Draft PCG 2025/D2 – Inbound Related Party Debt
Key Aspects of Draft PCG 2025/D2 The Australian Taxation Office (ATO) released Draft Practical Compliance Guideline PCG 2025/D2 on 29 May 2025. This draft provides guidance on how taxpayers should determine the arm’s length amount of inbound cross-border related party debt under Australia’s transfer pricing framework. It requires entities to justify not just the pricing (interest rate, terms), but also the quantum (amount) of related-party debt.
Risk Assessment Framework The draft PCG 2025/D2 introduces a risk assessment framework categorizing arrangements into four zones, indicating varying levels of risk, from low to high, and helps taxpayers self-assess their arrangements and correspondingly, the level of ATO scrutiny. Risk Zone White zone Green zone Blue zone Red zone
Factors Funding requirements Group policies and practices Return to shareholders Cost of funds Covenants Explicit guarantees
Risk Level Arrangements already reviewed and concluded with the ATO Low risk Compliance risk not assessed High risk
ATO implications The purpose of the debt informs the amount. The actual requirement may differ from the amount borrowed. Entities must consider the original purpose and historical context, not just current year metrics. Treasury and dividend policies may influence financing decisions. For example, target leverage or credit rating floors may limit debt amounts; dividend expectations may restrict debt levels to preserve distributable profits. The expected return from using the funds can affect the amount of debt. Higher financing costs reduce returns, impacting how much debt an entity would reasonably take on. Entities aim to minimise funding costs. The amount of debt can affect credit metrics and thus influence future borrowing capacity and interest rates. Existing loan covenants may restrict further borrowing. Borrowers must evaluate how new debt interacts with covenant thresholds, which can act as de facto limits on debt levels. Guarantees can affect lender willingness, but do not fully determine debt sizing. The borrower’s own creditworthiness and capacity remain key.
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