The Australian Taxation Office (ATO) has issued some observations about inbound financing in conjunction with property and construction structures. While the focus is on the construction industry, it is reasonable to anticipate that examiners will apply similar analysis to inbound financing in other areas.
The release reinforces the reliance on the arms length standard. The ATO is concerned about the amount of debt deductions. It ascribes this to the setting of unrealistic interest charges (e.g., too high an interest rate on a loan). The interest rate is a legitimate concern in any financing transaction, but other factors influence the amount of deductions, beginning with the amount of debt.
Companies generally try to calibrate reasonable working capital amounts based on the projected budget for any given project. Of course, construction and property projects are notorious for unanticipated issues that arise during the project. To a certain extent, a project may be “overfunded” in anticipation of such events. Failure to provide some cushion can lead to delays, which in turn extend the time of the project and the interest expense associated with it.
The ATO advises that to have reasonable audit experience, transfer pricing documentation should include:
- A discussion of all options realistically available to the company
- The rationale for selecting the specific debt structure
- How the debt was structured
- Mix of debt and equity
- Types of debt used
- Amount of debt
Equally important is how the debt is documented in terms of what steps were taken to create the instrument, the timing of the debt vis-à-vis reasonable length of the loan, the amount of the loan, repayment terms, ability to prepay, prepayment penalties, analysis of arm’s length nature of the rate, and most importantly, an actual loan document providing all of the details in a commercially acceptable format.
All of the above should be included in your transfer pricing documentation. Several countries also require a synthetic credit rating for the borrower and a debt capacity analysis. The world is becoming more document-oriented. It’s in your best interest to be prepared.
