ATO releases guidance on cross-border related party financing arrangements

The ATO’s Draft Practical Compliance Guideline (PCG) 2025/D2 outlines the tax authorities’ approach to evaluating inbound, cross-border related party financing arrangements.

Under the new draft guidance, the ATO has outlined a colour-coded approach to transfer pricing risk assessment, ranging from ‘white zone’ entities to ‘red zone’ entities.

“White Zone arrangements need not be self-assessed. Green Zone arrangements are either consistent with a ‘low risk’ example in The PCG or have been reviewed by the ATO and classified low risk,” Bill Yohana, BDO transfer pricing partner, said.

“Blue Zone arrangements are neither low risk nor high risk, while Red Zone arrangements are either covered by a high-risk example in The PCG or have received a ‘low assurance’ rating from the ATO.”

The new guidance has been provided in the wake of new laws which have modified how Australia’s thin capitalisation and transfer pricing provisions interact.

The legislation has been designed to ensure that multinational companies operating in Australia pay their fair share of tax, after the ATO’s 2022–23 corporate tax transparency report revealed that a third of large multinationals operating in Australia did not pay any domestic tax.

The incoming laws have been designed to close loopholes which enable multinational companies to shift their profits internationally and artificially reduce their Australian tax bill.

The draft PCG outlined a series of examples denoting how the ATO plans to assess high and low-risk cross-border arrangements.

One ‘green zone’ example arrangement described a company which had an inbound, cross-border related party financing agreement, but its leverage and interest coverage ratios were equal to (or better than) its global group and a set of comparable entities.

Because the company’s financial ratios were comparable to agreements between independent entities and its broader global group, the ATO would deem this transaction to have low transfer pricing risks.

For ‘green zone’ entities, the ATO would generally only apply compliance resources to verify a company’s self-assessment.

In contrast, a ‘red zone’ example outlined an Australian-based entity which had an inbound, cross-border related party financing arrangement that absorbed available capacity under the entity’s ‘fixed ratio earnings limit’ to generate a below-expected return.

Under such a scheme, the Australian-based entity could incur a loss through its cross-border related party finance agreements, reducing its Australian tax bill.

These arrangements are viewed as ‘high risk’ by the ATO because such entities appear to be using their cross-border transactions to generate additional tax deductions, rather than for genuine business reasons.

The PCG urged businesses with inbound, cross-border related party financing arrangements to maintain documentation to support the business case for their financial arrangements.

The ATO said it would use these documents to verify that the firm’s financing arrangements fulfilled certain assessment criteria, such as ‘arm’s length’ principles.

The PCG clarified that being flagged as a ‘red zone’ entity would entail closer scrutiny from the ATO, but did not bring on any immediate presumption that the company had obtained a transfer pricing benefit as a result of their financial arrangements.

The draft will be open for public comment until 30 June 2025, the ATO has said.