Debt creation provisions ‘detrimental’ to genuine transactions, warns AFMA

A subdivision within the government’s multinational tax integrity measures bill gives rise to unintended consequences and should be removed, the Australian Financial Markets Association (AFMA) has told the Senate Standing Committees on Economics.

The proposed measures in the bill apply from 1 July 2023 but are yet to be passed as law with Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 referred to the Senate Economics Legislation Committee in late June.

AFMA said the proposed debt creation rules in Subdivision 820-EAA have been broadly drafted, will apply in a broad number of circumstances and result in “practical issues and concerns”.

The first limb of proposed Subdivision 820-EAA broadly denies a debt deduction where the deduction is in relation to the acquisition of a CGT asset, or a legal or equitable obligation from an associate of the acquirer.

The second limb of the proposed debt creation rules broadly denies a debt deduction where the deduction is in relation to a debt interest that is issued to fund payments or distributions to an associate, including the entity to which the debt interest was issued.

The proposed debt creation rules were not included in the exposure draft for the reforms and have not been subject to industry consultation.

The AFMA submission warned the debt creation provisions raise a number of practical issues and concerns.

“The provisions appear to appear to apply to deny debt deductions even in circumstances where there is no increase in the overall debt held in Australia,” the submission said.

“The rules will apply to rationalisation of domestic businesses, where the debt in the aggregated entity is the same or even less than the debt of the segregated entities, which appears counterintuitive.”

The association also said the provisions may “disrupt the efficient operation of capital markets” with routine transactions such as securities lending arrangements and repo transactions potentially falling within the scope of the measures.

“Vanilla financing transactions where a bank raises funds in a certain jurisdiction to access capital markets and then on-lends those funds to the jurisdictions where business is undertaken, which is a routine transaction for any bank, would also appear to be caught by the second limb,” it said.

“Routine restructuring/rationalisation transactions and working capital arrangements may also potentially be within scope of the operation of the proposed rules.”

AFMA also noted that where related party debt is on-lent to an associate, the interest income will be assessable while the interest expense will be non-deductible, “resulting in significant asymmetry”.

The association has called for the removal of the provisions from the bill to allow for further consultation.

“To the extent that the provisions remain in the bill, [they should] only apply to “general class investors” to reflect the burden being placed on the taxpayer to trace debt funding and the inability for banks and financial entities that operate on a pool of funds basis to conduct such tracing,” the submission said.

AFMA also suggested that an anti-avoidance element should be included for both limbs of the proposed debt creations rules so that that provisions apply to schemes that are conducted for a principal purpose of enhancing the quantum of debt deductions claimed in Australia.

“Given Australia’s approach of adopting the Relevant Business Activity approach to branch attribution, the bill should also confirm that the debt creation rules do not apply to internal dealings within an entity,” the submission said.

The Australian Chamber of Commerce and Industry has similarly outlined concerns that the proposed debt creation rules will raise further complexity through their interaction with other provisions, including the proposed limitations on debt interest deductions.

“Contrary to the stated purpose in the Explanatory Memorandum that they will catch debt creation schemes “that lack genuine commercial justification”, they will inevitably result in the denial of reasonable and arm’s-length arrangements that have a commercial purpose and a commercial justification,” the ACCI said in its submission.

ACCI also said the reforms could “negatively impact production and investment in Australia”.

“Due to the creation of distortion between debt and equity financing, multinational firms that have cash that could be deployed efficiently to fund production or investment in a related Australian entity may be forced to either enter into more expensive equity funding arrangements, or to divert those funds to other countries in which they operate,” it said.

The provisions also have the potential to create completive distortions between multinationals that have Australian headquarters and those that have group financing based in other countries.

“Although support for Australian businesses is often justified, that support should be assessed and implemented as an express policy, not the side-effect of a distortionary tax rule,” ACCI said.