Thin capitalisation, profit shifting and tax evasion

The Australian Government has been working to tighten thin capitalisation laws and actively target profit shifting and tax evasion. It has made no secret of its intent to target individuals with international assets under the ATO tax amnesty scheme Project Do It.

Changes to the thin capitalisation laws passed the Australian Parliament on 24 September 2014, issuing a series of amendments that will apply retrospectively from 1 July 2014.  

Australian businesses with international dealings are being actively encouraged to review their cross-border strategy to ensure that their arrangements are in line with the amendments to ensure they don't fall foul of the ATO as these changes are applied. 

So what has changed with thin capitalisation?

Thin capitalisation rules apply to Australian entities with overseas interests, foreign-controlled Australian entities and foreign entities investing directly in Australia. 

• Tighter safe harbour limits. For general entities (i.e., excluding banks and financial entities) the safe harbour limit has been reduced from 3:1 to 1.5:1 on a debt to equity basis. This represents a move from 75% to 60% on a debt to net assets basis.
• Reducing the worldwide gearing ratio for outbound investors from 120% to 100%.
• Increasing the de minimis threshold from $250,000 to $2 million of debt deductions. This saves many SMEs from having to comply with the thin capitalisation rules although they will still need to consider the transfer pricing provisions when it comes to funding arrangements with either foreign investors or foreign subsidiaries.

ATO spotlight on tax evasion

There are other changes and ATO initiatives underway in addition to the thin capitalisation rules. Key target areas for the ATO, for example include:

• The use of tax havens
• Loading debt into Australian entities and
• Profit shifting offshore

In recent years, the ATO has been investing heavily in data matching and cooperation via international tax agreements to enhance its ability to catch out taxpayers who use these types of strategies to reduce tax liabilities in Australia.

Finance Ministers at the recent G20 meeting endorsed a common reporting standard for the automatic exchange of information. The new standard will be implemented in Australia in 2017 with the first year of exchange a year later.

Review your cross border strategy

Australian business with cross-border activities are strongly encouraged to look at whether they are potentially at risk from the renewed focus on tax avoidance.

Given the complexity of international tax, reviewing your current arrangements with our international tax team can help to identify and remediate potential risks.