Treasury has released details of the policy principles that will be used regarding the start date and transitional period of the 2018-19 Federal Budget thin cap changes.
In the 2018-19 Federal Budget, the Government announced that it will tighten Australia’s thin capitalisation rules by requiring entities to align the value of their assets for thin capitalisation purposes with the value included in their financial statements. [Budget 2018 website: Budget Paper No. 2, Revenue Measures (p.46)]
This is designed to remove the ability for entities to:
- revalue assets to a value different to that disclosed in their financial statements; and
- recognise certain assets that cannot be recognised for accounting purposes.
There were unresolved transitional issues, however, in the way the announcement was worded. Treasury seeks to address this, by articulating its current policy approach to resolving this.
The problem was there was a ‘gap’ in the policy announced.
- There is a ‘safe harbour’ gearing ratio, of 3/5ths debt to total assets values, which will allow full deductibility of ‘debt deductions’. [see ATO explanation].
- One of the permitted ways, of calculating this, was an average of the opening and closing values – meaning that valuations could be required at both the beginning and the end of the year. [see ATO explanation]
- Until this announcement, these valuations could occur outside the taxpayer’s accounts (for ‘thin cap’ purposes only).
- The announcement in Budget Paper 2, made it clear that this latitude (to value outside the accounts) would cease from the income year beginning on or after 1 July 2019. So far so good.
- But the Announcement then went on to say that (effectively) only pre-budget night valuations could be relied on, until the new regime began.
- The problem, of course was, that for the prior (transition) year, a valuation at the end of the year is required as well. And there was no guidance about whether a post-budget night valuation would be permitted.
- This announcement, is intended to fill that hole.
The answer Treasury has given – is this.
- The last pre-budget valuation, the tax payer has, will be not only the opening value but also the closing value.
- Effectively, the value of that asset(s) will be frozen at the last compliant, pre-budget valuation.
Treasury’s announcement was described as ‘policy principles’, to assist taxpayers plan and administer they tax affairs, during this interim period (though it stresses this is only ‘policy intent’ and, the law will be the law, as it is finally passed).
The announcement is in the following terms.
- The measure will apply to income years commencing on or after 1 July 2019. That is, for income years commencing on or after 1 July 2019, all entities will be required to align the value of their assets, for thin capitalisation purposes, with the value contained in their financial statements.
- Treasury says valuations that were made prior to 7:30PM (AEST) on 8 May 2018 may be relied on until the beginning of an entity’s first income year commencing on or after 1 July 2019.
- That is, for the period between the Budget announcement and the last day before the start of the income year commencing on or after 1 July 2019, entities may use the value reflected in their most recently completed compliant valuation for thin cap purposes (or can revert to using the relevant financial statement value).
- Treasury says the value of those assets will effectively be ‘frozen’ at the value reflected in their most recently completed compliant valuation, for thin cap purposes, prior to 7:30 PM (AEST) on 8 May 2018.
- Affected entities will not be required to undertake further valuations for thin cap purposes.
- A valuation will be regarded as completed and compliant if it satisfies the requirements of Subdiv 820-G of the ITAA97 before 7:30PM (AEST) on 8 May 2018.
- This measure will not affect the application of the accounting standards. That is, there will be no changes to an entity’s ability to revalue assets in their financial statements in accordance with the accounting standards.
The Government will release exposure draft legislation for public consultation at the earliest opportunity, Treasury said.
Comprehension questions (answers available)
- Is there a ‘safe harbour’ level of gearing that allows 100% deductibility of ‘debt deductions’?
- For most entities, is that debt at no more than 3/5ths of the value of the taxpayer’s assets?
- Is it possible to value the assets, for ‘thin cap’ purposes only (which is to say, that those values did not have to appear in the financial accounts?
- Is that latitude going to continue?
- Was one of the permitted ways, of valuing the assets, to take an average of the opening and closing values?
- Did the budget announcement deal with how both the opening and closing valuations would be done, in the transition year?
- Was Treasury’s answer to this policy gap’ to say that the closing value (for the transition year) would be the same as the opening valuation – effectively freezing the last valuation (in the transition year) at the last, pre-Budget Night, valuation?