How businesses operate
The following information explains how businesses might approach commercial funding of a project, the types of arrangements we see in our engagements and the practices that concern us.
This content is not intended to provide advice or guidance on the technical interpretation or application of Australia’s tax and transfer pricing rules. If you need to know the tax implications of any specific arrangement, we recommend that you seek advice. This could include consulting with tax and legal professionals or one of our ATO advice products.
Funding for property and construction generally
We have been observing third-party funding arrangements for property investments and developments across privately owned, wealthy groups. These arrangements are:
- project specific
- tailored to the requirements of the investment or development.
Projects are usually funded through a mix of:
- investor or developer equity (capital contributed such as unencumbered funds or cash)
- debt financing (such as loans).
The amount and term of a loan is typically matched to the funding needs of the specific investment or the relevant stage of the development project.
Commercial lenders:
- require equity to be available for a project before lending
- generally try to maximise the value of the security available against their debt.
Developers:
- provide security over property to obtain finance
- generally seek to refinance when circumstances change or a better funding opportunity becomes available
- repay loans as soon as practicable.
Development lifecycle
These are the stages of the development lifecycle and typical funding arrangements we observe in each stage.
Pre-acquisition
Pre-acquisition costs are generally borne by the investor or developer for activities such as analysis and development feasibility.
Land acquisition
Land acquisition is usually funded with an equity contribution by the investor or developer using unencumbered funds (for example, cash).
Planning, pre-sales and preparation
This stage involves design and approvals, pre-sales, arranging finance, and tendering and contracting. The developer obtains senior debt secured against the land to fund construction. The loan term matches the project duration.
Construction
From the commencement of construction through to practical completion, interest is payable regularly or capitalised when there is insufficient project cash flow.
Withholding tax is remitted regularly if applicable.
Additional equity may be required to fund construction.
In limited circumstances, short-term subordinated debt may be available to bridge funding gaps in excess of senior debt and equity capital.
Exit
This involves divesting or retaining and managing the property. Loans are repaid. Any remaining withholding tax is remitted.
What we are seeing in our engagements
Some taxpayers have cross-border related-party funding arrangements with terms and conditions that differ from third-party arrangements we are observing. This may result in excessive debt deductions through:
- non-arm’s length amounts of debt
- loans with higher interest rates.
It can also result in taxpayers claiming interest deductions with deferral of (or non-compliance with) interest withholding tax obligations.
For more information about arrangements that defer interest withholding tax, see Taxpayer Alert TA 2018/4 Accrual deductions and deferral or avoidance of withholding tax.
Practices that concern us
We are concerned with the following practices or behaviours observed in relation to related-party funding arrangements:
- insufficient evidence to support the arm’s length nature of funding
- lack of information about or disregard for the commercial borrowing practices of the private group
- undocumented loan arrangements
- conduct that is inconsistent with the related-party loan agreement or stated purpose of the funding
- absence of transfer pricing analysis or evidence to support the arm’s length nature of related-party loans (such as analysis of relevant third-party debt arrangements)
- related-party funding arrangements that are not monitored or reviewed throughout the project lifecycle and when circumstances change.