Senate Report on Thin Capitalisation Bill

On 22 September 2023, the Senate Economics Legislation Committee released its report on the recently introduced Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 (the Bill). The Bill contains important changes to the thin capitalisation rules (in Schedule 2), as well as the new public tax disclosure requirements on multinational groups (in Schedule 1). The Senate Committee report recommended there would be no major changes to the Bill. However, in relation to the thin capitalisation changes in Schedule 2 of the Bill, the Senate Committee recommended that consideration be given to amending the thin capitalisation changes for technical amendments foreshadowed by Treasury in the report. These include amendments to:

Deal with inflexibility in the fixed ratio and group ratio tests in relation to trusts
The third-party debt test to fix some issues identified in submissions including the residency test, which effectively excludes trusts and partnership from this test
Consideration of providing particular carve-outs and exclusions to the debt deduction creation rules to avoid inappropriate outcomes
Provide clarification and consideration of a transitional period in relation to the commencement date for these measures
Possible further technical amendments that will be considered by Treasury (no further details were provided).

Treasury is currently addressing feedback from submissions to the Senate Committee and undertaking consultation with stakeholders as well as considering further external consultation in relation to technical amendments to thin capitalisation rules.

The Senate Committee recommended that the new public disclosure requirements on multinational groups, contained in Schedule 1 of the Bill be passed unamended.

Prior to the release of the report, the Bill was passed with no amendment by the House of Representatives on 8 August 2023 and had its second reading in the Senate on 9 August. It now awaits to be considered by the Senate, subject to any changes recommended by Treasury.

Thin Capitalisation Changes

Schedule 2 to the Bill seeks to amend the thin capitalisation rules within Division 820 of the ITAA 1997, to limit the excessive use of debt that entities can deduct for tax purposes that lead to base erosion or profit shifting arrangements.

The amendments would, among other things:

Introduce new earnings-based interest limitation rules for general class investors to disallow an amount of an entity’s debt deductions based on the entity’s earnings or profits, replacing the current asset-based tests
Introduce a new Subdivision 820-EAA to disallow debt deductions to the extent that they are incurred in relation to debt deduction schemes.

Technical amendments foreshadowed by Treasury

In addition to the Senate Committee recommendation that the thin capitalisation changes be passed, these would be subject to further technical amendments foreshadowed by Treasury.

In its evidence to the Senate Committee, Treasury advised:

Fixed and group ratio tests - On the issue of trusts, the report indicated amendments to the fixed and group ratio tests were being considered in relation to trusts. This was in response to submissions that suggested trust groups be treated similarly to consolidated corporate groups, particularly where debt sits at various levels in a trust group structure.
Third-party debt test – Treasury acknowledged there were some unintended consequences in the way the provisions have been drafted for the third-party debt test. Treasury advised that several minor technical amendments would resolve key issues that had been raised, including making clarifications to the Australian resident requirements so that the test applies to trusts and partnerships that may have been ‘inadvertently exclude’ in the drafting of the Bill.
Debt deduction creation rules – Treasury acknowledged that the current drafting of the debt creation rules are broader in application than originally intended and is working with the ATO and other stakeholders to consider how amendments to these rules could potentially be made. There was a potential problem with the treatment of cash, in certain circumstances where consideration received by a vendor in selling an asset would result in inappropriate outcomes under the debt deduction creation rules. Treasury acknowledged there was possibly some benefit in including particular carve-outs, which essentially clarify the operation of the rules within the actual provision, rather than relying on other guidance and advice elsewhere in the tax system. Treasury also indicated that consideration is being given to include certain exclusions from these debt deduction creation rules, which may be modelled on the original provisions in former Division 16G of the ITAA 1997 (sic, it is assumed the report meant to refer to ITAA 1936).
Commencement date - Regarding the commencement date of proposed thin capitalisation rules and addressing recommendations that a transition period be implemented, Treasury assured the Committee there would be suitable time for entities to adjust to the new arrangements. In terms of transition, for some entities seeking to for example, restructure debt to be compliant with the new rules - which is not unusual in the way business funds activities - Treasury indicated that’s something that could be considered.
Other technical amendments - Treasury reassured the committee that other further technical amendments to the Bill were being explored but did not give further details. It did say stakeholder engagement has continued following the introduction of the Bill.

New Rules on Disclosure of Subsidiaries

The proposed amendments in Schedule 1 of the Bill, which the Senate Committee has recommended be passed unamended, introduce new rules to require Australian public companies (listed and unlisted) to disclose information about subsidiaries in their annual financial reports. The amendments would ensure all public companies have equal requirements for reporting basic information on their corporate structures. When enacted, the amendments will apply retrospectively to annual financial reports prepared for financial years commencing from 1 July 2023.

BDO Comment

The proposed technical amendments to the thin capitalisation part of the Bill do not cover all the important issues identified in the submissions to the Senate Committee. We hope the further consultation that is being undertaken by Treasury will at least consider these issues.

Should you have any questions regarding the content of this article, please contact your BDO tax adviser for further guidance.