The Australian Taxation Office (ATO) has released Draft Practical Compliance Guideline PCG 2025/D2, providing clarity on how it will assess inbound cross-border related party financing arrangements under the updated transfer pricing rules.
The ATO’s focus on inbound cross-border related party financing arises from awareness that there may be an attraction for foreign related parties to provide capital in the form of loans rather than equity capital, as returns on loans may be subject to concessional 10% interest withholding tax (within relevant thin capitalisation and transfer pricing frameworks).
For an Australian business with international operations, specifically where they receive related party financing to fund their local operations, understanding this guideline is essential to managing tax risk and ensuring compliance.
Why This Guideline Matters
PCG 2025/D2 follows legislative changes introduced as part of the change to Australia’s thin capitalisation rules. The change in the legislation means the ATO now expects entities to determine both the amount and interest rate of their financing arrangements under the Australian transfer pricing regime as if they were dealing with independent third parties / arm’s length conditions operated.
While PCGs are not legally binding, they provide the ATO’s compliance approach and introduce a risk framework to help taxpayers self-assess their arrangements and ultimately mitigate the transfer pricing risk in relation to their inbound, cross-border related party financing arrangements.
The ATO’s Risk Framework
The ATO categorises financing arrangements into four risk zones:
- White Zone: Transitional or under-review arrangements.
- Green Zone: Low-risk arrangements unlikely to attract ATO scrutiny.
- Blue Zone: Moderate-risk arrangements that may warrant further review.
- Red Zone: High-risk arrangements likely to be subject to compliance activity.
The risk rating is determined by several factors, which include:
- Genuine funding needs.
- Alignment with global group financing policies.
- Impact on shareholder returns.
- Market comparability of interest rates.
- Presence of guarantees or security.
- Debt serviceability and gearing levels.
For example, an entity that borrows from a related party while holding excess cash may fall into the red zone, whereas arrangements that reflect third-party debt terms and are well-documented may be considered low risk.
Documentation Is Key
The ATO places strong emphasis on adequate transfer pricing documentation. Taxpayers should maintain clear records demonstrating the commercial rationale for the financing, evidence of market-based pricing, and internal decision-making processes. This will be critical in substantiating the arm’s-length nature of the arrangement.
What Should Businesses Do?
Businesses with inbound, cross-border financing arrangements should:
- Review existing arrangements against the ATO’s risk factors.
- Assess documentation to ensure it supports the arm’s length principle.
- Consider restructuring high-risk arrangements to align with market norms.
- Engage with advisors to prepare for potential ATO scrutiny.
Importantly, PCG 2025/D2 is still in draft form, with the ATO still in the process of reviewing the feedback.
Final Thoughts
PCG 2025/D2 is a clear signal that the ATO is tightening its focus on multinational financing practices. FFor an Australian entity, proactively engaging with the guidelines can help mitigate risk and ensure compliance. Now is the time to review, document, and prepare.
This article was co-authored by Tom Peskett, Senior Manager Tax Consulting at HLB Mann Judd Melbourne