Thin cap changes to ‘discriminate against mid-market taxpayers’

Pitcher Partners has urged the government to amend a raft of “unwelcome changes” contained within the legislation for its new thin capitalisation rules.

The mid-tier firm has told the Senate Standing Committees that the Economics that the bill to implement the amendments to the thin capitalisation rules contains a significant number of issues which must be rectified.

The submission warned that a number of changes in the bill would discriminate against taxpayers in the middle market compared with taxpayers in the larger market sector.

“As currently drafted, the provisions will result in significantly inappropriate outcomes for taxpayers in the middle market that are not consistent with the policy approach recommended by the OECD in its BEPS Action 4 Report on the limitation of interest deductions. Many of the rules included in the provisions were also not contained in the Exposure Draft Legislation provided for public consultation,” the accounting firm said.

Pitcher Partners has called for the debt creation rules in subdivision 820-EAA to be completely removed from the bill until appropriate consultation has occurred.

“Proposed Subdivision 820-EAA was not included in the exposure draft and was instead included in the Bill without any prior public consultation. As drafted, the provisions have scope to apply to ordinary commercial arrangements resulting in a significant and unfair impact on taxpayers through the denial debt deductions,” the submission said.

“These rules would impact non-consolidated groups such as those in the middle market where trust structures are common.

“While the EM states that this Subdivision is targeted at schemes that allow for profits to be shifted out of Australia in the form of tax-deductible interest payments, the provisions are not drafted in a way that actually targets cross-border profit-shifting arrangements and instead applies to wholly domestic arrangements in circumstances where the arrangement would not be one that has a 'tax mischief.

Pitcher Partners said the proposed debt creation rules will have a “significant and disproportionate impact on non-consolidated structures commonly adopted by middle market taxpayers where there is no risk of profit shifting outside Australia”.

“Of particular concern is that the 90 per cent Australian asset exemption from the thin capitalisation rules, contained in section 820-37, is not proposed to apply to prevent the application Subdivision 820-EAA,” the accounting firm said.

“This means that Australian-headquartered outbound groups with an immaterial foreign investment, which may be as insignificant as the holding of a dormant foreign subsidiary with no assets, are brought within the scope of the rules where there is little potential scope of profit-shifting outside Australia.”

Without the development of sensible exclusions, following proper public consultation, Pitcher Partners said the current provisions will impact ordinary arrangements such as the use of borrowed funds by a retailer to purchase trading stock from an associated wholesaler or an entity using borrowed funds to establish a subsidiary company or unit trust.

“The rules would also appear to disallow all debt deductions of a conduit financier which incurs debt deductions in relation to holding debt in an associate. This overly broad application of the rules would make the overall operation of the rules non-sensical,” the submission stated.

It noted that many non-consolidated structures involve entities that serve separate functions where, under ordinary commercial arrangements, those entities make intra-group payments.

"These structures may also commonly include a central finance entity which provides finance to group entities. This is recognised in the conduit financing rules in proposed Subdivision 820-EAB. Such arrangements will result in debt deductions paid between associates that we believe would trigger the operation of section 820-423A(5)."

“For example, a group may be structured to have a finance company, an operating company and a service trust, all of which are associates. The finance company provides working capital loans to the operating company, part of the proceeds of which are used to pay a service fee to the service trust (e.g. to manage its payroll function or for the provision of staff employed by the service trust). The group has a minimal investment (<1 per cent of its overall business) in a foreign subsidiary or permanent establishment but otherwise its operations are wholly domestic.”

These types of arrangements could now result in substantial denials of debt deductions, the submission said.

Given that the potential for the provisions to have “retrospective detrimental impact on taxpayers”, Pitcher Partners also urged the Committee to consider a deferred start date until the issues with the bill can be dealt with.

“We highlight the recent deferred start date to the public country-by-country (CbC) reporting measures to 1 July 2024 as an example of the decision of the Government to get the legislation right rather than having to fix it later,” the submission said.

“If, however, the committee recommends that the bill should be passed with application from 1 July 2023, we request that the critical amendments be made to the bill where it is feasible for those amendments to be included within the bill in a timely manner;

Where amendments cannot be made before the passage of the Bill, that the Government commit to specifically outlining amendments that they are committed to making (with retrospective effect) so that taxpayers can have certainty in applying the provisions from 1 July 2023.