On 25 October 2022, as part of the 2022–23 Budget, the government announced it would strengthen Australia's thin capitalisation rules. Changes will be made to align with the Organisation for Economic Co-operation and Development's (OECD) best practice approach (OECD BEPS Action 4). This measure is now law.
The Treasury Law Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Act 2024External Link applies to income years commencing on or after 1 July 2023. The thin capitalisation rules apply to most multinational businesses operating in Australia with at least $2 million in debt deductions, on an associate inclusive basis.
The amendments established 3 new tests that apply to 'general class entities' (this includes most multinational businesses):
- The fixed ratio test is an earnings-based ratio test consistent with the OECD’s best practice approach. This test limits an entity’s net debt deductions to 30 per cent of its tax earnings before interest, taxes, depreciation, and amortization (EBITDA). Under this new test, debt deductions exceeding the 30% EBITDA limit will be denied. Denied deductions can be carried forward and claimed in subsequent income years (subject to the 30% EBITDA limit each year), for a maximum of 15 years. This method is the default method unless a taxpayer makes a choice to use the other 2 methods.
- The group ratio test is an earnings-based worldwide gearing ratio test consistent with the OECD’s best practice approach. This test limits net debt deductions using a ratio of the worldwide group’s net interest expense and EBITDA based on the worldwide group's financial statements. There is no carry forward of denied deductions under this method.
- The third party debt test limits an entity's debt deductions to those attributable to an entity’s external (or third party) debt except for non-qualifying external debt. Debt deductions attributable to related party debt are denied under this test. There is no carry forward of denied deductions under this method.
The current safe harbour test and worldwide gearing ratio test are retained for entities classified as financial entities and ADIs. The current arm’s length capital test is retained for ADIs. Financial entities which are not ADIs can choose the new third party debt test, and the current arm’s length debt test for non-ADIs is repealed.
These rules are supported by debt deduction creation rules that deny debt deductions arising in connection with relevant related party arrangements. These rules reduce the ability for multinational businesses with at least $2 million in debt deductions (on an associate inclusive basis) to create debt through internal transactions in order to utilise any additional debt deduction capacity under the above tests. The debt deduction creation rules apply to income years commencing on or after 1 July 2024.
More information
Labor’s plan to ensure multinationals pay their fair share of taxExternal Link media release – Andrew Leigh, MP