Revised thin capitalisation rules fail to deliver ‘substantive change’

CPA Australia said amendments made to a bill containing significant reforms to the thin capitalisation regime fail to address several concerns previously raised by the accounting industry and other stakeholders.

The accounting body previously raised concerns about the debt deduction creation rules as there is no tax purpose test to limit the rules applying to its stated purpose of targeting debt creation schemes lacking commercial justification.

Under the revised legislation these rules will still result in debt deductions being denied where an entity borrows to purchase trading stock from a related entity.

“We maintain our significant concerns with the lack of a tax purpose test for the rules in light of the changes proposed in the Exposure Draft,” the submission said.

The rules also continue to apply to domestic schemes that do not involve payments being transferred offshore despite the EM referring to profit-shifting arrangements, said CPA Australia.

The accounting body is also concerned that there is no grandfathering which means that the rules could apply to post-1 July 2023 debt deductions relating to asset acquisitions made before June 2023.

The government should consider providing a one-year grace period, according to CPA Australia.

“As was raised in our previous submission, it could be an asset transferred to an associate entity in 1995 that is still held by the associate entity,” it stated.

“This requires significant compliance costs to consider how every single asset held post-1 July 2023 was historically acquired.”

CPA Australia said its biggest concern with the revised exposure draft is the new ordering between the debt deduction creation rules and all other thin capitalisation provisions in Division 820, including three new alternative tests which are the fixed ratio test, group ratio test and third party debt test.

The new section 820-31 states that an entity first works out if its debt deductions are disallowed under the debt deduction creation rules.

To the extent their debt deductions are disallowed under those rules, the disallowed debt deductions are disregarded to apply all other provisions in Division 820.

“Due to the lack of a tax purpose test, this new ordering means unless the limited number of exceptions apply, the majority of the debt deductions in respect of the newly amended ‘financial arrangements’ will potentially be denied deductions under the amended debt deduction creation rules,” the submission said.

“This is irrespective of whether the arrangements have genuine commercial justification or not, as long as debt deductions are disallowed to the extent the borrowings do not satisfy the requirements of the debt deduction creation rules.”

CPA Australia warned that this will reduce the amount of deductible debt, increase taxes and decrease investment in Australia.

“It will also significantly increase the compliance burden for taxpayers in tracing their use of funds and acquisitions of assets,” it said.

“We recommend that for the new ordering, the debt deduction creation rules insert a tax purpose test to refine its application to only targeting arrangements lacking genuine commercial justifications.”

SW Accountants and Advisors said while the proposed changes don’t go as far as many had hoped they do include some welcome amendments to trusts.

Senior tax consultant Ned Galloway said the new exposure draft contains technical changes to ensure that trusts and partnerships can access the third-party debt test.

“In the original bill a drafting error existed which meant that trusts and partnerships were unable to access this test,” he said.

“The original bill provided that trust distribution income was excluded in the calculation of tax-EBITDA for the fixed ratio test. This meant that groups with geared holding entities would be significantly disadvantaged under the fixed ratio test.”

Mr Galloway said the proposed changes should allow for the transfer of excess EBITDA from a subsidiary trust to a holding trust which has an interest of at least 50 per cent in the subsidiary subject to satisfying certain conditions.

“The amount of excess EBITDA that may be transferred from the subsidiary entity will be the parent’s proportionate share of the excess.”

“Any amount of transferred EBITDA will also be taken into account in determining whether the transferee has any excess EBITDA, so that there may be successive ‘push up’ transfers in multi-tiered groups of eligible trusts.”

The accounting and advisory group said while the changes proposed to the TPDT and the debt creation rules are positive, many would have been hoping for changes of a more substantive nature.

Mr Galloway also said a 12-month deferral of the start date for the commencement of the new rules also would have been appropriate, given the rules have now been in operation for four months.

The commencement date is unchanged at 1 July 2023 with the one exception of the new debt creation rules.