Australia Targets Tax Integrity for Debt Equity Rules

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By Murray Griffin

Oct. 17 — Australia will redefine rules for deciding whether structures create debt interest or equity interest, based on advice from its Board of Taxation over concerns of uncertainty and significant practical difficulty for taxpayers.

The rules currently classify financing arrangements as debt, with deductible interest, or equity according to their economic substance. Returns on equity interests, such as dividends, may entitle the shareholder to franking credits, but aren’t deductible for the company. Returns on debt, such as interest, are generally deductible for the company but don’t carry franking credits.

The rules—which apply to financial institutions, life insurers, superannuation funds and large corporations—also contain “integrity rules” designed to prevent taxpayers from artificially splitting a single scheme into multiple schemes to achieve favorable tax outcomes.

The exposure draft, issued Oct. 10, takes into account suggestions from the Taxation Board on how to address the uncertainty and inconsistency that have increased compliance costs for business and increased the cost of administration for the Australian Taxation Office since the introduction of the rules in 2001.

The board also recommended that examples of the operation of the new integrity rules should be set out in a legislative instrument.

New Rules on Aggregated Schemes

The existing aggregation provisions, namely the related scheme rule and section 974-80, operate to aggregate debt and equity instruments for the purpose of determining their tax treatment.

Under the draft bill, schemes would be treated as one aggregated scheme if they have pricing, terms and conditions that are interdependent in a way that would change their debt or equity treatment under rules prescribed in Division 974 of the Income Tax Assessment Act 1997.

It must also be the case that the schemes were designed to operate to produce their combined economic effect—with the “design” test able to be satisfied based on either the intentions of the entities involved or their professional advisers.

If the link between schemes is only accidental, they would not be treated as aggregated. Nor does aggregation occur where one scheme merely funds, is stapled to or is subordinate to another scheme.

Currently, the test is whether the schemes are “related to one another in any way” and whether they are intended to have the combined effect of giving rise to either a debt or equity interest.

Adrian Varrasso, tax partner at MinterEllison in Melbourne, said that while the provisions remain subject to consultation, the draft law is “a considerable improvement” on the current legislation.

“The introduction of inter-dependency and objective design tests appears to more appropriately aggregate schemes whether it accurately reflects the economic substance of the schemes,” said Varasso.

‘Integrity Provision’ to Be Repealed

Significantly, the draft bill suggests repealing section 974-80, intended to target financing arrangements that effectively grant an investor an equity interest in a company through interposed debt interests.

Section 974-80, which reclassifies the interposed debt interests as equity interests, has been contentious because of its potentially very broad scope.

Teresa Dyson, Brisbane-based consultant with law firm McCullough Robertson, knows the debt and equity rules well, having assisted the Board of Taxation’s inquiry into them.

Dyson Oct. 17 told Bloomberg BNA by phone that the draft legislation “closely and carefully” followed the board’s recommendations.

The board’s 2015 report and recommendations were the result of “about 18 months of fairly intense discussion and negotiation between the private sector, government, Treasury and the Australian Taxation Office about how these rules could be reworked to make them more easily understood and less ambiguous,” she said.

She noted that while the problematic 974-80 would go, the new provisions would deal with the concerns it had sought to address in a way that was better targeted and provided more certainty.

Submissions on the draft bill close November 21.

To contact the reporter on this story: Murray Griffin in Melbourne at correspondents@bna.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bna.com

For More Information

Details on the proposed changes are at http://treasury.gov.au/ConsultationsandReviews/Consultations/2016/Improvements-to-the-Debt-and-Equity-Tax-Rules.

The March 2015 review of the debt and equity tax rules by the Board of Taxation is at http://taxboard.gov.au/files/2015/07/Debt_Equity_Final_Report.pdf.

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