16 December 2020

The Australian Taxation Office (ATO) has recently finalised its guidance on interest-free loans given by Australian entities to their related party. This forms part of Schedule 3 to PCG 2017/4 which relates to cross-border financing arrangements[1] and applies from 1 January 2020 to all existing and new arrangements.

The finalised guideline is largely based on the draft issued earlier this year and is likely to affect taxpayers who have issued interest-free loans to their associates. Particularly, those that have been issued during the year as a measure to support them during COVID-19.

Financing arrangements

PCG 2017/4 is a risk assessment tool to determine the risk rating of financing arrangements with overseas related parties. The risk associated with each financing arrangement is assessed based on a combination of various qualitative and quantitative indicators. The risk framework includes six risk zones ranging from red (very high risk) and amber (high risk) to green (low risk) and white (reviewed arrangements). The higher the risk rating, the more likely it is for the ATO to review the arrangement.

Schedules 1 and 2 of PCG 2017/4 relate to interest bearing loans and derivatives respectively. Schedule 3 released in draft on 12 August 2020 and finalised on 10 December 2020, relates to interest-free loans.

Changes made in the finalised guidance

The ATO has largely finalised the draft guidance issued earlier this year and has made very minor edits to the compliance guideline. Key changes include:

• Amendments to reflect changes to be in line with the Reportable Tax Position Schedule for the 2021 year. This includes disclosure of the risk zones of three largest related party financing arrangements instead of a single disclosure of the highest risk rating.

• Expectation that agreements are put in place for all related party financing arrangements. The intercompany agreements should include the key terms and conditions of such arrangements.

• Inclusion of recently introduced Taxpayer Alert TA 2019/1 Multiple entry consolidated (MEC) groups avoiding CGT through intra-group debt and Taxpayer Alert TA 2020/2 _Mischaracterised arrangements and schemes connected with foreign investment into Australian entities_to the list of applicable taxpayer alerts for determining the score under the motivational risk scoring table of Schedule 1 of PCG 2017/4 relating to interest-bearing financing arrangements.

• Exclusion of sovereign risk of borrower entity from the pricing risk scoring table in Schedule 3 of the PCG 2017/4 relating to interest-free outbound financing arrangements.

The finalised guideline applies to all arrangements in place or entered into after 1 January 2020. If you think you may be impacted by the new guideline, please speak with your adviser or get in touch with the Findex Tax Advisory team.

[1] Practical Compliance Guideline PCG 2017/4 ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions