Australia Consults On Debt Equity Rules And Transfer Pricing Rules Interaction

; posted on
November 1st, 2018

The Australian Taxation Office (ATO) has launched a public consultation on a draft taxation determination (TD 2018/D6) concerning whether the debt and equity rules in Division 974 of the Income Tax Assessment Act 1997 can limit the operation of the transfer pricing rules in Subdivision 815-B of the Income Tax Assessment Act 1997.


Referring to the draft Tax Determination, Australia’s transfer pricing rules take precedence over Division 974 debt-equity characterization rules. As a result, the debt equity rules do not limit the operation of the transfer pricing rules which, in a related-party setting, substitute arm’s length conditions for actual conditions to figure an entity’s taxable income, loss, offsets, and withholding.

The ATO catered the following examples in its draft guidance to illustrate the effect of the transfer pricing rules on the debt equity rules.

  1. Outbound loan to a distressed subsidiary situation – the ATO will apply the transfer pricing rules to the extent the interest loan fails to satisfy the debt test under the debt equity characterization rules. As such, the loan is not recharacterized as equity due to the non-contingent obligation to provide financial benefits with present value.
  2. Inbound related-party discretionary interest loan – the transfer pricing rules will apply to the interest loan treated as equity rather than a loan under the debt equity rules. As the outcome of transfer pricing rules, the loan hypothetically would give rise to debt interest. However, in the actual condition, there would be no interest withholding tax payable. Therefore, in this example, an Australian company, thus, gets a transfer pricing benefit equal to the full amount of the interest withholding tax that would be payable had the arm's length conditions been operated. Commissioner may adjust the interest deduction.
  3. Outbound interest-free loan – In this example, the foreign subsidiary company could not obtain debt financing from an unrelated party. Having regard of the transfer pricing rule the interest-free will satisfy equity test as the arm's length conditions are identified on the basis of commercial or financial relations that involve a contribution of equity rather than a loan. There is no transfer pricing benefit in this example, though, so the classification of the arrangement is unaffected by the transfer pricing rules.

Date of Effect

ATO is seeking feedback on its draft by November 30. When the final determination is issued, it is proposed to apply to income years commencing on or after 29 June 2013, which corresponds with the commencement of Subdivision 815-B.

Source: Australian Tax Authority

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