Chapter 2Views on the amendments
Introduction
2.1This chapter examines stakeholder views on the government amendments to the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share—Integrity and Transparency) Bill 2023 (government amendments). It is informed by the supplementary explanatory memorandum (SEM), submissions received to this inquiry and evidence provided at a public hearing on Wednesday 31January 2024.
2.2An indicative but not exhaustive account of key issues relating to the government amendments is provided, concluding with the committee’s views and recommendations. The discussion is presented under the following key headings:
General comments
Key points of concern
Committee view.
2.3Submissions to the committee included a number of drafting suggestions. The committee has chosen to focus on the overarching concerns, rather than detailed drafting.
Comments on the amendments
General comments
2.4Overall, submitters were broadly supportive of Treasury’s extended stakeholder consultation and noted the government amendments provide significant improvement to the bill.
2.5Some stakeholders continued to raise concerns about implementation timeframes and sought further amendments or clarifications. However, submissions highlighted that the amendments positively addressed many previously identified concerns.
2.6For example, the Australian Investment Council, praised the extensive consultation and resulting changes, stating:
The Council acknowledges the role of the Senate Economics Legislation Committee (the Committee) and Treasury in providing sustained engagement with stakeholders throughout the various iterations of the Bill, which has resulted in drafting refinements that enhance the Bill’s clarity.
Encouragingly, since its initial release for consultation, the Bill has evolved to take into account practical considerations for taxpayers and provide a taxation framework for globally focused businesses operating within Australia that is conducive to a productive, dynamic, and growing Australian economy. In particular, the broadening of the scope of the third-party debt test and the narrowing of the scope of the debt deduction creation rules will positively impact Australia’s private capital industry by creating a tax system that is easier to navigate, more transparent and consistent with existing domestic and international taxation regimes.
2.7The Australian Banking Association noted the amendments largely addressed their previous concerns.
2.8Infrastructure Partnerships Australia acknowledged the significant improvements made to the bill as released on 28 November 2023, addressing a range of important changes repeatedly requested by industry.
2.9The Business Council of Australia (BCA) similarly welcomed the continued consultation on the amendments, noting it ‘supports the overall objective that the proposed amendments “balance the tax integrity policy intent while continuing to support genuine commercial activity and being mindful of compliance costs”’.
2.10The Australian Tax Office (ATO) advised that it attended many of the stakeholder consultation processes and considers ‘the Bill and the proposed Government amendments appropriately address the tax risks explored throughout the development and consultation process’.
Consultation
2.11In their submission and during the hearing, Treasury and the ATO provided detail on the consultation and engagement they have had with interested parties, particularly the property and forestry sectors, to refine the bill through these amendments. Treasury described the process as iterative:
We have worked through a number of issues that they raised from that time and going forward. It's probably also important to note that it is an iterative process. We would identify resolutions to some of the issues that were being raised, and further issues were being identified as stakeholders had further time to consider the provisions.
2.12In their submission, Treasury stated that the amendments reflect ‘extensive consultation with stakeholder groups and respond to feedback provided’.They also detailed that additional policy changes were informed by ongoing public consultation with industry stakeholders, ‘This includes new information not previously provided by stakeholders in the previous rounds of consultation undertaken by Treasury’.
2.13Treasury also detailed the engagement ATO has sought, including writing to members of the Large Business Stewardship Group, the National Tax Liaison Group, and the Private Groups Stewardship Group to inform their public advice and guidance on the regime reforms. Treasury noted the ATO is expected to update their website in January 2024.
2.14In their submission, Treasury stepped out the stages of consultation that has gone into the development of the bill and parliamentary amendments (see Figure 2.1).
Figure 2.1Treasury consultation process on the bill
Source: Treasury, Submission 18, p. 10
2.15During the hearing, Treasury elaborated on the multiple rounds of consultation that informed the bill, and the following rounds of consultation that informed the amendments:
If we go back to our original discussion paper, we had 70 written submissions and a number of engagements with stakeholders. We had 55 written submissions to the public consultation on the exposure draft legislation and 38 submissions in relation to the parliamentary amendments. And held some 21 meetings with various stakeholder groups just in relation to the parliamentary amendments. I would say we have consulted very broadly and very much in an iterative way.
2.16The ATO also concluded that the outcomes of this consultation process struck an appropriate balance:
…through our contribution to this measure—and obviously there have been contributions from various different stakeholders here—there was always going to be a need to strike a balance here in terms of the policy outcomes, and I think other witnesses have recognised this through the hearing. There are trade-offs here. Based on our contribution, we consider the bill in its current form, with the government amendments, to strike an appropriate balance.
2.17Treasury gave evidence on the work that has gone onto accommodating the property sector through its consultation process, particularly addressing concerns raised during consultation and to the inquiry that there may be adverse impacts to housing supply and prices:
…the tax is only one of the factors that was into investment decisions by investors and developers. There are a range of other factors that weigh into development decisions. The other point I would make is that, compared to the bill as initially drafted, we have made significant changes in consultation with the property sector and other stakeholders to try to accommodate a lot of the arrangements that were cause for concern under both the fixed-ratio test and the third-party debt test. While we haven't done modelling per se, we don't see that there is likely to be material impact flowing through to prices.
Implementation
2.18Several submissions called for prompt implementation of the bill with the proposed government amendments and raised concerns that the passage of the bill has been mired by interest groups seeking to water down the effectiveness of the bill or repeatedly delay the changes.
2.19Dr Shumi Akhtar emphasised the need to promptly enact the legislation ‘to avoid an endless cycle of attempting to satisfy every stakeholder’ and avoid continued exploitation of existing loopholes. She noted the extensive period dedicated to consultation and the resulting significant improvements to the bill mean further delay is not warranted.
2.20Despite belief that further amendments could strengthen the bill, the Tax Justice Network Australia (TJN-Aus), the Centre for International Corporate Tax, Accountability and Research (CICTAR), Publish What You Pay – Australia (PWYP), Public Services International (PSI) and the Australian Nursing and Midwifery Federation (ANMF) also recommend the bill be passed with the proposed government amendments rather than be derailed by ‘a concerted campaign by some business groups and their allies’.
Key points of concern
2.21While the amendments address some key matters raised in earlier consultation, some submitters argued a number of issues remain, in particular:
possible unintended consequences on particular sectors;
a need for clarification of some terminology and guidance on the application of certain provisions;
the commencement date and retrospective application of debt deduction creation rules;
the scope of debt deduction creation rules;
tax EBITA limits and application;
excess capacity EBITDA conditions;
deferral of the commencement date for the thin capitalisation rules as a whole; and
an absence of review mechanisms.
2.22These matters are explored in further detail in the following sections.
Third party debt test
2.23The bill introduced the third-party debt test which replaces the existing arm’s length debt test. It allows all debt deductions which are attributable to third party debt or that satisfy certain other conditions. It disallows related party debt deductions.
2.24Treasury explained that it is intended to operate as a third party credit assessment test, based on the borrowing capacity of the Australian ‘borrowing entity’. Treasury further advised:
The test is an Australian specific, bespoke policy setting. While it operates as a concessionary departure from the [Organisation for Economic Cooperation and Development] OECD best practice approach – to principally accommodate capital intensive sectors, in recognition of their long investment horizons and cash-flow profiles – it nonetheless reflects the OECD guidance (generally, in relation to certain public benefit projects) that exclusions from the fixed ratio rule be ‘tightly targeted’ to third party loans linked to specific assets.
2.25The test targets sectors typically reliant on significant third-party capital and is ‘intended to facilitate investment, specifically in Australian real property and infrastructure projects, including greenfield projects in the development and construction phase’.
2.26The government amendments expand the application of the third-party debt test including:
credit support carve outs;
use of the term ‘Australian entity’;
clarification on the application to conduit financer arrangements;
ability to disregard lender recourse to ‘minor or insignificant’ ineligible assets; and
exemption from the prohibition on credit support for certain rights.
General comments on third party debt test
2.27Submitters raised concerns that the third-party debt test continues to create uncertainty and gives rise to a range of unintended consequences.
2.28The Property Council of Australia called for amendments to the third-party debt test to facilitate access by certain typical commercial arrangements. They noted:
…financing arrangements of wholly owned Australian entities with no offshore assets which borrow from external third party banks are potentially not able to satisfy the [third party debt test] TPDT conditions.
2.29Further, the Property Council reiterated earlier proposals for the removal of the deemed third party debt test choice for entities that have entered into cross-stapled arrangements unless the entities are members of an obligor group, explaining:
No member of an open-ended stapled property group will be able to apply the Third-Party Debt Test because this will result in full denial of deductions on cross-stapled loans as the stapled entities are now considered associate entities.
2.30On this matter, Chartered Accountants Australia and New Zealand and The Tax Institute recommended ‘that the Government Amendments include clarification that the deemed choice for cross staple arrangements does not include entities in a private group where there is no legal stapling’.
2.31CPA Australia suggested that the third-party debt test has limited utility in its current form as it does not reflect how third-party lenders operate. It advised:
Standard lending arrangements would see the lender also having (as a minimum) security over the equity in the borrower, as well as associate entities. The fact remains that very few third party lenders will lend having recourse to the assets of the borrowing entity only. They will require assets of related entities as security and guarantees instead. As it stands, some third party lenders will still not satisfy the third party debt test recourse requirements.
2.32CPA Australia argued the government should not pursue a general prohibition on recourse to assets that are credit support rights, instead recommending that:
…the test should insert a purpose test that limits its scope to disallowing debt deductions where a ‘debt dump’ of third party debt in Australia that is recoverable against the global group occurs. This was the specific concern highlighted in the Explanatory Memorandum.
2.33King & Wood Mallesons recommended the inclusion of objective tests and safe harbour limits to allow the rules to operate appropriately for legitimately highly geared taxpayers. They advised ‘the rules will potentially result in foreign investors that are geared offshore being more competitive than Australian bidders in the context of acquisitions of multinational groups’.
2.34Nufarm argued that some provisions, including eligibility criteria in the third party debt conditions, result in comparative and actual disadvantage to Australian multinational enterprise [MNE] groups. They considered that the ‘third-party debt condition in paragraph (d) of subsection 820-427A(3) of the Bill be deleted in its entirety’ as it ‘creates an impractical and seemingly unfair outcome for Australian MNE Groups in comparison to foreign headquartered multinational groups (Foreign MNE Groups) operating in Australia through a local subsidiary’. Nufarm added:
… it is our expectation that the requirement in paragraph (d) of subsection 820-427A(3) of the Bill is likely to effectively prevent large Australian ‘outbound investing’ MNE Groups from accessing the Third-Party Debt Test (TPDT).
2.35Some submissions commented that the third-party debt test is an ‘all or nothing test’ and called for the test to be amended. Infrastructure Partnerships Australia stated:
To the extent the conditions are partially satisfied, it is unclear why the law should not allow the debt to satisfy the Third Party Debt Test, that is, “to the extent” to which the conditions are satisfied? Such an approach would still be in line with the policy objectives and better align to the approach taken globally.
Conduit financing and hedging arrangements
2.36Submissions outlined ongoing concerns and drafting issues in relation to foreign currency hedging arrangements and the conduit financer rules under the third party debt test, particularly for the property sector.
2.37SW Accountants & Advisors argued the current amendments are drafted in such a way that the passing on of costs associated with managing foreign currency risk pertaining to the ultimate debt interest (the external loan) on behalf of the group would mean that a conduit financier would not be able to satisfy the third-party debt test.
2.38The Property Council of Australia raised concerns that debt deduction denials arise where interest free cash loans are made within a group, as the amount is not on-lent on the same terms as the third-party lender. They explained:
A conduit financer borrows from a third party and on-lends on the same terms to a Holding Trust. The Holding Trust uses most of those funds to subscribe for equity in subsidiaries (which is permitted) and uses a small amount to on-lend on a non-interest bearing basis to subsidiaries where they have short term cash needs.
2.39In a proposed solution, the Property Council of Australia suggested the on-lending be permitted under conduit financing rules where it gives rise to no debt deductions (i.e., is treated as "associate entity equity" under the current law).
2.40The Property Council also called for an expansion of the circumstances in which swap payments are considered attributable debt interests, in order to accommodate arrangements where ‘conduit financers enter into third party swaps, and then enters into back to back swap arrangements with the entity (or entities) to which it on-lends’. They also called for changes to:
… permit a related entity of the borrower to enter into swap arrangements, by treating the debt deductions as attributable to the debt interest. In certain structures, downstream vehicles may borrow from a third party, and an upstream holding entity may enter into swap arrangements on a portfolio basis.
2.41The Ontario Municipal Employees' Retirement System, Caisse de dépôt et placement du Québec, British Columbia Investment Management Corporation, and the Ontario Teachers' Pension Plan (the Canadian Investors) advised that, from a policy perspective, ‘a back to back swap should be treated the same as a back to back borrowing’. They further recommended that the treatment of cross-currency interest rate swaps meet the requirements for deductibility in section 820–427A(2).
2.42SW Accountants & Advisors highlighted the term ‘hedging or managing the interest rate risk’ needs clarification. They noted:
…it is unclear whether the term ‘hedging or managing the interest rate risk’ is a composite phrase or ‘hedging’ and ‘managing interest rate risk’ are separate exclusions. This wording creates uncertainty as to whether the hedging of foreign currency risks relating to debt would be able to be recovered by a conduit financier without breaching the conduit financier conditions.
2.43Additionally, SW Accountants & Advisors advised that an ‘entity that hedges foreign currency risk associated with a third party loan, should not be precluded from eligibility for the third party debt’ as it does not give rise to base erosion or profit shifting. They highlighted that hedging of foreign currency risk is a commercial necessity in some circumstances such as where the third party lender is only willing to lend in foreign currency where Australian entities are required to import debt capital into Australia. SW Accountants & Advisors proposed that ‘the hedging of this risk should be viewed in exactly the same way as arrangements to hedge interest rate risk’.
2.44SW Accountants & Advisors also highlighted that ‘the cost of hedging foreign currency risk relating to a foreign currency denominated debt does not fall within the meaning of ‘debt deduction’. They proposed amendments that would ‘align with OECD guidance to treat foreign currency hedges as an amount which could be passed through a conduit financer’.
Credit support carve-out
2.45There was some discussion among stakeholders about the expansion of credit support rights and intended application of the carve outs.
2.46Infrastructure Partnerships Australia, for example, raised concerns that a significant number of large scale infrastructure projects, such as large-scale transmission and distribution projects, will not be eligible for the carve out because of the ‘requirement that the relevant project “be” Australian land (including an interest in land situated in Australia) or moveable property situated on that land’. They noted, given the intent of the development carve out, such an exclusion appears to be an unintended oversight, explaining:
Electricity transmission and distribution infrastructure is developed on large corridors of land comprising a patchwork of legal land tenures … From a legal perspective, a licence or right of way is merely a contractual right between the transmission/distribution entity and the relevant landowner rather than an ‘interest in land’.
2.47Infrastructure Partnerships Australia and Deloitte recommended the wording of section 820–427A(5)(a)(iii) be amended to provide the appropriate ‘connection’ to land situated in Australia by substituting the words “an interest in land” for “a quasi-ownership right held over land”. The concept of a quasi-ownership right is used in subdivision 40-B and Division 43.
2.48Some submitters also proposed a limited extension to the development carve out to permit support from foreign associate entities of the borrower during the development phase, and even the post-development phase, of an otherwise qualifying project.
2.49Infrastructure Partnerships Australia explained:
It is a simple fact that the amount of external bank financing required for the development of large-scale greenfield infrastructure projects can often only be obtained by foreign controlled Australian groups with significant credit support from foreign parent entities. The provision of credit support in these circumstances increases access of the project to relatively lower cost external third party debt capital that lowers the cost of the project and, in turn, lowers that cost to end users. In the case of infrastructure critical to Australia’s energy transition, this means lower costs to Australian energy consumers including businesses and household consumers.
2.50The Property Council of Australia argued ‘the development asset concession needs to apply up to two years beyond the date of completion of the development to allow for stabilisation of the asset and noted this was highly relevant to build-to-rent assets. They further advised that foreign residents (regardless of their percentage holding) should be able to provide credit support during the development and post-development period to income stabilisation.
2.51CPA Australia similarly highlighted the concession’s ‘greenfields exception’ is ‘not available where a foreign entity that is an associate entity provides a guarantee or other form of credit support’. They argued that:
This requirement creates an unlevel playing field for development assets, where Australian entities that hold 50 per cent or more are permitted to provide a guarantee (even where the assets of the Australian entity are foreign assets), while non-residents are not permitted to provide a guarantee in these circumstances (even if their assets are Australian assets).
2.52The Public Sector Pension Investment Board (PSPIB) and The New Zealand Superannuation Fund (NZSF) called for an exception to the third party debt test for certain foreign entity support, in particular equity commitment letters from foreign associates. They explained:
In the context of long term development projects, it is customary for foreign institutional investors, such as the Foreign Funds [PSPIB and NZSF], to progressively provide equity to fund the development expenditure over time (rather than a lump sum upfront which is unapplied for a number of years). These arrangements involve equity commitment letters which are relevant to the third party lending to the project.
2.53PSPIB and NZSF noted that the government amendments introduce permission for certain types of credit support but noted:
… where such credit support allows recourse to a foreign entity that is an associate, the arrangement is not permissible under the current drafting of section 820-427A(5)(b) and therefore the Australian borrower cannot access the [third party debt test] TPDT to claim debt deductions in respect of the third party loans.
2.54They explained the risks of proceeding without implementing the proposed carve out:
Where these types of credit support cannot be provided by the foreign associate, it could give rise to broader policy considerations. For example, a lack of foreign entity credit support may result in third party debt may[sic] not being available for certain greenfield development projects or alternatively increase the cost of debt funding for such projects, thereby reducing the viability of construction projects in Australia.
2.55Treasury advised that it is cognisant of the arguments from some industry groups, particularly property and infrastructure sectors, in support of sectoral carve outs from the thin capitalisation changes. It advised the committee:
… sectoral carve-outs detract from the principle of neutrality. As noted above, the thin capitalisation changes are intended to apply to all sectors, and the third-party debt test is an explicit recognition that certain sectors have a different investment profile, and that some flexibility is warranted to minimise transition costs and support investment attraction.
Clarification of various terms
2.56Submitters also called for amendments to clarify some key terms and concepts related to the third party debt test.
Obligor group
2.57The term ‘obligor group’ has been amended to indicate that it includes any entity that has one or more assets to which the creditor has recourse.
2.58Infrastructure Partnerships Australia proposed a note be included in section 820–49(b) to clarify that indirect credit support is not the type of recourse intended to be covered by the section. They outlined:
recourse for these purposes does not [include] recourse that may be obtained by a creditor through the exercise a right under or in relation to a guarantee, security or other form of credit support as that term is used in section 820-427A(5).
2.59Likewise, Deloitte argued that examples should be included in the bill, or the Explanatory Memorandum as a less favourable option, to clarify the application of some provisions in ss820-49(1)(b) and ss820-427A(3)(c). It also proposed:
an amendment be made to ensure that a right that provides recourse, directly or indirectly, only to one or more Australian assets held by an Australian entity that holds membership interests in the borrower is subject to an exception under ss820-427A(5).
Applying the “minor or insignificant” carve-out
2.60Submissions highlighted that additional guidance is required as to how to apply the “minor and insignificant” carve-out.
2.61Dr Shumi Akhtar explained the concern, stating:
Clarity is needed on the third-party debt test for domestic outbound groups, specifically explaining the term 'the minor and insignificant foreign assets exclusion.' For instance, could this be defined as a scenario where the total minor and insignificant foreign assets are less than a certain percentage of the overall assets of the parent company, or is it defined as a specific, constant value, such as less than $X?
2.62Infrastructure Partnerships Australia similarly noted the need for practical guidance, explaining that it is unclear, for example, if foreign assets comprising five or 10 per cent of the secured assets should be considered ‘minor’ or ‘insignificant’.
2.63QIC also noted the term ‘minor or insignificant’ should be clarified in relation to the exception to the ‘Australian asset only’ requirement in the third-party debt conditions (subsection 820-427A(3)(c)), stating:
We recommend an objective test, for example by reference to the value of the ineligible asset as a proportion (such as 10%) of the security pool when the relevant debt is created, to provide certainty to taxpayers.
“Australian assets”
2.64Some stakeholders raised concerns that the term “Australian assets”, as referred to at 832–427(3)(c) and in the Explanatory Memorandum, is not explicitly defined in the bill or Explanatory Memorandum.
2.65The Explanatory Memorandum states:
‘Australian assets’ is intended to capture assets that are substantially connected to Australia. The following assets are not intended to be Australian assets:
Assets that are attributable to the entity’s overseas permanent establishments.
Assets that are otherwise attributable to the offshore commercial activities of an entity.
“hedging”
2.66Dr Shumi Akhtar highlighted that the term 'hedging' requires specificity. She explained the term:
… doesn't inherently refer to hedging interest rate risk or foreign currency risk. Given its various forms and implications in financial markets, particularly in the context of thin capitalisation, paragraph 820-427A(2) needs further clarification to delineate which risks are being hedged.
Debt deduction creation rules
2.67Subdivision 820 EAA introduces the debt deduction creation rules which disallow debt deductions (excessive interest deductions) to the extent that they are incurred in relation to debt creation schemes lacking genuine commercial justification.
2.68The amendments make changes to rule exemptions and exclusions to ensure genuine commercial transactions that are not the target of the rules are not inadvertently captured.
2.69The SEM clarifies that the debt deduction creation rules are applied before the fixed ratio or group ratio tests. Treasury also explained that the third party debt arrangements ‘are no longer within the scope of the operative provisions of the debt deduction creation rules’.
2.70The commencement of the debt deduction rules has been deferred to 1 July 2024.
Deferral of commencement
2.71Many stakeholders commended the deferral of the debt deduction creation rules in their entirety to 1 July 2024.
2.72The Australian Financial Markets Association noted the change was consistent with their previous submissions.
2.73Treasury noted the deferral of the debt deduction creation provisions was:
a pragmatic and further concession responding to stakeholder feedback to provide taxpayers with more time to analyse the final form of the debt deduction creation rules once the bill passes Parliament, and to restructure their arrangements as needed.
2.74A few stakeholders proposed the debt deduction creation rule commencement be deferred further, to 1July 2025, to allow taxpayers additional time to prepare.
Grandfathering and transitional issues
2.75A number of submitters raised concerns about the retrospective application of the debt deduction creation rules and the associated burden on taxpayers needing to consider historical arrangements to determine whether the debt deductions will be allowed.
2.76Stakeholders, including Infrastructure Partnerships Australia, Toyota Material Handling Australia (Toyota), King & Wood Mallesons, PKF and QIC, proposed the debt deduction creation rules only apply to debt created from the date the legislation is enacted, given the complexity of reviewing historical transactions.
2.77Pitcher Partners further advised the compliance burden could extend to all entities that may someday become subject to the rules, explaining:
The [debt deduction creation rules] DDCR would also impose current obligations on entities who are not subject to the rules but may become subject to the rules in the future (e.g. where their business and level of debt deductions grows and/or they begin to expand offshore). The first year that any entity becomes subject to the rules may require them to consider all their historic arrangements which could suddenly result in debt deductions being denied. Effectively, it puts all taxpayers on notice in respect of their current transactions, should they one day become subject to the DDCR.
2.78CPA Australia explained the lack of grandfathering of any pre-existing arrangements with the debt deduction creation rules may result in a need for a ‘complex tracing exercise to determine the original use of any existing and new related party debts, including where these debts have been refinanced multiple times’.
2.79The Property Council of Australia, Pitcher Partners and Chartered Accountants Australia and New Zealand and The Tax Institute argued the debt creation rules be removed from the bill, noting a need for further consultation and raising legislative drafting concerns.If the rules remain, the Property Council of Australia advised, the application should be deferred until income years commencing on or after 1 July 2024 and only apply to future arrangements.
2.80Similarly, PSPIB and NZSF called for the debt deduction creation rule to be removed from the bill and asked that the policy and legislative design of the bill be referred to the Board of Taxation for a comprehensive review.
2.81In response to these arguments, Treasury advised it is aware of stakeholder groups seeking full grandfathering of all existing arrangements. It noted:
… a wider concession, as sought by industry, would introduce competitive neutrality issues, reduce the integrity of the new thin capitalisation rules, and increase compliance complexity going forward. Integrity risks would include businesses seeking to roll over grandfathered financing arrangements (that would otherwise result in denied debt deductions) to avoid the integrity rules in perpetuity. We expect that the ATO, consistent with other legislative changes, will issue guidance on transitional arrangements to assist taxpayers.
2.82Treasury gave evidence on the work that has gone onto accommodating the property sector through its consultation process, particularly addressing concerns raised during consultation and to the inquiry that there may be adverse impacts to housing supply and prices:
There were a number of changes that were made for the bill that was then introduced into parliament. Whilst there have been further changes and, indeed, the parliamentary amendments, which were consulted on, do include a number of changes, those changes go to clarifying and streamlining the operation and to resolving a number of technical issues, as we've previously acknowledged. Our view is that the rules have been quite clear for stakeholders for some time.
Alternatives
2.83If no grandfathering is introduced, some stakeholders proposed additional measures and guidance be provided to assist businesses with the transition.
2.84Toyota proposed additional guidance be included in the Explanatory Memorandum to assist businesses understand how to implement the necessary historical review of transactions.
2.85Infrastructure Partnerships Australia proposed that the debt deduction creation rules only apply to debts first created during the five income years preceding 1July 2024 (“the look back period”), noting five years is:
...broadly equivalent to the period in which a taxpayer’s tax returns would reasonably be open for amendment, and therefore the period during which reasonable records from which to undertake the details DCR analysis would most likely be available.
2.86Infrastructure Partnerships Australia further noted the application limit should apply to debt created during the look back period for the primary purpose of refinancing a debt created prior to the lookback period.
Guidance and legislative clarity
2.87Stakeholders identified a need for further guidance on the application of the debt deduction creation rules to certain transactions.
2.88The BCA noted that the absence of transaction examples in the EM creates uncertainty. It explained:
Greater legislative clarity should be provided by including specific examples in the Explanatory Memorandum to the original bill and Supplementary Explanatory Memorandum to the proposed amendments of the types of transactions that are intended to be captured by the DDCR and those that are not considered artificial, contrived or lacking commercial justification.
2.89The Corporate Tax Association similarly highlighted that, without guidance, the resulting uncertainty ‘will be a time-consuming, resource-intensive and costly compliance exercise for the ATO and businesses impacted by the rules to unravel’.
2.90The Corporate Tax Association and the BCA emphasised that further guidance should be legislative. The Corporate Tax Association explained:
Legislative guidance can assist in this regard if it is capable of being considered by a Court. We do not recommend that examples simply be provided via ATO guidance, as that happens after the legislation is already passed, and in any event, is not capable of being considered by a Court in interpreting the underlying policy intent of the relevant provisions.
2.91In regard to anti-avoidance provisions, for example, the BCA and the Corporate Tax Association, called for greater certainty that:
… taxpayers undertaking reorganisations to comply with the [debt deduction creation rules] DDCR will not be subject to the anti-avoidance rule in section 820-423D or the general anti-avoidance provisions under Part IVA [of the Income Tax Assessment Act 1936 ].
2.92PSPIB and NZSF also highlighted the debt deduction creation rule does not accommodate for genuine group restructuring that involves related party debt funding, particularly in the period following a commercial transaction. They note post-acquisition restructuring is ‘common in transactions with ASX listed groups where the transaction is commonly governed by a Scheme of Arrangement that does not facilitate restructuring prior to the acquisition’. PSPIB and NZSF therefore called for the rules to be amended to apply to assets acquired outside an initial 12-month period post-acquisition to ensure that genuine commercial restructuring can occur without the arrangements being adversely impacted.
2.93Deloitte also advised a need for clarity on the interpretation and application of the anti-avoidance rules in Section 820–423D, calling for prescribed factors to be considered when exercising the Commissioner’s discretion in the scheme rules. They note that, while the current guidance in the SEM is helpful, a Court may not take it into account or be led to the same conclusion. Deloitte therefore argued wording in this vein should be included in the legislation, or as an example in the legislation.
2.94Another issue submissions called for clarity on was the financial arrangement involving associate pairs. The BCA called for changes to the wording of Subparagraph 820-423A(5)(b)(ii) to ‘remove residual uncertainty’, explaining,
This is particularly important for cash pooling arrangements in place where it may be difficult to trace the use of borrowed funds to an excluded distribution and to also ensure that companies that are undertaking expansion projects but continue to pay dividends are not adversely impacted. The [Corporate Tax Association] CTA’s submission dated 22December proposes replacing the proposed amendments with alternative wording to ensure it meets the stated policy objective in relation to financial arrangements involving associated pairs.
2.95BCA also called for clarification of the exclusions in subsection 820-423AA(1) to:
… ensure capital contributions that are new contributions of foreign equity (but technically not new membership interests) are not caught by the rules. This is necessary because in some jurisdictions, most notably Australia and the US, capital can be contributed without a new membership interest being issued.
2.96The ATO advised it has commenced public consultation, requesting stakeholder views on ‘priority issues that would inform the ATO’s administrative approach and public advice and guidance on this measure’. Stakeholder engagement with the request has been so far limited.
2.97During the hearing, the ATO provided further details on the steps it will take implementing these reforms with industry.The ATO committed to working closely and collaboratively with taxpayers and stakeholders and confirmed they will take a considered approach to companies as they restructure themselves to comply with reforms:
we're really mindful that taxpayers will need to manage the transition from the current thin capitalisation regime to the proposed new thin capitalisation regime on passage of the bill, and this may well require restructuring of existing financing arrangements. We're also mindful that there are some concerns within the stakeholder groups about whether that restructuring might fall foul of integrity rules, not just in the measure itself but also more generally.
What I'll say about that is that, as a general principle, the ATO would not be looking to apply integrity rules in the proposed new law or elsewhere where taxpayers are restructuring their arrangements as a means of seeking to comply with the underlying intent of the new law. This is an approach we have taken in the past.
2.98Similarly, they confirmed that matters raised through the inquiry that relate to technical and interpretive concerns from stakeholders and submitters will be considered and included in their public advice and guidance.
2.99The ATO and Treasury follow a best practice procedure for developing guidance that is applicable to all new tax laws.The ATO advised:
Without pre-empting stakeholder feedback, it is expected that initial consultation on public advice and guidance priorities will likely focus on transitional arrangements and identifying what advice and guidance is needed to deal with practical issues concerning related party debt funding of high-volume related party acquisitions and payments that may attract the operation of the [debt deduction creation rules] DDCR.
2.100The ATO provided information on potential public advice and guidance (PAG) topics for which ATO guidance will be prioritised, including identifying the debt deduction limitation rules for debt deduction creation.
Associate pairs
2.101The government amendments present a modified definition of ‘associate entity’ that is used throughout the new thin capitalisation rules. Minor amendments have been made to this modified definition ‘to ensure the related definition of ‘associate’ in section 318 of the ITAA 1936 does not conflict with the modifications to the definition of ‘associate entity’ in the ITAA 1997’.
2.102The Corporate Tax Association advised that the debt deduction creation rules should be consistent with the wider thin capitalisation rules by applying the same associate entity test rather than the category of “associate pair”. They explain:
For the wider purposes of the thin capitalisation rules, the “association” test refers to the requirements of “associate entity” in section 820-905 of the Income Tax Assessment Act 1997. By contrast, the DDCR create a new category of “associate pair” which ultimately refers back to the definition of “associate” in section 318 of the Income Tax Assessment Act 1936 in assessing “association” which is much broader than the associate entity test.
2.103Further, the Corporate Tax Association recommended Division 7A loan arrangements be clarified. They advised these should not be impacted by the debt deduction creation rules.
2.104Pitcher Partners highlighted that the application of the debt deduction creation rules to the acquisition of obligations needs to be properly explained and reconsidered, as well as calling for a rethink of the broad approach to indirect payments and acquisitions. Pitcher Partners noted:
In accordance with the ATO’s guidance on trust distributions to corporate beneficiaries (refer to TD 2022/11 and PCG 2022/2), corporate beneficiaries are encouraged to convert their unpaid trust entitlements into loans where the parties intend for the trust to retain the funds representing the entitlement. This may involve the satisfaction a trust entitlement considered to be a distribution accompanied by the entering into a financial arrangement to fund that distribution. Such a transaction generally occurs between associates.
It is possible that the [debt deduction creation rules] DDCR would apply to deny debt deductions in respect of this kind of common arrangement that occurs between members of private groups and supported by the ATO in the context of Division 7A and section 100A.
Scope of the debt deduction creation rules
2.105Some stakeholders opposed the amended scope of the debt deduction creation rules, arguing that it still has much broader application than is necessary to achieve policy objectives and will have potentially adverse impacts on investment.
2.106The Corporate Tax Association advised that, as the debt deduction creation They also clarified the intention of the bill including debt deduction creationsrules being based on OECD best practice rules is applied first, ‘it is critical that it should only deny related party debt deductions that are artificial and contrived, otherwise the other wider rules are superfluous’. They proposed a range of drafting suggestions aimed at addressing these concerns, which are described further in the following discussions on particular scope matters.
2.107Toyota argued that the debt deduction creation rules place businesses like theirs at a competitive disadvantage ‘compared to other lease providers who do not acquire assets from related parties’. They noted transfer pricing rules already exist to achieve neutrality and manage perceived concerns.
2.108The Property Council of Australia similarly noted ‘the broad operation of debt deduction creation rules to eliminate interest deductions is likely to give rise to outcomes that are not aligned with the policy intent’. They argued, for example, that many of the benefits from reforms to close the nation’s housing supply deficit will not be realised if the bill in its current form is passed, stating:
While we note that the Government’s amendments improve the Bill, it is not yet fit-for-purpose. Genuine business activities will still be captured, restricting the institutional property sector’s ability to debt finance projects. The Bill will disincentivise investment in and development of Australian homes.
2.109The Property Council of Australia proposed the Commissioner of the ATO be given a broad discretion not to apply the debt deduction creation rules to a particular arrangement to achieve flexibility if further unintended consequences of the bill are realised.
2.110Addressing views from some inquiry participants that existing anti-avoidance laws within part IVA of the Income Tax Assessment Act 1936 were sufficient, meaning the debt deduction creation rules may not be required, the ATO said:
What we would say is that part IVA … is a provision of last resort that is generally better suited to more egregious tax avoidance. In terms of actually achieving the intent of this measure, the underlying intent, I think it is important for something like the debt deduction creation rule to be in place to ensure that that intent is achieved.
2.111The ATO also clarified the intention of the bill, including debt deduction creation rules being based on OECD best practice:
…the OECD-recommended best practice, which is what this measure is ultimately based on, does recognise the need for targeted rules to address specific risks, and the ATO would certainly see the debt deduction creation rule falling within that remit.
Purpose test
2.112Submissions, including Perpetual, CPA Australia, QIC, the Financial Services Council and King & Wood Mallesons, continued to call for an overarching purpose test to be introduced to the debt deduction creation rules to ensure it doesn’t adversely impact genuine commercial transactions.
2.113CPA Australia noted that, despite the narrowing of its scope, the debt deduction creation anti-avoidance rules without a tax purpose test could result in the denial of commercially valid interest deductions. It argued that some genuine transactions will still fall outside the exclusion from the debt deduction creation rules, further discouraging investments into Australia. CPA Australia stated:
Investors need certainty – they are hesitant to invest in jurisdictions where tax anti-avoidance rules could apply to a genuine commercial transaction.
2.114King & Wood Mallesons noted a purpose test was necessary to ensure the measures did not apply to ‘purely domestic arrangements where the corresponding receipt of interest is assessable in Australia.’
Exclusion of authorised deposit-taking institutions
2.115The Australian Banking Association (ABA) and Australian Financial Markets Association (AFMA) welcomed the exclusion of Authorised Deposit-Taking Institutions (ADIs) and securitisation vehicles from the debt deduction creation rules contained in proposed Subdivision 820-EAA.
2.116ABA advised these are reasonable amendments that allow for ‘legitimate deductions for the cost of banking intermediation activities’, explaining:
…the financing structures are valid for banks; enabling them to compete for international wholesale funds and obtain the most efficient rate. Further, the exemption for ADIs does not undermine the intent of the legislation and is consistent with other aspects of the Bill, specifically the exclusion of ADIs from the new earnings-based tests.
2.117However, AFMA proposed the exemptions be extended to ‘entities classified as a “financial entity (non-ADI)” for thin capitalisation purposes’ to reflect the similar role such entities play in financial markets. AFMA notes exempting these entities is consistent with the policy rationale for the debt deduction creation rules.
Application to ordinary commercial transactions (including trading stock)
2.118There was some discussion among stakeholders that ordinary commercial transactions such as the debt-funded acquisition of trading stock from overseas related parties are unnecessarily captured by the amended rules.
2.119The BCA noted the rules ‘still impact related party debt-funded transactions in the ordinary course of business that are not an integrity concern and are in fact a routine element of efficient business operations’.
2.120PKF, Toyota, BCA and the Corporate Tax Association called for debt-funded acquisition of trading stock from related parties to be excluded from the application of the subsection.
2.121The Corporate Tax Association explained:
Related party debt (and cash pooling/management systems) are efficient forms of finance. If taxpayers must now use external third-party debt to fund the acquisition of trading stock, the pricing of debt may be more costly, and it is likely such funding would be exempt from withholding tax which would not be the case if related party debt is used. Businesses will need to restructure these transactions and then decide whether this unnecessary additional cost should be passed on to the end user.
2.122BCA argued the absence of a carve-out for related party funding of trading stock prevents access to ‘efficient forms of finance in the form of cash pooling between related entities’ and requires related parties to use more costly external, third-party debt.
2.123CPA Australia noted, for example, that the lack of exemption for trading stock means debt deductions:
… will likely be denied where an entity uses related party debt to fund the acquisition of trading stock from an associate. This is likely to capture situations where intercompany payables on stock purchases are left outstanding and begin to accrue interest.
2.124PKF further noted the rules contained in the former Division 16G of the Income Tax Assessment Act 1936 on debt creation contained such an exception.
2.125Treasury provided commentary on the application of the debt deduction creation rules to trading stock:
While we recognise that trading stock represents a recurrent business transaction, one of the overarching policy objectives of the debt deduction creation rules is to disallow related party debt deductions created through the mere transfer of assets between related entities. Noting the purchase of trading stock from a related party is usually capable of being financed from the working capital of the purchasing entity or settleable without attracting interest, the amendments in their current form are only likely to apply to scenarios where interest has accrued on unpaid stock purchases.
Circumstances where an entity does not have funds available to purchase inputs – that is, a business relying on using related party debt to acquire related party assets (to fund day-to-day business transactions) – is likely to be reflective of a thinly capitalised entity, which is what the underlying thin capitalisation framework is targeting, rather than being the norm. For businesses with a high volume of trading stock transactions, ATO guidance is expected to assist taxpayers on how to apply the debt deduction creation rules.
2.126The Property Council of Australia outlined a number of other genuine business activities that they believe may be captured by the bill despite not reflecting any risk to Australia’s multinational tax regime. For example, they called for exceptions for arrangements between wholly owned Australian entities, noting:
While an exception to the [Debt Deduction Creation Rule] DDCR is now provided if the entity elects the TPDT not all entities will be able to elect the [Third Party Debt Test] TPDT. In addition, and critically, the TPDT needs to be modified to accommodate typical commercial financing structures.
2.127Pitcher Partners similarly called for the expansion of the exclusion for the ‘acquisition of a new membership interest in an Australian entity or a foreign entity that is a company’ to acquisitions of membership interests in foreign trusts or foreign partnerships.
2.128Treasury addressed these arguments in its submission, highlighting that:
there are views among taxpayer groups that the exemptions do not go far enough and the former Division 16G should be transposed in full (in particular, an exemption for the acquisition of related party trading stock). As noted above, the new debt deduction rules are intended to reflect the evolution of financial arrangements since Division 16G was originally introduced in 1988.
Conduit financing
2.129CPA Australia raised concerns about the application of the debt deduction creation rules to conduit financing arrangements even where the entity has not chosen the third party debt test, noting:
… the debt deduction creation rules will still need to be considered where an entity has conduit financing arrangements that satisfy the conditions of the third party debt test but the entity has not chosen the third party debt test. This is because the entity also has related party debt or if it does not want to forfeit its ability to carry forward disallowed amounts under the fixed ratio test.
Exemptions for acquisitions of certain CGT assets:
2.130The Corporate Tax Association called for clarification of the exclusions in subsection 820-423AA(1) ‘to ensure capital contributions that are new contributions of foreign equity (but technically not new membership interests) are not caught by the rules’. They advised that this change ‘is necessary because in some jurisdictions (e.g. USA and Australia) capital can be contributed without a new membership interest being issued’.
Depreciating asset exemption
2.131Submitters suggested some aspects of the exemption for ‘acquisition of certain new depreciating assets’ are unnecessarily restrictive.
2.132PKF and Toyota noted the ‘time of acquisition’ requirement in 820–423AA(2)(a) is overly prescriptive, requiring a specific purpose at the time of acquisition to be identified rather than a test of what the asset is actually used for.
2.133Toyota noted the intent of the exemption is to allow Australian entities to deduct interest on borrowings to acquire depreciating assets from a related party where the criteria are met. Toyota explained, however, that its business operations are more complex than the rules allow for. They explained when they place an order they don’t always know the use of the asset as a minority is ordered as buffer and may be sold as trading stock or added to their rental fleet to be held as a depreciating asset. Toyota also noted how the time of acquisition is typically well before the assets have arrived in Australia as they are invoiced at the time the asset leaves the factory. It is therefore not known at the time of acquisition if all the assets will be used for taxable purposes, within 12 months and within Australia.
2.134Toyota was also of the opinion that the wording in the SEM doesn’t align with the purpose of the ‘depreciating assets’ exemption and should be clarified.Paragraph 1.38 of the SEM currently reads as follows:
The acquisition of certain new tangible depreciating assets is disregarded. The exception is broadly intended to allow an entity to bulk-acquire tangible depreciating assets on behalf of its associate pairs.
2.135 Toyota explained:
In our view the above comments do not accurately cover the scope of the ‘depreciating assets’ exemption. For example, in our case we are acquiring tangible depreciating assets for our own use (rather than on behalf of an associate pair) which does not seem to be a clear purpose of the exception based on the SEM.
Australian asset threshold test
2.136Submissions, including those from King & Wood Mallesons and Pitcher Partners, called for the existing exemption from the thin capitalisation rules for Australian businesses with over 90 per cent Australian assets be extended to the debt deduction creation rules to limit the compliance burden for businesses that have overwhelmingly domestic operations.
2.137Pitcher Partners explained:
An Australian entity that owns a dormant foreign company (with no assets) may be subject to the [debt deduction creation rule] DDCR even though its group assets are 100% Australian assets, and all transactions occur within Australia. The mere presence of a foreign subsidiary should not be the difference between the DDCR applying or not applying. This renders meaningless the requirement for the entity to be an outward investing entity to be subject to the DDCR. If the rules can apply to wholly domestic groups (that hold a controlling interest in a dormant foreign subsidiary) then there should not even be a requirement for the entity to otherwise be an inward or outward entity.
$2 million de minimis threshold
2.138Concerned with the current application of the de minimis rule in relation to the debt deduction creation rules, submitters called for amendments.
2.139The Corporate Tax Association, for example, advised that amendments were necessary to ensure ‘transactions currently not subject to the tax EBITDA rules (because the taxpayer is currently below the $2 million debt deduction threshold) are not subject to the [debt deduction creation rules] DDCR in the future.’ They explained:
If the taxpayer group is not subject to the tax EBITDA rules at the time of the relevant transaction, then a subsequent (and typically unrelated) event that brings the taxpayer group into the tax EBITDA rules with debt deductions in excess of $2 million should not result in debt deductions being denied as the nexus between the underlying transactions and the debt deductions being denied by these proposed rules is not readily apparent.
2.140CPA Australia and Pitcher Partners argued the $2 million de minimis threshold should be based on net debt deduction, not gross, to prevent amounts being duplicated within a group and being counted twice, and to ensure compliance costs are appropriately balanced for amounts that are relatively small. CPA Australia highlighted that, given the introduction of a ‘net debt deduction’ concept, the change:
would prevent taxpayers from being caught where amounts are duplicated within a group and counted twice and ‘lose’ their de minimis threshold. As an example, an amount borrowed and on-lent to a related party resulting in $1 million of interest on each leg of the back-to-back loan would result in $2 million total debt deductions in the group. Under a net debt deduction test there would more appropriately be $1 million of net debt deductions as the interest income derived by the interposed entity would reduce the $2 million gross amount to a $1 million net amount.
2.141Pitcher Partners noted such an amendment would ‘retain the status quo for middle market taxpayers under the new rules, would provide integrity to the provisions on a group basis, and would appropriately reduce unwarranted compliance costs’.
Fixed ratio test
2.142The bill proposed a default fixed ratio test allowing an entity to claim net debt deductions up to 30 per cent of its ‘tax EBITDA’, to replace the existing safe harbour test (60 per cent of average value of the entity’s Australian assets) in current tax law.
2.143It also allows for debt deductions that were disallowed over the previous 15 years to be claimed under a special deduction rule where an entity’s net debt deductions are less than 30 percent of its tax EBITDA.
2.144The tax EBITDA model is broadly the entity’s taxable income or tax loss adding back deductions for interest, decline in value, and capital works.
2.145The government amendments contain changes to the calculation of tax EBITDA, including:
new deductions relating to forestry establishment and preparation costs and capital costs of acquiring trees;
clarification on how corporate tax entities calculate their tax EBITDA;
changes so dividends will only be disregarded for tax EBITDA purposes where the entity receiving the dividend is an associate entity of the company paying the dividend, in line with treatment of partnership and trust distributions;
catering for calculation of tax EBITDA for Attribution Managed Investment Trusts (AMITs) and members of AMITs; and
requirements for notional deductions of research and development (R&D) entities to be subtracted from tax EBITDA.
Tax EBITDA
30 per cent EBITDA limit
2.146The amended thin capitalisation rules limit an entity’s debt deductions to 30 per cent of its tax EBITDA, which is the fixed ratio earnings limit. Stakeholders continued to raise concerns about unintended consequences of this change on some industries.
2.147AFPA, for example, highlighted the tax implications and negative flow on effect on plantation forestry expansion in Australia, particularly for companies participating in plantation expansion. It advised,
Currently, under the balance sheet method, plantation forestry companies could claim up to 60% of their debt costs. Under the Bill (including Government amendments), companies can only claim a deduction for financing costs up to 30% of their tax EBITDA with any disallowed deductions carried forward for up to 15 years.
2.148AFPA notes the unintended consequences could include reduced reinvestment in plantation expansion efforts, contrary to multi-party and international commitments.
2.149To address these concerns, AFPA proposed further consultation with Treasury to consider appropriate options or the introduction of ‘forestry policy initiatives which offset the increase in tax placed on plantation forestry sector’.
2.150CPA Australia also raised concerns about the 30 per cent tax EBITDA interest cap, noting it will reduce deductible debt, making Australia a less attractive investment option, in turn adversely affecting jobs and the economy. CPA Australia explained:
This means jurisdictions such as Canada and China with asset-based limits and who are competing with Australia for investment will have a more favourable and simpler thin capitalisation regime.
2.151Treasury provided the following comments:
The debt deduction creation rules are necessary to support the effective operation of the thin capitalisation rules, by limiting the ability of entities to use (create) interest-bearing debt between related parties to increase their interest expenses up to 30 per cent of tax EBITDA. The absence of such a rule would provide opportunities for the avoidance of tax, by facilitating profit shifting in the form of tax-deductible interest payments between related parties.
2.152During the hearings, Treasury also further clarified that in designing the new thin capitalisation regime, and the third-party debt test in particular, there was consideration given to sectors of the economy that use debt in more legitimate ways:
…the third-party debt test was actually designed to enable those types of arrangements to essentially avoid that 30 per cent earnings cap. We would see that as a set of arrangements that would apply for sectors such as the property sector. Indeed, as we have indicated in our submission, we've worked quite closely with the property sector, the Property Council and other stakeholders to improve the operation of the third-party debt test.
Tax loss treatment
2.153Submissions highlighted a risk of double counting tax losses under the fixed ratio test, such as where a company chooses not to utilise the tax losses in a year (for example, cases involving stapled structures).
2.154King & Wood Mallesons called for the scope of the treatment of prior year losses under the fixed ratio test to be ‘modified to ensure multiple counting of the same losses or the inclusion of pre-new regime losses does not occur’, explaining:
Paragraph 820-52(1A) requires an assumption that prior year losses of a corporate tax entity are fully utilised when calculating tax EBITDA. This means that such losses could be counted multiple times over a number of years to the extent they are not utilised.
2.155Nufarm and Deloitte similarly highlighted the proposed treatment of prior years’ tax losses is inconsistent with the policy intent of tax EBITDA being an amount that is not reduced by current-year tax depreciation amounts, as prior year tax losses will to some extent typically be attributable to prior year tax depreciation amounts.
2.156Nufarm advised it ‘is punitive for Australian MNE Groups that have their risk taking and entrepreneurial activities in Australia compared to Foreign MNE Groups with far more limited risk operations with respect to their Australian presence.'
2.157Deloitte further noted ‘the proposed treatment can have the effect of understating tax EBITDA in later years, and thus deferring or preventing interest deductions.’
2.158Nufarm called for tax EBITDA to be a year-by-year concept ‘such that taxpayer impacted by the thin capitalisation rules previously should not be disadvantaged twice’. As such, they proposed the amendments reflect the original bill ‘contemplating an ‘add-back’ for tax losses utilised in computing taxable income (absent the operation of Division 820)’.
We contend this approach is preferable as EBITDA (excluded deductions for prior year tax losses) can be viewed as more appropriately reflecting the economic performance of a taxpayer for a given income year.
2.159Deloitte and Nufarm submitted that carried forward losses incurred prior to the implementation of the bill should be grandfathered. Deloitte explained:
If the carry forward loss treatment remains as is, it is submitted that losses incurred prior to the start of the new interest limitation rules should be excluded from carry forward for the purposes of the tax EBITDA calculation. Such prior years and any resulting tax losses have already been subject to the then-prevailing interest limitation rules, and should not be subjected to a second round of interest limitation rules.
Forestry deductions
2.160New deductions included in the amendments will accommodate the planation forestry sector’s unique harvesting timelines of 30-50 years, which result in long lead-times for earnings.
2.161The Australian Forest Products Association (AFPA) expressed its support for this amendment, noting it will have a positive benefit for the plantation forestry sector.
Excess tax EBITDA (capacity sharing)
2.162The government amendments also introduce greater flexibility in the fixed ratio test allowing for shared tax EBITDA capacity and expanding the concept to accommodate additional entity types and financing structures, including companies and partnerships. The rule has ‘has been designed to maintain some consistency with the overall purpose of the thin capitalisation changes, through a 50 per cent controlling interest requirement.’ Treasury explained:
The objective is to ensure a genuine link between interest deductions and taxable economic activity, by allowing excess tax EBITDA capacity to be transferred only where the earnings can be linked to active investment decisions by the controlling entity.
2.163Where the fixed ratio test is used by ‘general class investors’, eligible controlled entities can pass up excess tax EBITDA to certain companies, partnerships, and managed investment trusts, in addition to unit trusts (the transferee), where the necessary conditions are satisfied.
2.164While the excess tax EBIDTA rules were received positively by stakeholders, a number of submissions raised concerns about some of the requirements that must be satisfied in relation to each eligible entity.
50 per cent controlling interest
2.165In particular, stakeholders argued that the requirement for transferee entities to hold a 50 per cent or more direct controlling interest in the transferor entity at any time during the relevant income year was too high and discourages investment below 50 per cent.
2.166Infrastructure Partnerships Australia expressed concerns about arbitrary outcomes arising under the proposed excess tax EBITDA controlling interest rule.They argued that ‘investors should be able to utilise a proportion of the excess gearing capacity of underlying investments where they hold 10 per cent or more in the relevant subsidiary entity’, rather than the 50 per cent proposed. For investments of 10 or more per cent, the investor would therefore ‘disregard distributions received from an investment and include that percentage proportion of any excess Tax EBITDA in its fixed ratio test calculation’.
2.167QIC proposed that the excess tax EBITDA controlling interest requirements ‘should be aligned with the 10% ownership trigger for the loss of Tax EBITDA (rather than the currently proposed 50%) to avoid asymmetrical outcomes and the creation of further complexity in the funds industry’.0 They note unfavourable outcomes will be produced ‘such as where amounts are excluded from Tax EBITDA but are not available for capacity sharing’.
2.168CPA Australia highlighted that property joint ventures and consortium investing in Australian housing developments could be curtailed as entities holding between 10 and 50 per cent controlling interest will not be able to benefit from transfer of excess tax EBITDA.
2.169AUB Group noted the current provisions:
… create a significant disadvantage for Australian businesses by limiting the attractiveness of minority investment, which is an important option for businesses seeking to secure capital and other strategic benefits that can arise through this investment approach.
2.170Proposing an alternative, AUB Group suggested that at a minimum, the threshold should be reduced to 40 per cent ‘to reflect common investment holdings’ and ‘be consistent with the level of control that is generally required in order for the [Controlled Foreign Companies] CFC rules to apply’.
2.171Addressing the above concerns, Treasury advised the committee that it is aware the changes represent a tightening compared to the current rules. It explained:
The 50 per cent threshold means that only entities with sufficient influence over the financial decisions of their ‘controlled’ subsidiary can benefit from an excess tax EBITDA transfer. This specifically targets single (non-consolidated) economic groups or controlled investments, where debt is either multi-tiered or held in a single entity (such as the head entity or a specific finance vehicle).
Discounted capital gains
2.172PSPIB and NZSF raised concerns that the current drafting of sections 820-52 (Meaning of tax EBITDA) and section 820-60 (Excess tax EBITDA amount) do not appropriately accommodate tiered trust structures and the operation of the capital gains tax (CGT) discount rules.They explained:
In a scenario where a trust (the underlying trust) disposes of property and distributes a net capital gain to another Australian trust (the holding trust), the calculation of the tax EBITDA for both the underlying trust and the holding trust would be based on the discounted capital gain (rather than the gross capital gain). This effectively results in the tax EBITDA being determined based on 50% of the gross capital gain realised by the underlying trust. Where the net income of the trust is ultimately assessable to foreign investors and subject to MIT withholding tax (or other taxpayers that do not qualify for the CGT discount, such as companies), an anomaly arises because the investors are liable to pay tax on the gross capital gain (excluding the CGT discount), but the debt deduction for interest is capped at 30% of the discounted capital gain. This could effectively result in a taxpayers “fixed ratio earning limit” being reduced by up to 50% of the intended amount.
2.173PSPIB and NZSF therefore called for a specific adjustment to ensure gross capital gains are included in the calculation of excess tax EBITDA for taxpayers that are ineligible for the CGT discount, such as foreign investors.
Discretionary trusts and individuals
2.174Submissions also argued the current excess tax EBITDA rules should accommodate for ‘resident taxpayers in the middle market’ holding controlling investments in subsidiaries as resident individuals or through Australian discretionary trusts. Pitcher Partners explained:
While we do not suggest that discretionary trusts and individuals should be able to attribute any of their own excess amounts to other entities, it should not be the case that unit trusts, managed investment trusts, companies and partnerships are only able to transfer their excess to controlling entities that are limited to unit trusts, managed investment trusts, companies and partnerships.
Definitions of ‘debt deduction’ and ‘economically equivalent to interest’
2.175Submission noted some terms used within the fixed ratio test rules were unclear and could lead to unintended consequences.
2.176AFMA raised concerns about amendments expanding the definition of ‘debt deduction’ in the bill to include amounts, they argue, are ‘economically equivalent to interest’. AFMA suggested this amendment may give rise to unintended consequences, likely capturing deductions on losses arising from circumstances unrelated to a debt interest because it ‘removes the nexus between the deduction and a debt interest issued by the entity’.
2.177AFMA proposed an amendment to Section 820-40(1) to retain a nexus between the cost and “a debt interest” and exclude payments on interest rate swaps that are unrelated to financing from being debt deductions. Alternatively, AFMA proposed that, if the expanded definition be retained, it not apply to ADIs, securitisation vehicles or financial entities, to ‘reduce the risk of significant unintended consequences for financing entities’.
2.178SW Accountants & Advisors noted ‘that there is no statutory definition or guidance regarding what constitutes an ‘amount that is economically equivalent to interest’.
2.179QIC called for greater clarification by way of examples of an ‘amount that is economically equivalent to interest’ identifying what is and what is not covered.
Carve out for property sector
2.180Property Council of Australia called for a carve-out for the property sector from the EBITDA-based fixed ratio rule to ensure Australia is not ‘out of step’ with other developed competitor economies. It explained:
A carve-out will result in a regime similar to the US and UK, which both recognise the commercial basis on which debt is legitimately used, and both of which directly compete with the Australian property sector for investment in the creation of city assets across property types including housing.
Associate entity test exemptions
2.181The original bill included an exemption for superannuation funds for the associate entity test.
2.182The Financial Services Council reiterated its previous arguments for the exemption from the associate entity test for superannuation funds to be extended to other common investment funds that satisfy the existing ‘widely held’ test, specifically managed investment trusts (MITs), attribution managed investment trusts (AMITs) and corporate collective investment vehicles (CCIVs).They note that without further amendment, there is ‘potential for competitive non-neutrality between investments made by a superannuation fund compared with other widely held entities’.The Financial Services Council explained:
Current drafting has the potential to distort market outcomes for similar investments, granting additional benefits to superannuation funds over other comparative forms of investment vehicle. This could create a disincentive for these entities to invest in assets requiring significant gearing, such as housing and renewable energy projects.
Commencement
2.183Submissions raised concerns that the commencement date for the proposed thin capitalisation rules remains at 1 July 2023 and generally supported deferring the commencement date.
2.184King & Wood Mallesons, BCA and the Corporate Tax Association, for example, support a deferred commencement date for the new thin capitalisation rules until 1 July 2024. BCA explained their concerns:
Due to the timing of the introduction of the proposed amendments, the new rules will not be finalised until early 2024 at the earliest. Given the further delays in finalising the legislation, the significant changes made in the latest amendments and their complexity, it would be appropriate to defer the commencement date of the EBITDA rules to 1 July 2024 to avoid the uncertainties associated with potential retrospectivity.
This would align with the proposed commencement date of the [debt deduction creation rules] DDCR.
2.185King & Wood Mallesons noted a revised bill may not be finalised until closer to the commencement of the 30 June 2025 financial year. They advised:
The 1 July 2023 start date, with no grandfathering or transitional rules, does not provide taxpayers with adequate time to consider and prepare for the new thin capitalisation rules, particularly as the final form of the new rules has yet to be settled.
…
At present, taxpayers do not have sufficient certainty as to the potential implications of these changes to their current arrangements.
2.186Infrastructure Partnerships Australia and Deloitte proposed taxpayers be given the choice between applying the measures from 1 July 2023 or deferring the application of the measures for one income year, given some taxpayers have already undertaken substantial work preparing for the introduction of the measures based on a 1 July 2023 start date. Infrastructure Partnerships Australia highlighted the final legislation will not be substantively debated until after the committee reports on 5 February 2024.
2.187Dr Shumi Akhtar supported implementation of the new thin capitalisation rules from 1 July 2024. She noted that ‘delaying or predating this implementation date will only lead to confusion and unnecessary expenditures of both time and resources, which are ultimately unproductive’.
2.188The Property Council of Australia called for a short transitional period until 1 July 2024 specifically for the property sector. It noted:
Due to the complex and varied nature of structures in the property industry, some businesses are disproportionately affected by the proposed changes and industry needs further time to understand the impacts to different business models.
2.189QIC proposed the start date for the amended rules be deferred to 1 July 2024, with the debt deduction creation rules in turn moving to a start of 1 July 2025 ‘to afford taxpayers an appropriate amount of time to prepare for what are significant changes in the law’.
2.190CPA Australia argued the new thin capitalisation rules should not have retrospective application. It contended that the rules ‘have been developed in haste, poorly conceived and still have significant issues that if not addressed, will drive investment offshore to jurisdictions with more favourable and simpler thin capitalisation rules’.
2.191Treasury advised that it is aware some industry groups seek to defer the thin capitalisation changes to 1 July 2024 ‘on the basis it would support taxpayer certainty given the legislation is yet to pass Parliament.’ In response to industry concerns, Treasury stated:
There has been sufficient certainty on the framework of the earnings-based and third-party debt test and the entities subject to these changes (noting the amendments process has focused on improving the operation of these rules).
Review mechanisms
2.192Some stakeholders, including King & Wood Mallesons and QIC supported the proposed amendment by Senator David Pocock for an independent review to be conducted on the operations of the government amendments made to Schedule 2, commencing no later than 1 February 2026. QIC explained:
We consider this to be a sensible proposal which will represent an opportunity to review the law to ensure that it is operating appropriately and address technical issues. Without such a mechanism, it is likely that many issues (including those identified in the various submissions on the new law but also many that we expect will become apparent once the law is operative) will remain unresolved for a long time (if they are indeed ever resolved).
Any such review should also address the impact of the new rules on foreign direct investment.
2.193Similarly, Infrastructure Partnerships Australia and Deloitte suggested Treasury commit to an ongoing and real-time post implementation review to address remaining uncertainties. Deloitte further noted:
it is expected that additional issues will arise in practice. It is not appropriate to leave such matters to the ATO and taxpayers to resolve where a legislative response is more appropriate.
2.194Dr Shumi Akhtar proposed the operations of the Australian real estate sector, in particular, be comprehensively reviewed in a stand-alone future inquiry to identify and eliminate loopholes in thin capitalisation within this sector and ‘ensure a fair tax contribution to Australia’. She states the sector currently operates with insufficient regulation ‘offering numerous opportunities for manipulation by foreign investors.’
Committee view
2.195The committee is of the view that the Government Amendments get the balance right between accommodating stakeholder feedback and maintaining policy integrity.
2.196The committee welcomes the government’s responsiveness to stakeholder proposals to provide further support for key industry sectors, while maintaining neutrality in the tax system.
2.197The committee further welcome stakeholder support for the amendments, designed to ensure that the thin capitalisation rules operate as intended and that debt deduction rules are appropriately targeted.
2.198The committee is reassured that the Government Amendments support important integrity measures in Australia’s multinational tax settings, closing loopholes, ensuring multinationals pay their fair share and aligning Australia with OECD best practice and global trends in the tax treatment of multinationals. This was a sentiment shared by many submitters to the inquiry.
2.199The committee is encouraged by the level of consultation and collaboration between government and industry in progressing these reforms. The committee notes consultation on these thin capitalisation reforms has progressed since March 2023, and detailed, parallel, sector-specific consultation has further enhanced the process.
2.200The committee acknowledges the delay to the commencement of the debt deduction creation rules, on the basis that these measures were announced after the thin capitalisation reforms, and welcomes this outcome of consultation with industry. These rules will perform an important anti-avoidance function, are unique to Australia, and are aligned with OECD best practice.
2.201The committee supports commencement of the thin capitalisation measures, as amended, effective tax year 23-24, noting the lengthy and extensive consultation, and the potential for some multinationals to rollover financing arrangements to avoid the rules, should they be delayed as requested by some submitters.
2.202The committee acknowledges some multinationals and stakeholders have presented suggestions which have not been adopted by government.
2.203The committee notes that further concessions to achieve the full agreement of those suggestions to be covered by new integrity and anti-avoidance measures would most likely come at the cost of important government and community goals, including enhancing the integrity of the Australian tax system, improving transparency, and aligning with the OECD/G20 base erosion and profit shifting framework.
2.204The committee is heartened by the ATO’s commitment to work with industry in the implementation of these reforms, as is usual practice. The committee particularly welcomes ATO evidence on its intention to manage the transition to the new regime in a consultative manner, and to consider further technical feedback provided by submitters to this inquiry in developing its public guidance material.
2.205The committee recommends the government amendments to the to the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share—Integrity and Transparency) Bill 2023 be agreed to and that the bill be passed as amended.
Senator Jess Walsh
Chair