Supplementary Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 1 - Thin capitalisation
Outline of chapter
1.1 Amendments 1 to 5, 8 and 9 refine a number of items in the thin capitalisation Schedules in the bill so that these items have their intended effect. Two new parts are added to Schedule 1 by amendments 6 and 7 to address an identified integrity risk and remove an anomaly in the thin capitalisation rules. There is a change to the explanatory memorandum that provides additional information on item 11 in Schedule 3.
Explanation of amendments
1.2 The amendments affect items 18 to 21 in Schedule 1 to the bill. These items detail new arrangements for borrowing securities in determining the maximum allowable debt of financial entities. The amendments insert a reference to 'financial entities' to clarify that the arrangements only apply to financial entities.
1.3 This amendment affects item 38 in Schedule 1 to the bill. Item 38 seeks to ensure that in determining the arm's length debt amount only Australian operations are included. The amendment inserts an important linking paragraph that will ensure that the provision operates as intended.
1.4 This amendment introduces a new part in Schedule 1 to the bill (Part 12). Because of the way in which worldwide equity is defined, it is possible for an Australian entity and its controlled foreign entities to have negative worldwide equity. The amendment will prevent an entity in this situation from using the worldwide gearing debt amount to determine its maximum allowable debt because otherwise the entity would be allowed more debt than assets for thin capitalisation purposes. This is an inappropriate outcome and the amendment is necessary to protect the revenue.
1.5 This amendment introduces a new part in Schedule 1 to the bill (Part 13). The amendment will ensure that all entities subject to the thin capitalisation rules use the same definition of non-debt liabilities. The current definition of non-debt liabilities only recognises a provision for a distribution of profit made by a corporate tax entity. The amendment allows all entities subject to thin capitalisation rules to exclude provisions for distributions of profit in their calculation of non-debt liabilities. This ensures, for example, that a company and a trust (in the same financial position) will have the same value for non-debt liabilities.
1.6 This amendment affects item 28 in Schedule 2 to the bill. The amendment addresses several unintended outcomes from the application of excluded equity interest introduced in TLAB 5 2003.
1.7 An equity interest (e.g. a share) is an excluded equity interest where it is issued prior to a valuation day (the time at which an entity's assets and liabilities are measured for thin capitalisation purposes) and cancelled shortly thereafter in order to allow the entity to hold a higher level of debt at the valuation day. Where an equity interest meets the definition of an excluded equity interest it is deducted from the assets of the entity thereby reducing the maximum allowable debt of the entity.
1.8 This amendment changes the meaning of excluded equity interest in TLAB 5 2003 to ensure that it is limited to transactions between associates and where the interest is on issue for less than 180 days. This will ensure that the measure is appropriately targeted.
1.9 This amendment is consequential to amendment 8.
Correction to the explanatory memorandum
1.10 The following text should replace paragraph 1.122. This text provides additional detail on the calculation of retained earnings in the definition of equity capital.
1.11 Equity capital also includes:
- •
- general reserves and asset revaluation reserves;
- •
- opening retained earnings (less any distributions declared but not paid that are not attributable to the entity's earnings for the current year) or accumulated losses (i.e. negative retained earnings);
- •
- current year earnings (net of expected tax and distributions) or losses; and
- •
- provisions for distributions.