Chapter 1Introduction
Referral of the inquiry
1.1The Treasury Laws Amendment (Making Multinationals Pay Their Fair Share—Integrity and Transparency) Bill 2023 (the bill) was introduced into the House of Representatives and read a first time on 22 June 2023.
1.2On 22 June 2023, the Senate referred the provisions of the bill to the Senate Economics Legislation Committee (the committee) for inquiry and report by 31August2023.
1.3On 31 August 2023, the committee tabled a progress report seeking an extension of the reporting date to 22 September 2023.
Purpose of the bill
1.4The bill proposes to make amendments to several Acts to implement two broad ranging measures which are contained in two schedules as follows:
Schedule 1—Multinational tax transparency—disclosure of subsidiaries; and
Schedule 2—Thin capitalisation.
1.5The intent of the bill was explained by the Assistant Minister for Competition, Charities and Treasury, the Hon Dr Andrew Leigh MP, on 22 June 2023. The Assistant Minister stated that the measures aim to introduce new rules to protect the integrity of the Australian tax system, improve tax transparency and help to ensure a fairer and more sustainable tax system.
1.6Details of each of the measures contained in the bill’s two schedules are outlined in more detail below.
Multinational tax transparency—disclosure of subsidiaries
1.7Schedule 1 of the bill seeks to amend the Corporations Act 2001 (Corporations Act) to require Australian public companies (listed and unlisted) to disclose information about subsidiaries in their annual financial reports for financial years commencing from 1 July 2023.
1.8There are global shifts towards public reporting as a means of enhancing public scrutiny of multinational arrangements. In 2013, the Organisation for Economic Corporation and Development (OECD) released its report, Addressing Base Erosion and Profit Shifting. Subsequently, OECD and G20 countries adopted the Base Erosion and Profit Shifting (BEPS) Action Plan, which identified 15 clearly defined (but interrelated) actions for implementation aimed at improving international tax cooperation and tax transparency. The Plan was a response to a ‘perception that the domestic and international rules on the taxation of cross-border profits are now broken and that taxes are only paid by the naive’.
1.9As explained by the OECD, BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity, but the taxes are low, resulting in little or no overall corporate tax being paid.
1.10Schedule 1 would ensure information is in the public domain, and therefore help facilitate an informed discussion on tax compliance and build trust in the integrity of the tax system, as outlined by the Assistant Minister above.
1.11In alignment with international approaches to enhanced corporate tax transparency, the proposed new measure would place an onus on companies to be more transparent about their corporate structures. The intent of the public disclosure of company’s subsidiary information within a company’s annual financial report, is to enhance scrutiny on companies’ arrangements. This includes how they structure their subsidiaries and operate in different jurisdictions, including for tax purposes.
1.12The rationale for increased transparency and disclosure requirements is outlined in the bills’ accompanying explanatory memorandum as follows:
From a tax perspective, the expectation is that more information in the public domain will help to encourage behavioural change in terms of how companies view their tax obligations, including their approach to tax governance practices, decision making around aggressive tax planning strategies and potential simplification of group structures.
1.13Schedule 1 partially implements the government’s election commitment on multinational tax integrity, as well as the Multinational Tax Integrity Package—improved tax transparency measure from the October 2022–23 Budget.
Thin capitalisation rules
1.14Schedule 2 of the bill would introduce amendments to existing thin capitalisation rules under the Income Tax Assessment Act 1936 (ITAA 1936), Income Tax Assessment Act 1997 (ITAA 1997) and the Taxation Administration Act 1953 (TAA) from 1 July 2023, by replacing the current asset-based tests in thin capitalisation rules with the OECD recommended earnings-based tests; and inserting a new anti-avoidance provision to target debt creation schemes.
1.15As succinctly articulated by the Australian Taxation Office (ATO), a thinly capitalised entity is one whose assets are funded by a high level of debt and relatively little equity. The process of thin capitalisation is described as follows:
“Thin capitalisation” may be described as the process of financing subsidiaries with greater amounts of debt in comparison with equity than would be normal in an arm’s length funding arrangement. Such a process may be carried out for tax-related reasons. Typically, a company resident in one jurisdiction will fund its subsidiary in another jurisdiction by means of as much debt as possible, so as to reduce the subsidiary’s taxable profits by enabling it to claim excessive deductions for interest paid to the foreign owner. Rules designed to counter this practice usually have the effect of denying tax deductions for interest paid on such debt funding, up to specific limits.
1.16The lack of coherence in international tax rules creates international tax gaps in a global digital economy where large Multinational Enterprises (MNEs) aggressively engage in tax avoidance practices. Three scenarios have been identified by the OECD’s BEPSAction 4, whereby MNEs strategically avoid restrictions on the interest deductions to avoid income taxes:
(1)groups placing higher levels of third-party debt in high tax countries;
(2)groups using intragroup loans to generate interest deductions in excess of the group’s actual third-party interest expense; and
(3)groups using third party or intragroup financing to fund the generation of tax-exempt income.
1.17To address this problem, the OECD BEPS Action Plan made recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense. The OECD explained:
The recommended approach is based on a fixed ratio rule which limits an entity’s net deductions for interest and payments economically equivalent to interest to a percentage of its earnings before interest, taxes, depreciation, and amortisation (EBITDA). As a minimum this should apply to entities in multinational groups. To ensure that countries apply a fixed ratio that is low enough to tackle BEPS, while recognising that not all countries are in the same position, the recommended approach includes a corridor of possible ratios of between 10% and 30%.
…The approach can be supplemented by a worldwide group ratio rule which allows an entity to exceed this limit in certain circumstances. Recognising that some groups are highly leveraged with third party debt for non-tax reasons, the recommended approach proposes a group ratio rule alongside the fixed ratio rule. This would allow an entity with net interest expense above a country’s fixed ratio to deduct interest up to the level of the net interest/EBITDA ratio of its worldwide group. Countries may also apply an uplift of up to 10% to the group’s net third party interest expense to prevent double taxation.
1.18The thin capitalisation regime is Australia’s current approach to limiting debt deductions and has been described as ‘generally more favourable than the [OECD] tests’. The rules were designed to limit the debt deductions that an entity can claim for tax purposes based on the amount of debt used to finance its operations compared with its level of equity, by restricting the amount of debt deductions a company can have based on its level of assets.
1.19The proposed changes within the bill seek to implement the recommendations made by the OCED, so that Australia’s thin capitalisation rules are aligned with the best practice guidance as outlined above. The amendments reflect the view that aligning debt deductions with taxable economic activity is a more robust approach to address base erosion and profit shifting. A summary of the proposed amendments within the Schedule are listed in further detail below.
1.20Schedule 2 of the bill implements the MNE interest limitation rules from the government’s election commitment on multinational tax integrity, as well as the Multinational Tax Integrity Package—amending Australia’s interest limitation (thin capitalisation) rules’ measure from the October 2022–23 Budget.
Provisions of the bill
Overview of the amendments
Schedule 1—Multinational tax transparency—disclosure of subsidiaries
1.21 Schedule 1 of the bill would amend the Corporations Act, introducing new rules on the disclosure of information on the part of companies’ regarding their subsidiaries.
1.22Currently, subsection 295(2) of the Corporations Act requires entities to prepare financial statements differently, dependent upon whether the accounting standards require the company to prepare financial statements in relation to a consolidated entity.
1.23Under the proposed new rules, for each financial year commencing on or after 1 July 2023, Australian public companies would be required, as part of their annual financial reporting obligations under Chapter 2M, to provide a ‘consolidated entity disclosure statement’.
1.24The schedule outlines details of the information that an entity would be required to disclose in relation to entities within a consolidated entity. Alongside these general reporting obligations, directors, chief executive officers and chief financial officers would be required to declare that the ‘consolidated entity disclosure statement’ is in their opinion, ‘true and correct’ at the end of that financial year.
Schedule 2—Thin capitalisation
1.25Schedule 2 of the bill would amend the ITAA 1997, ITAA 1936 and TAA to ensure that Australia’s laws align with the OECD recommendations as described above.
1.26Schedule 2 introduces three new thin capitalisation earnings-based tests for the new ‘general class investors’, which is a new concept introduced within the schedule. The new tests are the fixed ratio test, the group ratio test, and the third-party debt test.
1.27Entities which are found to be general class investors must apply one of the three new thin capitalisation tests. Entities found not to be general class investors will continue to apply the old thin capitalisation rules.
1.28The general class investor concept consolidates and replaces the existing ‘general’ class entities, which are ‘inward investor (general),’ ‘outward investor (general),’ and ‘inward investment vehicle (general).’
1.29Under the new rules, in a given income year an entity will be a general class investor when, in a whole income year:
the entity was not a financial entity or an authorised deposit-taking institution (ADI) that was an inward or outward investing entity; and
it was an inward or outward investing financial entity that was not an ADI.
1.30The effect of this new definition is that the following kinds of entities (that are not financial entities or ADIs) will now be classed as general class investors, including:
foreign entities which have investments in Australia;
Australian entities that are controlled by foreign residents; and
Australian entities that carry on business in foreign countries through an entity it controls or at or through a permanent establishment.
1.31Schedule 2 also strengthens the definition of ‘financial entity’ from merely requiring that a financial entity be a registered corporation under the Financial Sector (Collection of Data) Act 2001, to requiring that the entity in question carry on a business of providing finance (and not predominantly providing that finance either directly or indirectly to one of the entities associates), and for a particular income year, derives all or a substantial amount of its profits from that business.
1.32Summaries of the three new tests that would apply to general class investors are outlined below.
Fixed ratio test
1.33The proposed default ‘fixed ratio test’ (30 per cent of profits, using tax EBITDA as the measure of the profit) would replace the existing safe harbour test (60percent of average value of the entity’s Australian assets).
1.34Subject to conditions, the disallowed debt deductions under this test would be carried forward for up to 15 years to offset future taxable income—a special rule that considers businesses with volatile earnings such as start-ups and only available under this default test.
Group ratio test
1.35An alternative elective ‘group ratio test’ (group ratio of group EBITDA) would replace the existing worldwide gearing test (up to 100 per cent of gearing of the entity’s worldwide group) to allow an entity in a highly leveraged group to claim debt deductions up to the level of the worldwide group’s net interest expense as a share of earnings (which may exceed the 30 per cent EBITDA ratio).
Third party debt test
1.36Another alternative elective ‘third party debt test’ (to allow deductions for genuine third-party interest debt that funds Australian business operations and to disallow related party debt deductions) would replace the existing arm’s length debt test (notional estimates for related party debt deductions).
Application of the tests and related amendments
1.37If entities choose to adopt an elective option, revocation of that choice would be subject to the ATO’s approval.
1.38Under the proposed new rules, the treatment of financial investors would be left largely unaffected, except for replacing the arm’s length debt test with the external third-party debt test. The treatment of ADIs such as banks would be left largely untouched.
1.39Other related changes included in Schedule 2 to the bill include:
the introduction of new anti-avoidance rules to disallow debt deductions to the extent that they are incurred in relation to debt creation schemes;
the requirement for general class investors to demonstrate their actual quantum of debt is arm’s length for the purposes of the transfer pricing provisions, even if debt deductions are less than the threshold set under the fixed and group ratio tests;
narrowing the scope of entities that will continue to be subject to the existing safe harbour and worldwide gearing tests as a “financial entity”; and
the introduction of new debt deduction creation rules (Subdivision 820–EAA) to disallow debt deductions to the extent that they are incurred in relation to debt creation schemes.
Consultation
Multinational tax transparency—disclosure of subsidiaries
1.40Treasury sought feedback from stakeholders on the proposed reforms within Schedule 1 of the bill through a public consultation process on the exposure draft legislation and associated explanatory material. This consultation process occurred between 16 March and 13 April 2023 and received six written submissions.
1.41The minimal stakeholder feedback focused only on minor technical drafting suggestions, such as clarifying wording, and aligning definitions/concepts contained in the Corporations Act 2001. Minor changes were made to the exposure draft legislation in line with stakeholder feedback, as appropriate.
Thin capitalisation
1.42Treasury conducted extensive stakeholder engagement on the policy changes to the thin capitalisation framework which is outlined in detail in the EM. The first round of stakeholder engagement on the initiative was held in August and September 2022.
1.43Public consultation on the initial exposure draft legislation and accompanying explanatory material was undertaken from 16 March to 13 April 2023, with 55submissions received (including 15 confidential submissions) from a broad range of stakeholders.
1.44In response to feedback received during the consultation process and to encompass other policy considerations, various amendments were made to the schedule as follows:
Section 25–90 was not included within the bill.
The third-party debt test conditions were adjusted to accommodate an appropriate range of financing arrangements for greenfield/construction projects.
Technical changes were adopted to better reflect the arrangements within trusts and non-consolidated groups.
The business continuity test was adopted as a more suitable approach for allowing the carry-forward of previously disallowed debt deductions.
The ‘depreciation’ component of EBITDA was broadened and the definitions of ‘debt deduction’ and ‘net debt deduction’ were clarified and revised to be more closely aligned, intended to ensure a broader range of financing arrangements were not adversely affected.
Targeted debt creation rules were included to support the policy intent.
1.45Treasury continued to engage with targeted stakeholders after the public consultation closed, focusing on the property and infrastructures sectors, to refine the legislative text to address unintended consequences identified through the consultation process.
Commencement
1.46Schedule 1 of the bill will commence the day after Royal Assent. The amendments apply to annual financial reports prepared for financial years commencing on or after 1 July 2023.
1.47Schedule 2 of the bill will commence on the first 1 January, 1 April, 1 July or 1 October to occur after Royal Assent. The amendments apply to income years beginning on or after 1 July 2023.
Financial impact
1.48According to the EM, Schedule 1 of the bill is estimated to have an unquantifiable impact on receipts.
1.49Schedule 2 of the bill is estimated to have the following financial impact over the forward estimates period:
Table 1.1Financial impact of Schedule 2 ($m)
Source: Explanatory Memorandum, p. 2
Legislative scrutiny
1.50In its Scrutiny Digest 8 of 2023, the Senate Standing Committee on the Scrutiny of Bills did not raise any concerns regarding the bill.
Human rights implications
1.51As discussed in the EM, the Statement of Compatibility with Human Rights argues that the bill is compatible with human rights and freedoms recognised in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011, and thus does not raise any human rights concerns.
1.52In its Report 8 of 2023, the Parliamentary Joint Committee on Human Rights reported that the bill did not raise any human rights concerns.
Regulatory impact
1.53The EM to the bill provides a comprehensive Impact Analysis for both Schedules1 and 2. The Impact Analysis for both schedules address the intent of the proposed measures, policy options available, cost benefit analysis, summary of the consultation processes undertaken, as well as preferred options for implementation.
Conduct of the Inquiry
1.54The committee advertised the inquiry on its website and wrote to relevant stakeholders and interested parties inviting written submissions by 21July2023.
1.55The committee received 53 submissions (including one confidential submission) as well as additional information and answers to questions on notice, which are listed in Appendix 1.
1.56The committee held one public hearing for the inquiry on 15 August 2023. The names of witnesses who appeared at the hearing can be found at Appendix 2.
Acknowledgements
1.57The committee thanks all individuals and organisations who assisted with the inquiry, especially those who made written submissions and participated in the public hearing.