Thin Cap ‘Integrity’ measure announced in 2018 Budget – draft legislation released – from 1 July 2019: ‘financial statements’ only asset values and ‘consolidated’ groups both inward and outward like other taxpayers

On 1 August 2018, Treasury released draft legislation for the Government’s Thin Capitalisation integrity measures announced in its 2018 Budget.

There are 2 categories of change.

1. requiring entities to align the value of their assets for thin capitalisation purposes with the value included in their financial statements; and
2. ensuring that foreign controlled Australian consolidated entities and multiple entry consolidated groups that have foreign operations are treated as both outward and inward investing entities.

A. Requiring entities to use ‘financial statements’ values (ending thin cap only valuations)

The background is as follows.

• There is a ‘safe harbour’ gearing ratio, of 3/5ths debt to total assets values, which will allow full deductibility of ‘debt deductions’.
• 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.
• 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.
• Subsequently, Treasury announced that the transitional rule (for the current year) was that a taxpayer who already had a pre-Budget complying valuation could use that, too, for the closing valuation (before moving to the ‘financial accounts’ valuation regime or one the arm’s length gearing or worldwide gearing mechanisms). [See related TT Article.]

The relevant change would be to:

1. repeal s820-680(2)-(2E) which permitted revaluation of assets outside the financial accounts (whilst also repealing s820-683; s820-684; and s820-985); and
2. substitute a new ss(2) which makes the relevant asset value, the one used the taxpayer’s ‘financial statements’ (under relevant accounting standards); and, also, a new ss(3) which requires the taxpayer to use the most recent financial statements (if there are more than one that apply to the period).

B.  Allowing Australian Tax Consolidated Groups (or MEC Groups) to be both outwards and inwards investment entities

Background

• Where an Australian company was foreign controlled, it would be an inwards investing entity and, when it also had foreign subsidiaries, it would also be an ‘outward investment entity’ also.
• However, there is a provision only for ‘Australian tax consolidated groups’ (and MEC Groups) that deemed the head entity to only be an ‘outward investment entity’: s820-583(5)&(6).

The relevant change would be to:

1. To remove the words in the relevant provision: s820-583(5), that had this effect for ‘non-ADI’ (non Bank) taxpayers, so that Tax Consolidated Groups (and MEC Groups) would be both inward and outward investment entities, when the facts required.
2. To do the same for ADIs – in s820-583(6).

The effect of this change would be that Tax Consolidated Groups (and MEC Groups) would be the same as other entities that disqualified from applying certain thin capitalisation rules – for example: s820-37; s820-110; s820-216; and s820-217.

The changes would apply from income years commencing on or after 1 July 2019.

The Government invited interested parties to make a submission by 17 August 2018 (which has now passed).

FJM 19.8.18

[Treasury website: Consultation Page, Draft Bill, Draft EM; LTN 147, 2/8/18; KMPG Daily Tax News 2/8/18; Tax Month – August 2018]

Comprehension questions (answers available)

1. Has Treasury issued draft legislation to implement the Thin Capitalisation ‘integrity’ measures announced in the Federal 2018 Budget?
2. Is the first measure to require taxpayers to calculate their ‘safe harbour’ average asset values by reference to values adopted in their financial statements (and no longer by special valuation outside those statements)?
3. Would this this measure start in the tax year that commences on or after 1 July 2019?
4. Is a taxpayer automatically entitled to adopt a special valuation in the year prior to that?
5. Is the other measure to treat Australian Tax Consolidated Groups (and MEC Groups) the same as other companies, namely that they are both inward and outward investment entities, if they are foreign controlled and have foreign investments?
6. Is the practical effect of this that they can no longer use certain tests available only to ‘outward’ investment entities?