June 22, 2023
Australian thin capitalization and subsidiary disclosure measures introduced into Parliament
Following consultation on Exposure Draft (ED) legislation and submissions by EY and others, the Australian Government has introduced the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share — Integrity and Transparency) Bill 2023, which contains measures relating to Australia’s thin capitalization rules and certain additional disclosures in respect of subsidiaries.
The Bill seeks to align Australia with the Organisation for Economic Co-operation and Development’s (OECD’s) earnings-based best practice model, which limits an entity’s interest expense deductions to a benchmark earnings ratio (30% of its tax EBITDA) while offering flexibility by allowing access to two alternative tests (provided certain conditions are met), being the Group Ratio Test and the Third-Party Debt Test (for general class investors and financial entities that are not ADIs).
New disclosure of subsidiaries’ requirements will apply for public company financial reporting.
Other elements of the Government’s multinational tax integrity package — to deny deductions for payments by significant global entities to low-tax jurisdictions relating to intangible assets (intangibles integrity rule) and introduce public country-by-country reporting — were not included in the Bill.
Thin capitalization and subsidiary disclosure measures
The Bill to implement changes to Australia’s thin capitalization interest limitation rules was introduced into Parliament on 22 June 2023.
Following is a brief summary and initial high-level analysis of the measures, which include new debt creation rules.
Importantly, the Bill does not address the other multinational enterprise (MNE) tax integrity and transparency measures following previous EDs:
The Government had announced that both of these measures will apply from 1 July 2023 (with some drafting uncertainty as to whether the public CbC reporting applies to entities with substituted accounting periods from years starting on 1 January 2023).
Parliament does not sit again until 31 July and there has been no announcement from the Government as to why these measures were not included in the Bill or whether there may be any changes. Absent such an announcement, business should proceed on the basis that the application dates will not change when we eventually see the law introduced.
Note however that, for the public CbC reporting proposals, Treasury has proposed in an “impact analysis” included in the explanatory memorandum to the Bill that some CbC reporting data disclosures should be removed, proposed to defer the measure’s application by 12 months, to apply from 1 July 2024, and noted that further consultation may be beneficial.
Thin capitalization interest limitation rule changes
In addition to proposing to replace the current asset-based thin capitalization rules for general class investors with the three new tests outlined above (Default Fixed Ratio, Group Ratio, Third-Party Debt), the new rules also include transfer pricing changes that will apply to income years commencing on or after 1 July 2023.
Key changes from the previous ED include:
1. Fixed Ratio Test — calculation of tax EBITDA:
2. 15-year carry forward under Fixed Ratio Test — FRT disallowed amounts:
3. Conditions to use alternative tests:
Affected businesses should finalize their analysis of the new rules’ potential impact and determine what action may be appropriate in response to potential denials of interest deductions and plan how these will be implemented. Significant additional work could be required to determine if the alternative tests can be used.
Denial of deductions for interest expenses incurred to derive certain NANE income “deferred”
The Bill does not include proposals from the March 2023 thin capitalization ED to amend sections 25-90 and 230-15 of the ITAA 1997to deny a deduction for interest expenses incurred to derive certain non-assessable, non-exempt (NANE) income (i.e., dividends from foreign subsidiaries and branch profits). The changes were proposed to apply to income years commencing on or after 1 July 2023.
The explanatory memorandum to the Bill states that the proposed amendments have been deferred and will be considered via a separate process. We are monitoring for Government announcements to clarify the application date for this proposal.
Impacted businesses should continue to consider how borrowings may be affected and should remain ready to identify and/or progress work required to track affected deductions and consider available financing responses to the proposal when its status is clarified.
New debt creation rules included
As part of the thin capitalization changes, the Bill includes the unexpected reintroduction of debt creation rules that would deny a deduction for interest on borrowings to either acquire assets from related parties, or to fund dividends or other distributions to related parties.
Although the interest denial would only be from 1 July 2023, it appears that, subject to further clarification, the related-party acquisition or related-party funding of distributions may be covered even if it occurred before 1 July 2023.
Multinational tax transparency — disclosure of subsidiaries
The Bill introduces new Corporations Act requirements for Australian public companies (listed and unlisted) to disclose information about their subsidiaries in their annual financial reports, for financial years commencing on or after 1 July 2023.
If the accounting standards require a public company to prepare financial statements in relation to a consolidated entity, the “consolidated entity disclosure statement” in the company’s annual financial reports must provide the following information in relation to entities within the consolidated entity:
Public companies that are not subject to the rule (i.e., no consolidated statements) must state this in their annual financial report.
There are no substantive changes from the previous ED to the Bill.
Impacted companies should ensure policies and processes are updated to comply with these new requirements.
For additional information with respect to this Alert, please contact the following:
Ernst & Young (Australia), Sydney
Ernst & Young (Australia), Brisbane
Ernst & Young (Australia), Melbourne
Ernst & Young (Australia), Perth
Ernst & Young LLP (United States), Australia Tax Desk, New York
Ernst & Young LLP (United Kingdom), Australia Tax Desk, London
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor