Geoffrey Yiu and James Macky assess the potential impact of a rumoured reduction to the thin capitalisation limit in the upcoming Federal Budget.
This week, major newspapers have reported a Federal Budget "advertising ‘leak’ showing $16 billion in savings over the next four years”.
One of the changes reported to be pursued by the Government concerns multinational tax avoidance and, under that umbrella, is a rumoured reduction of the 'safe harbour' thin capitalisation limit from 60 percent to 50 percent of assets.
If the safe harbour ratio does come down, or if your organisation is otherwise at its thin capitalisation limit, a number of strategies can be pursued. As 30 June approaches, it is probably a good time to review your thin capitalisation strategy anyway.
One of the most common approaches to thin capitalisation is for management to consider swapping debt for equity. However, such a strategy may only result in replacing non-deductible interest with non-deductible dividends, with no consequential impact on the organisation’s Australian income tax position.
Generally, groups should only implement such a strategy if it results in a different global tax position, taking into account factors such as Australian withholding tax and the parent company’s ability to claim a credit; the parent company’s tax rate and access to exemptions on interest and dividends; the parent company’s own limitations on interest deductibility; as well as the group’s cost of capital.
Australia’s commercial debt forgiveness, share capital tainting and capital injection rules also need to be managed.
In working through your thin capitalisation strategy, the following methodology may be useful:
Finally, consideration should be given to the alignment and flexibility of your thin capitalisation strategy to other changes in the tax landscape that can impact structuring and financing, such as the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting action plan and the multi-national anti-avoidance legislation.
Is it time to review your thin capitalisation strategy?