ATO guidance released on compliance obligations for cross border related party transactions

On 21 April 2021, the Australian Commissioner of Taxation released Draft Practical Compliance Guideline PCG 2021/D3: Imported hybrid mismatch rule – ATO’s compliance approach which sets out the Commissioner’s view on the compliance risk associated with the imported hybrid mismatch rule and the extent to which taxpayers must make ‘reasonable enquires’ to ensure compliance with these rules.

Hybrid tax outcomes are common in multinational groups, and arise where a payment or an entity is treated differently for tax purposes in multiple jurisdictions.

The imported hybrid mismatch rule has a very wide reach and can deny an Australian taxpayer a deduction for a cross border related party payment, unless it can show that the payment does not fund a hybrid tax outcome in non-Australian jurisdictions.

Australian subsidiaries of a multinational group with cross border related party payments, you need to consider your obligations under this draft PCG, and its impact on the Australian deductibility of those payments.

In detail

Australia’s imported hybrid mismatch rules deny Australian taxpayers a deduction for payments that directly or indirectly fund a deduction that arises under an ‘offshore hybrid mismatch’. An ‘offshore hybrid mismatch’ is a payment that arises in a foreign jurisdiction which gives rise to either a:

• deduction/non-inclusion mismatch (D/NI mismatch) –where a payment gives rise to a deduction in one jurisdiction, but is not assessable in another; or
• deduction/deduction mismatch (D/D mismatch) – where a payment gives rise to a deduction in multiple jurisdictions.

Whilst the rules apply to Australian taxpayers who make payments to non-residents, the underlying offshore hybrid mismatch relates to the tax treatment between non-Australian entities.

The rules require the Australian taxpayer to make reasonable enquiries to ensure that the payment from Australia does not fund a mismatch somewhere further up the chain.  This can be an issue for multinationals with a relatively small presence in Australia as the Australian tax team may not be able to obtain sufficient information to get complete comfort on this position.

The level of enquiries needed to satisfy the Commissioner that ‘reasonable enquiries’ have been made is high.  The Commissioner’s ‘recommended approach’ for non-structured arrangements involves either:

• a ‘top-down’ review approach where the taxpayer identifies any mismatches within the global group, and filters this information down through any interposed jurisdictions until the taxpayer can demonstrate that those mismatches are not within the scope of Australia’s hybrid mismatch rules; or
• a ‘bottom-up’ approach where the taxpayer identifies all related party deductible payments in Australia, and traces those payments through interposed jurisdictions until the taxpayer can demonstrate that none of these payments gave rise to an offshore hybrid mismatch.

The Commissioner expects that enquiries will be made (in writing) of qualified and responsible individuals, such as the group tax controller, and those responsible for the tax compliance in the jurisdictions where the mismatch arises. The Appendix to the draft PCG, sets out a non-exhaustive list of the types of enquiries that the Commissioner expects a taxpayer to make. This list is extensive.

Importantly, a taxpayer will not be able to claim a deduction for a payment unless they are able to obtain sufficient information to conclude that the deduction should not be disallowed under these rules.

The draft PCG includes a risk assessment framework with respect to a taxpayer’s compliance with these rules and the taxpayer’s risk rating must be disclosed in its Reportable Tax Schedule.

Moving forward

The change in the imported hybrid mismatch rules will apply to tax returns due on or after 1 July 2021 and therefore action needs to be taken immediately. If you are an Australian subsidiary of a multinational group which makes cross border related party payments, it is critical that you ensure you have appropriate systems in place to support a deduction for these payments.

If you require any assistance with the application of these rules, please contact Norton Rose Fulbright team who can guide you through the rules and advise what action needs to be taken.