This Bill contains the following measures:
- Thin capitalisation (previously released in this Exposure Draft (ED)); and
- Multinational tax transparency - disclosure of subsidiaries (previously released in this Exposure Draft).
This alert discusses the Thin Capitalisation measures. Our alert on the Multinational tax transparency measures can be found here.
Taxpayers will have very little time to consider these measures as they are proposed to come into effect for income years commencing on or after 1 July 2023.
Even after this start date, there will still be uncertainty as the final legislation will not be available until at least after the Senate Economics Legislation Committee releases its report due on 31 August 2023. It is therefore somewhat disappointing that the Government chose not to defer the start date by say another one year, as was requested in various public submissions.
This Bill adopts (with substantial changes) the prior ED’s capping of interest and other debt deductions for ‘general investors’ (broadly non-financial entity or non-ADI entities) based on either the default method (the Fixed Ration Test (FRT) – focussing on tax Earnings Before Income Tax Depreciation and Amortisation or ‘tax EBITDA’), or two optional methods (the Group Ratio Test (GRT) focussing on Group (financial) EBITDA and the Third Party Debt Test (TPDT).
The pre-existing $2m gross debt deduction annual de minimis threshold is retained. However, higher interest rates will likely force many more cross-border general investor taxpayers than previously to consider these Thin Capitalisation rules and likely be denied tax deductions because interest/debt expenses will be much larger proportionally to EBITDA.
Financial entities and Authorised Deposit-taking Institutions (ADIs) may still access the existing thin capitalisation tests (except for the former arm’s length debt test which is replaced by the TPDT).
The changes to the ED, partly due to public submissions, include the following:
- In the original ED, it was proposed that Australian companies would no longer be able to deduct interest/debt costs used to equity fund foreign operations to derive “NANE” dividends. It is pleasing to note that Grant Thornton and other industry/professional body submissions have been accepted and this aspect has been removed from the revised Bill. It is noted that there will be a separate process in relation to enacting this provision in the future.
- The FRT “tax EBITDA” will (compared to the ED) be further restricted to exclude the “addback” for current year deductions for tax losses, franked amounts, dividend income, and associate (based on a 10 per cent TC control interest test) entity trust and partnership net income and distributions. These changes will generally reduce tax EBITDA compared to the ED formulation, and thus make it more likely for affected taxpayers to be denied tax debt deductions and defer these for future use. Groups that receive large amounts of dividend income will need to be particularly careful as this income will not be able to be factored in when considering thin capitalisation capacity. Further, entities that have prior year tax losses which are being recouped will likely find that the FRT test will produce a negative result and would need to consider other tests.
- Debt deductions which are denied under the FRT may be carried forward as FRT disallowed amounts subject to satisfying, for a company, the Tax Loss carry forward rules in Division 165, 166 and 167 or, for a trust, the Schedule 2F Trust Loss rules. This broadly allows reliance on a Continuity of Ownership Test or the alternative Same Business Test or Similar Business Test.
- The Explanatory Memorandum clarifies that FRT disallowed amounts carried forward may be deducted by a taxpayer even in years where the taxpayer is no longer subject to the Thin Capitalisation rules (for example, because the taxpayer falls below the $2m de minimis gross debt deduction threshold).
- New 820-FA will integrate FRT disallowed amounts into tax consolidations rules by treating them broadly as tax losses on entry and exit, including giving a choice to ‘cancel’ the FRT disallowed amount for ACA purposes.
- New Subdivision 820-EAA will deny debt deduction for TC entities which create debts with associates by acquiring a CGT asset or legal or equitable obligation.
- New Subdivision 820-EAB substantially relaxes the TPDT to take into account expanded conduit financing rules. The ‘same terms’ requirement in the ED has now been somewhat relaxed to only apply to terms which relate to the cost incurred in relation to the relevant debt interest.
- The TPDT choice rules in subsections 820-46(4) and (5) introduce a ‘concession’ to allow the choice to be made by entities in an ‘obligor group’ instead of by all associates. An ‘obligor group’ includes obligors for debt issued by a debtor entity which is a 20 per cent associate (subsection 820-48(2)).
- The GRT expanded definition in subsection 820-54(5) of ‘associate entity’ for grouping purposes will now be increased to 20 per cent instead of the ED proposed 10 per cent.
- An entity may now apply to the Commissioner to revoke in writing its GRT or TPDT choice. The ED proposed that the choice was to be irrevocable. The Commissioner may revoke the choice if it is ‘fair and reasonable’ to do so (that is, the Commissioner must be satisfied that at the time the choice was made the taxpayer reasonably believed that the chosen test would result in a higher deduction than the FRT).
Next steps
Taxpayers who are currently eligible to claim interest/debt deductions in Australia under the existing Thin Capitalisation laws may find that their interest/debt deductions either cease to be available or become severely restricted from as early as 1 July 2023. The first step for affected taxpayers is to therefore model the impact of these changes on their debt deductions under each of the new tests. From there, important decisions will need to be made regarding the making of elections and determining the ongoing levels of debt financing.
We have previously commented on the Thin Capitalisation Exposure Draft measures below.
Please contact us if you wish to discuss these measures further.
Amended Multinational tax transparency reporting rules introduced into Parliament
