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Australia Updates Guideline on Risk Assessment of Related Party Financing Arrangements for Derivative Arrangements — Orbitax Tax News & Alerts

The Australian Taxation Office (ATO) has published an updated version of Practical Compliance Guideline (PCG 2017/D4), which explains the ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions. The update includes the addition of a finalized Schedule 2: Related party derivative arrangements.

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Scope of this Schedule

115. This Schedule sets out specific risk indicators for related party derivative arrangements that are used to hedge or manage the economic exposure of a company or group of companies. In the normal course of events any derivative transaction being scored needs to be with a related party and hedging a related party financing arrangement. Notwithstanding this defined scope there is one exception where the scope of the Schedule is broadened. Where the transaction or contract involves a derivative being a total return swap (TRS) then the TRS should be scored even where the parties are not related. There is no need for the TRS to be related to a financing arrangement or be with a related party to be scored under this Schedule.

116. Where a derivative is used for commercially rational hedging purposes, that is, to manage an economic exposure for a company or group of companies, the derivative will normally be entered into with an unrelated third party (either directly or indirectly via one or more interposed related parties). Where the derivative is entered into with a related party, the ATO is likely to consider the arrangement as higher risk unless the terms and conditions of the related party derivative are then backed out to a non-related party dealing at arm's length in the external market on mirror terms. Where a derivative has been either directly or indirectly, via one or more interposed related parties, backed out to the external market to a non-related party dealing at arm's length on mirror terms then the arrangement being scored will only be in either the green or blue zone (this excludes TRS arrangements).

117. The risk indicators set out in this Schedule have been developed with these matters in mind. You can use the indicators to consider the risk of compliance activity in relation to the following issues which arise in relation to related party derivative arrangements:

  • deductibility of payments
  • liability to withholding tax
  • the application of the transfer pricing rules in Division 815 of the ITAA 1997
  • the application of Part IVA of the ITAA 1936 to schemes which are confined to such arrangements.

118. This Schedule does not provide interpretative or related guidance on Division 815, Part IVA or any other taxation provisions.

119. In addition, this Schedule does not set out our compliance approach to reviewing other taxation issues which can arise in relation to related party derivative arrangements, including but not limited to:

  • the application of the debt/equity rules in Division 974 of the ITAA 1997
  • the application of the thin capitalisation rules in Division 820 of the ITAA 1997
  • the application of the hybrid mismatch rules in Division 832 of the ITAA 1997.

Interaction with future schedules

120. The risk indicators set out in this Schedule may be modified by future schedules to this Guideline. Where relevant, the nature and extent of any interaction between this Schedule and a future schedule will be contained in that future schedule.

Date of effect

121. This Schedule has effect from 1 January 2019 and applies to existing and newly created related party derivative arrangements.