The Government has included in this year’s Budget some very significant corporate tax integrity measures. These include the alignment of the off-market buy-back rules for listed companies with the on-market rules, the introduction of new thin cap measures that will limit deductions to 30% EDITDA for most global entities, and the denial of deductions for related party payments for intangibles in low tax jurisdictions. The Budget also includes some clarity on the fate of a suite of announced but unenacted tax measures, such as the self-assessment of the effective life of intangibles announced in the 2021-22 budget, which will be dropped.
Improving the integrity of off-market share buy-backs
The Government has announced a new integrity measure to align the tax treatment of off-market share buy-backs undertaken by listed public companies with the treatment of on-market share buy-backs.
Under the current rules, the buy-back price under an off-market share buy-back is treated as consideration for the disposal of the shares to the extent it is attributable to paid up capital (i.e. debited to capital in the company accounts) and partially as a frankable dividend. The buy-back price is commonly discounted to account for the benefit of the franking credits. Conversely, on-market buy-backs are treated as the disposal of an asset in the same way as if the share was sold to a third party via a broker (which may qualify for the CGT discount if it has been held on capital account for over 12 months).
The new measure will come as a shock to taxpayers as it was not previously foreshadowed. Companies with significant franking balances will now be incentivised to return capital to shareholders via franked dividends as opposed to off-market buy-backs. Companies with few franking credits are likely to be indifferent or potentially welcome the changes as it may result higher buy-back prices.
The current off-market buy-back measures will continue to apply for unlisted companies.
This measure will apply from announcement on Budget night (7:30pm AEDT, 25 October 2022).
Multinational Tax Integrity Package – amending Australia’s interest limitation (thin capitalisation) rules
The Government has introduced significant changes to Australia’s thin capitalisation rules. These changes follow on from Treasury’s consultation paper, Government election commitments: Multinational tax integrity and enhanced tax transparency (Consultation Paper), released in August (see our alert).
Current thin cap rules
Under the current thin capitalisation rules, entities subject to the thin capitalisation rules (foreign controlled entities investing into Australia and Australian entities investing overseas) can generally deduct interest expenses based on rules focused on the level of debt (with transfer pricing to first adjust any excessive level of interest on that debt). There is currently a ‘safe harbour’ allowing an entity to deduct interest on debt provided the level of its debt does not exceed 60% of its assets. Alternative rules can allow interest deductions in excess of the safe harbour on a level of debt equal to what an arm’s length lender would lend to the entity and the entity would borrow (arm’s length debt test) or up to the same level as the worldwide group of which it is part (worldwide gearing test).
The changes
The changes seek to implement the OECD Base Erosion and Profit Shifting (BEPS) Action Item 4 from 2015 and were foreshadowed by the now government during the 2022 Australian federal election campaign. Similar rules have already been adopted in the United Kingdom (since 2017), the United States (since roughly 2018) and the EU (generally from 2018-2019).
They key aspects of the new measures are as follows:
- 30% EBITDA test. The safe harbour test will be replaced with a new earnings-based test which under which an entity's debt-related deductions will be limited to 30% of profits (using EBITDA as the measure of profit).
- Carry forward rules. Deductions denied under the EBITDA test to be carried forward and claimed in a subsequent income year (up to 15 years). This is a welcome development, as it was unclear whether carry forward rules would be included, and 15 years is much longer than most other OECD countries that have implemented BEPS Action Item 4 measures (typically 5 years or less).
- Earnings-based group ratio. The worldwide gearing test will be replaced to and allow an entity in a group to claim debt deductions up to the level of the worldwide group's net interest expense as a share of earnings (which may exceed the 30% EBITDA ratio).
- Arm’s length debt test. Importantly, the arm’s length debt test will be retained as a substitute test. However, this will apply only to an entity’s external (third party) debt, disallowing deductions for related party debt under this test.
- Scope. The changes will apply to multinational entities operating in Australia and any inward or outward investor, in line with the existing thin capitalisation regime. However, financial entities will continue to be subject to the existing thin capitalisation rules.
- Effective date. The changes will have effect from 1 July 2023.
The Budget Papers do not provide any clarity on the following important aspects of the changes that were raised in the Consultation Paper or by commentators:
- Grandfathering. There is no provision for the grandfathering of existing debt. The absence of transitional rules or grandfathering rules could have significant negative consequences for long dated investments made on the basis of law existing at the time of investment, noting in particular that tax is an economic factor that goes to the value of an investment and would have been considered at the time based on existing laws.
- Exemptions. There is no provision for exemptions for specific sectors, such as public benefit infrastructure exemptions. Such an exemption was flagged in the Consultation Paper.
- De minimis. No changes to the de minis exemption (which limits the impact of the thin cap rules to deductions above $2m per year) have been flagged in the Budget Papers.
Making COVID-19 business grants non-assessable non-exempt
In response to COVID-19, payments from certain state and territory business grants, made prior to 30 June 2022, can be made non-assessable, non-exempt (NANE) for income tax purposes, subject to eligibility. This tax treatment is only provided in exceptional circumstances, such as the severe economic consequences facing businesses during the COVID-19 pandemic.
The Government has made the following state and territory COVID-19 grant programs eligible for NANE treatment, which will exempt eligible businesses from paying tax on these grants: Victoria Business Costs Assistance Program Four – Construction, Victoria Licenced Hospitality Venue Fund 2021 – July Extension, Victoria License, Hospitality Venue Fund 2021 – Top Up Payments, Victoria Business Costs Assistance Program Round Two – Top Up, Victoria Business Costs Assistance Program Round Three, Victoria Business Costs Assistance Program Round Four, Victoria Business Costs Assistance Program Round Five, Victoria Impacted Public Events Support Program Round Two, Victoria Live Performance Support Program (Presenters) Round Two, Victoria Live Performance Support Program (Suppliers) Round Two, Victoria Commercial Landlord Hardship Fund 3, Australian Capital Territory HOMEFRONT 3, and Australian Capital Territory Small Business Hardship Scheme.
Anti-avoidance: denial of SGE deductions for payments for intangibles
The Government will introduce an anti-avoidance rule to prevent significant global entities (entities with global revenue of at least $1 billion) (SGEs) from claiming tax deductions for payments made directly or indirectly to related parties in relation to intangibles held in low- or no-tax jurisdictions. For the purposes of this measure, a low- or no-tax jurisdiction is a jurisdiction with:
- a tax rate of less than 15%; or
- a tax preferential patent box regime without sufficient economic substance.
These measures were also first flagged in the Consultation Paper released in August this year.
The measure will apply to payments made on or after 1 July 2023.
Providing certainty on unlegislated tax and superannuation measures announced by the previous Government
The Government has announced in the Budget that it will not proceed with a number of legacy tax and superannuation measures that were announced but not legislated by the previous Government, including the following corporate tax measures:
- Self-assessment of the effective life of intangibles. Initially introduced in the 2021-22 Budget, the Government has reversed the decision to enact a measure allowing taxpayers to self-assess the effective life of intangible depreciating assets. The Government has stated that this decision will avoid any potential integrity concerns with the previously announced measure. This maintains the current position of taxpayers – i.e. the effective life of such assets will continue to be set by statute
- Debt/equity rules. The 2013-14 MYEFO measure that proposed to amend the debt/equity tax rules.
- TOFA changes. The 2016–17 Budget measure that proposed changes to the taxation of financial arrangements (TOFA) rules (a delayed start date was announced in 2018–19 Budget).
- Asset backed financing. The 2016–17 Budget measure that proposed changes to the taxation of asset-backed financing arrangements.
Further, the Government will defer the start dates for a number of legacy tax and superannuation measures to allow sufficient time for policies to be legislated and implemented. This includes the 2021–22 Budget measure that proposed making technical amendments to the TOFA rules.
See more detail on a number of these measures in our client alert here.
