 13 would not be applied where the Commissioner is satisfied that the contribution of funds should be treated as equivalent to an equity investment. The principal factors that will be taken into account in determining whether a particular loan agreement should be treated as equivalent to a contribution of equity are set out in paragraph 60 of Taxation Ruling TR 92/11. In addition, paragraph 61 of the ruling stresses that while the factors identified in paragraph 60 and other factors will be of relevance, what is important is the total picture that emerges from the transaction. In the present case, the following factors support the conclusion that the economic substance of the advances of funds by Australian company is that of an equity investment in its wholly owned foreign subsidiary: As the taxpayer, the Australian company, is the sole shareholder of the entity receiving the funds, it will be entitled to any dividends out of profits arising from the R&D activities for which the funds were advanced. There are no agreed terms for repayment or redemption of the advances. Hence there are no conditions in respect of the repayment of funds which are inconsistent with its characterisation as equity. The funds have largely been utilised to fund R&D activities and fixed assets/new equipment, i.e. they represent long term investments in the subsidiary. The debt-to-equity ratio of the foreign subsidiary would be higher than the industry norm in this type of industry if the funds advanced were regarded as debt. As there is no agreement in relation to the terms of the provision of funds or as to the rights and obligations of the parties in respect of the transfer the Australian company's legal rights in respect of the funds provided to the foreign subsidiary may be limited to those they hold as a shareholder. In the present case the only available documentation is the balance sheet of the foreign subsidiary which indicates that the arrangement for the supply of funds by the Australian company to its foreign subsidiary was in the form of a loan or credit facility. However there are no written or oral agreements in relation to the terms on which the funds have been provided or as to the rights and obligations of the parties in respect of the transfers. No interest or dividends have been paid on these advances nor are there any agreed terms under which interest, or other form of accretion is payable on a deferred basis which would be inconsistent with its characterisation as equity. The foreign subsidiary has entered into a subordination agreement with a third party lender which would effectively subordinate any claims of Australian company's to those of the other creditor. Whilst it is not determinative, there is no written loan agreement. A start up company in this type of industry is analogous to the prospecting or exploration company depicted in the example given in part (g) of paragraph 60 of the Ruling. Equity funding for a start up company in this type of industry would be anticipated. Although the foreign subsidiary has a small portion of third party funding, during the period over which the funds were advanced, the subsidiary did not have significant assets that could be provided as a security for the level of funding advanced, nor did it have sufficient or reliable cash flows to be able to borrow its full amount of funding from arm's length third parties. The foreign subsidiary has not made sufficient turnover or profit to facilitate the payment of a commercial interest rate. Accordingly, having regard to the factors set out above, it is considered that the advances of funds made by Australian company to its foreign subsidiary should be characterised as a contribution of equity, and thus section 136AD should not be applied. Consequently, the Commissioner will not make a determination that Division 13 of the ITAA 1936 should apply to the arrangement.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: An Australian company which is a resident company is part of an international company group that develops and supplies certain devices. | Operations originally commenced in Australia. A company structure with an Australian company as head company was created some years ago. | In 2007, the Australian company acquired 100% of the shares in a foreign resident company, which manufactured these devices. | In 2009, the Australian company incorporated a subsidiary in this foreign country. In 2010, this foreign subsidiary became the parent of all group affiliates after a redomiciliation process. | In the initial period, research was conducted in Australia, funded by share capital raised in Australia. As a "start-up" company, funds for R& D of the technology were raised almost exclusively from share capital raisings. | After the purchase of the foreign subsidiary, some of the equity raised in Australia was transferred by the Australian company to the foreign subsidiary to fund research carried out in the foreign country. By 2009, the Australian company had raised share capital which was largely used to fund R&D operations. Borrowings by the group were minimal and were only able to be secured against the assets of the foreign subsidiary. | There have been two capital raisings in the foreign country which funded further research there. | To date the Australian company has advanced a substantial amount of funds to its foreign subsidiary. | The balance sheets for the income years 30 June 2010 to 2012 of the foreign subsidiary reflect the amounts provided as long term intercompany debts owing the Australian company. Other than the balance sheets of the foreign subsidiary, there is no written loan agreement or other documentation that provides evidence as to the character of the transactions, the terms on which the funds have been advanced or as to the rights and obligations of the parties in respect of the transfers otherwise than as recorded in the financial statements. | No interest or dividends have been paid by the foreign subsidiary to the Australian company for these advances. No interest or other form of accretions is payable or accrued on the advances on a current or deferred basis. It was stated that the foreign subsidiary had no intention or capacity to repay the funds advanced and future earnings will continue to be reinvested into the business. | No form of written or oral contract, undertaking, agreement or understanding exists that requires the funds to be repaid by the foreign subsidiary to the Australian company or makes them redeemable by Australian company or under which interest or other form of accretions are payable on the advances. | The funds were primarily sourced from equity capital raisings and equity contribution, and were provided to fund R&D, fixed assets/new equipment and working capital. Without this funding, the foreign subsidiary would have been in breach of its debt covenants. | The foreign subsidiary has some third party liabilities and was required to enter into subordination agreement in relation to a third party loan. | The foreign subsidiary has also received funds from other intercompany long term debt. If the funds advanced by the Australian company were regarded as debt, its debt-to-equity ratio would be significantly higher than the industry norm. | The foreign subsidiary has made operating losses in the 2010, 2011 and 2012 year. Its liabilities outstripped assets as at 30 June 2012 with a substantial amount of liabilities attributable to the intercompany loan amounts. | Reasons for decision: All legislative references are to the Income Tax Assessment Act 1936 (ITAA 1936).