The government has introduced more amendments to the thin capitalisation and debt deduction creation rules Bill. While the changes to the Bill are positive, across our client base there are genuine third-party arrangements that will not satisfy the third-party debt test due to inadvertent technical breaches.

SW continues to work with industry bodies to highlight the impact to Treasury. We hope that further amendments will be made to the Bill to ensure it is a targeted and measured response to the issue of base erosion. 

Taxpayers will face a further period of uncertainty regarding how the law applies as the Bill has again been referred to a Senate Economics Committee due to report to parliament on 5 February 2024.

What can taxpayers do to prepare?

The focus has largely been on the amendments to the thin capitalisation rules due to its effective date. Our recap of the changes proposed in the Exposure draft can be found here.

However, taxpayers should start identifying the types of arrangements that could be impacted by the debt deduction creation rules as their material impact is arguably greater. The debt deduction creation rules commence on 1 July 2024 for all arrangements and include historical arrangements arising prior to the introduction of the rules.

What are the details of the rules? 

The original Bill and amendments are contained across separate documents. This means taxpayers will need to read each document collectively, which is no easy task.

To help you we have prepared a more detailed analysis of the Bill in our Technical Briefing. Our Technical Briefing summarises the application of the proposed law as well as the amendments to the original Bill. Due to the complexity of thin capitalisation, we encourage you to talk to our SW team.  

Summary of changes to the Bill

Below are the key changes between the original legislation, released on 22 June 2023 and the Senate amendments made on 29 November 2023:

How can SW help? 

Our experts can assist with: 

• modelling the potential impact of the new rules on your debt deductions 
• assessing the feasibility of restructuring the financing structure of the group 
• considering whether one of the alternative tests would be applicable and beneficial to your circumstances. 

Reach out to your SW advisor for support from our specialist tax team. Download the Technical Briefing for a deeper dive into the technical details.

Contributors

Kate Wittman

Ned Galloway

Ian Kearney

The post More thin capitalisation reforms – changes to Bill released appeared first on SW Accountants & Advisors.

Significant reforms to the thin capitalisation regime were introduced in the Bill¹ into the House of Representatives on 22 June 2023.  A detailed outline of the reforms contained in this Bill were provided in an earlier SW client alert.  The original Bill contained rules considered by many to be controversial. These issues were highlighted in submissions made by many stakeholders (including SW) to the Senate Economics Legislation Committee (Committee) as part of a review conducted on the impact of the Bill.  In response to this review, on 18 October 2023, Treasury has released in exposure draft form a further round of proposed amendments for public comment.  These amendments address some of the concerns raised in relation to the original Bill.   

We have summarised below the issues and recommendations made in the SW Accountants & Advisors submission to the Committee compared to the changes to the Bill that have been proposed by the exposure draft. 

We have below provided a brief summary of the main proposed changes included in the exposure draft.  

Main changes  

Welcome amendments proposed for trusts  

• technical changes to ensure that trusts and partnerships are able to access the third party debt test (TPDT). In the original Bill a drafting error existed which meant that trusts and partnerships were unable to access this test
• the original Bill provided that trust distribution income was excluded in the calculation of tax-EBITDA for the purposes of the fixed ratio test.  This meant that groups with geared holding entities would be significantly disadvantaged under the fixed ratio test. The proposed changes should allow the transfer of excess EBITDA from a subsidiary trust to a holding trust which has an interest of at least 50% 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.   

Third Party Debt Test (TPDT) 

• changes are proposed to the TPDT.  For the most part these should broaden the applicability of this test. The proposed changes include: 
  • interest rate swap costs which relate to multiple debt interests, will now be deductible under the TPDT, subject to meeting certain conditions,  
  • a relaxing of the conditions for the TPDT in relation to permissible recourse arrangements. This will permit the following asset types to be subject to recourse arrangement without breaching the TPDT eligibility conditions: 
    • Australian assets owned by the entity, 
    • Australian assets that are represented by membership interests in the entity, except when the entity has a direct or indirect legal stake in assets not considered Australian. This ensures that membership interests cannot be tied to non-Australian assets, and  
    • Australian assets owned by an Australian entity within the obligor group related to the tested debt interest. 

Where the TPDT is being considered for ‘conduit financiers’, the modifications referred to above will broadly also apply to the conduit financier and entities that borrow from the conduit financier.  

• The provision in the original Bill permitting the use of credit support rights linked to the creation or development of land or other real property in Australia is proposed to be broadened.  This concession is proposed to be extended to include the creation and development of specific movable assets located on the land. This expansion is intended to accommodate property that, while not considered part of the land, has a significant economic association with it. 

Debt creation rules  

• The proposed debt creation rules are widely regarded as controversial and not well targeted.  As previously noted, these rules broadly targeted arrangements involving:  
  • an entity acquiring an asset (or obligation) from an associate which is funded by interest bearing debt, and  
  • an entity borrowing from an associate to fund a payment to that, or another, associate and incurring interest on the relevant debt. 

• In response to the numerous submissions made to the Committee on these rules, refinements have been proposed, including: 
  • excluding Authorized Deposit-Taking Institutions and securitisation vehicles as well as certain special purpose entities that are exempt from the thin capitalisation provisions  
  • the introduction of exceptions to the conditions regarding the acquisition of an asset from an associate, in broad terms: 
    • the acquisition of a new membership interest in an Australian entity or a foreign company,  
    • certain new tangible depreciating assets, and  
    • the acquisition of certain debt interests, to allow for related party lending in certain circumstances.  
  • the introduction of exceptions to the rules targeting borrowings to fund payments to associates, in broad terms:  
    • payments that are merely back-to-back loans on the same terms relating to costs, and  
    • certain payments of principal under a debt interest. 
  • in addition to the above, various other amendments are proposed, including amendments specifying the order in which debt creation deduction rules and the thin capitalisation provisions apply (essentially, the debt creation rules apply first).  

Commencement, application and transitional provisions 

Many submissions made to the Committee urged the Committee to conclude that the new measures, particularly the debt creation rules, be deferred until 1 July 2024.  However, the Committee has not adopted such recommendations, save for one exception.  The effective date for the thin capitalisation measures remains 1 July 2023, so that any income year starting on or after that date would be affected.  The one timing concession that is reflected in the new proposals is that for financial arrangements established before 22 June 2023, there is to be a one-year grace period in relation to the debt deduction creation rules.  However, the debt creation rules will apply to all arrangements (whether pre-existing or new) from 1 July 2024.   

SW comment  

The changes proposed to the thin capitalisation rules in relation to trusts are most welcome.  The changes proposed to the TPDT and the debt creation rules are positive, but many would have been hoping for changes of a more substantive nature.   

Should the legislation proceed, inclusive of the most recent round of proposed changes, the thin capitalisation rules changes and the new debt creation measures will represent significant changes to the tax law affecting multinational groups.        

We are now four months into the first year of operation of the new rules. Given these rules are still not settled, a 12-month deferral of the start date seemed appropriate. This, of course, will not be the case with the commencement date unchanged at 1 July 2023 (subject to the one exception noted for the new debt creation rules).   

However, consultation on the reforms continues with submissions in relation to the exposure draft changes closing on 30 October 2023.  

How can SW help?  

Given that the basic thrust of the new thin capitalisation regime remains unaltered, it is important that if you are affected by the new rules, you clearly understand how these arrangements are likely to impact your existing arrangements.  To understand how these measures and the proposed amendments referred to above may impact you, please contact your SW adviser or, alternatively, one of the contacts listed.  

Contributor

Ned Galloway

The post Thin capitalisation reforms – changes to Bill released   appeared first on SW Accountants & Advisors.

Introduced into Parliament on 22 June 2023, the Bill is in line with the Government’s commitment to address tax avoidance practices of multinational enterprises and streamline with (OECD) best practice guidelines. There are some important distinctions from the Exposure Draft legislation, which SW detailed here in March.

From 1 July 2023, the new proposed thin cap provisions will replace the existing rules and limit the amount of interest deductions for certain entities. The Bill has been referred to the Senate Economics Legislation Committee for review, which will complete on 31 August 2023. This means that final legislation may not be released before September 2023.

Who do the new thin cap rules apply to?

The new regime applies to:

• foreign controlled taxpayers and taxpayers with foreign operations. These remain broadly unchanged from the existing rules
• only applies to general investors and, in part, to financial entities
• certain exemptions will continue to apply – including the $2 million (debt deduction) de minimis exemption.

What are the new tests?

The new regime’s safe harbour will be broadly based on the taxpayer’s current year taxable income – instead of the current safe harbour which is based on a taxpayer’s balance sheet.

The new safe harbour will be known as the Fixed Ratio Test (FRT). The FRT will limit interest deductions to 30% of a taxpayers Tax EBITDA. The Tax EBITDA will broadly be calculated as a taxpayer’s taxable income adjusted for interest deductions, tax depreciation and certain distributions received. Any non-deductible interest can be carried forward for 15 years.

Two other tests will be available:

• The Group Ratio Test (broadly replacing the worldwide gearing test)
• The Third Party Debt Test (broadly replacing the arm’s length debt test).

The Group Ratio Test will apply to disallow interest deductions by applying a group ratio to the taxpayer’s tax EBITDA – instead of the 30% FRT. The group ratio is calculated by applying a complex formula broadly equal to the net third party interest expense of the global group divided by the Group EBITDA.

As the name suggests, the Third Party debt test will only apply to debt issued to external third parties – meaning taxpayers may no longer be able to deduct interest issued to related parties even where third parties would have loaned funds on the same terms.   There are exceptions in relation to the use of Australian conduit financing entities.

Notable changes from the Exposure Draft legislation

Some notable changes in the Bill that has been added, or else removed from the Exposure Draft legislation, include:

• Changes to the calculation of tax EBITDA, particularly in relation to:
  • excluding dividends and franking credits
  • excluding trust distributions and partnership distributions from associate entities
  • adding back all amounts under Division 40 and Division 43 except to the extent that the amounts are immediately deductible and
  • removing the add back for prior year tax losses that was in the original Exposure Draft.
• Removal from the proposed legislation of changes to section 25-90 of the ITAA 1997 (about deductions for debt deductions incurred to derive foreign non-assessable non-exempt income from non-portfolio investments) At this stage, no announcement has been made as to the future of this controversial proposed change.
• The choice to apply one of the two new alternative tests is revocable, although a taxpayer will need to apply to the Commissioner to have a choice revoked.
• Removal of limitation to apply the third-party debt test where all associate entities had not made the choice. This has been replaced with a deemed choice for members of an obligor group.
• Addition of new Subdivision 820-EAA to disallow debt deductions to the extent they are created under debt creation schemes without commercial justification.

What is the detail of the rules?

A more detailed analysis of the Bill is contained in our Technical Briefing, linked below.  We encourage you to talk to the SW team to understand these changes further.

Application Date

The new legislation is set to apply to income years beginning on or after 1 July 2023.  

How should taxpayers prepare?

We recommend that taxpayers subject to the thin capitalisation regime review their existing arrangements having regard to the new Bill as a high priority, noting that the proposed date of effect is  1 July 2023. Whilst we hope that common sense will prevail and technical amendments will be made to ensure that the 3^rd party debt test can be used by business, the Bill is predominantly based on the OECD guidance.

How can SW help?

Our SW team can assist with:

• modelling the potential impact of the new rules on your debt deductions
• assessing the feasibility of restructuring any existing financing arrangements for your group
• considering whether one of the alternative tests would be applicable and beneficial to your circumstances.

Reach out to your SW advisor for support from our specialist tax team.

Contributors

Ned Galloway

Ian Kearney

The post Bill for new thin capitalisation regime introduced appeared first on SW Accountants & Advisors.

We recommend that all fund managers review their funds’ existing financing arrangements immediately to understand how the proposed rules impact interest deductions. For further details of the of the proposed changes, please see our previous article: New thin capitalisation regime details released.

These rules will broadly apply to property funds that have:

• a foreign investor that has a controlling interest in the fund or where the fund invests in foreign assets, and
• debt deductions over $2 million.

Potential impact on property funds

We have considered the potential impact on several of our property fund clients. Our key findings are:

• The Fixed Ratio Test (FRT) limits interest deductions to 30% of a taxpayers tax EBITDA (Earnings before Interest, Taxes, Depreciation and Amortisation). The FRT is likely to deny interest deductions for most taxpayers that fall within the regime based modest gearing and market interest rates. Of note, if borrowings are taken out at the head trust level the interest denial will be significant. Importantly, if debt deductions are denied under the FRT the taxpayer can carry forward the excess for up to 15 years. 
• It may be difficult for some funds to obtain the relevant information to perform the required calculation under the Group Ratio Test (GRT).
• The External Third-Party Debt Test (ETPDT) should provide an appropriate mechanism to allow interest on Australian bank debt to be claimed.  However, the proposed rules only allow this test to be used if:
  • debt is borrowed from a third parties, i.e. related party debt not permitted
  • all 10% associate entities choose to apply it (it will be practically difficult to get agreement on this from all 10% associate entities), and
  • recourse can only be to assets of the borrower. This is practically difficult to achieve and not in accordance with currently lending practices particularly large-scale construction projects where banks typically look for parent support and guarantees
  • debt borrowed is used to only fund Australian investments.
• The 15-year carry forward of excess deductions is only available under the FRT. Therefore, property funds will not be able to switch between methods and recover any interest denied under the FRT.

How can SW help?

The proposed changes are likely to have a significant impact on the property funds management industry, which relies heavily on debt financing. 

SW Accountants & Advisors has already contributed to submissions that have highlighted these issues to Treasury. Even if most of the issues identified for improvement were to be adopted, there is likely to be some level of interest denial in property funds that fall within the regime. 

If you would like to discuss your individual circumstances, please reach out to SW advisor or the team listed here.

Contributors

Luke Fernandes

Ned Galloway

The post Property funds to be impacted by proposed thin cap changes appeared first on SW Accountants & Advisors.

Whilst the important details of the framework have yet to be released (and remain the subject of an intended consultation process), the Albanese Government’s intention is to “to ensure multinationals pay their fair share of tax“.

The Government plans to do this via 4 major areas of reform or expansion:

1. implementation of BEPS 2.0
2. modification of thin capitalisation rules
3. restricting Intellectual Property deductions, and
4. expanding Tax Transparency measures, including requiring:
   • public release of Country-by-Country (“CbC”) information
   • a public registry of ultimate beneficial ownership of entities
   • mandatory reporting of “tax haven exposure”, and
   • transparency requirements for Australian government tenderers.

Adoption of BEPS 2.0

The ALP has confirmed its commitment to the timely implementation of the Base Erosion and Profit Shifting framework (BEPS 2.0) to follow through on Australia’s agreement to the global arrangement reached in October 2021 and membership of the OECD’s Inclusive Framework.

This will include the domestic implementation of what is known as a 2-Pillar solution, which includes:

• a global minimum effective minimum corporate tax rate set at 15% for multi-nationals, and
• a fairer distribution of profits by multinationals.

The new Government is clearly hoping that the introduction of these measures will increase Australia’s proportion of the tax take on many multinationals.

Thin capitalisation reform

The ALP is proposing to further limit interest deductions to bring Australia in line with the OECD recommended approach. In particular, the Government is proposing to limit interest deductions to 30% of EBITDA from 1 July 2023, while retaining the arm’s length and worldwide gearing debt tests.

The proposed reform is simple in statement but difficult in execution, and will likely have significant impact on a range of sectors that are traditionally highly leveraged and increase the compliance burden for many multinationals.

Thankfully, the ALP has stated that these reforms will only proceed after industry consultation, and we hope that due consideration is given to the broader implications of such a change.

Intellectual Property restrictions

The Government has seemingly sought to ‘borrow’ certain integrity measures from other tax systems such as the UK and US in seeking to deny tax deductions for the use of intellectual property when those payments are paid to a tax haven jurisdiction.

These measures are intended to only apply to Significant Global Entities (SGEs) and are intended to stop “treaty shopping”. The Government intends to introduce provisions that would deny such a payment unless it could be substantiated that the royalty payment was not for the dominant purpose of avoiding Australian tax.

There are many complexities evident with this proposal, not the least the interaction of these proposed rules with existing tax provisions such as Part IVA and Diverted Profits Tax.

Tax Transparency expansion

The remainder of the ALP’s reform agenda is focused on expanding requirements for multinationals to be transparent in their dealings.

These expansions focus on 4 areas:

Public reporting of CbC information

It is currently only mandatory to provide CbC Reporting information to the ATO. The ATO then shares that information with certain other global revenue authorities.

The ALP intends to require “large multinational firms” (presumably SGEs) to publicly disclose the CbC information.

Ultimate beneficial ownership information

The Government intends to create and maintain a public registry of ultimate beneficial ownership. Ultimate beneficial ownership is essentially the identity of who ultimately owns, controls, or receives profits from a company or other type of entity.

Implementation of a public register of such information will bring Australia in line with other G20 nations such as Canada, UK, and the US.

We expect that such a register would be limited in scope to large multinationals given the broader context of the reform agenda. However, limited information has been provided at this stage.

Mandatory reporting of “tax haven exposure”

Presumably tied to the implementation of BEPS 2.0, these changes will require multinationals operating in jurisdictions below the proposed global minimum 15% tax rate to disclosure a “material tax risk” to shareholders.

Tax transparency requirements for Australian Government tenderers

Lastly the ALP plan to implement a “Fair Go Procurement Framework” requiring companies tendering for Government contracts worth more than $200,000 to disclose their country of domicile for tax purposes.

ALP plan needs broad consultation

The ALP’s proposals clearly represent a significant pivot from policies in previous elections and have generally focused on ways of addressing tax avoidance by multinational corporations. Whilst they may provide some headaches and uncertainties for taxpayers, they are unlikely to unsettle Australian voters or mums and dads.

Nonetheless, the potential application of the reforms are significant and may impact many small and medium sized enterprises – as well as the SGEs. We welcome the opportunity for broad consultation to ensure that the plan achieves its objectives in an appropriate and measured way.

Contributors

Jae Debrincat

The post How will multinationals “pay their fair share” under the new Government? appeared first on SW Accountants & Advisors.