PCG 2017/4EC: Compendium
Document type: Compendium
Status: Draft

Schedule 3 operates to reduce the risk rating for an outbound interest-free loan in certain circumstances. It does not increase the risk rating otherwise provided by the Guideline. Accordingly, Schedule 3 can only operate favourably to taxpayers and it is not considered necessary to apply it prospectively only. We have made further amendments to Schedule 3 to clarify this position (see paragraph 222 of the final Guideline). Note: Additional examples were requested for controlled but not fully owned entities which hasn't been specifically covered in the point above. It is not possible to provide examples covering all situations. Taxpayers with unique circumstances should engage with us if they require certainty regarding their arrangements. If so, the ATO should provide advance notice and from which income year reporting period. There have been no specific changes made to Schedule 3 as the content of the final Guideline has been amended to address the potential changes. We recognise that this may result in high risk ratings, however given the associated risk profile of these transactions, this is considered to be an appropriate outcome. We have updated Schedule 3 to provide clearer guidance on the relevance of motivational risk indicators (see paragraph 205 of the final Guideline). It is observed that the application of this indicator could result in inappropriate risk scores being allocated to arrangements that fund activities/projects in high-rated countries but have a low prospect of raising interest-bearing third-party debt due to the nature and stage of the project or the circumstances of the borrower. Hence, the sovereign risk of the country is not a reliable indicator. The sovereign risk indicator will continue to apply for interest-bearing loans. Concern has been expressed the ATO may seek to review and challenge tax deductions for foreign exchange losses that arise from interest-free outbound funding to related parties that would not have previously been considered. For example, we expect the tax treatment of foreign exchange gain/losses on an interest-free loan that is characterised as equity to be the same as any other equity instrument. We do not consider it necessary to make any further changes to Schedule 3. We believe that the risk assessment required under Schedule 3 does not impose additional burden on taxpayers over and above the self-assessment requirements of Subdivision 815-B. It is possible that in some circumstances the minimum required factors are not met although arm's length conditions may support a zero-interest rate or an equity contribution. For example, it is possible in certain circumstances that the rights under an instrument are different from the rights of a shareholder and there is an intention of creating a debtor-creditor relationship. If this was to occur, even though the 'additional factor' would be evidenced, Schedule 3 would not apply to reduce the score, because the minimum required factor would not be evidenced. In short, ten points would apply, even though the arm's length conditions could otherwise be considered to exist between the parties that support a zero-interest rate/equity contribution. Taxpayers with unique circumstances should engage with us if they require certainty regarding their arrangements. However, it is important to note that any evidence supporting a Step 2 assessment is not determinative in isolation and has to be considered along with the factors and evidence for Step 1. Taxpayers with unique circumstances should engage with us if they require certainty regarding their arrangements. Taxation Ruling TR 2014/6 Income tax: transfer pricing - the application of section 815-130 of the Income Tax Assessment Act 1997 provides guidance on the application of section 815-130. This Schedule should be read in conjunction with TR 2014/6. Accordingly, any technical law interpretation is not considered necessary for the purpose of this Schedule. It is recommended the ATO include an introductory paragraph to Schedule 3 to state more explicitly that this guidance is not merely a risk assessment and provides a documentation framework that the ATO expects taxpayers to follow. As the scope and purpose of this Schedule is clearly defined, no additional explanation is considered necessary. Taxpayers with unique circumstances should engage with us if they require certainty regarding their arrangements. It is recommended that the ATO provide a clearer distinction between the two steps, and a clearer explanation of what Step 2 involves (as these factors appears less well defined than the Step 1 factors), as well as refine language for paragraph 214(b)(ii) in Schedule 3 which requires taxpayers to demonstrate 'the borrower is in a position where it has questionable prospects for repayment and is unable to borrow externally'.






Relying on this Compendium: This Compendium of comments provides responses to comments received on draft Schedule 3 (Interest-free loans between related parties) to Practical Compliance Guideline PCG 2017/4DC2 ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions. It is not a publication that has been approved to allow you to rely on it for any purpose and is not intended to provide you with advice or guidance, nor does it set out the ATO's general administrative practice. Therefore, this Compendium does not provide protection from primary tax, penalties or interest for any taxpayer that purports to rely on any views expressed in it.

The ATO has not provided a proposed date of effect for the final Schedule 3. | Schedule 3 will have effect from 1 January 2020 and will apply to existing and newly-created related party interest-free outbound loans (see paragraph 201 of the final Guideline). | When finalised, Schedule 3 should apply prospectively. Retrospective application will create substantial work for taxpayers. Having retrospective application will also mean taxpayers will need to re-examine positions from previous years in which contemporaneous analysis and documentation has been prepared and finalised. | The final Guideline should state that ATO will not issue penalties or interest on the basis that a taxpayer has not applied the concepts in Schedule 3. | As noted in the response to Issue 2 of this Compendium, our position regarding these arrangements has not changed. Hence, it is not considered necessary to provide any general concessions regarding penalties or interest. | The final Guideline should clarify whether the risk assessment should be updated in future when facts and circumstances change, or if the initial characterisation will apply for life of the arrangement. | In relation to factors that require evidencing of intention of the parties, additional guidance and/or examples are sought to clarify how such intention can be evidenced and what would constitute sufficient evidence. | The intention of the parties can be evidenced by way of written documentation which could include agreements, emails or memorandums. As this is dependent on the facts and circumstances of each arrangement, we do not believe further guidance is necessary. | Guidance is sought on inbound interest-free loans in the context of withholding tax transfer pricing benefit. | It is recommended to make it clear that while the motivational risk indicators have not been modified for Schedule 3, these indicators still need to be considered to determine the overall risk rating. | The level of analysis and requirement to demonstrate evidence under Schedule 3 is subjective will place extensive burden on taxpayers (particularly for smaller taxpayers with less resources/experience) and is disproportionate to the actual level of risk posed. | A specific pricing risk scoring table should be included in the final Schedule 3 to clarify its operation. A new table could be included which sets out the broader spectrum of points. Alternatively, a different approach could be adopted which relies on negative scores or score reductions (for example, '-3') where certain factors are present. | The operation of the pricing risk scoring table in Schedule 3 of the Guideline has been clearly defined. Further changes are not considered necessary. | With respect to the additional factors in Step 2 of draft Schedule 3, it is not clear whether only one of the factors in this section is sufficient to satisfy the reduction in the score, or whether several, or all. It would appear that only one factor may be sufficient. However, whether and when this will be the case should be clarified. Consideration should be given as to whether a more definitive view could be expressed, to provide greater certainty and clarity. For example, more definitive guidance could be offered in relation to particular factors. | Convertible debt should be expressly dealt with in the final Schedule 3. | Clarification should be provided of how Schedule 3, and the Guideline more generally, may apply to private groups. | Schedule 3 would apply equally to all taxpayers that have outbound interest-free loan arrangements that meet the requirements of the cross-border test in Subdivision 815-B. | Clarification should be provided regarding the average cost of debt and non-interest related costs of debt. | We acknowledge the use of cost of debt can cause confusion as it is not a factor directly used in the risk framework. We have removed references to cost of debt in all examples. | Draft Schedule 3 goes further than a risk assessment and suggests elements of how the reconstruction provision in section 815-130 should be interpreted on the matter. However, it does not fully explain the technical analysis of the reconstruction provisions. | The draft Schedule 3 does have not provide any de minimis thresholds. It is recommended that the ATO implement a de minimis threshold (for example, balances of $2 million or less). | No de minimis thresholds are considered necessary for Schedule 3 as self-assessment is voluntary. However, we may consider a de minimis standard for reporting purposes. | We do not believe further changes are required to the two-step framework. Taxpayers can exercise their judgment in determining if, in their circumstances, evidence provided in Step 1 will also be relevant for Step 2.

Related rulings and determinations: TR 2014/6