Cheap Oil Inc., a company incorporated in the US, is the parent company of a wholly owned subsidiary incorporated in Australia. The Australian subsidiary in turn has a wholly owned subsidiary incorporated in the US.

Due to the group's overall top credit rating and with a guarantee from Cheap Oil Inc., the US subsidiary borrowed funds from third parties at an interest rate of 1%. The funds are then lent to the Australian company at an interest rate of 9%, which the group argues to be the arm's length interest rate for the Australian subsidiary. Under the tax structure, the interest income received by the US subsidiary from the Australian company is not subject to taxation in the US or anywhere else. In addition, the interest payments to the US subsidiary are allowed under the thin capitalisation regime in Australia.

Answer the following questions:

1. Explain why the intra-group loan is subject to Australia's transfer pricing regime.

2. What arguments can Cheap Oil put forward to support the claim that 9% is the arm's length interest rate?

3. On what basis can the ATO challenge the 9% claim under the transfer pricing regime?