Talking Tax – Issue 164

Debt deductions under the thin capitalisation rules

On 17 July 2019, the Commissioner of Taxation (Commissioner) released Taxation Determination (TD) 2019/12, which clarifies what types of costs are considered to be debt deductions within the scope of Australia’s thin capitalisation regime.

This is important for determining an entity’s quantum of debt funding for an income year, before comparing it to its maximum allowable debt calculated under the rules.

Specifically, the ruling addresses section 820-40(1)(a)(iii) of the Income Tax Assessment Act 1997 (Cth) (ITAA97) which defines a ‘debt deduction’ to include a cost incurred in relation to a debt interest, to the extent to which the cost is:

any amount directly incurred in obtaining or maintaining the financial benefits received, or to be received, by the entity under the scheme giving rise to the debt interest.’

In TD 2019/12 the Commissioner has provided the following non-exhaustive list of costs that are considered within the scope of section 820-40(1)(a)(iii):

  • costs of tax advisory services giving rise to or in connection with the debt capital;
  • establishment fees;
  • fees for restructuring a transaction;
  • stamp duties;
  • regulatory filing fees (for example ASIC lodgement fees);
  • legal costs of preparing documentation associated with the debt capital;
  • costs to maintain the right to draw down funds; and
  • any costs considered to be borrowing expenses under section 25-25 of the ITAA97.

Pursuant to the thin capitalisation provisions contained in Division 820 of the ITAA97, all or part of a debt deduction that is claimed during an income year will be disallowed when the claiming entity’s adjusted average debt exceeds its maximum allowable debt.

Taxpayers seeking to claim debt deductions need to be conscious of the potential for expanded debt capital amounts other than interest expenses (for example ASIC lodgement fees) being included in the debt calculation.

Churning out new guidance

On 17 July 2019, the Commissioner provided final guidance on the operation of the churning provisions contained in section 716-440 of the ITAA97 by releasing the Law Companion Ruling (LCR) 2019/2.

Broadly, the consolidation churning measures have the effect of switching off entry tax cost setting rules in certain circumstances involving foreign owners ceasing to hold membership interests in a joining entity. Australian groups undertake a transaction that results in obtaining an uplift to the tax cost base of certain Australian assets under the tax consolidation regime, where:

  • the foreign vendor ceases to hold membership interests in the joining entity (or a higher level entity which holds the interest) within the specified 12 month test period;
  • the foreign vendor was not taxable on the capital gain pursuant to Division 855 of the ITAA97; and
  • there was no change in the underlying beneficial ownership of the Australian group as a result of the transaction.

Specifically, LCR 2019/2 addresses some difficulties in interpreting the eligibility criteria contained in section 716-440 and supplements the Explanatory Memorandum to the Treasury Laws Amendment (Income Tax Consolidation Integrity) Act 2018 (Cth), by providing various practical examples.

Taxpayers should be cognisant of the churning rules and updated ATO guidance when considering restructures of foreign owned Australian tax groups.

Commissioner negligent? Maybe

Justice Wigney of the Federal Court has added another instalment in the ongoing dispute against the Commissioner in Farah Custodians Pty Limited v Commissioner of Taxation [2019] FCA 1076.

In early 2017 Farah Custodians Pty Ltd (Farah) filed an originating application against the Commissioner in respect of alleged misdealing by the Commissioner who made refunds to an account controlled by Farah’s tax agent, who the ATO suspected of engaging in fraudulent activity.

In his decision, Justice Wigney found that it was at least reasonably arguable that the Commissioner owed Farah a duty of care, and breached that duty.

From late 2012 to early 2014, Farah had engaged the services of a registered tax agent (Agent). The Agent set up a bank account that was held by a company he controlled and directed that the refunds due and payable by the Commissioner on Farah’s Running Balance Account surpluses be paid into that account. Farah however, never instructed or authorised the Agent to nominate that account.

In the originating application filed against the Commissioner in 2017, Farah alleged that several ATO officers had been investigating the activities of the Agent and were aware of the risk that the Agent may have been attempting to redirect refunds payable to clients to entities he controlled and that he had not been remitting those refunds to clients. Farah also claimed that these ATO officers had failed to inform it of this risk and continued to pay the refunds into the account controlled by the Agent despite their concerns about his potentially fraudulent activity.

Most recently, Farah sought the leave of the Court to amend its pleadings to include a claim for negligence by the Commissioner. This was on the basis that the Commissioner, the Commonwealth or its employees and agents owed Farah a duty of care in relation to the payment of the refunds that arose from their knowledge of the risks posed by the Agent’s conduct. Farah also sought to have the Commonwealth joined as a party based on the argument that the Commonwealth could be held vicariously liable for breaches by the Commissioner or the ATO officers involved.

Justice Wigney ultimately agreed and granted leave to Farah to amend its pleadings to include a claim of negligence against the Commissioner as the Commissioner was not, at this early stage, able to demonstrate that Farah’s claims were not reasonably arguable. This was the case despite Justice Wigney noting that the common law duty of care alleged by Farah was ‘undoubtedly novel’ and may ultimately be found to be unsustainable at trial. Wigney J also granted leave to add the Commonwealth as a party to the proceeding.

While this dispute is still a long way from a fully contested hearing, the Commissioner will, no doubt, be keen to put to bed the possibility of any future claims of negligence against the Commissioner or other ATO officers arising from similar circumstances. On the other hand, taxpayers with prior grievances about the Commissioner’s conduct will be watching this case with interest.

This article was written with the assistance of Charlie Renney, Lawyer.

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Andrew O’Bryan

Andrew specialises in taxation law. He is a CPA Australia Fellow and Chairman of its Taxation Centre of Excellence.

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