Summary of issues raised and responses
is unworkable in practice, there are other effective ways of preventing excessive debt deductions, but without the attendant uncertainty and compliance costs. 2. for the purposes of the transfer pricing provisions, is inconsistent with the clearly stated policy objective to minimise compliance costs as stated in paragraph 11.11 of the EM. 3. for purposes of application of the transfer pricing provisions as proposed in the Ruling rather than applying the transfer pricing provisions on the basis of the actual debt that a taxpayer has diverges from accepted practice in the interpretation of the arm's length principle as set out in the OECD's 'Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ', in particular paragraph 1.36. 4. which is notional rather than the actual amount appears to be a key element of the ATO's position so should be clearly stated. 5. requires practical guidance from the ATO on how this should be done. 6. imposes an additional compliance burden so the ATO should implement administrative practice(s) to mitigate this burden.
Compendium
The ATO published responses to 12 submissions on this ruling in TR 2010/7EC. Outcome labels are heuristic — read the ATO response for the detail.
1The examples in the ruling should more clearly illustrate the principles in the ruling. Example 1 deals with the situation where Aus Co's debt level ($400m) is above the Div 820 safe harbour ($375m) and is also above the level that an independent lender would be prepared to lend ($334m). The example concludes that 'The transfer pricing provisions would not be applied to deny additional debt deductions by adopting a higher excess debt amount and because the actual interest rate does not exceed the arm's length rate.' The aspect that I'm unclear on is the reference in this sentence to the interest rate not exceeding the arm's length rate. It would seem that on the assumed facts 10% is an arm's length rate on $334m but not on $375m. Is the position then that one would work out the arm's length rate on the arm's length level of debt (that is, on the $334m) and apply that rate to the lower of the actual level of debt ($400m) and the Div 820 safe harbour amount ($375m)? Example 2 could lull taxpayers and advisers into a false sense of security by thinking that the ATO would generally accept 3:1 as being an arm's length debt amount. In point of fact, we understand that in a number of cases that ATO is likely to conclude that a 3:1 level of gearing is not what parties dealing at arm's length would do and absent CUPs or other methodologies the ATO would resort to the indirect methods referred to in paragraph 27. We request that the draft Ruling include an example illustrating the guidance provided in paragraphs 28-36 in the case where Aus Co is not able to borrow the whole amount of related party debt from unrelated parties and the ATO considers that the interest rate paid by Aus Co is more than the arm's length consideration. In our view, Example 2 simply illustrates the position addressed in Part E of TR 92/11 and the view expressed in paragraph 1.78 of the EM to Div 820 and is therefore of limited value.accepted
ATO response
Refer to paragraphs 13 to 31 of the final Ruling. Example 1 in the draft Ruling was intended to illustrate that the transfer pricing provisions cannot defeat the operation of the thin capitalisation provisions. Accordingly, in the example the arm's length rate of interest of 10% was applied to the total debt (that is, the 'adjusted average debt') of Aus Co of $400m, giving an otherwise allowable amount of debt deductions of $40m, before applying the thin capitalisation provisions in Division 820. Example 2 in the draft Ruling addressed a situation where a borrowing company did not have any 'excess debt' for the purposes of the thin capitalisation provisions. However, its debt was priced in excess of the arm's length price. Here the transfer pricing provisions would apply and the ATO could reduce the amount debt deductions claimed by Aus Co to the arm's length consideration. Division 820 would have no application because the level of cost bearing debt was within the statutory 'safe harbour debt amount'. In the light of the feedback received, the Examples in the final Ruling have been amended and additional examples have been inserted, to provide greater clarity - see paragraphs 13 to 31. In particular, new Example 4 in the final Ruling addresses a scenario where, after considering all arm's length pricing methods and taking account of all the necessary elements of comparability, it is not possible to ascertain the arm's length consideration in respect of the relevant acquisition, there being no evidence that similar arrangements would have been entered into between unrelated parties. In such a case one possible option, though not the only option, might be to price the amount of debt by having regard to the amount of debt that the taxpayer would reasonably be expected to have if it was dealing at arm's length with other parties. We consider this is one method that the Commissioner could use to work out the appropriate interest rate to be applied to the actual debt of the taxpayer, as a means of determining an arm's length consideration for the transactions actually entered into by the taxpayer. Other approaches may be equally valid, depending on the facts and circumstances of the case.