Latest income tax developments May 2022

Post-election Update

The 2022 Federal Election resulted in a majority for the Australian Labor Party in the House of Representatives, and Labor has formed Government .  This post-election special primarily discusses the tax policies proposed in Labor's Economic Plan and Budget Strategy Statement. 

We outlined Labor's key tax policies in our April in Australian Tax Bulletin.  In this month's Bulletin we consider in more detail how Labor's policies may impact Australian businesses, and some of the key design elements of the policies that remain to be clarified. 

Thin capitalisation changes

Labor intends to repeal the safe harbour debt amount (generally, 60% of gross assets less non-debt liabilities) and implement in its place a limitation on debt deductions where they exceed 30% of earnings before interest, taxes, depreciation and amortisation (30% EBITDA Rule).  This is consistent with the OECD's recommended approach for limiting the deductions multinationals can claim on interest payments.

There remain a number of unclear aspects relating to Labor's proposal, including:

• how it may apply during periods of no or low income earning (such as the construction phase of projects);
• whether it will apply to typically heavily geared sectors such as infrastructure;
• whether any debt deductions denied (or excess thin capitalisation capacity) will be able to be carried forward into future periods; and 
• whether it may be limited to related party debt.

With respect to infrastructure projects, the OECD proposed in Action Item 4 a potential exclusion that countries could adopt for certain infrastructure projects where interest was paid to third party lenders, referred to as "public benefit projects".  The OECD permitted the exclusion because the nature of such projects and close link to the public sector was considered to reduce the base erosion and profit shifting (BEPS) risk, as well as recognising that these projects are typically highly geared.  The proposed criteria developed by the OECD for such projects were as follows: 

• an entity (the operator) establishes a project to provide, operate or maintain assets on a long-term basis, lasting not less than 10 years and these assets cannot be disposed of at the operator's discretion;
• a public sector body or public benefit entity (the grantor) contractually or otherwise obliges the operator to provide goods or services in which there is a general public interest; 
• interest is payable by the operator on a loan or loans obtained from and owed to third party lenders on non-recourse terms; 
• the loan or loans do not exceed the value or estimated value of the assets at acquisition or once constructed; 
• the operator, interest expense, project assets and income arising from the project are all in the same country, where income must be subject to tax at ordinary rates; and
• similar projects are not substantially less leveraged with third party debt, taking into account project maturity. 

Alternatively, it may be considered that it is not necessary to introduce such an exclusion, as Labor intends to retain both the alternatives to determine the maximum allowable debt under the thin capitalisation rules, being the arm's length debt amount and worldwide gearing debt amount.  Although many infrastructure participants may already be relying on the arm's length debt amount, the proposed 30% EBITDA Rule could result in many more taxpayers relying on the arm's length debt amount.  At present, there is a high administrative burden in complying with the relevant documentation requirements to rely on the arm's length debt amount (even where the debt is genuinely third party debt), such that it may be prudent to relax that administrative burden in genuine third party circumstances.

With respect to whether any denial under the 30% rule is permanent or temporary, the OECD indicated that countries may allow for the carrying forward of denied interest deductions.  The United Kingdom, which introduced rules consistent with the parameters of Action Item 4, opted to allow excess thin capitalisation capacity to be carried forward for a period of five years, and also to allow denied deductions to be carried forward indefinitely.  This may be a reasonable approach in circumstances where there was no exclusion from the 30% rule for assets that were not presently income earning (e.g., as a consequence of being under construction).  However, at this stage there is no indication from Labor as to their position in this regard.

The OECD approach also contained an alternative group ratio rule, which was intended to assist sectors where there are high levels of leverage.  Broadly, the group ratio rule operates to cap interest deductions at an amount equal to taxable EBITDA multiplied by the ratio of worldwide net interest expense to worldwide EBITDA.  This is somewhat similar to the worldwide gearing debt amount, albeit calculated by reference to interest expense.  Given the existence of the alternative worldwide gearing debt amount, it would seem unlikely that the group ratio rule would be introduced, although given the different underlying bases of the rule (i.e., one focussed on interest expense compared to EBITDA, the other focussed on assets compared to debt), this remains to be confirmed. 

Finally, it is worth noting that the Labor material associated with the proposed 30% EBITDA Rule has a particular focus on related party debt, including references to the base erosion risk associated with creating "artificial debts … within related entities".  It is possible that the measure may be focussed on related party debt specifically rather than debt generally.

Deductibility of royalties paid to related entity in "tax haven" jurisdictions

Labor proposes to limit the ability of large multinationals to deduct royalties where they are paid to related entities in jurisdictions with which Australia has concluded a Double Tax Agreement ("DTA"), where that jurisdiction is considered a tax haven.  It is not presently clear which jurisdictions are considered tax havens.  

In relation to scope, Labor has provided that: 

• the measure will only apply to significant global entities (being certain entities that, along with their relevant economic group, have a global turnover over $1 billion); and 
• the only affected transactions are those that fail the "sufficient foreign tax test" aspect of the Diverted Profits Tax or involve a harmful tax preferential regime.  

If a transaction falls within the scope, deductions from for the royalties will be denied unless the taxpayer can demonstrate that the royalty payments are not for the purpose of tax avoidance. 

Labor has stated that this proposed measure is "related" to those in the United Kingdom, United States and the Netherlands.  The United Kingdom's Anti-Treaty Shopping Rules prevent the exploitation of double taxation agreements where a person makes an IP royalty payment to a connected party, and the payment is made under a double taxation agreement tax avoidance arrangement (DTA tax avoidance arrangement).  DTA tax avoidance arrangements are arrangements where the main purpose, or one of the main purposes, of the arrangement is to obtain a tax advantage by virtue of any provisions of a double taxation agreement and obtaining that tax advantage is contrary to the object and purpose of those provisions (Income Tax Act 2007 (UK), s 917A(4)).  Therefore, the rules deny treaty benefits that would otherwise be available.

Given that many of Australia's DTAs already contain anti-treaty shopping provisions (including as a result of modifications made by "The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting" or "MLI"), the additional scope of this measure is unclear, although it could catch some DTAs which have not yet been modified by the MLI .

BEPS 2.0:  The Two Pillar Solution  

Labor plans on implementing the OECD's Two-Pillar solution.  The Secretary-General of the OECD, Mathias Cormann, has announced that the implementation of the Two-Pillar Solution will be pushed back a year so that practical implementation will now happen from 2024 onwards.

At present, no draft legislation exists for this measure, and other than material released by the OECD, there is limited guidance on how it will be introduced in Australia.

Labor's position on lapsed tax bills

When the Federal election was called on 10 April 2022, the Parliament was prorogued and House of Representatives was dissolved from 11 April 2022.  As a result, all unpassed Bills before Parliament lapsed, although some of these lapsed Bills may be re-introduced.  The table below outlines Labor's position on the key tax Bills that lapsed. 

Tax measures not introduced into Parliament

• Any tax measures that were announced by the previous Government, but not yet introduced into Parliament, may also be considered by the incoming Labor Government.  
• The Digital Games Tax Offset (DGTO), for which, as discussed in our March in Australian Tax Bulletin, draft legislation was released in March 2022 for consultation.  However, the consultation period on the draft legislation closed after 11 April 2022 and Labor has not given a statement on its position in relation to the DGTO and the draft legislation. 
• A small business technology investment boost and small business skills and training boost was announced in the previous Government's 2022-23 Budget.  The proposed measures would allow small businesses to deduct an additional 20% of expenditure on specific training courses provided to employees and the costs incurred on business expenses and depreciating assets supporting digital adoption, such as portable payment devices.  Legislation is not been publicly released for consultation, and Labor has not yet issued a statement on this proposed measure. 
• In the 2018-19 Federal Budget, the previous Government announced a measure to prohibit managed investment trusts (MITs) and attribution MITs (AMITs) from accessing the 50% capital gains tax (CGT) discount at the trust level.  It was characterised as an integrity measure to ensure that MITs and AMITs operate as "genuine flow-through tax vehicles", such that beneficiaries not entitled to the CGT discount would not receive the benefit of the discount being applied at the trust level, notwithstanding that in certain circumstances it would have resulted in taxation treatment that was inconsistent with flow through treatment, and also would have created an inconsistency in treatment between non-MIT trusts and MITs and AMITs.  
  
  The measure was to apply from 1 July 2019.  It was subsequently delayed to 1 July 2020, and then further delayed to apply to "the income years commencing on or after three months after the date of Royal Assent of the enabling legislation".  As at the date of this Bulletin, the relevant legislation has not been introduced into Parliament.  Labor's position on the measure is not clear.