Tax Insight - Senate Report on Thin Capitalisation Provisions

On 22 September 2023, the Economics Legislation Committee handed down the final report of its inquiry into the provisions of the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share-Integrity and Transparency) Bill 2023. The Report is deeply disappointing and does not augur well for other important consultations. This Tax Insight focuses on the parts of the Bill and Report dealing with the thin capitalisation provisions.

1.  Background

The background to this Bill starts with the proposal announced by the ALP in April 2022 as part of its tax policies for the 2022 election to change the thin capitalisation test to one based on the ratio of interest expense to earnings, rather than the ratio of debt to asset values. (The ALP’s election policies with respect to tax are available here.)

After the election, in August 2022, Treasury released a Consultation Paper, Government election commitments: Multinational tax integrity and enhanced tax transparency which laid out some of the likely parameters of the new design. (Our Tax Insight on the Consultation Paper is available here.)

In March 2023, Treasury released an Exposure Draft of provisions to give effect to the policy. The Draft did give effect to the Government’s promise to reconceptualise the thin capitalisation regime, but it also included an unexpected proposal to repeal s. 25-90, denying a deduction for interest incurred to capitalise or buy foreign subsidiaries. While this surprise attracted the most attention, the Exposure Draft contained other problematic provisions. (Our Tax Insight on the Exposure Draft is available here.)

The furore created by the Exposure Draft caused Treasury to modify its position somewhat. When the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 was introduced into the House of Representatives in late June 2023, the contentious proposal to repeal s. 25-90 was removed for further consultation, but it was replaced by another surprise – a so-called “debt deduction creation” regime. Many of the problematic provisions of Exposure Draft had not been resolved. (Our Tax Insight on the Bill is available here and our podcast is available here.)

2.  Senate Committee process and recommendations

The Senate then referred the Bill to the Senate Economics Legislation Committee. The Committee received 53 submissions on the Bill by 21 July and held one day of public hearings on 15 August. Its report was released on 22 September 2023.

Most of the submissions from the tax profession and industry addressed technical shortcomings with the design and the drafting, focussing on issues such as:

• issues in the current calculation of EBITDA,
• difficulties in the accessing the external debt test,
• difficulties meeting the conditions for the conduit financier regime,
• problems applying the fixed ration and group ratio rules to groups of trusts,
• transitional rules and commencement dates,
• substantial issues in relation to the “debt deduction creation” regime and the seemingly broader than anticipated scope of operation,

and so on. Those submissions were consistent and thorough.

The Committee split along party lines with a majority position endorsed by the 4 members from the ALP and Greens, and a minority position from the 2 Liberal members. The majority recommendation was that, “the bill be passed subject to technical amendments foreshadowed by Treasury.” In other words, the Committee was completely unmoved by any of the submissions other than accepting an undertaking by Treasury to make “minor technical amendments” which Treasury acknowledged in the hearing. These included:

• “making clarifications to the Australian resident requirement so that the third party debt test applies to trusts that may have been ‘inadvertently excluded’ in the drafting of the bill”;
• a possible “narrowing of the (debt deduction creation) rules” which could involve “excluding the securitisation vehicles and even perhaps the authorised deposit-taking institutions (ADIs) on a similar basis to how they're excluded from the proposed amendments to the thin capitalisation rules…”; and
• “Including certain exclusions which would clarify the operation of the rules modelled on the former 16G ITAA 1997 (sic) exclusions”

The qualification that Treasury can make the “technical amendments [it] foreshadowed” implies that these changes have been evaluated and endorsed by the Committee, but apparently “this committee has not seen those amendments, despite the request by committee members for Treasury to provide them ...” This is particularly disappointing given industry had less than 4 weeks to make submissions but Treasury, having had the benefit of 2 months to review the submissions and 5 weeks from the public hearings, was still not in a position to provide the proposed amendments to the committee for review. So, it seems the majority was content to leave everything to the wisdom of Treasury and inquire no further.

Equally as concerning was the majority’s acceptance of the justification for the debt creation rules. Treasury and the ATO only provided high level reasons, without specific examples of issues that were of concern: “When we drafted the current debt deduction creation law, we drafted it with a view to other guidance and perhaps changes in legislation that have occurred since the original rules were in place” … and  “… we are aware of views in the tax advisor community that the absence of the debt creation laws since 2001 actually allowed for debt creation schemes to take place in a way that we can't otherwise address without these rules, so there's evidence of it in the past.”

Similarly, requests by taxpayers and the profession for the debt deduction creation rules to be grandfathered were waved away as being too administratively difficult for taxpayers to track and too complex to draft, despite a grandfathering rule having been introduced when changes were made to the rules governing sovereign immunity. In addition, requests for the start date of the thin capitalisation rules to be deferred were met with a dead bat on the basis that “essentially, the changes commencing from 1 July 2023 would only need to be reported in tax filings for the 2023-24 financial year, which, for ordinary June balances, would not be until later in 2024. So there is also time for entities to make appropriate changes accordingly.”

3.  Next steps

Given tenor of the report, it seems likely that the Government will simply accept the report and adopt its recommendations. Whether or not Treasury will decide to fix any of the technical drafting defects before the Bill is enacted remains to be seen, but given the composition of the committee, it is almost certain that whatever Treasury decides to do will just be rubber-stamped by both Houses of Parliament.