Introduction of New Australian Thin Capitalization Rules
- On 8 April 2024, the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share—Integrity and Transparency) Bill 2023 received royal assent which introduces new thin capitalization earnings-based tests for the new ‘general class investors’ except for FIs and ADIs.
- The new interest limitation rules will applicable from 01st July 2023 and the debt creation rule applies from 01st July 2024.
- Where net debt deductions of an entity and associates are AUD 2 million or less (de minimis threshold), the carve out from the interest limitation rules continues.
- There are three potential tests available for interest limitation rules to general class investors to choose from:
- ‘Fixed Ratio test’ – It will replace the existing safe harbour test capping the net debt deduction @30% tax EBIDTA; subject to conditions, the disallowed debt deductions can be carried forward for up to 15 years.
- ‘Group Ratio test’ – It will replace the existing worldwide gearing test to allow an entity in a highly leveraged group to claim debt deductions up to the level of the worldwide group’s net interest expense as a share of earnings.
- ‘Third party debt test’ – It will replace the existing arm’s length debt test.
- Fixed ratio test would be the default method but the entity will have option to choose any other alternative method by making an application to the tax authorities. In case an entity choose the alternative method and they have some carry forward interest expense on the basis Fixed ratio test method then the said carry forward interest expense shall be lapsed.
- The government also amended the definition of “debt deduction” wherein the debt deduction includes not only interest but also the amounts economically equivalent to interest such as interest rate swap.
- In respect of Fixed Ratio test and Group Ratio test, the debt creation rules take priority over the general operation of the new interest limitation rules. Meaning, that even if the debt deduction falls within the limit of FR / GR test, but if it is within the scope of debt creation rules, then the amount is denied (in whole or in part) by those rules and will not even get carried forward.
Rishabh Jain, Executive Direct and International Tax, SW
