Safe harbours for Trans-Tasman related party loans
Tax Alert - August 2016
By Bart de Gouw and Kirstie Vervoort
New Zealand multinationals commonly engage in financing transactions with related parties in Australia. In an effort to reduce compliance costs both Inland Revenue and the Australian Tax Office (“ATO”) maintain ‘safe-harbour’ guidance for small value loans. Where transactions fall within the scope of the guidance, the specified safe-harbour rates may be applied and will be accepted by Inland Revenue and/or the ATO as complying with the arm’s length principle.
The inherent bi-lateral nature of loan agreements has left a degree of uncertainty regarding which guidance to apply and when. This article aims to outline the material differences between the two sets of guidance and when each may be applied.
Inland Revenue Guidance
In order to rely on Inland Revenue’s small value loan guidance, the value of the cross border associated party loans must not exceed in aggregate NZD 10m principal. Provided this threshold is not exceeded, taxpayers may apply the safe-harbour rate specified by Inland Revenue; currently equal to an “appropriate base rate” plus 250 basis points. This rate was recently reconfirmed and is due to be reviewed by Inland Revenue on 30 June 2017. Aimed at reducing compliance costs, the guidance may generally be relied upon for qualifying transactions and no additional more robust analysis is required. A circumstance in which a taxpayer may not be able to rely on the guidance is where a debt instrument with similar terms and risk characteristics is readily available.
The eligibility criteria for the ATO guidance is more detailed than Inland Revenue’s, but broadly applies to documented AUD loans into Australia for a group of entities that have a combined “cross-border loan balance” (including all interest-bearing and interest-free loan balances for amounts borrowed and loaned) of AUD50m or less.
Taxpayers that meet the eligibility criteria may apply a maximum interest rate equal to the Reserve Bank of Australia indicator lending rate for ‘small business; variable; residential-secured; term’ (published monthly). Currently this indicator rate is 6.50% per annum. Qualifying transactions priced in accordance with this guidance should not be subject to further scrutiny from an Australian transfer pricing perspective.
It is important to note when relying on such guidance, that the tax authorities continue to focus on the appropriateness of the overall arrangement to ensure all material aspects of the loan are both commercially appropriate and reflected in the interest rate applied. This includes determining and being able to support the term of the loan, interest rate reset periods and base interest rate applied.
Applying the guidance
The eligibility criteria for application of the Inland Revenue and the ATO guidance varies substantially, with Inland Revenue placing greater emphasis on the principal value of the transaction and the ATO taking a holistic view of a group’s international financing arrangements. Of particular note, Inland Revenue’s guidance applies to both outbound and inbound loans whereas the ATO guidance is limited to inbound AUD denominated loans.
For New Zealand taxpayers lending to Australian related parties, there will be scenarios where it may be possible to apply either set of safe harbour guidance.
1) Outbound loans (NZ taxpayer lending to Australian related party)
- AUD loans which fall under both the NZD$10m and the AUD$50m thresholds may be eligible for both sets of guidance. Where the ATO safe harbour rate exceeds the Inland Revenue safe harbour, it may be favourable for New Zealand taxpayers to apply the ATO safe harbour rate to maximise interest received.
For example, consider an AUD$5m ‘on-demand’ loan from a NZ entity to an associated Australian entity. Applying Inland Revenue guidance, the interest rate receivable is approximately 4.25% (being the current AUD cash rate plus 250 basis points). Applying ATO guidance, the interest rate receivable is approximately 6.50% (being the current indicator lending rate), offering a further 2.25% above that prescribed by the Inland Revenue guidance. As this rate exceeds the Inland Revenue safe harbour, no NZ transfer pricing risk arises.
- Loans which exceed the NZD$10m threshold but fall within the AUD$50m combined cross border loan balance criteria will fall outside the scope of Inland Revenue small value loan guidance, but may be eligible for the ATO simplified record keeping option for low value loans, provided they are denominated in AUD. In such cases additional analysis may be needed to satisfy the Inland Revenue that the rate applied is not less than arm’s length.
2) Inbound loans (borrowing from an Australian related party)
For qualifying inbound loans, taxpayers may apply the Inland Revenue’s safe harbour guidance in the absence of more robust analysis. As the ATO safe harbour guidance excludes loans outbound from Australia, ATO simplified record keeping guidance may not be relied upon, so in this case only the Inland Revenue guidance is available.
It should be noted that reliance on the safe harbour guidance prescribed by one tax authority may result in some exposure to transfer pricing risk in the other jurisdiction, depending on the size of the loan and the interest rates applied.
We therefore recommend consideration of safe harbours prescribed by both tax authorities when entering into trans-Tasman financing arrangements, as this may save compliance costs and optimise the outcome in New Zealand. Such guidance should be applied prudently and consideration should be given as to the level of documentation in place (particularly the existence of formal loan agreements), and related issues such as the impact on foreign exchange gains / losses, the borrowing entity’s thin capitalisation position, and non-resident withholding tax arising on interest payments.
More information relating to Inland Revenue and ATO safe harbour guidance can be found at the respective tax authorities’ websites. If you require any further information or wish to discuss a particular transaction and how this guidance may be applied please contact one of our transfer pricing specialists.
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