Third-party debt test rules overly restrictive and impractical, says CPA
The third-party debt test is overly restrictive and imposes impractical compliance burdens on taxpayers, CPA Australia has said.
CPA Australia has called on the ATO to adjust the third-party debt test (TPDT), a thin capitalisation reform dictating the amount of debt that eligible companies can deduct on tax.
“The ATO appears to adopt a policy stance that the TPDT is only intended for a narrow class of taxpayers - primarily those in the property and infrastructure sectors. This interpretation significantly limits access to the TPDT, despite the legislation itself not expressly imposing such constraints,” CPA tax policy lead Jenny Wong wrote in a recent submission.
“Even where a taxpayer’s circumstances should allow them to qualify for the TPDT, the evidentiary burden imposed by the ATO makes it practically unworkable unless significant pre-planning measures were taken.”
According to the ATO, the third-party debt test is designed to be narrow and accommodate only genuine commercial relations, which relate solely to Australian business operations.
“It is not intended to accommodate all debt financing arrangements that may be accepted as current practice within industry,” the ATO wrote.
To be eligible to deduct third-party debt, the debt interest must be issued by an Australian entity to a non-associate, third-party entity. The debt must be backed by Australian assets, the proceeds of the debt must fund commercial activities in Australia, and there should be no recourse to foreign assets or entities.
According to CPA Australia, the TPDT may only become relevant for many businesses when their earnings decline or when interest costs increase, circumstances that are difficult to anticipate. However, stringent TPDT requirements would disallow them from accessing the debt deductions without significant planning.
“If Parliament had intended to limit access to the TPDT to specific sectors, this could have been achieved in a more transparent and targeted manner rather than through overly restrictive administrative interpretations,” Wong wrote.
CPA’s submission noted that the ATO’s narrow definition of ‘minor or insignificant’ assets regarding the TPDT is overly restrictive, and suggested that the phrase should be assessed relative to the taxpayer’s total asset base rather than an absolute measure.
It also said that the approach to determining whether an asset is ‘Australian’ is overly complex and goes beyond legislative intent. CPA said this creates significant uncertainty, especially regarding shares in Australian companies that have foreign permanent establishments.
Furthermore, the ATO’s view that capital management does not constitute a commercial activity does not align with the reality of business financing and investment structures, according to CPA Australia.
They also urged the ATO to hold off on finalising the ruling until after the 2024–25 income year, to allow taxpayers adequate time to plan their operations in line with the TPDT.
“CPA Australia urges the ATO to reconsider these positions to ensure the TPDT is a viable and practical option for businesses with genuine third-party debt. We encourage a more flexible and pragmatic approach that reflects commercial realities and aligns with the legislative intent,” Wong wrote.
