Government to overhaul thin capitalisation changes after inquiry

The government intends to undertake further consultation on a range of measures contained in the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 and defer the start date of the thin capitalisation changes until July 2024 following a recent inquiry into the measures.

The Economics Legislation Committee handed down its recommendations on the multinational tax integrity measures in the bill in a report released late last week.

The Committee has recommended that one of the most controversial aspects of the bill, the debt deduction creation rules, be removed from the bill and instead be subject to a full and comprehensive Treasury consultation process through an exposure draft bill.

The debt deduction creation rules contained in the bill disallowed debt deductions to the extent that they are inured in relation to debt creation schemes.

Stakeholders warned the Committee that the scope of the debt deduction rules was too broad and would lead to a number of unintended consequences and negative outcomes for Australian companies.

The Tax Institute raised concerns that the rules may unintentionally and unfairly apply to common and low-risk arrangements, as well as those in place prior to 1 July 2023.

This approach, it said, would “impose a significant compliance burden on taxpayers” and that the “outcome would be disproportionate to the intended purpose of the rules.”

The Committee has also recommended that the fixed ratio test and method of tax EBITDA be amended to accommodate non-consolidated tax structures such as trusts, and other affected sectors.

The report said the government could consider removing the exclusion of unfranked dividends from tax EBITDA or including an associate entity excess rule similar to the rules in section 820- 920 of the Income Tax Assessment Act 1997.

The government could also look at changing the tax EBITDA method to enable plantation depletion costs and plantation establishment costs to be added in at step 3 of the tax EBITDA method; and allowing an excess thin capitalisation capacity for underlying entities, the report said.

The Committee has also called for the third party debt test to be removed from the bill or deferred by 12 months to allow for further consultation. The arm’s length debt test would remain in the interim.

The third-party debt test would disallow an entity’s debt deductions to the extent that they exceed the entity’s debt deductions attributable to the third party debt.

Industry groups involved in the consultation raised concerns about the proposed third-party debt test creating uncertainty and called for the test to be further refined.

CA ANZ said the implementation of the test and its application was unlikely to be straightforward in the case of a business structure with more than one entity —noting that an entity that is a general class investor may make a choice to apply this test instead of the fixed ratio test.

CA ANZ said the drafting would cause practical difficulties and, in some cases, preclude access to the third-party debt test and argued that practical guidance is required.

Stakeholders such as the Tax Institute also warned that the exclusion of trusts would result in disproportionate and unfair outcomes for many common structures involving trust groups.

The Tax Institute said the test could be broadened to make it clear that trusts and partnerships that are not foreign-controlled are able to access the third party debt test.

The Committee has recommended that the third party test be amended to accommodate non-consolidated tax structures such as trusts.

The report said the government should give consideration to:

• Amending “Australian resident” to “Australian entity” to ensure the test applies properly to trust structures.
• Removing the limitation to only Australian assets with respect to the recourse for payment of debt.
• Amending the test so that a cross-stapled entity is only deemed to make an election where it is a member of the obligor group in respect of the relevant debt interests.
• Permitting widened recourse requirements in the context of the conduit financing provisions.
• Allowing for recourse to forms of credit support as part of the conditions of the test.
• Allowing for the hedging of interest rate risk and foreign currency hedging arrangements with respect to one or more debt interests.

It also recommended that the bill be amended so that the proposed exemption from the associate entity test for superannuation funds also applies to other investment funds, e.g. managed investment trusts, attribution managed investment trusts and corporate collective investment vehicles.

It also called for the start date of the new thin capitalisation rules to be deferred to 1 July 2024.

The Committee said this would allow for further consultation on the rules, allow for entities to restructure existing financial arrangements in compliance with the rules and ensure the application of the rules is not retrospective.

“In its current form, the bill provides that the provisions will apply retrospectively from 1 July 2023, given the bill was introduced in June 2023 and it is now September 2023. Multiple witnesses recommended that the provisions instead apply from 1 July 2024 to avoid any retrospective effect,” the report said.

“The committee’s attention was drawn to significant infrastructure arrangements and projects in particular, where major investment and money have been pulled together on the basis of particular laws at the time. With no transitional relief measures and a number of drafting issues still present in the bill, retrospective operation may be extremely disadvantageous.”