Tax Insight: Government Introduces Thin Capitalisation Changes

The Government has introduced into the House of Representatives the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 to enact its proposed changes to Australia’s thin capitalisation regime. This Tax Insight gives a brief summary of the key points; a fuller analysis will follow.

Thin capitalisation changes

So far as thin capitalisation is concerned, the Bill will enact the key components of the policy which the ALP took to last year’s election and released for consultation earlier this year. See our Tax Insight at https://hsfnotes.com/taxaustralia/2023/03/27/tax-insight-changes-to-thin-capitalisation-rules/

For general investors:

• The current safe harbour for general investors (the level of debt must not exceed 60% of the value of assets) will be replaced by test which limits debt deductions to no more than 30% of tax EBITDA.
• Where interest is denied under this test, the deficiency may be carried forward for up to 15 years.
• The current option which allows gearing of the Australian entity up to the gearing level of the worldwide group will be replaced by a test based on the adjusted earnings ratio of the worldwide group.
• The arm’s length debt test has been replaced by an external third party debt test.
• The new tests start from 1 July 2023.

There have been modifications to some of the detail in the Exposure Draft, but the key design elements remain.

Section 25-90 deferred, but …

An Exposure Draft of the Bill released for comment earlier this year had included a proposal to repeal s. 25-90. See our Tax Insight at https://hsfnotes.com/taxaustralia/2023/03/17/tax-insight-new-limits-on-deducting-interest/

This measure has been omitted from the Bill, but it is not dead. The Explanatory Memorandum to the Bill says, “stakeholder concerns regarding section 25-90 were considered by Government, with the proposed amendment deferred, reflected in its removal from the final legislation, to be considered via a separate process to this interest limitation measure.”

And the deferral of s. 25-90 came at a price. The Bill includes new “debt creation” rules (based on the former Div 16G ITAA 1936) which were not released for consultation. The Explanatory Memorandum to the Bill says, the “targeted debt creation rules were progressed in its place.” The measure will disallow debt deductions, “to the extent that they are incurred in relation to debt creation schemes”. The Bill outlines 2 cases:

• an entity borrows to acquire an asset from an associate, and
• an entity borrows from an associate to fund a payment it will make to that entity or another associate.

These rules will operate independently of the thin capitalisation regime, as a discrete measure to deny interest deductions. They will require careful and detailed analysis.

Other measures in the Bill

The Bill also contains amendments to the Corporations Act 2001 to require Australian public companies (listed and unlisted) to disclose itemised information about subsidiaries in their annual financial reports. This requirement will apply to financial reports for financial years starting on and after 1 July 2023.

Status update

The Government also took the opportunity to give an update on the work toward meeting some of its election commitments, re-announced in the October 2022 Budget, and previously released for consultation. Consequently, a large part of the Explanatory Memorandum to the Bill has nothing to do with measures in the Bill; it is devoted to explaining what is happening elsewhere. These measures include: