ATO releases trifecta of guidance on the Diverted Profits Tax and cross-border related party financing
20 December 2017
On 18 December 2017 the ATO released a trifecta of important guidance on the application of the Diverted Profits Tax (DPT) and cross-border related party financing arrangements post Chevron. Comments are due on Draft Law Companion Guideline LCG 2017/D7, which covers DPT on 16 February 2018.
The Diverted Profits Tax (DPT) legislation received Royal Assent on 4 April 2017, with Schedule 1 to the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act 2017 implementing the DPT and Diverted Profits Tax Act 2017, applying a 40% tax on profits found to be diverted to low tax jurisdictions from years starting on 1 July 2017. The DPT provides the ATO with the additional tools to deal with significant global entities (i.e. entities part of a group with consolidated global turnover in excess of AUD 1 billion), which it believes are diverting profits offshore through related party arrangements to avoid Australian tax. On 18 December 2017 the ATO released important guidance on application of DPT.
Draft Law Companion Guideline LCG 2017/D7 - Diverted Profits Tax
LCG 2017/D7 explains how the ATO will apply the new DPT law and, in particular, clarifies new concepts introduced by the measure to provide taxpayers with greater certainty on the application of the new law. LCG 2017/D7 provides guidance on various aspects of the following tests:
- The principal purpose test and the 11 matters which the ATO Commissioner considers when applying this test. LCG 2017/D7 notes that the same test applies for the purposes of the MAAL rules (except that the list of relevant matters is necessarily different)
- The sufficient foreign tax test; and
- The sufficient economic substance test (an exception to the DPT).
Law Administration Practice Statement PS LA 2017/2 - Diverted Profits Tax assessments
PS LA 2017/2 provides specific direction to ATO staff on the internal administrative oversight framework for the DPT. It has an emphasis on the processes leading to the issuance of a DPT assessment, which will provide assurance to taxpayers that the new rules will be applied with the appropriate levels of internal review.
Practical Compliance Guideline PCG 2017/4 - Cross-border related party financing arrangements
PCG 2017/4, which takes effect from 1 July 2017, is a final version of the ATO’s guidance on cross-border related party financing arrangements and related transactions post Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation  FCAFC 62 (Chevron). It applies to any financing arrangement entered into with a foreign related party, whether inbound or outbound, and contains a related party financing arrangement risk framework with 6 risk zones.
- White (arrangements already reviewed and concluded by the ATO). The ATO says taxpayers in this zone should not expect a review, other than to confirm "on-going consistency with the agreed/determined approach"
- Green (low risk). Provided there have been no material changes (as outlined in para 33(b) of PCG 2017/4), the ATO will generally only apply compliance resources to the arrangement to: confirm that the taxpayer's calculations were done according to ATO guidance; verify the taxpayer's eligibility; extend the benefits of PCG 2017/2 (Simplified transfer pricing record keeping options); where requested, agree on an APA; and not seek to apply DPT
- Blue (low to medium risk). The ATO will actively monitor the taxpayer's arrangements using available data and will review arrangements by exception
- Yellow (moderate risk). The ATO says it will work with taxpayers to understand and resolve areas of difference
- Amber (high risk). Reviews are likely to be commenced as a matter of priority, but the ATO says it will still work with taxpayers to understand and resolve areas of difference
- Red (very high risk). Reviews are likely to be commenced as a matter of priority. Further, cases might proceed directly to audit (and possible litigation) and the taxpayer will not be able to access the APA program. It is also likely that the ATO will use its formal information gathering powers.
PCG 2017/4 also includes a schedule covering related party debt funding. To encourage "willing and co-operative future compliance", for a limited period, the ATO says it is willing to remit penalties and interest if certain pre-conditions are met.
BDO will analyse the ATO guidance and prepare detailed BDO Transfer Pricing Alerts on LCG 2017/D7 and PCG 2017/4 in the near future so that companies can assess how this latest guidance may impact their own circumstances.
In the meantime, BDO can assist clients to:
- Prepare submissions on draft LCG 2017/D7 due by 16 February 2018
- Review and risk assess the arrangements that are likely to fall within the scope of DPT
- In light of PCG 2017/4, analyse, document and evidence intragroup financing arrangements having regard to commerciality, ensuring that arrangements do not deviate from Group policies; and
- Risk assess existing and future arrangements in light of the Chevron decision and explore options realistically available to a borrower in the hypothetically arm’s length scenario to ensure that the arrangement entered into is commercially viable.