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  • Valuation of assets for the purposes of the Thin capitalisation regime

    As part of the 2018–19 Budget, the Government announced on 8 May 2018 that Australia’s thin capitalisation rules (contained in Division 820 of the Income Tax Assessment Act 1997) would be tightened by requiring entities to align the value of their assets for thin capitalisation purposes with the value included in their financial statements.

    Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2019 amends the relevant provisions of Income Tax Assessment Act 1936 and Income Tax Assessment Act 1997. The amendments finally passed both houses of parliament on 9 September 2019 and received royal assent on 13 September 2019.

    These amendments require an entity to use the value of the assets, liabilities (including debt capital) and equity capital that are used in its financial statements; remove the ability for an entity to revalue its assets specifically for thin capitalisation purposes; and ensure that non-ADI foreign controlled Australian tax consolidated groups and multiple entry consolidated groups that have foreign investments or operations are treated as both outward investing and inward investing entities.

    Explanation

    Alignment of values with financial statements

    Under subsection 820-680(1), for the purposes of the thin capitalisation rules, an entity must comply with accounting standards in:

    • determining what are its assets and liabilities; and
    • calculating the value of its assets, liabilities (including debt capital) and equity capital.

    An entity must determine or calculate these matters (the relevant matters), for the purposes of the thin capitalisation rules in the same way as they are determined or calculated in the entity’s financial statements if:

    • the entity is required by an Australian law to prepare financial statements for a period in accordance with the accounting standards; and
    • the relevant matters are determined or calculated in accordance with the accounting standards for the purpose of the entity’s financial statements in relation to the period.

    The entity’s assets and liabilities for thin capitalisation purposes are those recognised in its financial statements. The entity must calculate the value of each of its assets, liabilities, debt capital and equity capital as measured in its financial statements.

    If an entity is not required to prepare financial statements in accordance with accounting standards under an Australian law, the entity must determine its assets, liabilities (including debt capital) and equity capital, and calculate the value of those assets, liabilities (including debt capital) and equity capital, in accordance with the Australian accounting standards (subsection 820-680(1)). This applies even if the Australian accounting standards do not apply to the entity (subsection 820-680(3)).

    As a result of these amendments, the ability for an entity to revalue its assets and recognise certain intangible assets specifically for thin capitalisation purposes has been removed. Consequently, any revaluation and recognition of assets by an entity must comply with accounting standards.

    Thin capitalisation classification of the head companies of tax consolidated groups

    Thin capitalisation rules have been amended to remove provisions which deemed the head company of an Australian tax consolidated group or multiple entry consolidated group to be an outward investing entity only. Consequently, an entity that is the head company of an Australian tax consolidated group or multiple entry consolidated group will be classified as both outward investing and inward investing entity if the following conditions apply:

    • it is foreign controlled; and
    • it holds investments in a foreign entity or has a foreign permanent establishment.

    Entities that are classified as both outward investing and inward investing entities are disqualified from applying certain thin capitalisation rules (such as, for example, sections 820-37, 820-110, 820-216 and 820-217 which are only available for outward investing entities)

    Application and transitional provisions

    Valuation of assets

    The amendments relating to the requirement for an entity to adopt the same methodology for determining its assets, liabilities (including debt capital) and equity capital, and for calculating the value of those assets, liabilities (including debt capital) and equity capital, as reflected in the entity’s financial statements apply after 7.30 pm (by legal time in the Australian Capital Territory) on 8 May 2018 (the transition time).

    The amendments relating to the repeal of the provisions which enabled an entity to revalue its assets for thin capitalisation purposes for the determination and calculation of an entity’s assets, liabilities (including debt capital) and equity capital apply also after the transition time.

    A transitional rule applies for an entity that has determined or calculated its assets, liabilities (including debt capital) and equity capital prior to the transition time. The transitional rule will apply if:

    • the revaluation of assets is supported by the entity’s most recent valuation that complies with the thin capitalisation rules made prior to the transition time; and
    • those revaluations can only be relied upon by the entity for income years beginning before 1 July 2019 (that is, until the last day before the start of the income year commencing on or after 1 July 2019)

    The value of these revalued assets will effectively be frozen at the value reflected in the entity’s most recent valuation made before the transition time that is compliant with the requirements of Division 820.

    Thin capitalisation classification of the head companies of tax consolidated groups

    The amendments relating to thin capitalisation classification of the head companies of tax consolidated groups to treat these as both inwards and outwards investing entities apply in relation to income years beginning on or after 1 July 2019.

    Administrative treatment

    If you have lodged according to the old law you will need to review your thin capitalisation positions for the impacted years.

    If your tax return was not lodged in accordance with the new law you should seek an amendment. If an increase in liability results and you request an amendment within three months of royal assent:

    1. no tax shortfall penalties will be applied; and
    2. any shortfall interest accrued will be remitted to base interest rate.

    If you require further time to lodge an amendment you should discuss your circumstances with us.

    For the avoidance of doubt, no tax shortfall penalty or interest will be remitted to the extent a tax shortfall arises as a result of failing to satisfy all the requirements of the law which prevailed prior to the enactment of the new law (for example, failure to comply with the requirements for a compliant asset valuation under section 820-680, or the record keeping requirements in Subdivision 820-L, of the Income Tax Assessment Act 1997).

    If you instead chose to lodge in accordance with the law change and your lodged position is subsequently determined to be wholly consistent with the legislated change, you do not need to do anything further.

    Legislation and supporting material

      Last modified: 05 Nov 2019QC 56110