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08 May 14 Thin capitalisation reforms: Exposure draft legislation

On 8 May 2014 the Commonwealth Treasury released for public comment by Friday, 6 June 2014 a draft amending Bill and Explanatory Memorandum which propose reforms to tighten the thin capitalisation rules to prevent erosion of the Australian tax base. The draft Bill is entitled the Tax and Superannuation Laws Amendment (2014 Measures No 3) Bill 2014: Thin capitalisation and 23AJ.

The proposed amendments in the draft Bill:

  • reduce the maximum debt limit from 3:1 to 1.5:1 (on a debt-to-equity basis) for general entities and from 20:1 to 15:1 (on a debt-to-equity basis) for non-bank financial entities
  • reduce the “outbound” worldwide gearing ratio from 120% to 100% with an equivalent adjustment to worldwide capital ratio for ADIs, and
  • increase the safe harbour capital limit for ADIs from 4% to 6% of their risk weighted Australian assets.

To minimise compliance costs for small businesses, the de minimis threshold for the application of the thin capitalisation limits will be increased from $250,000 to $2 million of debt deductions.

To provide greater flexibility for inward investors, a new “inbound” worldwide gearing ratio test will be introduced. This test allows the financial markets to limit gearing, and mirrors market outcomes for businesses that, as a whole, have naturally higher gearing levels. This will provide a further option to inward investing entities, where they do not fall within the safe harbour limit, and do not meet the arm’s length debt test. To minimise compliance costs, this test will utilise the consolidated financial statements that are already required to be prepared by the foreign parent.

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