Chapter 3
Schedule 2—modification of the thin capitalisation regime
Background
3.1
On 24 January 2005, the former Treasurer announced a three-year
transitional period in respect of the application of Australian equivalents to
International Financial Reporting Standards (AIFRS) under the thin
capitalisation rules in Division 820 of the Income Tax Assessment Act 1997.
3.2
In the period following this announcement, entities would elect,
on an annual basis, to use either AIFRS or the previous accounting standards,
the Australian Generally Accepted Accounting Principles, to make thin
capitalisation calculations.[1]
3.3
When making this announcement, the former Treasurer also
indicated that the Government would examine whether the existing thin
capitalisation rules, following the adoption of AIFRS, were appropriate.
3.4
On 13 May 2008, the Treasurer and the Assistant Treasurer and
Minister for Competition Policy and Consumer Affairs jointly announced that the
government will amend the thin capitalisation regime to accommodate certain
impacts arising from the adoption of the AIFRS accounting standards. For
example, certain assets and liabilities will not be permitted to be recognised
by particular entities for thin capitalisation purposes.
3.5
In adopting globally accepted standards, Australia more closely
aligns itself with international accounting practice. In addition, through
adopting such standards, Australia can facilitate comparisons of
cross-jurisdictional financial information and reduce the complexity for
investors when making investment decisions.
Thin capitalisation
3.6
A non-financial company is said to be thinly capitalised when its
liabilities are made up of a much greater proportion of debt than equity.
3.7
This is perceived to create problems for two classes of people:
- consumers and creditors bear the solvency risk of the company;
and
- revenue authorities, who are concerned about excessive interest
deductions.
3.8
Thin capitalisation rules are applied to determine an upper level
of debt above which income tax deductions for interest payments are denied.
They are designed to ensure that Australian and foreign-owned multi-national
entities do not allocate an excessive amount of debt to their Australian
operations. It operates to limit the deductibility of interest payments when
debt exceeds certain thresholds.[2]
As the explanatory memorandum states, the thin capitalisation regime:
...is designed to ensure that Australian and foreign-owned
multinational entities do not allocate an excessive amount of debt to their
Australian operations. It does this by disallowing a proportion of otherwise
deductible finance expenses (eg, interest) where the debt used to fund the
Australian operations exceeds certain limits.[3]
Proposed modifications
3.9
Under the existing income tax arrangements there exists an incentive
to use debt over equity for financing investment and business activity, and to
maximise debt deductions in Australia.
3.10
Under the modified thin capitalisation rules a threshold will be
established beyond which an entity will be subject to the denial of debt
deductions. However, this threshold does not represent an absolute limit as entities
can maintain higher gearing ratios where they are prepared to forgo debt
deductions for that proportion of their debt in excess of the statutory gearing
limits.
3.11
Assets and liabilities which will not be recognised for thin
capitalisation purposes include: deferred tax assets and liabilities (within
the scope of Australian accounting standard AASB 112 Income Taxes) and
assets and liabilities arising from defined benefit plans (within the scope of
Australian accounting standard AASB 119 Employment Benefits).
3.12
There are circumstances in which particular entities may choose
to recognise or revalue certain intangible assets, contrary to the relevant
accounting standard. This primarily relates to intangible assets within the
scope of Australian accounting standard AASB 138 Intangible Assets.
3.13
The committee did not receive any submissions relating to this
Schedule.
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