Tax directors say the lack of policy detail could introduce short-term uncertainty and long-term compliance costs as the incoming Labor government in Australia seeks to limit tax deductions on interest expenses to 30% of EBITDA and retain the flexibility of the arm's-length test from July 2023.
The Australian Labor Party, led by Anthony Albanese, won the federal election on May 23 with a platform that included several corporate tax reforms, including changes to thin capitalization rules.
Under Australia's thin capitalisation rules, the limit on tax deductions is expected to replace the safe harbour, which limits debt to 60% of assets in a 1.5-to-1 debt-to-assets ratio. The move may benefit digital businesses with higher profits over brick-and-mortar businesses with valuable assets.
The change in thin capitalisation rules will necessitate a significant rewrite of Division 820 of the Income Tax Assessment Act 1997, but Australia's rules will be aligned with the OECD's BEPS Action 4 to limit deductions by capping debt use at 30% rather than 60% of a company's assets.
The proposal, however, has few details, according to Jock McCormack, a tax partner at DLA Piper in Sydney.
"There are limited details provided in the proposal and, despite the simplicity, its implementation is unlikely to go unchallenged," McCormack says.
"Companies will require further clarification as to the practical application of the arm’s-length and safe harbour tests, if any," says McCormack, who predicts that after the Labor government launches a public consultation in the coming months, there will be several corporate responses.
According to Ann-Maree Wolff, head of tax at Rio Tinto in Brisbane, there could be cross-border differences in how Australia sets up its thin capitalization rules.
"It will be interesting to see whether carve-outs such as in the UK will be included, and how practical issues such as volatility in earnings will be dealt with," Wolff says.
The switch from a safe harbor debt limit of 60% of asset value to an interest deduction limit of 30% of profit could benefit companies with high profitability and low asset values while hurting companies with high asset values and low profitability.
Changes to thin capitalisation rules are expected to hurt highly leveraged sectors like infrastructure, private equity, and real estate, especially since they faced depreciating asset valuations during the COVID-19 pandemic.
In terms of calculating the maximum allowable debt to fund certain business operations, the pandemic had an impact on corporate compliance across these sectors.
Debt financing is also used extensively by mining, extractive industries, and utilities companies. According to its annual financial reports, APA Group, an Australian energy provider, has debt liabilities worth at least 60% of its assets through the safe harbour.
The revised thin capitalisation rules, however, limit the amount of debt required to fund foreign companies investing in Australia and Australian companies investing abroad.
It means that, in the short term, the revisions will increase corporate compliance costs because taxpayers may be relying on less objective debt tests.
Labor is implementing the OECD's global minimum corporate tax rate of 15% alongside reforms to thin capitalisation rules. Despite the lack of concrete details on how the tax will be implemented, tax experts anticipate no delays in the incoming government meeting the 2023 deadline.
"I will be paying close attention to the proposal’s details," Wolff says, "since we have major projects that can incur large capital gains taxes that have a material impact on our business’s tax books."
Australia already has a 30 percent corporate income tax rate, which is higher than the global average of 23 percent.
From July 2023, Labor proposes to eliminate tax deductions for using intellectual property (IP) in treaty shopping and profit shifting to low-tax jurisdictions.
Only large multinational corporations with accounting revenue in excess of A$1 billion ($722 million) will be affected by the measure. However, according to Rhys Jewell, head of tax at Corrs, Chambers, and Westgarth in Melbourne, the exact scope of denying deductions for the use of IP is still unknown.
"The precise impact of this measure on royalty deductions will depend on whether it is confined in scope to a specific scheme of concern by way of narrow extension of existing general anti‑avoidance rules or is drafted in more expansive terms to capture a broad range of transactions involving intellectual property," Jewell says.
The incoming government's tax reform agenda also reflects a desire to improve Australia's tax transparency regimes.
Labor proposes a public country-by-country (CbCR) framework to improve tax transparency on international tax structures. Companies with a global annual income of more than A$1 billion in Australia are already subject to the CbCR.
The proposal does, however, state that public reporting will only apply to large multinational corporations, and that it will follow the European Commission's lead on disclosure requirements.
While the global compliance burden is increasing with additional reporting obligations, Karl Berlin, vice president and head of tax at rsted, a Danish international energy company, tells ITR that it also provides an opportunity for in-house tax departments to collate their data.
"Compliance burdens from CbCR and other comprehensive tax reporting regimes might speed up the transition to a singular source of truth," Berlin says.
A public beneficial ownership registry, in addition to a public CbCR, is being proposed to show who ultimately owns, controls, or receives profits from an Australian company.
The final point in Labor's tax transparency strategy is to require companies to disclose as a material tax risk when they operate in a jurisdiction with a tax rate lower than the OECD's global minimum of 15%.
Similarly, all companies bidding on Australian government contracts worth more than A$200,000 must declare their country of domicile for tax purposes.
These international tax measures are expected to raise at least A$1.89 billion over the next four years, assisting Australia's post-pandemic budget and preventing long-term profit shifting among Australian businesses.
While Labor's tax agenda's revised thin capitalisation rules are likely to have the greatest impact on multinational companies, a public CbCR and a beneficial ownership registry could significantly increase corporate compliance costs starting in 2023.
By fLEXI tEAM