How GPs go about structuring their investments in Australia could change as the government mulls updates to its “thin-capitalization rules.” The rules limit how much interest paid on corporate debt is tax deductible.
Under proposals released last month, only 60 percent of a portfolio company’s debt could be used to shield itself against tax, that’s down from the 75 percent currently allowable. Any debt over the new threshold would have to meet an “arm’s length debt test” to capture tax savings. The test would examine whether the debt could be considered “commercial or independent”, and if that squares with what independent commercial lenders would typically lend to the business. The test is being reviewed by the tax board, which will provide its recommendation to the government sometime in December.
Nonetheless the tax reforms are set to take effect this July, creating a gap between when the arm’s length test is crystalized and the new, lower debt tax shield begins.
In a letter sent to Australia Treasurer Joe Hockey earlier this month, the Australian Private Equity and Venture Capital Association (AVCAL) said the gap will create harmful tax uncertainty for an industry that relies on long-term investment. Last year, the Australian venture capital and private equity industry made $2.7 billion-worth of investments, according to AVCAL stats.
“The changes to the thin capitalization rules in the [exposure draft] will require investors to review and restructure their financing arrangements regarding their Australian investments within a very short time frame,” the letter said. Creating further problems is a requirement to satisfy the arm’s length debt test on an annual basis, AVCAL argued in its letter, which does “…not suit every taxpayer or industry, particularly those involved in the property and infrastructure industries.”
AVCAL is lobbying the Australian tax office to delay the tax reforms to next July so that they align with the enactment of any rule change arising from the arm’s length debt test review.
“It is vitally important that the timing of any changes to the thin capitalization regime are coordinated and implemented in an orderly manner, so that the taxpayer has certainty of tax outcome during this transition period,” AVCAL said in its letter.