On October 25 2022, as part of the Australian Federal Budget, the new Albanese government announced important initiatives to strengthen the thin capitalisation rules limiting debt-related deductions.
These initiatives principally involve replacing the safe harbour and worldwide gearing tests with an earnings-based test (30% of earnings before interest, taxes, depreciation, and amortisation, or EBITDA) and, while retaining the arm’s-length debt test as a substitute or alternative test, limiting its application to third-party unrelated debt.
Importantly, however, any debt deductions denied under the 30% EBITDA test can be carried forward and claimed for up to 15 years thereafter.
These changes will apply to income years commencing on or after July 1 2023 and no transitional or grandfathering rules will apply to existing debt arrangements.
The proposed changes would apply to multinational entities operating in Australia and any inward or outward investors, in line with the existing thin capitalisation rules. However, financial entities will continue to be subject to the existing thin capitalisation rules.
It is expected that exposure draft legislation will be available in early 2023 and that the Australian Treasury will continue to consult on key aspects of the revised thin capitalisation regime.
DLA Piper Australia expects that the A$2 million ($1.3 million) de minimis rule will be retained. However, multinational businesses are encouraged to review their debt arrangements and prepare for these intended changes to the Australian thin capitalisation rules.
Denial of deductions for certain payments or intangibles
The government proposes a new anti-avoidance rule to prevent significant global entities (with global revenues of at least A$1 billion) from claiming tax deductions for payments made directly or indirectly to related parties in relation to intangibles held in low- or no-tax jurisdictions. These jurisdictions are referenced with a tax rate of less than 15% or a tax-preferential patent box regime without sufficient economic substance.
Similarly, the new rules will apply to payments made on or after July 1 2023.
It is expected that this new anti-avoidance rule will address ‘embedded royalties’ related to payments for goods and services, including potentially related to marketing intangibles. Further consultation on the proposed rule is expected in the coming months.
Double tax treaty expansion
The government signed a new double tax treaty with Iceland on October 12 2022 that, among other things, contains various features associated with the OECD/G20 BEPS initiatives.
These features include provisions associated with:
Transparent entities and collective investment vehicles;
Permanent establishments;
Concessional dividend, interest, and royalty withholding taxes;
Limitation of benefits and treaty abuse;
Mutual agreement procedures, dispute resolution, and arbitration; and
Non-discrimination provisions.
Work continues on a significant expansion and update of several Australian double tax treaties with a view to concluding or amending 10 treaties by the end of 2023. The Albanese Government announced on 16 November 2022 that new negotiations would commence for treaties with seven countries including Bulgaria, Colombia, Croatia, Cyprus, Estonia, Latvia and Lithuania. It has also made good progress with the proposed amendments to the India–Australia treaty dealing with technical services as distinct from royalties.
