ATO releases final PCG for thin capitalisation, DDCR

On Wednesday (20 August), the Australian Taxation Office released its final practical compliance guide (PCG) outlining its approach to evaluating restructures carried out in response to new thin capitalisation and debt deduction creation rules (DDCR).

The Tax Office said its new guidance incorporated feedback from stakeholders, including additional guidance on low-risk structures.

“We've incorporated submissions from stakeholders into the finalised guideline. This includes additional permissive guidance on types of low-risk restructures that taxpayers can enter into in response to the new laws,” the ATO noted.

Under new thin capitalisation changes, the ATO introduced three new tests limiting the amount of debt deductions general class investors are allowed for an income year.

The rules were introduced to curb multinational profit shifting, where large corporations operating in Australia could reduce their domestic taxable income by moving profits to lower-tax jurisdictions through intra-group debt.

The ‘fixed ratio test’ (FRT) disallowed debt deductions which exceeded 30 per cent of the entity’s ‘tax EBITDA.’ The ‘group ratio test’ limited net debt deductions using a ratio of the net interest expense and EBITDA of the worldwide group to which an entity belonged.

The ‘third party debt test’ placed limits on entities’ gross debt deductions in a bid to prevent multinationals from deducting debt-related costs from their Australian tax bills.

Furthermore, new DDCR disallowed debt deductions arising from certain related party arrangements.

The ATO’s risk assessment framework relied on colour-coded risk zones: ‘white’ zones that did not require further risk assessment, ‘yellow’ zones where compliance risks had not been assessed, ‘green’ low risk zones and ‘red’ high risk zones.

In the PCG, restructured arrangements with no debt deductions, those that replaced related party debt with third party debt and arrangements that disposed of foreign assets were exemplified as low-risk arrangements.

Firms that found themselves in the ‘red zone’ could look forward to greater ATO scrutiny and audit risk.

Accounting body CA ANZ welcomed the final PCG, calling it an improvement from the draft version.

“CA ANZ is pleased that many of our recommendations regarding restructuring and the debt deduction creation rules (DDCR) have been accepted and reflected in the final document, notably, the expansion of the white zone to include restructures that have been subject to ATO review or audit and received a low-risk or high-assurance rating," Susan Franks, CA ANZ tax, superannuation and financial services leader said.

“We also support the introduction of a de minimis threshold for restructures, where total debt deductions of the whole group are $2 million or less. These changes demonstrate a practical and proportionate compliance approach."

A controversial aspect of the PCG, rules regarding the third-party debt test, was not included in the guideline. It awaits a final taxation ruling, TR 2024/D3 ‘Income tax: aspects of the third-party debt test’, due in September.

“We remain concerned around the treatment of taxpayers who restructure to access the third-party debt test under the thin capitalisation rules. Greater clarity is needed to ensure that legitimate choices under the law are not inadvertently flagged as high-risk," Franks noted.

Accounting bodies have previously called out the ATO’s proposed compliance approach to the third-party debt test (TPDT) as overly restrictive and impractical.

CA ANZ said the ATO should allow more time for taxpayers to choose to apply for the TPDT, allow taxpayers to amend returns after they have been lodged to apply the TPDT, and allow taxpayers to revoke TPDT choices.

CPA tax policy lead Jenny Wong warned that the proposed TPDT rules would be “unworkable” in practice.

“Even where a taxpayer’s circumstances should allow them to qualify for the TPDT, the evidentiary burden imposed by the ATO makes it practically unworkable unless significant pre-planning measures were taken,” Wong wrote in a submission.