The International Financial Reporting Standards (IFRS) came into effect in Australia on January 1 2005. It was clear some time ago that these new accounting standards would impact directly on Australia's thin-capitalization rules, which seek to limit interest expense deductions for certain taxpayers that exceed certain debt-to-asset ratios. This is because the thin-capitalization safe harbour calculation is made with reference to accounts prepared in accordance with Australian accounting standards.
On January 24 2005 the federal treasurer announced a three-year transitional period for the purposes of the thin-capitalization rules. The treasurer indicated that "during the transitional period, taxpayers will be able to undertake their safe harbour calculation using the Australian General Accepted Accounting Principles as they existed pre-January 1 2005."
The announcement advised that the transitional period would provide sufficient time for the government to examine whether the existing thin-capitalization rules are appropriate following the adoption of IFRS.
Most taxpayers assess their thin-capitalization position on the basis of the safe harbour debt test. This rule allows taxpayers a debt-to-asset ratio of up to 75%. Where a taxpayer exceeds this ratio, a portion of their interest expense deductions is denied unless they can satisfy the worldwide gearing test or the arm's-length test.
It would appear from the announcement that continuing to use the pre-January 1 2005 standards for the purpose of Australia's thin-capitalization rules will be optional rather than compulsory, although this is not entirely clear from the words of the announcement which we have quoted above.
There had been concerns expressed by industry and the professions that the effect of IFRS would be to reduce reported net assets by Australian reporting entities. This is principally due to new rules under IFRS which generally do not permit the revaluation of intangibles, require more rigorous impairment testing of assets, and require the recognition of derivatives as well as the booking of defined benefit superannuation plan shortfalls.
Peter Collins (peter.collins@au.pwc.com), Melbourne
