The Australian Senate Economics Legislation Committee has secured a time extension to report on the Bill currently before Parliament which contains, amongst other things, significant reforms to Australia’s thin capitalisation rules, i.e. the Taxation Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023. This Bill was introduced to the Australian Parliament on June 22 2023, and it is now expected that the Senate Committee will make several recommendations and proposed amendments relating to, amongst other things, the fixed ratio test, the third-party debt test and the debt deduction creation rules.
The new legislation proposes significant changes to Australia’s thin capitalisation rules for multinational enterprises (non-bank/non-financial entities), particularly impacting those involved in capital intensive industries like economic and social infrastructure, property and energy and natural resources.
The transition to the OECD’s earnings-based model from the existing safe harbour test and arm’s-length debt tests has raised various issues and concerns, which are the subject of various submissions by industry and professional bodies to the Senate Committee.
As currently proposed, the primary test would be the fixed ratio test where net debt deductions (i.e., interest deductions) are limited to 30% of the entity’s tax EBITDA. Alternative approaches based on a group EBITDA ratio test or the third-party debt test limit would be available in prescribed and limited circumstances.
The proposed legislation introduces an additional integrity measure that would disallow debt deductions related to debt creation schemes.
Further, since gearing levels would no longer be governed by the thin capitalisation rules for taxation purposes, the gearing levels of Australian entities (in addition to the interest rate for the debt) may also need to be reviewed from an arm’s-length perspective under Australia’s transfer pricing rules, in respect of any cross-border debt (including shareholder or unit holder loans).
Comparisons have been drawn with other countries’ approaches to specific interest limitation rules, particularly the proposed new Canadian interest limitation rules. These provide an effective carve-out from the rules (and thus do not limit the deductibility of interest and related financing expenses) that are incurred in respect of many Canadian public-private partnership infrastructure projects that utilise third-party/arm’s-length debt.
Expansion of double tax treaty network
Australia has recently announced the review and update of its double tax treaty with New Zealand, adding to the significant expansion of its treaty network, particularly in Europe.
The New Zealand treaty was last updated in 2009 and was regarded as a modern version of Australia’s contemporary double tax treaties. This treaty is also subject to the overlay of the multilateral instrument and the updated version should be a very good indicator of Australia’s evolving double tax treaty policy initiatives.
Including the New Zealand treaty review, Australia has an ambitious treaty expansion program with 14 new or updated treaties being pursued at this time, including with Greece, Portugal, Luxembourg and Columbia.
It will be important to increasingly evaluate the potential application of the proposed expanded Australian general anti-avoidance rule (Part IVA). This rule, applicable from July 1, 2024, is intended to apply to ‘reductions’ in a withholding tax liability (in addition to a nil withholding tax liability) that might be available, amongst other reasons, under an applicable double tax treaty (e.g. involving ‘treaty shopping’).