House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

General outline and financial impact

Thin capitalisation

This bill inserts Division 820 into the ITAA 1997 which contains the new thin capitalisation regime. It also makes consequential amendments to both the ITAA 1997 and the ITAA 1936 as a result of new Division 820. The measures in this bill will:

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apply to both foreign entities investing in Australia, and to Australian entities investing overseas;

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set a limit on the amount of debt that can be used to finance the Australian operations of non-ADIs;

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set a minimum level for the amount of equity capital that is required to be used to finance the Australian operations of ADIs;

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require certain non-resident entities carrying on business through permanent establishments in Australia (Australian permanent establishments) to prepare financial statements;

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repeal the existing thin capitalisation regime;

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repeal the existing debt creation regime;

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repeal the existing provisions dealing with the capitalisation of foreign bank branches;

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amend the existing provisions that deal with the deductibility of interest expenses for outward investors;

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amend section 389 of the ITAA 1936 to ensure the new thin capitalisation provisions are excluded from the calculation of attributable income;

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amend the record-keeping provisions of the ITAA 1936 to include records that must be kept for the purposes of the new thin capitalisation regime;

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amend section 128F of the ITAA 1936 to allow Australian permanent establishments to gain access to the interest withholding tax exemption under that provision; and

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amend section 128F to replace the definition of the term associates.

Date of effect: The dates of effect of the measures are as follows:

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the new thin capitalisation regime will apply from the start of a taxpayers first year of income beginning on or after 1 July 2001;

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Australian permanent establishments will be required to prepare financial statements from the start of their first year of income beginning on or after 1 July 2002;

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the current thin capitalisation regime, the current debt creation regime, and the current provisions dealing with the capitalisation of foreign bank branches, will be repealed as of 1 July 2001 but will continue to operate for our income year commencing before 1 July 2001;

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the amendments to the provisions that deal with the deductibility of interest expense for outward investors will take effect from an income year beginning on or after 1 July 2001;

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the amendment to allow Australian permanent establishments to gain access to section 128F will apply to debentures issued on or after 1 July 2001; and

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the amendment to section 128F to replace the definition of the term associates will apply from 1 July 2001.

Proposal announced: This proposal was originally announced in Treasurers Press Release No. 74 of 11 November 1999 (in particular, refer to Attachment G of that Press Release). Changes to the proposal were announced in Treasurers Press Release No. 38 of 22 May 2001.

Financial impact: The financial impact of these measures will be a gain to the revenue as outlined in the following table:

Compliance cost impact: A separate regulation impact statement is available for the measures in this bill.

Summary of regulation impact statement

Regulation impact on business

Impact: The measures contained in this bill are part of the Governments broad ranging reforms that will give Australia a New Business Tax System. These reforms are based on the recommendations of the Review of Business Taxation that the Government established to consider reforms to Australias business tax system.

Any increase in compliance costs will be offset by broader economic benefits from increasing the integrity of the tax system.

Main points:

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The objective of the thin capitalisation regime is to ensure that multinational entities do not allocate an excessive amount of debt to their Australian operations. This is to prevent multinational entities taking advantage of the differential tax treatment of debt and equity to minimise their Australian tax. More generally, as a measure introduced as part of the New Business Tax System it will also contribute to the fairness and equity of the tax system, by maintaining the integrity of the Australian tax base.

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The New Business Tax System will provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings. The measures in this bill will contribute to that end by improving the integrity of the tax system by preventing multinational taxpayers who are able to shift debt around the world from obtaining an unfair competitive advantage by doing so.

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Potential compliance, administrative and economic impacts of the measures contained in this bill have been carefully considered by the Review of Business Taxation and the business sector. Substantial consultation with the business sector was undertaken both as part of the Review of Business Taxation and the ongoing development and finalisation of the measures.

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The measures will contribute significantly to the fairness and integrity of the tax system by reducing the opportunities to avoid tax which arise from complexities and certain anomalies in the current thin capitalisation legislation.