Jenny Wong discusses how the proposed changes to thin capitalisation rules in the Federal Budget may affect inward and outward tax consolidated groups.
Thin capitalisation changes featured in this year’s Federal Budget. There was issue floating around a few years back with some clients that were both an inward and outward consolidated group. The issue was whether they could have unrestricted access the worldwide gearing test.
Before 2014, the issue arose because if it was an inward and outward standalone entity, the taxpayer does not have access to the worldwide gearing test (and therefore not permitted access to a higher level of debt allowance before interest expense is denied as a deduction).
The way the law was drafted before the thin cap changes in 2014 is that an inward and outward consolidated group received the benefit of the worldwide gearing test (see 820-583(5) & 820-90) despite the fact a standalone entity that was both inward and outward for thin purposes could not. Broadly, this was on the basis that a literal reading of s820-583 treated a head company of an inward and outward consolidated group as only being an outward investing entity and not an inward investing entity per s820-583(5) and so it could access the worldwide gearing test since it was not also an inward investing entity.
Under the 2014 thin cap changes (Tax and Superannuation Laws Amendment (2014 Measures no.4) Act 2014), the position did not changed. However, the worldwide gearing test in the 2014 amendments extending the test to inward and outward entities is narrower as there is an integrity rule that must be satisfied before entities can access the test – refer s820-90(2)(c) and (3) which applies to an outward investing entity which is also an inward investing entity. Generally, the Australian assets cannot exceed more than 50 percent of the worldwide assets. This integrity rule does not apply to an inward and outward consolidated or Multiple Entry Consolidated (MEC) group (s820-90(1)(c) does not include an equivalent 50 percent threshold test). The explanatory memornadum (EM) at the time at paragraph 1.43 contains an explicit acknowledgment that the head company of a tax consolidated group or MEC group that is both inward investing and outward investing is an ‘outward’ investing entity for the purposes of the worldwide gearing debt test and confirms that the worldwide gearing test in s820-110 for outward investing entities would apply. Section 820-110 explicitly states that the method statement applies where the entity is an outward investor (general) and not also an inward investment vehicle.
This raises the question of whether this is the right policy outcome though, as standalone entities that are both inward and outward have a higher threshold to meet to access interest deductions than consolidated groups that are both inward and outward, before they can access the worldwide gearing test.
Well, it looks like the Government is on the same page now. The Government announced on Federal Budget night on 8 May 2018 they will ensure that foreign controlled Australian consolidated entities and multiple entry consolidated groups that control a foreign entity are treated as both outward and inward investment vehicles for thin capitalisation purposes. This will apply for income years commencing on or after 1 July 2019. This change will ensure that inbound investors cannot access tests that were only intended for outward investors.