On 16 December 2021, the ATO issued Practical Compliance Guideline PCG 2021/5 (PCG), which finalises their compliance approach to the assessment of relative levels of tax compliance risk associated with imported hybrid mismatches addressed by Subdivision 832-H of the Income Tax Assessment Act 1997 (ITAA 1997).
The final PCG confirms the ATO's approach contained in the prior draft (PCG 2021/D3), released on 21 April 2021, as summarised in our previous article which provides a more detailed summary of imported hybrid mismatches
The final PCG outlines the compliance obligations and expected level of enquiry undertaken by taxpayers and their controllers to identify and assess the expected tax treatment of payments to entities in foreign counterparty jurisdictions (limited to members of the same Division 832 control group or payments made under a structured arrangement).
Date of effect
The PCG 2021/5 will apply retrospectively for income years which commenced on or after 1 January 2019 for importing payments made under a structured arrangement, and 1 January 2020 for all other imported hybrid mismatch arrangements.
What hasn’t changed in the final PCG?
- The Commissioner’s expectation is that taxpayers demonstrate they have taken appropriate and adequate steps to collect information demonstrating that the imported hybrid mismatch rule does not apply, or that the taxpayer has identified all imported hybrid mismatches, including where there is a denial of Australian tax deductions
- The Commissioner’s view is that a taxpayer should not claim a deduction for any cross-border payments made to a member of its Division 832 control group unless the relevant taxpayer is able to obtain sufficient information to support a conclusion that a deduction is not disallowed under the imported hybrid mismatch rule
- The recommended methodologies (‘top-down’ and ‘bottom-up’) should be used to demonstrate that reasonable enquiries have been made in assessing application of the imported hybrid mismatch rule
- The risk framework for taxpayers to self-assess their compliance risk and the likelihood of ATO engagement and assurance activity continues to apply.
What has changed in the final PCG?
There are a number of changes from the draft PCG, most of which clarify how the taxpayer should apply the methodologies and risk assessment framework, including:
- ATO’s recommended approach: The PCG clearly states that a combination of the 'top-down' and 'bottom-up' approach is acceptable, if the process results in sufficient information to substantiate the position taken by the taxpayer
- A broader scope for an indirect payment: The PCG explicitly states that payments considered indirect payments to an offshore entity that result in a hybrid mismatch do not need to be a series of payments; it is sufficient that further payments are made from the interposed offshore entity to the offshore entity with the hybrid mismatch
- Risk zone changes: There are less risk zones, plus some changes to risk zones and definitions in the self-assessment risk framework including:
- An expansion of the green zone, which now includes the $2 million de minimis entry that was previously in the blue zone. This should give a lower risk rating for taxpayers undertaking a risk self-assessment with lower international related party dealings
- The new yellow zone enables multinational groups that have, and apply, a global policy for managing risks associated with imported hybrid mismatches consistent with the OECD Action Item 2 Report
- A taxpayer can rely on the risk self-assessments completed in two preceding income years where the circumstances have not materially changed for the blue and green zones.
- Consequence of risk rating: The ATO has included a table indicating their level of compliance activity for each level of self-assessed risk, thus providing taxpayers clear expectations of the consequences for non or low compliance with the PCG
- Insight into the ATO’s risk assessment: For larger taxpayers, i.e. those that need to lodge a reportable position schedule, there is an increased risk of review activity by the ATO, unless a reasonably high level of compliance with the PCG exists, and therefore the reporting of a self-assessed colour zone of Blue or better
- Relevance of foreign tax advisors: The PCG includes an example to further illustrate the need for the Australian taxpayer to review whether the basis of a foreign tax advisor’s conclusion that foreign hybrid mismatch rules don’t apply is consistent with the requirements of Australian imported hybrid mismatch rules
- Voluntary disclosure: The ATO will consider reducing the shortfall penalties and interest charge for voluntary disclosures made within 18 months from the publication of this PCG.
Recommended actions
Now that the final guidance has been issued, if taxpayers have not already started the process of re-assessing their international payments and collating relevant evidence e.g. loan agreements, group treasury policies, etc., then they should do so urgently and complete prior to the lodgement of their next tax return.
Where such a review process indicates a need to submit a voluntary disclosure to the ATO, consider doing so within the 18 month period after the publication of this PCG to take advantage of the ATO’s increased propensity to reduce penalties and interest charge.
Taxpayers, particularly those that need to lodge a reportable tax position schedule, should consider what risk rating is deemed acceptable in the context of their tax governance policy and complete sufficient work prior to the lodgement of the tax return to obtain such a rating.
Please reach out to a BDO tax adviser if you would like to discuss your level of exposure to the PCG, including the impact of the risk assessment tool and the application of this PCG to your company’s circumstances.