‘Significant tightening’: Details revealed on thin capitalisation changes
Details around proposed changes to the thin capitalisation rules have raised concerns many companies could be unintentionally captured by the rules.
A recent exposure draft released on the proposed changes to the thin capitalisation rules provides important details on how the government will implement its multinational tax integrity measures, according to Chartered Accountants Australia and New Zealand (CA ANZ) and CPA Australia.
The government announced the measures in the October budget last year, stating it would look to strengthen the thin capitalisation rules to address the use of excessive debt deductions.
The amendments, which are based on the OECD’s best practice guidance, replace the safe harbour debt test with a 30 per cent EBITDA test to limit debt deductions. Deductions denied under the 30 per cent EBITDA test are allowed to be carried forward for up to 15 years.
The worldwide gearing test will also be replaced, with entities in a group allowed to claim debt deductions up to the level of the worldwide group’s net interest expenses as a share of earnings.
The government also previously announced that it would modify the arm’s length test by allowing it to apply only to an entity’s external third party debt, disallowing deductions for related party debt.
CA ANZ said the details of these changes released in the exposure draft and explanatory memorandum reveal a “significant tightening of the provisions to address integrity concerns”.
The accounting body noted, for example, the definition of debt deduction has become wider and now includes amounts economically equivalent to interest.
It also highlighted that the ability for carry forward deductions that are denied under the 30% EBITDA test for up to 15 years will now be subject to a modified continuity of ownership test.
The exposure draft legislation also outlines that while financial entities and ADIs will still be able to apply the thin capitalisation rules, financial entities will not be able to apply the old arm’s length test and will be subject to the new external third party debt test.
CA ANZ said it was pleased that the exposure draft has confirmed that the tax figures will be used for the calculation.
The accounting body previously pushed for the use of tax figures rather than accounting figures in the earlier consultation on the measures.
“The use of tax figures to calculate an entity’s EBITDA is easy to apply and audit as they should be capable of being obtained from the tax return,” it stated in its submission.
“CA ANZ is also pleased that the existing exemptions from the thin capitalisation rules will be maintained under the new rules,” the accounting body stated.
Entities that meet the exemptions include those with debt deductions that do not exceed $2 million or have 90 per cent or more of the total average value of all its assets represented by Australian assets.
Exempt special purpose entities which satisfy certain conditions under s820-39 of the Income Tax Assessment Act 1997 will also remain exempt under the amendments.
CPA Australia tax policy expert Elinor Kasapidis said it was disappointing there wasn’t at least a $5 million exemption threshold for the new thin capitalisation rules.
“Rising interest rates will see the $2 million threshold breached relatively quickly. Lots of companies may be unintentionally captured by these rules,” warned Ms Kasapidis.
For businesses that sit around the thresholds, Ms Kasapidis said it would be important for them to test the proposed rules to identify any unintended or harmful impacts on commercial decisions and seek advice.
While the proposed changes to the thin capitalisation rules are part of a global shift in how debt levels and interest deductions are treated, Ms Kasapidis said CPA wants to see the rules target businesses that have aggressive financing arrangements, rather than genuine commercial operations.
“We must ensure investment and growth in Australian businesses are not hindered by these tax rules. We don’t want tax to make business investment too expensive,” she stated.
CA ANZ has also raised concerns about the proposed timing for the measures.
“The proposed changes apply to income years commencing on or after 1 July 2023, just over 3 months away, but the legislation has not been finalised or introduced to, and passed by Parliament. It is extremely unlikely that this will occur before 1 July 2023,” the accounting body stated.
“Multinationals will need to review draft legislation that fundamentally changes their entitlements to debt deductions with very limited time to alter their financial structure to comply with the proposed legislation.”
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