PCG 2024/D3 - Restructures and the new thin capitalisation and debt deduction creation rules - ATO compliance approach (draft PCG).
The Tax Institute and Chartered Accountants Australia and New Zealand (together, the Joint Bodies) welcome the opportunity to make a submission to the Australian Taxation Office (ATO) in relation to the draft PCG.
In the development of this submission, we have closely consulted with our tax committees to prepare a considered response that represents the views of our broader memberships.
The debt deduction creation rules (DDCR) contained in Subdivision 820-EAA of the Income Tax Assessment Act 1997 (ITAA 1997) deny deductions where they relate to a debt creation scheme. The Explanatory Memorandum (EM) to the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share - Integrity and Transparency) Bill 2023 (Bill) that introduced the DDCR, states that the DDCR were needed to supplement the operation of the changes to Division 820 of the ITAA 1997 (interest limitation rules) as the interest limitation rules do not address the risk of excessive debt deductions for debt created in connection with an acquisition from an associate entity or distributions or payments to an associate entity. This is on the basis that such debt deductions would only ever be indirectly and at most partially restricted by the interest limitation rules.
We also note that paragraph 2.146 of the EM states that the schemes to which the DDCR are targeted are “debt creation schemes that lack commercial justification”. More specifically, the EM states that the DDCR:
- disallow debt deductions where artificial interest-bearing debt is created within a multinational group, which over time allows for profits to be shifted out of Australia in the form of tax-deductible interest payments (paragraph 2.149); and
- have been drafted broadly to help ensure they are capable of applying to debt creation schemes of varying complexity. This is stated to be necessary due to the ability of multinational groups to enter into complex debt creation arrangements (paragraph 2.153).
In our submission we have been guided by:
- the policy objectives and approach to the drafting of the DDCR;
- the need to ensure that the DDCR do not apply to mere restructuring, without any associated artificiality or contrivance, out of an arrangement that would otherwise be caught by the debt deduction creation rules;
- comments made by Deputy Commissioner, Policy, Analysis and Legislation, Mr Ben Kelly to the Senate Economics Legislation Committee on 31 January 2024, regarding the ATO’s general approach (to not apply the integrity rules in the proposed measure or elsewhere) to situations where taxpayers are restructuring their arrangements as a means of seeking to comply with the underlying intent of the new law (i.e. during the transitional period);
- the general role of ATO Practical Compliance Guidelines (PCGs). We note that PCGs “[…] represent material on how the ATO will allocate its compliance resources according to assessments of risk and may outline administrative approaches that mitigate practical difficulties relating to the operation of tax laws.” (PCG 2016/1 - PCGs: role in ATO’s public advice and guidance, paragraph 23); and
- the need for certainty for taxpayers.
The Joint Bodies appreciate the ATO’s engagement with stakeholders during the consultation that helped formulate the examples set out in the Schedules in the draft PCG. However, our members are concerned that there appears to be a disconnect between the intended target of the relevant integrity provisions in relation to restructures carried out in response to the DDCR as per the EM, and the draft PCG’s classification of the examples in the various risk zones and ATO compliance approach. In particular, we are concerned with the classification of the simple restructure of replacing related party debt with third-party debt as high risk. Our detailed comments are set out in Appendix A.