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August 5, 2022
2022-1191

Australian Treasury releases Discussion Paper on new thin cap rules, royalty deduction rules and public tax disclosure rules

  • The discussion paper addresses the Labor Government's election proposals under its tax integrity package to address tax avoidance and improve transparency.
  • The paper discusses the background to the proposals, policy issues and implementation considerations, with a series of consultation questions for each measure.
  • Responses to the consultation are to be submitted by 2 September 2022.
  • Taxpayers should review the proposals and consider the implications on their Australian operations.

The Australian Treasury has released a discussion paper on Multinational Tax Integrity and Tax Transparency on the Labor Government's election proposals, made as part of their multinational enterprises (MNEs) tax integrity package to address tax avoidance practices of MNEs and improve transparency through better public reporting of MNEs' tax information.

This discussion paper confirms that the many technical questions raised following the election announcements are open for discussion. It does not contain references to potential application dates (expected from 1 July 2023 or the 2023/24 year).

The discussion paper seeks to consult on the implementation of proposals to:

  • Amend Australia's existing thin capitalization (thin cap) rules to limit interest deductions for MNEs in line with the Organisation for Economic Co-operation and Development's (OECD) recommended approach under Action 4 of the Base Erosion and Profit Shifting (BEPS) program
  • Introduce a new rule limiting MNEs' ability to claim tax deductions for payments relating to intangibles and royalties that lead to insufficient tax paid
  • Ensure enhanced tax transparency by MNEs, through measures such as:
    • Public reporting of certain tax information on a country-by-country basis
    • Mandatory reporting of material tax risks to shareholders
    • Requiring tenderers for Australian government contracts to disclose their country of tax domicile.

The discussion paper does not consult on the following aspects of Labor's MNE Tax Plan:

  • Implementation of the OECD two-pillar solution (which includes the 15% global minimum effective tax rate on profits of large MNEs). The consultation paper on Pillar Two is expected to be issued in the coming weeks.
  • Implementation of a public registry of beneficial ownership to improve transparency on corporate structures, to show who ultimately owns or controls a company or legal vehicle.

The paper discusses the background to the proposals, policy issues and implementation considerations, with a series of consultation questions for each measure.

Implications

Responses to this consultation must be submitted by 2 September 2022. The discussion paper containing 53 questions, some of them of complex issues, together with the aspiration to get draft law out sooner rather than later, makes the opportunity to influence decision look limited but should nevertheless be used to prevent outcomes that would put Australia out of step with global best practices.

Following consideration of responses to the discussion paper, the Australian Government will issue and consult further on exposure draft legislation prior to introducing any legislation into Parliament.

Some additional initial observations on two important measures open to consideration

Taxpayers with global investment structures need to monitor further developments with respect to the following:

  • Changes potentially denying debt and royalty deductions are proposed to start from 1 July 2023, currently with no stated additional transitional measures.
  • It is expected that any change to thin cap would apply to companies with non-June tax year ends from their next income year, e.g., from 1 January 2024 for December balancers, although this has not been confirmed. The precise application date for royalty payments is also to be confirmed for companies with non-June tax year ends.

The potential denial of certain debt and royalty deductions in Australia requires attention because the anticipated start date of 1 July 2023, currently without grandfathering or transitional rules, does not allow much time for planned adjustments and reviews.

The changes will need to be modelled into existing and future investment decisions and structures.

Limitation on debt-related deductions by MNEs at 30% of EBITDA

This measure is about replacing the existing safe harbor test for MNEs of 60% of assets with an earnings before interest, tax, depreciation and amortization (EBITDA) test while retaining a form of arm's-length debt test (ALDT) and a form of the worldwide gearing test (WWGT).

Net interest expense deductions are to be limited to 30% of the entity's EBITDA but the discussion paper does not refer to taxable EBITDA.

The EBITDA test is proposed to commence from 1 July 2023. It is expected that this measure will apply to companies with non-June tax year ends from their next year so from 1 January 2024 for December balancers, although this has not been confirmed.

The discussion paper envisages that financial entities and authorized deposit-taking institutions would, in the interim, continue to be subject to the existing thin cap rules.

The discussion paper does not discuss carryforward of disallowed interest expense or carryforward of excess capacity, but the ALDT and WWGT are considered as fallbacks. It's noticeable that in most countries where carryforward is allowed there is no ALDT fallback. Tightening of the ALDT is being considered and so are changes to the WWGT.

New rule limiting MNEs' ability to claim tax deductions for payments relating to intangibles and royalties that lead to insufficient tax paid

It was announced that this measure would apply to significant global entities (SGEs) (parent entities or consolidated groups) with global turnover exceeding AU$1bn) from 1 July 2023. The discussion paper sets forth the concepts included in the limited detail previously provided, this includes whether the application should be broader than SGEs or limited to corporate SGEs.

The reference to the tax haven integrity rule has been dropped and discussion has opened up on what is meant by insufficient tax paid.

The definition of royalty is also not settled or necessarily limited to treaty definitions. In particular, the discussion paper explores whether embedded royalties should be covered and if yes, what the practical challenges would be in identifying them.

There is discussion around profits reduced by migrated intellectual property and DEMPE (Development, Enhancement, Maintenance, Protection and Exploitation) functions and whether unrelated party payments should be caught.

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CONTACTS

For additional information with respect to this Alert, please contact the following:

Ernst & Young (Australia), Sydney

Ernst & Young (Australia), Perth

Ernst & Young (Australia), Brisbane

Ernst & Young (Australia), Melbourne

Ernst & Young LLP (United States), Australia Tax Desk, New York

Ernst & Young LLP (United Kingdom), Australia Tax Desk, London

 

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