Opposition Targets Thin Capitalisation as Key Tax Reform Area

Thursday 5 March 2015 @ 11.17 a.m. | Corporate & Regulatory | Taxation

It has been reported that the Federal Opposition has responded to calls from the government and the media for it to release details of how it would deal with and go about providing alternative budget savings to those proposed by the Government. The opposition proposes a plan that would, based on a Parliamentary Budget Office assessment, target multinational tax avoidance to the tune of $1.9bn over three years. The plan was announced on 2 March 2015 by the leader of the opposition and the shadow treasurer. The key element of the plan and the one likely to derive the most savings is a proposal to change the amount of debt for which companies can claim deductions in Australia, in other words a plan to further tighten the "Thin Capitalisation Rules" .

What are the Thin Capitalisation Rules?

Essentially, the Thin Capitalisation Rules seek to prevent multinational enterprises from shifting profits out of Australia by funding their Australian operations with high levels of debt in order to reduce their Australian taxable income. This is done by limiting debt-to-equity gearing ratios so that where those ratios exceed prescribed debt limits, tax deductions for interest expense and borrowing costs may be limited.

The types of business whose Australian operations are typically affected by Thin Capitalisation Rules are businesses like:

  • Australian entities that operate internationally and some of their associates;
  • Australian entities that are foreign controlled; and
  • Foreign entities that operate in Australia.

The relevant legislation can be found in the Income Tax Assessment Act 1997  (Cth) at Part 4-5 Division 820 (Thin Capitalisation Rules).

Recent Changes to the Rules

The last changes to the Thin Capitalisation Rules were made in late 2014 by the Tax and Superannuation Laws Amendment (2014 Measures No. 4) Act 2014 No 110 (Cth) which reviewed the statutory debt limits set under the legislation in 2001 to bring them more closely into line with current commercial debt levels or, in the case of banks (and non-bank financial entities), closer to the current regulatory requirements. The aim of the reforms being to reduce the incentive for multinational enterprises to allocate excessive levels of debt to their Australian operations, and claim excessive debt deductions in Australia, thereby reducing their Australian taxable income.

The changes also introduced a new test for inbound investors to restrict tax deductible gearing of their Australian operations to the level of gearing of the group worldwide and changes were made to assist small and medium enterprises having overseas operations by reducing the cost of determining whether they complied with the Thin Capitalisation Rules. The threshold for complying with the regime increased from $250,000 to $2 million of total debt deductions.

These changes were changes initiated by the last Labor government and subsequently enacted by the current government,

How the Opposition Proposal Would change Current Rules?

The opposition is reported as indicating that $1.65bn would be recouped in three years by changing the current Thin Capitalisation Rules. This would be done by amending legislation to ensure that multinational companies could no longer claim up to a 60% debt-to-equity ratio for their Australian operations, the test would be changed to be instead, the ratio of the company’s entire global operations.

The opposition is quoted as saying:

“This means that if a company has an average 30% debt-to-equity ratio across its different subsidiaries, it will only be able to claim tax deductions up to that level.”

The opposition characterises the plan as attempting to shut down the loopholes that allow big multinationals to send profits overseas and say the plan goes beyond the changes to Thin Capitalisation that passed the parliament in 2014 described above.

Other Tax Reform Measures Proposed

Measures apart from the Thin Capitalisation changes announced were reported as:

  • The better alignment Australian rules on hybrid entities with tax laws in other countries, which is estimated to deliver $100 million to the Federal budget;
  • Escalating by one year the July 2016 start date for third-party reporting and data matching, estimated to deliver $90 million to the Federal budget;
  • Providing funding for increased compliance by the Australian Taxation Office to ultimately deliver a net saving of $67 million over the budget cycle; and
  • Setting up a “multinational tax expert panel” to ensure the changes work as they are intended and to “assist with the implementation and refinement” of the measures proposed.

Comment and Reaction

The press reports Treasurer Joe Hockey as saying his advice from Treasury was that the opposition proposal on Thin Capitalisation tax changes would cost jobs by making it more expensive for international businesses to operate in Australia causing them to simply reduce their operations. The Treasurer citing car manufacturing companies as an example of this.

Kate Carnell, CEO of the Australian Chamber of Commerce and Industry is also reported as claiming the Thin Capitalisation proposal would cost jobs and saying any such changes should only be taken as part of coordinated global action.

“Any changes to Australia’s international tax rules must be made in cooperation with our OECD partners and be part of the wider tax white paper process. Otherwise we run the risk of undermining investment and worsening unemployment, . . .”

The Business Council of Australia’s chief executive, Jennifer Westacott, is reported as saying further changes to Thin Capitalisation Rules after the 2014 changes might be premature, “. . . it would be surprising and disappointing to see ad hoc changes before the impact of these changes can be fully assessed”.

The Secretary of the ACTU Dave Oliver is reported as backing the policy announcement saying:

“For too long, large multinationals have been ripping off Australian taxpayers by hiding their profits and using loopholes in the Australian tax system.”

The announcement is clearly a response to the Government's repeated calls for the opposition to offer alternatives and for the Labor party to stop “sabotaging” budget repair by joining with other parties to block contentious measures in the Senate. With pending economic statements in a worsening economy and the lead up to the next budget this proposal is likely to be the subject of much more comment and discussion in the coming weeks.

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