Unclear interactions among provisions for thin cap reforms: The Tax Institute

Despite The Tax Institute lauding the ATO’s broad policy objective of aligning Australia’s thin capitalisation rules with international practices, in its thin capitalisation regime, Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Act 2024 (Cth), the institute said in its submission that several of its provisions introduce significant uncertainty and administrative complexity that are not justified from a policy perspective, and not consistent with broader initiatives to reduce red tape in the tax system.

One of the rules under the reform requires taxpayers to make an election on an approved form before lodging their tax return to apply the group ratio test (GRT) or third-party debt test (TPDT), or else the fixed ratio test (FRT) applies by default.

“This creates a rigid framework that limits taxpayers’ ability to respond to uncertainty or evolving interpretations,” the institute said in its submission to the ATO.

“The current framework imposes unnecessary rigidity and compliance risk, reduces flexibility for taxpayers, and may lead to outcomes that are inconsistent with the intended operation of the thin capitalisation regime,” the institute added.

“Feedback from our members indicates that these issues are already affecting financing decisions, increasing compliance costs, and creating uncertainty regarding the deductibility of genuine third-party debt … This may deter investment in Australia at a time where foreign investment is needed to support broader Government objectives,” the institute said.

For the institute, the current rules impose significant tracing and evidentiary burdens, particularly regarding legacy arrangements and complex financing structures, thereby increasing compliance costs and uncertainty.

In its submission, the institute pointed to issues including the “third-party debt test, fixed ratio test, and debt deduction creation rules, as well as inconsistent and insufficient ATO guidance”.

“This results in outcomes that, at times, appear inconsistent with the policy intent of the rules, particularly where overlapping provisions apply to the same arrangement. It also increases compliance complexity, as taxpayers and their advisers are required to interpret and reconcile multiple regimes without clear legislative or administrative guidance,” it said.

In its submissions, the institute sought changes through its recommendations, including greater flexibility allowing taxpayers to change their chosen thin capitalisation method without the commissioner’s discretion, eliminating the “black hole” in EBITDA (earnings before interest, taxes, depreciation, and amortisation) for interests of more than 10 per cent but less than 50 per cent, and providing greater clarity and embedding greater consistency with policy intent and statutory language.