Coalition Senators' Dissenting Report

Introduction

1.1Corporations must pay taxation as legally required in Australia. Regrettably, there are persistent efforts to avoid taxation, but generally Australia’s corporate tax collection rates are high. Australian business is expected to pay $140 billion in the 2022–23 financial year, which is one of the highest in the Organisation for Economic Co-Operation and Development (OECD).

1.2Coalition Senators support the intent of legislation to improve the integrity of the tax system, address tax avoidance and counter tax base erosion and profit shifting.

1.3However, we are very concerned that the government has included debt deduction creation rules in this bill which may further damage investment in Australia. Lower levels of investment will in turn equate to fewer job opportunities for Australians.

1.4Accordingly, the government’s anti-business disposition is actually an anti-jobs position. The debt deduction creation rules are a case in point. They have been included in the bill without any consultation and they directly threaten significant projects in Australia which will generate Australian jobs.

1.5The former Coalition Government implemented more than a dozen measures to combat multinational tax avoidance, including by:

playing a leading role in the original OECD domestic tax base erosion and profit shifting (BEPS) project, and committing to the OECD two-pillar solution to multinational tax; and

introducing the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and the Diverted Profits Tax Bill 2017; strengthening the thin capitalisation and transfer pricing rules; doubling penalties for multinational tax avoidance; and establishing the Tax Avoidance Taskforce.

1.6Despite promising to only raise taxes on multinationals at the election, the Labor Government has broken promises to raise taxes on superannuation, on unrealised capital gains, on franking credits, and ending small business tax incentives.

1.7The original form of this bill, and its last-minute changes, show once again that the Labor Government have an anti-business approach to consultation, regulation and policy to support small business.

1.8The proposed legislation is half-baked and reflects a flawed approach to sensitive tax changes. It is unclear whether the broad drafting is intentional or unintentional. Furthermore, it is not known whether the bill is intended purely to address tax base erosion through anti-avoidance measures and appropriate rule adjustments, or to quietly expand the tax base underhandedly through the guise of an anti-avoidance objective. As the Law Council of Australia has recognised, ’despite the title of the Bill, the thin capitalisation rules are not limited to multinationals’.[1]

1.9During their appearance before the Committee, the Treasury was ambiguous in its explanation of the proposed measure as follows:

It's a revenue measure in so much as it is a change in tax policy and tax legislation that will have an impact on revenue. If your question is asking if it is an avoidance measure or primarily a revenue-raising measure, I would say that the rules are quite unapologetically aiming to tighten the way in which businesses and entities can claim tax deductions…In the sense that they are tightening the existing thin capitalisation regime and that will result in some level of denied deductions there will of course be a revenue consequence of that…[2]

1.10On this point, the Property Council of Australia submitted:

Through the consultation on the Bill, we have subsequently been advised that a further intention (although never publicly acknowledged) is to expand the Commonwealth’s revenue base, not merely limit base erosion.[3]

1.11The current bill is the product of a rushed and chaotic consultation process. There was commentary during the public hearing suggesting this consultation had been successful because it had been long and “iterative”. However, the measure of a successful and genuine consultation process should be the extent to which there are unintended consequences that arise after the legislation has been presented to parliament.

1.12The government seems to have prioritised this measure politically to the detriment of careful and considered legislative drafting. There are several key issues with the proposed legislation which warrants amendment in the Senate. Whether the government is serious about coherent, fair and congruent anti-tax avoidance rules and reforms to thin capitalisation depends entirely on its willingness to consider and adopt the necessary amendments to the bill.

1.13The majority committee report recommends that Schedule 2 of the bill be passed ‘subject to technical amendments foreshadowed by Treasury’. This committee has not seen those amendments, despite the request by committee members for Treasury to provide them in its answers to questions on notice.

1.14On of the primary and most important roles of a Senate Committee is to investigate and scrutinise proposed legislation as it is presented to Parliament and throw and make recommendations with-respect-to that proposed legislation.

1.15Coalition Senators agree that Schedule 2 should not be passed as currently drafted. We are of the strong view that in the absence of any proposed amendments from the Treasury, the proposed legislation before this committee is essentially incomplete or defective. Numerous amendments are required to fix this bill.

Deficient or non-existent consultation

1.16During the public hearing, it was evident that stakeholders were unable to gauge the overall policy thinking underpinning some of the government’s legislative drafting. There was a lack of transparency on why some amendments flagged during the preceding Treasury consultations were adopted but not others.

1.17All witnesses were completely unaware of the new debt deduction creation rules prior to their appearance in the bill as presented before the Parliament.

1.18Chartered Accountants Australia and New Zealand (CAANZ) noted that their clients were road-testing refinancing options based on the proposed measures during the consultation in advance of them becoming law. However, this process has been made more difficult given the debt deduction creation rules had not been seen before. Mr Michael Croker from CAANZ stated:

The surprise there, Senator, was that the first time we saw the debt creation rules was in the bill that's now before parliament. So, in what I call road-testing, which may require refinancing, the worry now is that the refinancing activity attracts the debt creation measure, which we hadn't hitherto seen in any other draft.[4]

1.19Perpetual Limited noted that although they were consulted on the proposed section 25-90 repeal, which was subsequently removed from the bill following feedback from stakeholders, it was not aware of the debt creation rules before the bill came before Parliament:

...we were surprised that the debt deduction creation rules had been reintroduced and reintroduced in such a broad manner without the exclusions that were there to form protections under the old division 16G.[5]

1.20They also noted a lot of incongruences between the bills’ explanatory memorandum (EM) and the drafting of the legislation, noting that a lot of the specificity implied in the EM is not ’included in the provisions as drafted’.[6]

1.21The Financial Services Council (FSC) told the committee that ‘no questions were put about measuring compliance costs of those measures in the consultation’.[7] Furthermore, they were not aware of exactly why the debt deduction creation rules were introduced without consultation as articulated by Mr Spiro Premetis as follows:

Senator DEAN SMITH:So are you suggesting that the Treasury has included the debt deduction creation rules without consultation in response to a perceived risk or a perceived threat?

Mr Premetis:That would be my guess at their motivation, yes.

Senator DEAN SMITH:What is that perceived threat or perceived risk?

Mr Premetis:Having not been consulted on those specific provisions, I couldn't tell you.[8]

1.22A significant majority of submitters expressed considerable concern about the debt deduction creation rules, which were proposed without consultation, and recommended that they be removed from the bill to allow for a proper consultation.

1.23Given there are still eight Parliamentary sitting weeks between the tabling of this report and the end of 2023, King & Wood Mallesons agreed that it was not unreasonable to request a further consultation on the debt deduction creation rules.[9] King and Wood Mallesons contended that the rules had been ‘consciously drafted to be broad’ given that ‘a very simple, normal commercial transaction could be subject to the rules’.[10]

1.24Consistent with other witnesses, with regard to the debt deduction creation rules, the Australian Banking Association (ABA) stated that they ‘first became aware of these changes with the introduction of the bill to parliament. As a result, this committee is the only consultation with industry on these complex changes;.[11] While they supported the policy intent of the bill, they stressed that ‘adequate consultation occurs before implementing those measures’.[12]

1.25Without an adequately timed and orderly consultation, stakeholders are limited in their ability to provide quality feedback to the government. The ABA hinted at this, noting that their submission is based on an assessment of the impact of these measures ‘given a short period…to consider the bill and to assess the implications’.[13]

1.26Appearing before the committee, Australian Chamber of Commerce and Industry (ACCI) said that it ‘had no indication that this [debt deduction creation rules] was going to be included’.[14] They described themselves and their members as being ‘blindsided by it’.[15]

1.27Regarding the bill’s application to trusts, the Property Council of Australia told the committee that:

‘it has not been asserted to be the problem with Australian property trusts at any point over the last nine months since broad consultation on the broad changes around the state of integrity objectives were flagged.[16]

1.28The introduction of the debt deductioncreation rules, which were repealed in 2001, has introduced confusion as to the policy objectives of the provisions, their congruence and how all the parts work together. Noting that the thin-capitalisation rules were broadened in 2001 to be fully comprehensive and apply to all debt, consistently to both inbound and outbound taxpayers, the Property Council of Australia queried why the debt creation rules are being introduced alongside the thin capitalisation rule changes. Mr Stephen Whittington from the Property Council explained that:

...the debt creation rules were repealed on the basis that the rules were now sufficiently comprehensive. The rules, as proposed, are just as comprehensive, but it appears like we may end up with an additional poorly targeted integrity measure, with the potential for the government to still consider a repeal of section 25-90.[17]

1.29Introducing measures without consultation and a clear policy rationale is more evidence of a poor consultation process overall. When Treasury was asked about the introduction of the debt deduction creation rules, it sounded as if it was policy on the run. It appears that the inclusion of the new rules were a last minute addition to the bill given how poorly the proposed repeal of section 25-90 was received by stakeholders and experts. For example, this was highlighted in evidence provided to the committee by Treasury as follows:

When we were contemplating the removal of section 25-90 and right from the start we were contemplating the possible need for additional rules to deal with potential integrity issues in moving from an asset safe harbour approach to the earnings based test. That was when we started to consider the debt deduction creation rules. I would point out that those rules do have a different intent to what was intended by the removal of the section 25-90.[18]

…

We took the view that the removal of section 25-90 deductions, or at least the amendment of those deductions, would do a lot of the heavy lifting. As I mentioned before, even though they were targeting quite specifically different actions by entities, we thought it important to include the debt deduction creation rules.[19]

1.30During its appearance before the committee, Treasury officials could not be sure whether engagement had taken place with ministers around whether or not to consult with industry about the debt deduction creation rules.[20]

1.31Treasury conceded on multiple occasions that amendments were required to several components of the proposed thin capitalisation changes and the debt creation rules. Of significance, Treasury officials also recognised a range of unintended consequences of the bills drafting.[21]

1.32The committee heard further evidence of the lacklustre consultation from the Australian Forest Products Association (AFPA). AFPA were not contacted independently, by the Treasury during the consultation process, and as a result, the potential impacts on the industry were entirely overlooked during the drafting process:

We found out on the final day for consultation on the exposure draft that the forestry sector was impacted. We were notified by one of our members, and so I promptly contacted Treasury and they were fortunately able to give me a one-week extension. On that final day, I knew two companies were impacted. By the following week, I knew that we had another one company, so three companies. As of today, I know that 14 companies are impacted, so we are gathering companies that have been impacted throughout this process. We were not contacted independently, AFPA and our members, and we are not aware of any of our members being contacted in relation to this bill.[22]

1.33Given this half-baked consultation by the Treasury, it is the role of this committee to assess the concerns raised by submitters in response to the now introduced legislation and make recommendations on possible amendments to the provisions.

Debt deduction creation rules

1.34 Schedule 2 of the bill includes new debt deduction creation rules, a purported anti-avoidance measure to disallow debt deductions to the extent that they are incurred in relation to schemes that ‘lack genuine commercial justification’.[23] These are look-through measures which ‘borrow bits and pieces from the thin cap rules’, but will operate separately to the thin capitalisation rules.[24]

1.35The debt creation rules were completely unanticipated by stakeholders. CPA Australia said that ’like the other 50 submissions, everyone was caught off guard’.[25] They suggested that it was likely a quick replacement or ‘a trade-off between deferring 25-90 and putting this in’.[26] Mr Bill Leung stated:

The way we look at it in this current form is as a high concern not just for our members but for everyone who’s affected by this proposal in its current form…It will cause enormous uncertainty for anyone operating in Australia or trying to branch out.[27]

1.36When asked about the debt deduction creation rules, the Community and Public Sector Union (CPSU), who support the bill, said they “don’t know anything about that”.[28] Ironically, when asked, the Australian Council of Trade Unions (ACTU) could not say how much tax they had paid in the last financial year.[29]Unions who submitted to the inquiry all supported the measures put forward by the government.

1.37The FSC confirmed they had not been consulted on the measures, and they were much more extensive in scope than required.[30] Perpetual Limited concurred with this FSC, noting that the proposed rules ‘operates very broadly with potentially unintended consequences, including the application to transactions that do have a genuine commercial justification’.[31]

1.38The FSC provided an example of a legitimate commercial transaction that could be captured by the proposed rules, and the subsequent consequences:

One example would be that an Australian entity borrowing to fund its associate on an arm's length terms would be denied debt deductions on that borrowing, and, as a result, that entity would be taxed on gross interest income. That would practically mean that a corporate group would be forced to raise finance on an entity-by-entity basis, potentially resulting in a large increase in the cost of funds and putting a drag on economic activity.[32]

1.39King and Wood Mallesons were also not consulted on the debt deduction rules. They noted that as the rules are supposed to commence on 1 July 2023, and that there are no grandfathering or transitional provisions, this would mean ‘debts that were entered into a long time ago, for legitimate commercial reasons, may be affected by the operation of the rules’.[33] King and Wood Mallesons noted that they ‘don't have a lot of clarity about the particular transactions at which the rules are aimed, because they do encompass a lot of very ordinary commercial transactions.’[34]

1.40King and Wood Mallesons identified several examples of ordinary transactions that could be captured:

I can provide another example, in addition to some of the other examples: in the amalgamation of two Australian groups where there is no increase in debt as a consequence of that transaction, so there is no debt creation as such, any debt that is borrowed from third parties in order to facilitate that would be subject to these rules.[35]

1.41The ABA expressed their deep concern about the provisions, noting they ‘will directly impact ordinary-course funding arrangements by banks that have no tax minimisation purposes’.[36] They were also not consulted on the new rules or aware of their inclusion within the bill prior to its introduction in Parliament.

1.42The ABA gave evidence that the provisions if passed ‘in its current form would risk increasing the cost of funds for Australian banks and in turn the cost for Australian borrowers’.[37]

1.43The Committee heard that the changes would increase the cost of capital, and affect their ability to offer competitive rates. Mr Christopher Taylor from the ABA stated that:

...the changes in this bill would potentially increase the costs for banks to raise capital that they use to lend to customers and to satisfy prudential requirements….They are legitimate commercial activities designed to ensure that banks have access to commercial funding for the lowest rates available. This allows banks to provide customers with competitive offers. As this committee is aware, Australian banks are subjected to a range of capital and liquidity requirements that limit and control their funding arrangements. Access to stable funding is critical to maintaining Australia's unquestionably strong banks, and any changes to these requirements should not be taken lightly or, indeed, without adequate consultation.[38]

1.44The ABA referred to two examples of ‘relatively plain vanilla and ordinary course funding structures utilised by banks that would be impacted by the very broad drafting of the debt deduction creation rules’.[39]

1.45Firstly, wholesale funding raising could be affected, as banks borrow funds from international investors. If the bill was passed in its current form, the interest costs of that debt could not be deduced for income tax purposes as they are passed through a foreign entity. This ‘would significantly impact the cost of utilising wholesale funding through this structure’.[40]

1.46Secondly, securitisation would be affected ‘where mortgages are provided as security for the raising of funds through a SPV’.[41] The ABA noted that these are entirely domestic activities, but ‘these provisions would apply and interest costs for the debt that is raised through those securitisation vehicles would not be able to be deducted’.[42]They are also used ‘in circumstances of extreme financial distress’, such as the global financial crisis (GFC).[43]The ABA noted that many of that of its members ’would utilise securitisation vehicles…most of the large banks utilise this in a common way and on a regular basis’.[44]

1.47The bottom line is that, according to the ABA, the debt deduction creation rules would make ’wholesale funding more expensive and it would therefore make the rate at which you can provide loans to customers more expensive’.[45] MrTaylor from the ABA succinctly stated:

It is likely that it would raise the cost of borrowing funds for customers… It would mean more expensive mortgages’.[46]

1.48When asked, the ABA agreed that the thin capitalisation changes could proceed without the debt deduction creation rules.[47]

1.49On the rules, ACCI told the Committee that they:

don't believe it's essential. In fact, we are quite concerned by its inclusion, as the provisions are very broad and complex and may raise some further problems given their interaction with other provisions of the bill, such as the limitations on debt deductions under thin capitalisation and the anti-avoidance provisions.[48]

1.50The ACCI stated that of their membership, there could be ’hundreds of businesses affected’ by the new rules.[49]

1.51When asked whether costs to households and business borrowers would increase if the debt deduction creation rules proceeded in their current form, the ACCI agreed:

Yes, I agree in terms of the impact on businesses. If the debt creation rules are maintained, then it is likely that businesses will be required to seek alternative forms of funding for certain investments, and that funding is likely to come at a higher cost.[50]

1.52The ACCI also confirmed that the measures would also affect domestic small and medium-sized enterprises (SMEs), despite the bill being entitled ‘Making Multinationals Pay their Fair Share’. Mr Peter Grist from the ACCI commented:

I'd agree, in that it will affect the ability of all businesses to attract financing, and so it will affect domestically based small and medium businesses as well.[51]

1.53Submitters have noted that the OECD has not recommended debt creation rules as broad as this. On this point, Infrastructure Partnerships Australia submitted:

The OECD BEPS Action Four Report does not recommend a rule that operates as broadly as the proposed debt creation rules contained within the Bill.[52]

1.54International investors have argued that debt deduction creation rules are entirely unnecessary and are drafted too broadly.

1.55The American Chamber of Commerce in Australia submitted that:

…the proposed Debt Deduction Creation rules…do not align with OECD norms and will result in Australia becoming a global outlier with overly restrictive debt limitation rules compared to our peers.[53]

1.56They recommended that ’the Debt Creation rules be removed from the Bill and are not further pursued further’ because the new thin capitalisation measures and tests in Bill ’already restrict the quantum of deductible debt to appropriate amounts’.[54]

1.57Regarding these measures, the National Foreign Trade Council, an ‘association of U.S. business enterprises engaged in all aspects of international trade and investment’, submitted that ’the net investment in the country [Australia] will decrease as MNC’s factor in an increased cost of using debt to their investment cost’.[55]

1.58During the public hearing, Treasury told the Committee that they were ’aware of stakeholder views on the debt deduction creation rules’.[56] The Treasury conceded that the rules ’as currently drafted, it is too broad, and we have some amendments in mind’.[57]

1.59Furthermore, Treasury admitted that they should have consulted on the rules before introducing them in this bill. Mr Marty Robinson advised the committee:

Had we had more time, we definitely would have consulted publicly before drafting those amendments into the final bill. I certainly acknowledge that.[58]

1.60The Treasury told the committee that they were thinking of ’the narrowing of the rules’ and that could involve ’excluding the securitisation vehicles and even perhaps the authorised deposit-taking institutions (ADIs) on a similar basis to how they're excluded from the proposed amendments to the thin capitalisation rules…’[59] It is extraordinary that the government would present these rules to Parliament, without consultation, and then concede that such fundamental amendments are necessary due to drastic unintended consequences.

1.61To date, the committee has not seen any of the amendments proposed by the Government at the time of tabling, despite asking the Treasury for such details both at the public hearing and in questions on notice.[60]

1.62Most submitters did not support the debt deductioncreation rules as currently drafted.

1.63Many submitters, including domestic business groups and investment funds, accounting bodies, law firms, industry associations and foreign investor groups recommended that the debt deduction creation rules be removed from the bill to allow for a proper consultation.[61]

1.64The ABA, Port of Brisbane, Gilbert + Tobin and the American Chamber of Commerce in Australia recommended that the debt deduction creation rules not proceed at all.[62]

1.65Coalition Senators note that the breadth of the rules as drafted are ’extreme’ and have been produced without consultation.[63] As the Property Council of Australia has noted:

...with respect to the debt creation rules, in our view they should be deferred until proper consultation can be undertaken to determine an appropriate scope to those rules. To be honest, they apply to very common restructure and refinancing arrangements in circumstances where there appears to be no mischief that is actually being targeted. So, to take a very straightforward example, those debt creation rules can apply where there's actually no net debt created at all. If you move an asset between two vehicles and you gear it at the same level, those rules will apply to deny your debt deductions. There's no discernible logic as to why the rules operate in that manner.[64]

1.66As noted by Perpetual Limited, the rules go beyond targeting any perceived mischief:

These provisions go much further than that and actually attack domestic transactions which have no impact on Australian revenue whatsoever.[65]

1.67There is overwhelming evidence from submitters that the proposed rules are not fit for purpose and should not proceed as drafted. The Treasury has already conceded as much. They should therefore be removed from the bill and subject to a full and comprehensive consultation.

Issues with tax EBITDA method

1.68Tax EBITDA is earnings before interest, taxes, depreciation and amortisation, which means it is an entity’s annual taxable income, net debt deductions for the income year, capital works deductions and other various adjustments according to regulations. The tax EBITDA model forms the basis of the proposed fixed ratio test, a default test for general class investors which disallows net debt deductions in excess of 30 percent of an entity’s tax EBITDA, which is the fixed ratio earnings limit.

1.69Evidence presented to the committee suggested that due to the inflexibility of the tax EBITDA model as drafted, particular Australian industries or asset types will face major unintended consequences. This evidence is outlined in more detail below.

1.70For example, AFPA recommended that the bill be amended to enable plantation forestry to continue to utilise the current asset based safe harbour test rather than the new tax EBITDA model for determining the quantum of debt deductibility.[66] AFPA recommended that if its first recommendation was not put forward, the tax EBITDA method be changed to enable plantation depletion costs and plantation establishment costs to be added in at step three of the tax EBITDA method.[67]

1.71The tax EBITDA method as drafted is not suitable for an industry like plantation forestry because the harvesting period is between 30-50 years.[68] If the bill was passed as drafted, AFPA gave evidence that the plantation forestry industry would shrink significantly, and so too would Australia’s supply of timber and our competitiveness on the international stage.[69]

1.72If the bill was passed with amendments to the tax EBITDA, plantation forestry companies would continue to operate, albeit with increased tax bills, but would be unable to expand.[70] This unintended consequence of the bill is contrary to the government’s own policy under the Glasgow pledge to cease deforestation by 2030King and Wood Mallesons raised the example of a commonly structured real estate trust, where a holding trust does the borrowing but the underlying asset is held by a subsidiary trust:

In that situation, you wouldn't actually be able to access the 30 per cent EBITDA as ability to claim deductions, or the deductions would be denied, because there is no recognition of the nature of trusts and how you may have group arrangements for them.[71]

1.73The bill excludes franked distributions and dividends from entity’s assessable income under section 44 of the Income Tax Assessment Act 1936 (ITAA 1936) an entity’s tax EBITDA, on the basis that it avoids ’double counting income as the dividend represents profits which have already been taxed at the company level and are referable to the company’s tax EBITDA’.[72] According to the EM, this is ’to prevent the duplication of EBITDA capacity between associate entities’.[73]

1.74However, as Gilbert + Tobin have noted, an unfranked dividend is not paid out of taxed company profits.[74] This creates several inconsistencies in Australia’s tax laws with respect to dividend income:

Further, the franking rules within the 1997 Act allow companies to determine whether to frank dividends (subject to various anti-avoidance rules), allowing the potential for a mismatch between the distribution of franking credits (representing tax paid on profits) and the cash amount of dividends paid out of taxed profits. And not all foreign-sourced dividends are exempt (for example, dividends paid by companies in which the shareholding is less than 10%), meaning there will be circumstances where foreign dividend income is taxable but then excluded from tax EBITDA.[75]

1.75It was unclear to stakeholders why the underlying dividend is excluded, as there are cases ’where the underlying company may not be funded in part by any debt and thus not have any debt deductions’.[76] The Australian Investment Council (AIC) submitted that the justification for this exclusion ’fails to recognise that some profits may not have been subject to corporate tax and may be distributed as unfranked dividends’.[77]

1.76The Corporate Tax Association has recommended “that the law is amended to either include the sec 44 dividend” in an entity’s tax EBITDA, ’or excess capacity is transferred to the associate”, which happened under the existing thin capitalisation’.[78]

1.77Furthermore, SW Accountants & Advisors contended that ’not allowing distributions from a sub trust to be counted towards the Tax EBITDA of the head trust is disproportional to the objective of ensuring that there is no double counting of income’.[79] They recommended that this be removed from the bill or amended. SW Accountants & Advisors accordingly submitted:

... amend the legislation to allow a proportional ownership % of the excess FRT capacity of a sub trust to be ‘pushed up’ to the head trust. This is similar to the concept of associate entity excess amounts in the current thin capitalisation rules.[80]

1.78To fix this, BDO has suggested that exclusion of dividends and associated trust/partnership distribution income from tax EBITDA be modified ‘to allow sharing of the thin cap debt deduction limit to account for debt funding at the ownership level’.[81]

1.79Alternatively, the AIC argued that the exclusion of unfranked dividends is untenable. AIC stated that it should be removed from the bill ‘to address difficulties with tracing the source of profits and whether corporate tax has been paid on those profits…’[82]

1.80CPA Australia submitted that ‘while the removal of distributions from tax EBITDA prevents “double counting” benefits, it also unfairly attacks structures where there is no double counting, but debt is merely at the wrong level, that is, at the parent entity level’.[83] They have argued that:

The adoption of an associate entity excess rule with respect to excess capacity would properly complement the removal of trust distributions and dividends from an entity’s tax earnings before interest, taxes, depreciation, and amortisation (tax EBTIDA).[84]

1.81The tax EBITDA provisions should be amended with consideration given to removing the exclusion of unfranked dividends from tax EBITDA, or including an associate entity excess rule similar to the rules in section 820-920 of the Income Tax Assessment Act 1997.

1.82Furthermore, consideration should be given to changing the rules to enable plantation depletion costs and plantation establishment costs in step 3 of the tax EBITDA method.

Fixed ratio and group tests

1.83The bill introduces a default fixed ratio test, which limits net debt deductions in excess of 30 percent of an entity’s tax EBITDA. Furthermore, the bill proposes a group ratio test which requires an entity to determine the ratio of its group’s net third party interest expense to the group’s EBITDA for an income year. Debt deductions are disallowed which exceed an entity’s group ratio earnings limit.

1.84The proposed tests would replace the existing safe harbour debt and worldwide gearing debt tests and for general investors.

1.85Submitters to the inquiry spoke to the value of the current safe harbour rules for less sophisticated tax-payers. For example, CA ANZ explained:

From a practitioner viewpoint, safe harbours are valued by less sophisticated taxpayers … who don't possess large in-house tax groups with all the resources that large corporates have.

…those safe harbour and de minimis exclusions are very much valued by those smaller end taxpayers who lack the sophistication and resources to fund in-house tax teams and, quite frankly, struggle to pay the fees for professional accounting and legal firms to advise them. They're really appreciated at the lower end.[85]

1.86It is therefore crucial that any replacement tests are carefully designed to avoid serious unintended consequences and high compliance costs.

1.87Stakeholders have expressed concern about how this fixed ratio test, as currently drafted, might affect debt financing for property assets. The Property Council of Australia stated that

…the fixed-ratio test and the group test severely limit flexibility of where debt can sit in a structure—for example, at a downstream entity level or an upstream entity level. Debt deductions arising in upstream vehicles will be denied access under these measures. Upstream debt is common where debt is sourced to finance a portfolio of assets or where debt is sourced to finance the acquisition of a property holding vehicle—so that is smack bang in the heart of a lot of property investment in this country.[86]

1.88Gilbert + Tobin argued that ’the fixed ratio test discourages Australian entities borrowing to fund overseas operations, including the acquisition of foreign subsidiaries’.[87]

1.89Furthermore, the committee has heard that the fixed ratio test and group ratio tests also require amendments to ensure they properly apply to trust structures, and that they are currently not fit for purpose. On this point, the Property Council of Australia stated:

Consistently across the fixed ratio test, the group ratio test and the third-party debt test, they each create unique issues for non-consolidated structures and unit trusts in particular. So, notwithstanding that there has been consultation on those elements of the rules, effectively the bill that has been introduced is not fit for purpose when it comes to unit trusts and the real estate sector.[88]

1.90The Tax Institute clarified that these tests should operate with respect to trust groups under the same principles as consolidated corporate groups noting that the tests as drafted ’allows an allocation rule based on a one-time group wide election to either calculate tax EBITDA at the level of a nominated holding trust or the SPV trusts’.[89] This would mean ’only the holding trust would be able to apply the FRT, reducing the ability for trust groups to blend outcomes and reach unintended outcomes’.[90]

1.91Like with the other tests in the bill, the fixed ratio test is not appropriate for trust structures, such as the case with attributed managed investment trusts (AMITs). King and Wood Mallesons noted that ’the ‘tax EBITDA’ rules do not apply to AMITs as the provisions refer to ‘net income’, which is a Division 6 concept that does not apply to AMITs’.[91] They perceive this to be an oversight on the part of the drafters. Furthermore, King and Wood Mallesons oppose the ‘the exclusion of distributions from sub-trusts from a trust’s “tax EBITDA”’, which they believe gives rise to inappropriate and inequitable outcomes and explained as follows

It results in the loss of debt deductions by head trusts and interposed trusts of investment trust groups that are debt funded for genuine commercial reasons. This will have deleterious effects on the Australian property, infrastructure funds and funds management industries which operate using this form of legal structure.[92]

1.92The FSC agrees that the EBITDA test should be amended so that it correctly applies to AMITs.[93]The use of the concept of ’net income’ for trusts with respect to taxable income in the test would not work for AMITs, meaning that ’neither the main EBITDA test, nor the third-party debt test, are available for AMITs that incur interest expense’.[94] This would purportedly ’place a substantial tax penalty on AMITs that borrow, which would include many infrastructure and property investment funds’.[95]

1.93According to the Corporate Tax Association, one recommendation to alleviate this would be to amend the bill:

to allow an entity to include any excess tax EBITDA capacity from associate entities similar to the existing associate entity excess rules in section 820-920 of the Income Tax Assessment Act 1997.[96]

1.94In their submission, the Property Council agreed that allowing excess thin capitalisation capacity of a downstream associate entity to flow to an upstream associate entity would ensure ’that structures where external debt is sourced at an upstream level (e.g., debt related to a portfolio of assets) are not adversely impacted’.[97]

1.95Foreign investors, such as the Canadian pension funds, agreed that the fixed ratio test ’should be amended to allow upstream entities to utilise excess thin capitalisation capacity of downstream entities’.[98]

1.96During the public hearing, the Treasury conceded that the drafting of ’the income rules for calculating tax EBITDA for attribution managed investment trusts’ would cause unintended consequences.[99]When asked about amendments needed, the Treasury said:

It also goes to ensuring, for example, that the EBITDA tax calculation can accommodate attribution managed investment trusts, which need some specific rules to address their circumstances.[100]

1.97Furthermore, the Treasury agreed amendments were needed for the fixed-ratio test.[101]

1.98Consideration should be given to amending the rules so that they are fit for purpose and properly apply to AMITs and making excess thin capitalisation capacity available to underlying entities.

Third party debt test

Application to trusts

1.99Schedule 2 introduces a third-party debt test for general investors and financial entities which will disallow debt deductions that exceed the third party earnings limit. Entities can choose to apply this test instead of the fixed ratio test. If a general class investor that issues debt interest choses to use this test, the associate entities in that entity’s obligor group in relation to that debt interest are thereby deemed to have chosen the third party debt test. If the bill is enacted, the third party debt testwould replace the current arm’s length debt test.

1.100Despite changes to the exposure draft, submitters still identified a number of key issues with the test. For example, the American Chamber of Commerce in Australia said that ’they unfortunately reflect the unjustifiably rushed implementation of very complex legislation just prior to its commencement with significant amendments to the previous exposure draft’.[102]

1.101King and Wood Mallesons have summarised what they believe to be consequences of the test if passed:

The new ‘third party debt test’ will create a disincentive for Australia to be a holding company jurisdiction for multi-national companies.

At present, the test will not be available to Australian groups that have foreign subsidiaries. … it is likely to cause foreign multi-national companies to seek to separately acquire and/or hold foreign subsidiaries of Australian entities.

As a result, a multinational buyer…is now more likely to choose to use separate offshore acquisition vehicles to acquire each of the Australian and New Zealand entities. This is likely to reduce Australia’s tax revenue base. This is because the third party debt test is unlikely to be able to be relied upon by Australian taxpayers except in the very simple base case of an Australian entity with no foreign investments.[103]

1.102The proposed third-party debt test has serious problems regarding its application to trusts and joint ventures, as the FSC has identified:

Third-party debt [tests] require an entity to be an Australian resident, but the relevant definition excludes trusts and partnerships. This would exclude most investment vehicles used in Australia from applying the test. Further, current drafting would deny all interest deductions for attributed managed investment trusts, as neither the third-party debt test nor the main EBITDA test could apply. This would produce a substantial tax penalty for these vehicles when borrowing, compared to other forms of trusts……

In addition, a trust structure where a head trust receives all of its income through associated subsidiary trusts cannot claim deductions, as subsidiary trust income is fully omitted from the calculation of taxable income.[104]

1.103As the FSC have also noted, most investment vehicles in Australia use trusts and partnerships are also extensively used.[105] It makes very little sense to treat such entities differently in terms of tax treatment, particularly given that trusts do not satisfy the definition of ‘Australian resident’ as required by the third party debt test. The Corporate Tax Association has made a similar analysis.[106]

1.104The Property Funds Association concurred that the new framework would disallow interest deductions for common commercial transactions involving trust structures.[107] They submitted that the rules ’should apply to trust groups under the same principles that apply to consolidated corporate groups’.[108]

1.105King and Wood Mallesons expressed its concerns about ‘certain types of structures being treated inequitably, particularly property trusts and infrastructure trusts’.[109]

The way in which these rules will apply to them will be at a disadvantage to broader corporate structures. Similarly, in relation to more joint venture types of arrangements, they're going to be required to fund on a basis different to their competitors or other kinds of structures. That's a significant issue for quite a number of our big public funds.

…there are really going to be limited situations, on the basis of the current draft, in which these rules will actually be able to be relied on as a concession. Particularly, the types of security and arrangements that can be put in place that would ordinarily be expected by third-party financiers are going to mean that quite a number of the ordinary commercial transactions will not actually be eligible to rely on this test.[110]

1.106Although there are limited provisions relating to trusts in the bill, they are not adequate. King and Wood Mallesons further argued:

There are provisions dealing with trusts—as I said, they are quite limited in the circumstances in which a trust can fall within the current rules as drafted ...what you are required to determine is what the taxable income of the trust is, which is then taxed in respect of respective beneficiaries of that trust.[111]

1.107The Property Council of Australia contended that, with respect to the test ‘when you look at standard lending arrangements, very few, if any, actually qualify for the third-party debt test’.[112]

1.108Trusts are especially important to the property sector and its ability to invest in more housing. Property industry groups were adamant that the proposed third-party debt test was inadequate for their sector. As the Property Council of Australia explained:

The bill inadvertently captures genuine vanilla third-party debt that is relied upon by the property industry as a necessary means of doing business. The most common investment vehicle to invest in real property is a unit trust structure. These trust structures will not be able to access the third-party debt test, while the fixed-ratio and group-ratio tests will apply inappropriately to them. If passed unamended, the bill will render investment returns from a significant number of projects too low to proceed. We know this from our members who rely on and speak regularly with foreign pension funds and sovereign wealth funds to partner with them to build the homes Australians need. This would be a perverse policy outcome.[113]

1.109The Property Council predicted that the outcome of this legislation would essentially constitute tax on housing supply:

In its current form, we think the bill is a direct tax on the supply of 150,000 new homes for Australian renters, undoing the good work of balancing the playing field for build-to-rent housing investment and amounting to an own goal on the government's one million new homes by 2029 target. It is also a rationale-free new tax on investments in the productivity of our cities, more broadly impacting the entire property sector, including commercial, industrial and office.[114]

1.110Furthermore, as these vehicles cannot satisfy the third-party debt test, the bill would consequently put at risk Australia’s future supply as investment becomes less viable:

Oddly, this bill immediately puts at risk financing for 20,000 new homes under construction or in planning, and it otherwise puts at risk those 150,000 apartments over the next decade, which I mentioned before. In one of the scores of examples, a pipeline of more than a thousand apartments worth more than $2 billion and commencing next year will not go ahead now because the investment assumptions no longer stack up as a direct result of the simple propositions of the bill as drafted.[115]

1.111As outlined above, the reasoning for this is that ’the property would not have access to third-party debt deductions, which is a pillar of the property trust financing structure’.[116] The Property Council of Australia has explained how property trusts would not satisfy the third-party debt test:

To take the most straightforward example there: a trust structure is not an Australian resident, so it is automatically prevented from accessing the third-party debt test. More generally, standard commercial terms of the third-party lending arrangement will also not satisfy the third-party debt test, resulting in third-party debt deductions being denied.[117]

…

The particular type of unit trusts in the property sector can't tax consolidate. That means that the rules need to accommodate non-consolidated structures accessing the third-party debt test in circumstances where security is taken over different levels in the structure and where you may have certain intragroup lending arrangements.[118]

1.112In order for this test to be viable, it was submitted by most stakeholders that ’there does need to be quite significant amendments to a range of different elements embedded in the base third-party debt test and the conduit financing provisions’.[119]

1.113When appearing before the committee, Treasury admitted that there were serious unintended consequences with the third party debt test, particularly in relation to trusts. They concede that the drafting was focused on corporate entities:

Our work with industry stakeholders has identified a number of unintended consequences with the bill…including some issues that inadvertently affect trust structures, principally in relation to the third-party debt test.

… there have been some unintended consequences in the way the provisions have been drafted for the third-party debt test. In particular the focus of the drafting had been on how it relates to corporate entities. Some of the ways the provisions are drafted inadvertently exclude the operation of trusts.[120]

1.114Despite a supposedly extensive consultation on these thin capitalisation changes, Treasury flagged the necessity of amendments ’which would assist in the effective operation of the third-party debt test for trust structures, particularly in the use of applications in the property sector’.[121]

1.115On the third party debt test, the committee has yet to see any amendments from the Treasury. Based on stakeholder feedback, Coalition Senators recommend several amendments be made to the provisions in order to resolve the unintended consequences, which could be potentially catastrophic to simple commercial arrangements in Australia.

1.116One way to ensure the third-party debt test applies effectively to trusts and partnerships is for the test to refer to “Australian entity” instead of “Australian resident”, as has been submitted by a joint submission of Canadian pension funds.[122] CPA Australia and the Property Council have made the same recommendation.[123]

1.117The New Zealand Superannuation Fund has also submitted that such a change would be needed, as the group ratio test ’is not expected to be available to Foreign Funds’ and the fixed ratio test ’is not sufficient to maintain deduction for third party external debt arrangements on typical real estate and infrastructure investments owned though trust structures’.[124]

1.118Without this, the New Zealand Superannuation Fund has contended that there would be severe consequences for foreign investors in Australia, such as increasing the ’effective tax rate on affected investment’s above the 30 percent corporate tax rate:

The potential for institutional investors, such as the Foreign Funds, is that some or all of the debt deductions for genuine third party debt will not be deductible in working out the next taxable income of a trust entity which will increase the effective tax rate on affected investments, potentially above the 30% corporate tax rate in Australia.[125]

1.119Alternatively, to solve the trust issue, the test could be amended to include ’an resident trust estate’ as an entity that could satisfy the test.[126] The Tax Institute agrees that the ’scope of the residency requirements’ in the test should be broadened to accommodate trusts and partnerships.[127]

1.120The Treasury has conceded that this issue with trusts exists with the test, when speaking on unintended consequences. Mr Marty Robinson stated:

I mentioned a few of those in relation to the third-party debt test, in particular the inadvertent exclusion of some types of entities—in particular, trusts—due to the definition of 'Australian resident', as we heard before.[128]

1.121To fix this oversight, the bill must be amended so that trusts and other non-consolidated tax structures are able to effectively access the third-party debt test.

Recourse to Australian assets requirement

1.122Gilbert + Tobin have noted that the third party debt test ’takes into account debt secured only by Australian assets’. They contend that it will make the test unworkable because: ‘

…the relevant debt interest, to satisfy the third party debt condition, must have recourse for payment of the debt only to Australian assets held by the taxpayer and not rights under or in relation to a guarantee, security or other form of credit support.[129]

…

In our experience, no lender limits recourse just to Australian assets. Our view is that no lender will change its practices to limit recourse just to Australian assets. This is simply not a rational decision by a lender who seeks the most amount of security to minimise the risk of the lending.[130]

1.123Consequently, Gilbert + Tobin recommended that this limitation to only Australian assets be removed from the third-party debt test, and that a broader review of the test be undertaken.[131]

1.124King & Wood Mallesons has similar concerns about the test, noting that start-ups and small businesses which often rely on credit support from their founders will not be able to rely on the third party debt test.[132]

1.125The Property Council of Australia expressed concern about the recourse for payments to Australian assets requirement, noting:

The requirement that the third party lender only have recourse for payment to the assets of the entity will often mean that the ETPDT will not be available, for example it is common for the third party lender to have recourse to the membership interests in the borrowing entity, assets of subsidiary entities, or for another entity to provide a guarantee (although this could potentially be structured as an asset of the borrower).[133]

1.126They recommend that changes be made to the conditions of the third party debt test to reduce these unintended consequences. The Property Council has submitted extensive technical drafting changes that could be adopted.[134]

1.127The AIC argued that ’rather than creating a ‘cliff’, the policy intent could be met by restricting a percentage of interest deductions’.[135] They recommend further amendments to clarify the breadth of the third party debt test in this respect.[136]

1.128Consideration should be given to removing the limitation to only Australian assets with respect to the recourse for payment of debt.

Conduit financier rules

1.129There appears to be major deficiencies in the third party debt conditions of section 820-427A(3), particularly related to the conduit financier rules. Section 820-427A(3)(c) allows lenders to have recourse to the assets of entities that are members of the obligor group where borrowing is done via a related “conduit”. Where borrowing is done from an external lender directly, however, the lender may only have recourse to the assets of the borrowing entity.[137]BDO submitted to the Committee that:

The ETPDT is punitive in its application and provides very little flexibility for groups entering into third party financing arrangements via a conduit associate entity.[138]

1.130Witnesses also noted that the requirement for conduit financiers and borrowers to be Australian residents may preclude trusts and partnerships. This policy could have major consequences for Australian private companies seeking to expand overseas.[139]

1.131King and Wood Mallesons recommended that the conduit finance rules should be extended to include offshore conduit financing entities.[140]Furthermore, the Property Council submitted that the exclusion for “associate entity debt” should be removed, as it will severely limit or even effectively remove the ability for the ultimate borrower to on-lend borrowed funds to an Australian group entity.[141]

1.132Witnesses brought the Committee’s attention to a number of drafting issues with the conduit financing provisions.

1.133CAANZ submitted that:

There would also appear to be drafting issues with the conduit financing rule, in particular, the condition in section 820-427C(1)(f) which requires that the ultimate debt interest satisfies the third party debt condition. It is not possible for the conduit financier to satisfy the condition in section 820- 427A(3)(d)(ii) as this requires that it uses the proceeds to fund its commercial activities that do not include the holding of any associate entity debt. Under a standard conduit financing arrangement, the conduit financer would issue the ultimate debt interest to the ultimate lender and then on-lend the proceeds to the borrower which would constitute the holding of associate entity debt.[142]

1.134The Property Council of Australia submitted that:

Section 820 427C needs to apply to each debt interest separately, rather than requiring that all debt interests within an associate entity group must satisfy the requirements (which would prohibit, for example, non-interest bearing loans funded through excess cash in the structure). The requirements should be limited to amounts financed out of amounts borrowed externally. As drafted, there is a requirement that all debt between associate entities satisfy the rules (and, if one fail, they all fail). This does not make sense…[143]

1.135Furthermore, the Property Council of Australia recommended that section 820-427A(2)(a) be amended to allow hedging of interest rate risk in respect of “one or more debt interests:[144]

Where a swap hedges interest rate risk across a number of debt interests that each qualify under the third party debt conditions, the swap payments should be deemed to be attributable to a debt interest and therefore deductible.[145]

1.136Finally, King and Wood Mallesons submitted that:

The ‘same terms’ requirement should be amended such that the core terms of a debt interest issued by the conduit finance entity, such as interest rate, repayment dates, and maturity are required to be ‘substantially the same’ as the relevant debt interest issued by the borrower.[146]

1.137When making amendments to the bill, consideration should be given to permitting widened recourse requirements in the context of the conduit financing provisions.

Deemed choice

1.138Witnesses raised concerns with the workability of the bill’s approach to entities deemed to make a third-party debt election. The Property Council said that at a minimum there should be a ‘requirement that the party to the cross staple arrangement must be a member of the borrower’s obligor group’ with respect to deemed election.[147] The American Chamber of Commerce agreed that the test should be amended along these lines.[148]

1.139On the third party debt test, it should be that a cross-stapled entity is only deemed to make an election (i.e., because its cross-stapled arrangement entity has made an election) where it is a member of the obligor group in respect of the relevant debt interest. This ensures that if its assets and/ or income are not supporting the debt (i.e., by being in the obligor group), then it is not deemed to have made an election.

1.140The bill should be amended with consideration given to removing the requirement or limiting that deemed election with respect to the third party debt test where entities are part of an obligor group.

Credit support and loan recourse

1.141Witnesses raised concerns with the suitability of the bill’s treatment of credit support and loan recourse under section 820-427A(3)(c)(ii). INPEX submitted:

The exclusion of debt interest from satisfying the third party debt conditions where there is recourse to forms of credit support is not reflective of commercial project financing arrangements. The strict security requirements are placed on borrowers by lenders, who often require credit support as a condition to the project financing arrangement. This commercial requirement is to manage the construction risk period for the lender.

…

The current drafting would see these arrangements fail the Third Party Debt Test, despite debt being issued from a third party. There is no tax rationale for this requirement, and no multinational tax avoidance issue. Absent any credit support, often the response of commercial lenders is to increase the cost of borrowings, reduce the quantum they can offer, or withdraw lending commitments entirely.[149]

1.142Consideration should be given to amending the bill to allow recourse to forms of credit support as part of the conditions of the test.

Retrospectivity

1.143In its current form, the bill provides that the provisions will apply retrospectively from 1 July 2023, given the bill was introduced in June 2023 and it now September 2023. Multiple witnesses recommended that the provisions instead apply from 1 July 2024 to avoid any retrospective effect. The committee’s attention was drawn to significant infrastructure arrangements and projects in particular, where major investment and money have been pulled together on the basis of particular laws at the time.[150] With no transitional relief measures and a number of drafting issues still present in the bill, retrospective operation may be extremely disadvantageous. Infrastructure Partnerships of Australia were of the view that:

A start date of 1 July 2023 does not give any time for stakeholders to consider and prepare for the new law, noting that taxpayers currently require further information to be able to assess the impact of the measures and to understand the consequences for existing and proposed investment activities.[151]

1.144To allow for further consultation on the rules, and furthermore, to allow for entities to restructure existing financial arrangements in compliance with the new rules, the start date of the new thin capitalisation rules be deferred to 1 July 2024 to ensure they are not unduly retrospective.

Associate entity test superannuation exemption

1.145The bill includes an exemption for superannuation funds for the associate entity test.[152]The test excludes ‘complying superannuation funds and wholly owned subsidiaries of complying superannuation funds from the interest limitation rules’.[153] The associate entity test is designed to determine whether an entity is subject to the thin capitalisation rules. Such entities that are associate entities do not satisfy the third party debt conditions for the purposes of purposes of third party debt test.

1.146The EM provides a rather ironic and questionable justification for such an exemption, noting the definition of associate entity is drafted ‘too broadly in relation to superannuation funds and inappropriately restricts their ability to borrow’.[154] Justifying the exemption, the EM reads as follows:

…superannuation funds have grown to have significant investments in a variety of different assets and are now an important source of capital investment for Australian assets, particularly infrastructure assets. Under the current rules, these investments may cause superannuation funds to have a relatively large number of associate entities, which would bring their investments into scope of the thin capitalisation rules. However, superannuation funds are subject to a relatively strong regulatory regime and generally do not exercise any meaningful control over their associate entities. On this basis, the associate entity definition (to the extent it relates to the thin capitalisation rules) is no longer fit-for-purpose for Australian superannuation funds.[155]

1.147The government’s rationale for exempting superannuation funds from the test, with regard to the thin capitalisation rules, are mirrored almost exactly by those concerns expressed by stakeholders with respect to other affected entities such as AMITs, managed investment trusts (MITs), corporate collective investment vehicles (CCIVs) and other investment funds who are not exempt from the test.

1.148This is another example of the government making legislation that suits their fellow travellers in the superannuation sector. As with the government’s financial advice reform road map, they're preferencing the superannuation sector over other sectors. This is entirely against the principle of sector neutrality with respect to taxation and regulation. Furthermore, superannuation funds already receive generous tax exemptions.

1.149In their submission, the FSC recommended that investment funds should also be exempt from the associated entity test, noting the reasons given for the super fund exemption also apply to investment funds:

Investment funds, just like superannuation funds, collectively have significant investments in different assets.

Investment funds, just like superannuation funds, are important sources of capital investment for Australian assets, particularly infrastructure assets.

Under current interest limitation rules, some investment funds may have a relatively large number of associate entities, which would bring their investments into scope of the thin capitalisation rules.

Investment funds, just like superannuation funds, are subject to a strong regulatory regime.

Investment funds, just like superannuation funds, generally do not exercise any meaningful control over associate entities.[156]

1.150The FSC have argued there ‘is there is no good public policy rationale for the interest limitation rules introducing a competitive disadvantage for independent investment funds’.[157] Furthermore, the value of investments that are covered by the exemption is likely to be similar to the value of investments not covered, given the value of the $500 billion invested in retail unit trusts as of March 2023.[158]

Given the above, the FSC recommends the Bill be amended so that the proposed exemption from the associate entity test for superannuation funds should also apply to other investment funds that satisfy the existing ‘widely held’ test, specifically MITs, AMITs and CCIVs.[159]

1.151The Tax Institute has also argued recommended the exemption be expanded on this basis:

We recommend that further consideration on whether this exemption should also apply to MITs, AMITs and CCIVs should be undertaken given therationale provided regarding superannuation funds in the EM could seemingly apply to managed funds.[160]

1.152King and Wood Mallesons made the same recommendation and made a similar analysis, noting that ‘other types of investment funds such as MITs…are also likely to have many associates and are subject to high regulation and a typical lack of control of entities they invest in’.[161]

1.153To correct this inconsistent policy approach, the bill should be amended so that the proposed exemption from the associate entity test for superannuation funds also apply to other investment funds such as MITs, AMITs and CCIVs.

Consequences of passing without amendments

1.154While the Coalition is supportive of genuine efforts to improve the integrity of the tax system, the Coalition cannot support this bill in its current form without amendment.

1.155The potential consequences of this bill passing without amendments were clearly articulated by witnesses. The Property Council spoke about the potential significant consequences for capital investment:

The foreign investors will choose not to invest here; they will go elsewhere. It will have a dramatic adverse impact on the housing targets of the government.[162]

It already has had a major impact. We have heard from foreign wealth funds that this bill in its current form will make Australia uncompetitive in the global arena.[163]

1.156Perpetual Limited agreed, telling the committee:

[T]he prospective application of these rules to ordinary commercial transactions may act as a real disincentive for investment in Australia and, relevantly for us at Perpetual, a real disincentive for Australian companies seeking to invest offshore.[164]

1.157Without a fit-for-purpose approach with the proper carve-out provisions in place, Australia will not be in a position to compete with our neighbours for investment:

The UK and the US, which have carve-out provisions in place, would have a far higher internal rate of return on projects than what we would have in this country as a result of this bill.[165]

1.158The committee heard that the key flaw in the drafting of this bill is in its single-minded focus on the OECD’s stated objectives because it misunderstands how the one-size-fits-all approach does not apply in Australia. This misunderstanding has, according to the Property Council, not arisen in the United States or the United Kingdom:

They've understood how trusts work and they've decided to act to create those intelligent safe harbours which preserve various standard commercial operations and render those two jurisdictions particularly competitive for international investment.[166]

1.159CAANZ told the committee that the government’s ‘rushed approach to commencement is contrary to the OECD’s best practice approach to implementation of the new fixed ratio rule’.[167] At the bare minimum, it is expected that the government would give entities reasonable time to restructure existing financial arrangements before the rules become operational.

1.160To reiterate, the provisions, particularly the debt deduction creation rules go beyond OECD best practice anti-avoidance measures designed to limit base erosion and profit shifting:

These provisions go much further than that and actually attack domestic transactions which have no impact on Australian revenue whatsoever.[168]

1.161When asked, Treasury admitted that they had not done any analysis of the impact on economic activity these measures may have, neither at a sector-by-sector level nor at a macro level. During the public hearing officials outlined that a revenue impact analysis had only been undertaken:

Our analysis has probably been more along the lines of estimating the revenue impacts of the policy change. Our analytical area has looked at what the changes and the rules would do and has estimated what levels of interest deductions that are currently being claimed would subsequently be denied, and that's really formed the basis of the estimated revenue impact.[169]

1.162King and Wood Mallesons agreed that a deferral of Schedule 2 was necessary, submitting that the provisions should allow for ’appropriate reorganisation of arrangements to meet the new legislative requirements without the risk of anti-avoidance rules applying’.[170]

1.163To avoid these risks, Schedule 2 of the Bill as currently drafted should not proceed without amendments.

1.164That the debt deduction creations rules (subdivision 820-EAA) be removed from the bill and instead be subject to a full and comprehensive Treasury consultation process through an exposure draft bill. This section is not necessary to achieve the overall objective of the bill.

1.165That the fixed ratio test and method of tax EBITDA be amended to accommodate non-consolidated tax structures such as trusts, and other affected sectors, with consideration given to:

removing the exclusion of unfranked dividends from tax EBITDA, or including an associate entity excess rule similar to the rules in section 820-920 of the Income Tax Assessment Act 1997;

changing the tax EBITDA method to enable plantation depletion costs and plantation establishment costs to be added in at step 3 of the tax EBITDA method; and

allowing an excess thin capitalisation capacity for underlying entities.

1.166That the third party debt test be removed from the bill or deferred by 12 months to allow for further consultation, maintaining the arm’s length debt test in the interim.

1.167That the provisions for the third party debt test be amended to accommodate non-consolidated tax structures such as trusts, with consideration given to:

amending “Australian resident” to “Australian entity” to ensure the test applies properly to trust structures;

removing the limitation to only Australian assets with respect to the recourse for payment of debt;

amend the test so that a cross-stapled entity is only deemed to make an election where it is a member of the obligor group in respect of the of the relevant debt interests;

permitting widened recourse requirements in the context of the conduit financing provisions;

allowing for recourse to forms of credit support as part of the conditions of the test; and

allowing for the hedging of interest rate risk and foreign currency hedging arrangements with respect to one or more debt interests.

1.168That the bill be amended so that the proposed exemption from the associate entity test for superannuation funds also apply to other investment funds such as managed investment trusts, attribution managed investment trusts and corporate collective investment vehicles.

1.169That the start date of the new thin capitalisation rules be deferred to 1July 2024, for the following reasons:

to allow for further consultation on the rules;

to allow for entities to restructure existing financial arrangements in compliance with the rules; and

to ensure the application of the rules is not retrospective.

Footnotes

[1]Law Council of Australia, Submission 39, p. 1.

[2]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 52.

[3]Property Council of Australia, Submission 37, p. 2.

[4]Mr Michael Croker, Tax Leader, Australia Chartered Accountants Australia and New Zealand (CA ANZ), Committee Hansard, 15 August 2023, p. 13.

[5]Mr John Kirkness, Head of Tax, Group Finance, Perpetual Limited, Committee Hansard, 15August2023, p. 25.

[6]Mr John Kirkness, Head of Tax, Group Finance, Perpetual Limited, Committee Hansard, 15 August 2023, p. 25.

[7]Mr Spiro Premetis, Executive Director, Policy and Advocacy, Financial Services Council (FSC), Committee Hansard, 15 August 2023, p. 26.

[8]Dialogue between Senator Dean Smith and Mr Spiro Premetis, Executive Director, Policy and Advocacy, FSC, Committee Hansard, 15 August 2023, p. 26.

[9]Ms Judith Taylor, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 28.

[10]Ms Judith Taylor, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 29.

[11]Mr Christopher Taylor, Chief of Policy, Australian Banking Association (ABA), Committee Hansard, 15 August 2023, p. 30.

[12]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 31.

[13]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 33.

[14]Mr Peter Grist, Principal Economist, Director, Economics, Industry and Sustainability, Australian Chamber of Commerce and Industry, Committee Hansard, 15 August 2023, p. 34.

[15]Mr Peter Grist, Principal Economist, Director, Economics, Industry and Sustainability, Australian Chamber of Commerce and Industry, Committee Hansard, 15 August 2023, p. 35.

[16]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15August 2023, p. 37.

[17]Mr Stephen Whittington, Member, Capital Markets Committee, Property Council of Australia, Committee Hansard, 15 August 2023, pp. 39-40.

[18]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 48.

[19]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 50.

[20]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 52.

[21]Mr David Hawkins, Director, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 50.

[22]Ms Sara Bray Senior Policy Manager, Australian Forest Products Association, Committee Hansard, 15 August 2023, p. 44.

[23]Explanatory Memorandum, p. 35.

[24]Mr Wayne Sutherland, Head of Tax, Treasury and Transfer Pricing, ABA, Committee Hansard, 15 August 2023, p. 31.

[25]Mr Bill Leung, Tax Technical Adviser, Policy and Advocacy, CPA Australia, Committee Hansard, 15 August 2023, p. 14.

[26]Mr Bill Leung, Tax Technical Adviser, Policy and Advocacy, CPA Australia, Committee Hansard, 15 August 2023, p. 14.

[27]Mr Bill Leung, Tax Technical Adviser, Policy and Advocacy, CPA Australia, Committee Hansard, 15 August 2023, pp. 14-15.

[28]Ms Karen Batt, Joint National Secretary, Community and Public Sector Union (CPSU), Committee Hansard, 15 August 2023, p. 20.

[29]Mr Joseph Mitchell, Assistant Secretary, Australian Council of Trade Unions (ACTU), Committee Hansard, 15 August 2023, p. 20.

[30]Mr Spiro Premetis, Executive Director, Policy and Advocacy, FSC, Committee Hansard, 15 August 2023, p. 22.

[31]Mr Chris Green, Chief Financial Officer, Perpetual Limited, Committee Hansard, 15 August 2023, p. 23.

[32]Mr Spiro Premetis, Executive Director, Policy and Advocacy, FSC, Committee Hansard, 15 August 2023, p. 23.

[33]Ms Judith Taylor, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 27.

[34]Ms Judith Taylor, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 27.

[35]Ms Judith Taylor, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 27.

[36]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 30.

[37]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 30.

[38]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 30.

[39]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 30.

[40]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 30.

[41]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 30.

[42]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 30.

[43]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 32.

[44]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 32.

[45]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 32.

[46]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 32.

[47]Mr Christopher Taylor, Chief of Policy, ABA, Committee Hansard, 15 August 2023, p. 31.

[48]Mr Peter Grist, Principal Economist, Director, Economics, Industry and Sustainability, Australian Chamber of Commerce and Industry, Committee Hansard, 15 August 2023, p. 34.

[49]Mr Peter Grist, Principal Economist, Director, Economics, Industry and Sustainability, Australian Chamber of Commerce and Industry, Committee Hansard, 15 August 2023, p. 34.

[50]Mr Peter Grist, Principal Economist, Director, Economics, Industry and Sustainability, Australian Chamber of Commerce and Industry, Committee Hansard, 15 August 2023, p. 35.

[51]Mr Peter Grist, Principal Economist, Director, Economics, Industry and Sustainability, Australian Chamber of Commerce and Industry, Committee Hansard, 15 August 2023, p. 35.

[52]Infrastructure Partnerships Australia, Submission 9, pp. 6-7.

[53]American Chamber of Commerce in Australia, Submission 21, p. 5.

[54]American Chamber of Commerce in Australia, Submission 21, p. 5.

[55]National Foreign Trade Council, Submission 30, p. 6.

[56]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 47.

[57]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 49.

[58]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 51.

[59]Mr David Hawkins, Director, Corporate and International Dax Division, Treasury, Committee Hansard, 15 August 2023, p. 53.

[60]Department of the Treasury, IQ23-000095, p. 1.

[61]See, for example: Infrastructure Partnerships Australia, Submission 9, p. 5; Ontario Municipal Employees' Retirement System (OMERS), Caisse de dépôt et placement du Québec (CDPQ), British Columbia Investment Management Corporation (BCI), and the Ontario Teachers' Pension Plan (OTPP), Submission 11, p. 15; Australian Chamber of Commerce and Industry, Submission 12, p. 5; Perpetual Limited, Submission 13, p. 3; ABA, Submission 14, pp. 5-6; FSC, Submission 15, p. 5; New Zealand Superannuation Fund, Submission 16, p. 8; Business Council of Australia, Submission 18, p. 4; American Chamber of Commerce in Australia, Submission 21, p. 6; Property Funds Association of Australia, Submission 22, p. 5; Corporate Tax Association, Submission 24, p. 22;Deloitte, Submission 28, p. 3; CPA Australia, Submission 31, p. 2; King and Wood Mallesons, Submission 35, p. 5; Australian Financial Markets Association, Submission 36, p. 4; Property Council of Australia, Submission 37, pp. 11-12; Australian Investment Council, Submission 38, p. 3; Law Council of Australia, Submission 39, p. 2; Pitcher Partners Advisors Proprietary Limited, Submission 42, p. 3; Chartered Accountants Australia and New Zealand, Submission 44, p. 16; QIC, Submission 48, p. 3; Port of Melbourne, Submission 51, p. 6; Vector Metering, Submission 53, p. 1.

[62]See, for example: ABA, Submission 14, pp. 5-6; Port of Brisbane, Submission 50, p. 4; Gilbert + Tobin, Submission 23, p. 5; American Chamber of Commerce in Australia, Submission 21, p. 6.

[63]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15August 2023, p. 38.

[64]Mr Stephen Whittington, Member, Capital Markets Committee, Property Council of Australia, Committee Hansard, 15 August 2023, pp. 39.

[65]Mr John Kirkness, Head of Tax, Group Finance, Perpetual Limited, Committee Hansard, 15August2023, p. 25.

[66]Australian Forest Products Association, Submission 40, p. 14.

[67]Australian Forest Products Association, Submission 40, p. 17.

[68]Ms Sara Bray Senior Policy Manager, Australian Forest Products Association, Committee Hansard, 15 August 2023, p. 44.

[69]Ms Sara Bray Senior Policy Manager, Australian Forest Products Association, Committee Hansard, 15 August 2023, p. 44.

[70]Ms Sara Bray Senior Policy Manager, Australian Forest Products Association, Committee Hansard, 15 August 2023, p. 45.

[71]Mr Scott Heezen, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 28.

[72]Explanatory Memorandum, p. 20.

[73]Explanatory Memorandum, p. 97.

[74]Gilbert + Tobin, Submission 23, p. 3.

[75]Gilbert + Tobin, Submission 23, p. 3.

[76]Corporate Tax Association, Submission 24, p. 6.

[77]Australian Investment Council, Submission 38, p. 5.

[78]Corporate Tax Association, Submission 24, p. 7.

[79]SW Accountants & Advisors, Submission 25, p. 6.

[80]SW Accountants & Advisors, Submission 25, p. 6.

[81]BDO, Submission 34, p. 1.

[82]Australian Investment Council, Submission 38, p. 6.

[83]CPA Australia, Submission 31, p. 1.

[84]CPA Australia, Submission 31, p. 1.

[85]Mr Michael Croker, Tax Leader, Australia, CAANZ, Committee Hansard, 15 August 2023, p. 15.

[86]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15 August 2023, p. 38.

[87]Gilbert + Tobin, Submission 23, p. 2.

[88]Mr Stephen Whittington, Member, Capital Markets Committee, Property Council of Australia, Committee Hansard, 15 August 2023, p. 39.

[89]The Tax Institute, Submission 26, p. 7.

[90]The Tax Institute, Submission 26, p. 7.

[91]King and Wood Mallesons, Submission 35, p. 11.

[92]King and Wood Mallesons, Submission 35, p. 11.

[93]FSC, Submission 15, p. 6.

[94]FSC, Submission 15, p. 5.

[95]FSC, Submission 15, p. 6.

[96]Corporate Tax Association, Submission 38, p. 7.

[97]Property Council of Australia, Submission 37, p. 5.

[98]Ontario Municipal Employees' Retirement System (OMERS), Caisse de dépôt et placement du Québec (CDPQ), British Columbia Investment Management Corporation (BCI), and the Ontario Teachers' Pension Plan (OTPP), Submission 11, p. 6.

[99]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 52.

[100]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 49.

[101]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 49.

[102]American Chamber of Commerce in Australia, Submission 21, p. 3.

[103]King and Wood Mallesons, Submission 35, p. 7.

[104]Mr Spiro Premetis, Executive Director, Policy and Advocacy, FSC, Committee Hansard, 15 August 2023, pp. 22-23.

[105]FSC, Submission 15, p. 5.

[106]Corporate Tax Association, Submission 24, p. 8.

[107]Property Funds Association of Australia, Submission 22, p. 3.

[108]Property Funds Association of Australia, Submission 22, p. 4.

[109]Mr Scott Heezen, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 27.

[110]Mr Scott Heezen, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 27

[111]Mr Scott Heezen, Partner, King and Wood Mallesons, Committee Hansard, 15 August 2023, p. 28.

[112]Mr Stephen Whittington, Member, Capital Markets Committee, Property Council of Australia, Committee Hansard, 15 August 2023, p. 38.

[113]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15 August 2023, p. 37.

[114]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15 August 2023, p. 37.

[115]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15 August 2023, p. 37.

[116]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15 August 2023, p. 37.

[117]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15 August 2023, pp 37 - 38.

[118]Mr Stephen Whittington, Member, Capital Markets Committee, Property Council of Australia, Committee Hansard, 15 August 2023, p. 39.

[119]Mr Stephen Whittington, Member, Capital Markets Committee, Property Council of Australia, Committee Hansard, 15 August 2023, p. 38.

[120]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 47.

[121]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 47.

[122]Ontario Municipal Employees' Retirement System (OMERS), Caisse de dépôt et placement du Québec (CDPQ), British Columbia Investment Management Corporation (BCI), and the Ontario Teachers' Pension Plan (OTPP), Submission 11, p. 7.

[123]CPA Australia, Submission 31, p. 3; Property Council of Australia, Submission 37, p. 13.

[124]New Zealand Superannuation Fund, Submission 16, pp. 4-5.

[125]New Zealand Superannuation Fund, Submission 16, pp. 4.

[126]SW Accountants & Advisors, Submission 25, p. 3.

[127]The Tax Institute, Submission 26, p. 7.

[128]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 49.

[129]Gilbert + Tobin, Submission 23, p. 2.

[130]Gilbert + Tobin, Submission 23, p. 3.

[131]Gilbert + Tobin, Submission 23, p. 3.

[132]King and Wood Mallesons, Submission 35, p. 7.

[133]Property Council of Australia, Submission 37, p. 14.

[134]Property Council of Australia, Submission 37, p. 14.

[135]Australian Investment Council, Submission 38, p. 4.

[136]Australian Investment Council, Submission 38, p. 5.

[137]CPA Australia, Submission 31, p. 2.

[138]BDO, Submission 34, p.1

[139]CAANZ, Submission 40, p. 10.

[140]King and Wood Mallesons, Submission 35, p. 10.

[141]Property Council, Submission 37, pp. 13-14.

[142]CAANZ, Submission 40, p. 12.

[143]Property Council of Australia, Submission 37, p. 17.

[144]Property Council of Australia, Submission 37, p. 19.

[145]Property Council of Australia, Submission 37, p. 19.

[146]King and Wood Mallesons, Submission 35, p. 10.

[147]Property Council of Australia, Submission 37, p. 7.

[148]American Chamber of Commerce, Submission 21, p. 4.

[149]INPEX, Submission 27, pp 1-2.

[150]King and Wood Mallesons, Submission 35, p. 27.

[151]Infrastructure Partnerships Australia, Submission 9, p. 4.

[152]Explanatory Memorandum, p. 36.

[153]The Tax Institute, Submission 26, p. 8.

[154]Explanatory Memorandum, p. 36.

[155]Explanatory Memorandum, pp. 36–37.

[156]FSC, Submission 15, p. 6.

[157]FSC, Submission 15, p. 7.

[158]FSC, Submission 15, p. 7.

[159]FSC, Submission 15, p. 7.

[160]The Tax Institute, Submission 26, p. 8.

[161]King and Wood Mallesons, Submission 35, p. 12.

[162]Mr Mitchell Beare, Chair, Income Tax Committee, Property Council of Australia, Committee Hansard, 15 August 2023, p. 40.

[163]Mr Antony Knep, Executive Director Capital Markets, Property Council of Australia, Committee Hansard, 15 August 2023, p. 40.

[164]Mr Chris Green, Chief Financial Officer, Perpetual Limited, Committee Hansard, 15 August 2023, p.23.

[165]Mr Antony Knep, Executive Director Capital Markets, Property Council of Australia, Committee Hansard, 15 August 2023, p. 40.

[166]Mr Mike Zorbas, Chief Executive Officer, Property Council of Australia, Committee Hansard, 15 August 2023, p. 41.

[167]CAANZ, Submission 40, p. 8.

[168]Mr John Kirkness, Head of Tax, Group Finance, Perpetual Limited, Committee Hansard, 15 August 2023, p. 25.

[169]Mr Marty Robinson, First Assistant Secretary, Corporate and International Tax Division, Treasury, Committee Hansard, 15 August 2023, p. 52.

[170]King and Wood Mallesons, Submission 35, p. 6.