The Federal Treasurer has announced a number of proposed changes to the Australian tax system designed to remove what are seen as opportunities for foreign investors to transfer profits from Australia with a consequent erosion of the corporate tax base.

While there is currently no draft amendment bill or proposed date for tabling such a bill in Parliament, the Assistant Treasurer announced a number of consultation arrangements with interested parties and a Proposals Paper has been released by the Government entitled “Addressing profit shifting through the artificial loading of debt in Australia”. This announcement is therefore subject to the risk that most of these measures may not find their way into law before the Government goes to the polls in the Federal Election in September 2013. The reforms are projected for implementation as far out as 2016.

Of particular note in the package announced in the Budget are the following:

Thin Capitalisation

There was much speculation prior to the Budget that there would be some tightening up of the thin capitalisation rules that apply to the capitalisation of Australian businesses by foreign interests. With these proposals the Government is challenging the generosity of the current thin capitalisation regime and suggesting that there is currently far too much scope for foreign investors to shift profits offshore through the use of debt deductions. The Government has proposed that from 1 July 2014:

  • for general investors, including funds managers, sovereign funds and pension funds, the debt to equity safe harbour will be reduced from 3:1 to 1.5:1 (ie from a maximum of 75% debt to total assets down to 60%);
  • for non-bank financial entities, the debt to equity safe harbour will be reduced from 20:1 to 15:1 (ie from 95.24% to 93.75% debt to total assets);
  • for banks, the capital limit will be increased from 4% to 6% of their risk weighted assets of the Australian operations;
  • for outbound investors, the worldwide gearing ratio will be reduced from 120% to 100% (with an equivalent change to the worldwide capital ratio for banks) and this limitation will also be applied to inbound investors.

The Government has also proposed an increase in the de minimis threshold from A$250,000 to A$2 million of debt deductions before the thin capitalisation rules can apply. This is designed to reduce compliance costs for small business.

The Federal Treasurer also announced that the Board of Taxation has been asked to consider ways to improve the operation of the arm's length test to make it easier for the thin capitalisation rules to apply and to clarify the circumstances in which they will apply. The Board’s report is expected by December 2014.

Debt Equity Rules

The Board of Taxation has also been requested to review the debt equity rules to consider whether they can be improved to address any inconsistencies between the Australian tax system and those of other countries to eliminate tax arbitrage opportunities.