Proposed changes to Australia’s thin capitalisation rules
Tony Nunes & Susan Ma
by Tony Nunes & Susan Ma
In the October 2022 Federal Budget, the Australian government announced potential changes to Australia's thin capitalisation rules to adopt the OECD's recommended approach in BEPS Action 4. A draft legislation is currently undergoing a consultation process until 13 April 2023 (the Draft). The changes, if enacted, will apply to multinational business operating in Australia (except banks and financial entities) with at least AUD 2 million in tax deductions for interest expenditures, for income years commencing on or after 01 July 2023.
Under the current rules, interest deductions for a non-financial entity in relation to its cross-border investments are limited by statutory tests where the maximum allowable deduction is the greater of the following:
1. The safe harbour debt amount, being 60 percent of the average value of the entity's Australian assets (the Safe Harbour Test);
2. the arm's length debt amount, which is determined based on an analysis of what level of funding and terms an independent lending institution could reasonably be expected to provide to the entity (the Arm's Length Test); or
3. the worldwide gearing debt amount, which allows the entity to gear its Australian operations in certain circumstances up to 100 percent of the actual gearing of its worldwide group (the Worldwide Gearing Test).
The proposed changes in the Draft include:
The Safe Harbour test will be replaced with an earnings-based test which limits debt-related deductions to 30 percent of Earnings before Interest, Taxes, Depreciation and Amortisation (EBITDA). Debt-related deductions exceeding 30 percent of EBITDA will be disallowed, however the deductions may be carried forward to subsequent income years for up to 15 years.
The Arm's Length Test will be retained for deductions with respect of third-party debts, effectively disallowing deduction entirely for related party debt under this test.
The Worldwide Gearing Test will be replaced with an earnings test based on a share of the group's EBITDA.
The changes will apply to multinational entities operating in Australia and any inward or outward investor. Financial entities and authorised deposit-taking Institutions will continue to be subject to the existing thin capitalisation rules.
According to the Draft, there is no change to the current AUD 2 million de minimis threshold before thin capitalisation rules are activated.
The Draft also included unexpected changes that effectively repeal the ability of companies to deduct interest incurred to earn certain exempt foreign income (which was not announced in the October 2022 Budget). There is no provision in the Draft which would "grandfather" existing debt structures.
If enacted, these new rules will have the effect of reducing the amount of interest that companies can claim as a deduction. Multinationals with operations in Australia should re-test their thin capitalisation limits using the new rules now, so as to have sufficient time to restructure their debt where these rules are tripped.
Kelly + Partners Chartered Accountants is a specialist chartered-accounting business that assists private businesses, private clients, and families to manage their business and personal financial affairs. The Kelly + Partners Tax Consulting Practice is respected as one of the foremost tax advisory firms in Australia and offers a full range of direct, indirect, and international tax services.
Susan Ma has 10 years of experience looking after accounting and tax affairs for a diverse range of clients including SMEs, private family groups, high net worth individuals, and global mobile expats. Susan’s areas of tax expertise include tax residency and cross-border taxation, small business tax concessions, employee share schemes, and restructure. As a qualified CA and a lawyer, Susan understands the intricacies of how accounting, tax, and law operate together to provide pragmatic solutions for clients. Contact Susan.
Tony Nunes has over 25 years’ experience in providing tax advice to clients, especially on issues affecting cross-border transactions, acquisitions and restructures, and on all aspects of structuring the ownership and financing of corporations and their operations. Contact Tony.
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