Statutory review of Australia’s thin capitalisation reforms
The Tax Institute welcomes the opportunity to provide a submission to the Board of Taxation’s statutory review of Australia’s thin capitalisation reforms (the Review).
In the development of this submission, we have closely consulted with our National Large Business and International Technical Committee to prepare a considered response that represents the views of the broader membership of The Tax Institute.
Australia’s thin capitalisation regime was substantially amended by the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Act 2024 (Cth) (the Amending Act). The Explanatory Memorandum (EM) and the Supplementary Explanatory Memorandum (Supplementary EM) (together, explanatory material) explain the policy rationale of the Amending Act.
While we are supportive of the broad policy objective of aligning Australia’s rules with international best practice, we are concerned that several of the provisions, as enacted, give rise to significant uncertainty and administrative complexity that are not justified from a policy perspective and are not consistent with broader initiatives to reduce red tape in the tax system. This submission identifies the key issues our members have encountered in applying the rules and sets out our recommendations for reform.
Many of these issues arise from unclear interactions among provisions, including the third-party debt test (TPDT), fixed ratio test (FRT), and debt deduction creation rules (DDCR), as well as inconsistent and insufficient Australian Taxation Office (ATO) guidance. This results in outcomes that, at times, appear inconsistent with the policy intent of the rules, particularly where overlapping provisions apply to the same arrangement. It also increases compliance complexity, as taxpayers and their advisers are required to interpret and reconcile multiple regimes without clear legislative or administrative guidance.
Summary of key concerns
Our key concerns with the current thin capitalisation rules are as follows:
- The choice requirements for the group ratio test (GRT), TPDT and FRT introduce unnecessary administrative complexity and inflexibility that is not justified on policy grounds.
- There is uncertainty about who may make a TPDT election, and the ATO has issued guidance that appear to be inconsistent with the legislation.
- The inadvertent removal of the exclusion for debt attributable to the overseas permanent establishments of outward-investing general class investors creates outcomes inconsistent with the policy intent of the rules.
- There is a ‘black hole’ in tax earnings before interest, taxes, depreciation, and amortisation (EBITDA) for investments in entities in which the taxpayer holds an interest between 10% and 50%, which has no policy basis.
- There are a number of technical limitations and uncertainties within the FRT, including the treatment of carried forward tax losses and the utilisation of disallowed amounts where an entity exits the regime.
- The GRT is difficult to apply in practice and may not be accessible to a range of taxpayers due to its complexity and structural limitations, raising concerns as to whether it is achieving its intended policy objective.
- The definition of ‘associate entity’ for the purposes of the TPDT has been broadened substantially beyond what the policy requires, creating significant practical difficulties.
- A number of key terms in the TPDT, including ‘Australian asset’, ‘commercial activities in connection with Australia’ and ‘minor or insignificant’, are undefined or subject to ATO interpretations that appear to be inconsistent with the statutory language and policy intent.
- The conduit financing rules are complex and difficult to apply in practice, particularly with respect to weighted-average pricing, foreign-exchange (FX) hedging costs, the passing on of swap costs, and residency requirements.
- The DDCR can be triggered inappropriately in circumstances involving conduit financing arrangements with an ultimate third-party lender.
- More broadly, the scope and operation of the DDCR extend beyond their intended policy objective, capturing commercial and, in some cases, wholly domestic arrangements, and give rise to disproportionate compliance and reporting obligations.
- The rules impose significant tracing and evidentiary burdens, particularly in relation to legacy arrangements and complex financing structures, increasing compliance costs and uncertainty.
Our detailed response and recommendations are contained in Appendix A.
Legislative clarity is fundamental to the integrity and effective operation of Australia’s tax system. Taxpayers and their advisers must be able to understand and apply the law with confidence, without relying on administrative guidance that may be withdrawn or qualified over time or that is inconsistent with the statutory language. Where the legislation is ambiguous or yields outcomes inconsistent with policy intent, legislative amendment, rather than administrative practice, is the appropriate remedy.
The issues identified in this submission are not merely technical. They are areas of real uncertainty for businesses seeking to structure their financing arrangements and risk producing outcomes, including the denial of deductions for genuine third-party debt costs that are disproportionate and contrary to the policy objectives of the reforms. We are of the view that this Review presents an important opportunity to address these issues and to ensure that Australia’s thin capitalisation rules operate as intended.
Feedback from our members indicates that these issues are already affecting financing decisions, increasing compliance costs, and creating uncertainty regarding the deductibility of genuine third-party debt. This may deter investment in Australia at a time where foreign investment is needed to support broader Government objectives.