From an Australian transfer pricing perspective, related party financing has featured strongly in Australian Taxation Office (ATO) audit and litigation activity over the last few years and our newly enacted transfer pricing legislation, with its concept of 'arm’s length conditions', provides fertile ground for potential dispute in this area.
The new rules require taxpayers to consider, support and price related party financing (and other) arrangements on the basis of terms and conditions that might be expected to operate between independent parties. There are some key aspects or conditions in financing arrangements that can have a profound effect on arm’s length pricing and are consistently the subject of debate with the ATO upon review:
- credit rating of the borrower and whether parental affiliation (implied support) should be factored in
- the debt/gearing level
The above comments are equally applicable to situations where the parent or an affiliate has provided a guarantee to support the local subsidiary’s third party borrowings.
Given the spotlight currently on related party financing arrangements and the possibility of contention, taxpayers proposing to refinance existing related party borrowings, or implement new arrangements, may want to consider an Advance Pricing Agreement (APA).
A bilateral APA would mitigate the risk of two revenue authorities (with opposing perspectives on the arm’s length interest rate) coming to different views on any of the key aspects of a related party financing arrangement and, in particular (given the ATO’s position for inbound financings), the applicability of parental affiliation for credit rating purposes.