Focus on terms of related-party debt transactions
For related-party debt arrangements, the manner in which key terms are documented could have a substantial impact on arm’s length pricing.
For example, when a borrower under a fixed-rate loan has the right to prepay at any time without penalty, transfer pricing issues emerge. A third-party borrower would use such a right to seek to refinance if interest rates were to fall materially (or renegotiate a lower rate with the original lender).
Practically, from a transfer pricing perspective, this means that the interest rate needs to be re-benchmarked over the life of the loan, with the arm’s length rate potentially reducing if market rates have fallen (but with no corresponding potential for increase).
An attempt to remedy this situation on an existing loan by simply amending the agreement could be problematic. An amendment to the agreement could be viewed as giving rise to the disposal of a valuable right without consideration.
These issues would not arise if the loan had been floating rate or, if fixed rate, the borrower had been required to indemnify the lender’s reasonable break costs in relation to early prepayment (as is typical in third-party fixed rate debt arrangements).
Taxpayers need to consider undertaking a review of all current and proposed related-party financing documentation, and determining whether the terms and conditions reflect those that might be expected to exist in arrangements with an independent lender. To the extent that the conditions differ, then the arm’s length pricing implications would need to be further considered.
For more information, contact a KPMG tax professional in Australia:
+61 2 9455 9170