5 July 2006
Ms Jo Laduzko
Manager
International Tax Framework Unit
The Treasury
Langton Crescent
PARKES ACT 2600
jladuzko@treasury.gov.au
Dear Ms Laduzko
Thin Capitalisation
The adoption within Australia of Australian Equivalents to International Accounting Standards [AIFRS] will have long term benefits for Australia. The G100 strongly supports the adoption of these standards. Generally, the transition to AIFRS has been smooth with both investors and other stakeholders coming to terms with differences in reporting outcomes.
However, following the adoption of AIFRS, an important area within the application of tax legislation is still outstanding. The G100 has previously made representations to Government regarding the need to ensure that the adoption of AIFRS does not have unintended tax consequences for Australian companies.
It was identified, as early as 2003, that under AIFRS there would be a substantial risk of adverse impacts on the thin capitalisation position of various companies. Further, it was generally acknowledged that action would need to be taken by Government to neutralise this adverse impact.
As you would be aware, a major source of the potential adverse impact of AIFRS on the thin capitalisation position of companies is the requirement that intangible assets can only be carried at cost in the financial statements. This, not only had a significant impact on the ability of some companies to meet the safe harbour test immediately on implementation of AIFRS, but it meant that companies with significant intangible assets may in the future be restricted under the thin capitalisation rules since the true/economic value of their assets would not be able to be taken into account.
The Government recognised these concerns at the end of 2004 and introduced a three-year period in which companies would essentially be able to continue to use old AGAAP values to satisfy the safe harbour thin capitalisation test. The Government undertook to develop a longer-term solution to the thin capitalisation problem caused by the introduction of AIFRS during this three-year interim period.
The G100 believes that a longer term solution is now required. None of the parties to the adoption of AIFRS intended that there would be thin capitalisation risks caused by the introduction of AIFRS. Given the adoption of AIFRS has not affected the fair/economic value of companies' assets or their cash flows, it is an anomalous outcome that companies could be economically disadvantaged by suffering either a direct tax detriment or, at best, tax uncertainty as a result.
In broad terms, the goal of any longer term solution to this problem should be to ensure that companies are no worse off under the thin capitalisation rules after the adoption of AIFRS than they were before its adoption. This result is achieved by the grandfathering provided under the three-year transitional arrangements referred to above.
Going forward the specific longer term solution needs to achieve similar outcomes to this grandfathering. Options to achieve this include moving to a fair/economic value based system for testing the thin capitalisation rules. The previous accounting standards upon which the safe harbour thin capitalisation test was based essentially allowed companies to recognise the fair/economic values of selected assets for thin capitalisation purposes. Therefore, now that AIFRS restricts the use of fair/economic values for certain assets, amending the tax law to allow the use of such values would allow outcomes to be achieved by companies that are consistent with their pre-AIFRS thin capitalisation position. This can be achieved in conjunction with maintaining Australia's commitment to adopting international accounting standards.
A further option would be to extend the current grandfathering arrangements indefinitely. This would have compliance benefits for companies as opposed to a full fair value regime and would continue to provide companies with outcomes consistent with their pre-AIFRS positions.
There is likely to be several variations to the above two broad options which may alleviate taxpayer and Government concerns over aspects of those options. However, the overriding principle should be that companies are not adversely affected from a tax perspective due to a change in accounting standards which has not disturbed the underlying economic position of those companies.
The G100 believes that the alternative arm's-length test currently provided in the thin capitalisation rules does not provide a true alternative for affected companies. It is widely acknowledged that the arm's-length test is difficult to apply in practice and provides no certainty for companies. Accordingly, a specific amendment to the safe harbour test is required.
Yours sincerely
Tom Honan
National President