Changes to the Thin Capitalisation Legislation

In a response to concerns raised around asset revaluations for the purpose of calculating an entity’s thin capitalisation ratio, the Government announced in the 2018-19 Federal Budget that they would be proposing legislation to tighten the Thin Capitalisation rules.

As a result of this announcement, Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2019 was introduced to parliament on 4 July 2019 and received Royal Assent on 13 September 2019.

The three outcomes of the above legislation being passed are as follows: 

• Entities are now required to use the same valuation method for their assets, liabilities (including debt liabilities) and equity as used in the preparation of their financial statements;
• An entity can no longer revalue its assets specifically for the purposes of calculating their thin capitalisation ratios;
• Any foreign controlled Australian tax consolidated or multiple entry consolidated groups who are non-ADI entities and that have foreign investments are now treated as both inward and outward investing entities.

The tightening of the requirement to use financial statement values when performing thin capitalisation calculations is likely to make it more difficult for entities with significant internally generated intangible assets to satisfy the safe harbour debt rules, or entities that undertake valuations of assets for thin capitalisation purposes that are not reflected in the financial statements.

Entities will be required to apply the new legislation for income years commencing on or after 1 July 2019, however, there is a transitional rule which allows entities to continue to use the last compliant valuation made before 8th May 2018 (Budget Time) up to years commencing on or after 1 July 2019.

Interaction with the change to Leasing Accounting Standard (AASB 16)

Recent changes to the accounting leasing standard (compulsory for entities preparing general purpose financial statements from financial years commencing on or after 1 January 2019) requires entities to record all leases on the balance sheet.

As a result of the above changes to the thin capitalisation regime, this will result in leased assets and the associated liabilities will now be required to be considered when calculating the thin capitalisation ratio.

Penalties?

Importantly, the Australian Taxation Office (“ATO”) has announced that it will accept tax returns as lodged according to previous law during the period up until the 2018-19 Budget announced law change was passed by Parliament.

Administratively, if a tax return was not lodged in accordance with the law change, taxpayers should seek an amendment. However, if as a result of an amendment there is an increase in liability, provided the taxpayer requests an amendment within 3 months of Royal Assent i.e. by 13 December 2019, the ATO says:

• no tax shortfall penalties will be applied; and
• any shortfall interest accrued will be remitted to base interest rate.

If you require further information regarding thin capitalisation, please contact your local tax adviser.