Global Daily Tax News, Australia To Engage Large Firms On New Thin Cap Rules, (Feb 7, 2025)

The Australian Taxation Office has set out how it intends to engage with Top 100 and Top 1,000 taxpayers with regards compliance with Australia's new thin capitalization rules.

The changes were introduced in the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Act 2024.

The amendments to Australia's thin capitalization rules introduce new earnings-based tests (including a third-party debt test) for certain classes of entities to replace the existing asset-based rules for those entities.

The amendments also provide a new integrity provision (also known as "debt deduction creation rules") that will apply to debt creation schemes.

The changes are intended to strengthen the regime, by aligning the rules with the OECD's best-practice approach.

The new thin capitalisation rules apply to tax assessments for income years commencing on or after July 1, 2023, while the debt deduction creation rules apply to assessments for income years starting from July 1, 2024.

Under the legislation, "general class investors" are subject to one of three tests:

• A fixed ratio test, which limits net debt deductions to 30 percent of earnings before interest, taxes, depreciation, and amortisation (EBITDA) measured on a tax basis;

• A group ratio test, which is based on the proportion of group net third party interest expense to group (EBITDA); or

• A third-party debt test, which replaces the arm's length debt test and limits debt deductions other than those relating to third-party debt interests that meet certain conditions.

"Financial entities", meanwhile, continue to be subject to the existing safe harbor test and worldwide gearing test. Alternatively, they may select to be subject to the new third-party debt test.

The following entities are specifically excluded from the new debt deduction creation rules:

• authorized deposit-taking institutions (ADIs);

• securitization vehicles; and

• Australian plantation forestry entities.

The ATO has said, "The new thin capitalization and debt deduction creation rules are likely to have a significant impact on the affairs of some taxpayers. The application of these new rules will be a key focus area of our Top 100 and Top 1,000 justified trust compliance and assurance programs when we review years where the new rules apply."

"If you're in these programs and subject to a justified trust review, we'll engage with you about thin capitalization and the debt deduction creation rules to understand the impact of the new rules on your affairs. We'll ask for information that is relevant and tailored to your individual circumstances, having regard for reporting you already provide."

The ATO said the information sought will include, among other things:

• calculations and working papers that support reported thin capitalisation information;

• information in relation to how restructuring may have impacted the application of the thin capitalisation and debt deduction creation rules; and

• a copy of the signed and dated approved form for entities that have chosen to apply the third party debt test or group ratio test.