5 December 2006
Ms Jo Laduzko
Manager - International Tax Unit
International Tax and Treaties Division
The Treasury
Langton Crescent
PARKES ACT 2600
Dear Ms Laduzko
Thin Capitalisation
Application of Accounting Standards
The Group of 100 (G100) which is an organisation representing the chief financial officers of Australia’s largest business enterprises is pleased to the Treasury Discussion Paper ‘Thin Capitalisation: Application of International Financial Reporting Standards’.
The G100’s comments on the issues and options raised by Treasury in the November 2006 discussion paper are attached.
The G100 supported the introduction of Australian equivalents to International Financial Reporting Standards (AIFRS). However, it was not the intention of AIFRS to produce significantly different tax outcomes for companies. The impact of AIFRS on companies’ thin capitalisation positions was identified as an issue well before the effective date of AIFRS. Accordingly, the G100 regard the resolution of this thin capitalisation issue as being necessary to complete the introduction of AIFRS.
The importance of this issue should not be underestimated. A failure to reverse the detrimental and unintended impact of AIFRS on companies’ thin capitalisation positions will not only lead to potential immediate financial impacts at the end of the 3-year transition period but will also potentially constrain the future growth of some companies.
It would appear that the accounting for intangibles issue is the main area of impact on companies. Accordingly, it this aspect that needs to be rectified in a clear and unambiguous manner. There may be merit in providing a specific solution to the intangibles issue and a more generic solution to the other areas of concern which appear to be of lesser importance.
Please feel free to call me to discuss any part of our response to Treasury’s discussion paper on 03 9415 5107.
Yours sincerely
Tom Honan
National President
The G100 was and continues to be supportive of the introduction of AIFRS. However, the impact of AIFRS on the thin capitalisation positions of Australian companies is an outstanding issue with regard to the introduction of AIFRS that needs urgent resolution. The urgency is due to the fact that companies are currently making decisions that will have impacts well beyond the end of the 3-year transition period in December 2007.
It would appear that the most significant issue by far is the impact of AIFRS on the valuation of intangibles. This is the most material issue both in terms of the number of companies affected and the quantum of the impact.
Australian companies have made long-term funding decisions based on the thin capitalisation provisions as they operated under Australian Generally Accepted Accounting Principles (AGAAP). These funding decisions cannot easily or economically be undone. Further, companies need certainty with regard to future funding decisions and companies that have internally developed intangible assets should not be put at a competitive disadvantage to those companies that have acquired intangible assets.
The G100 is concerned with the length of time this issue has remained unresolved. As set out above, companies have been making long-term funding decisions based on the assumption that there would be a practical solution to this issue to operate after the end of the 3-year transitional period. We would request that the Government announce that:
We believe such a request of the Government is reasonable given the significant uncertainty that is building within companies in regard to this issue.
The G100 has consistently raised the point that the unintended impact of the AIFRS changes on companies’ thin capitalisation positions needed to be reversed.
The G100 believes that the thin capitalisation rules should be amended to ensure that they operate in a manner consistent with their operation prior to the introduction of AIFRS. While the options in the Discussion Paper are a good summary of the available options, we believe that they can be narrowed further. We do not believe the grandfathering of the full set of AGAAP standards is practicable nor that the full-scale departure from the use of accounting standards (option 3) is necessary or desirable. Accordingly, our preferred options are either:
The arm’s-length test was always only ever intended as a last resort. Whilst we agree an improved arm’s-length test is needed, it should remain a last resort measure and should not be seen as an alternative to remedying the impact of AIFRS on the safe harbour calculation for affected companies.
AASB 138, AASB 112, AASB 136, and AASB 139 have been identified as the standards most directly impacting on the operation of the thin capitalisation rules. Are there any other standards causing concern?
The G100 believes that the standards identified in Question 1 are the standards that have had an impact on thin capitalisation calculations. However in terms of material impact on companies’ thin capitalisation positions, it is the intangibles issue arising from the adoption of AASB 138 that is of most concern and is the area where a solution is of critical importance.
How effective would this option be in addressing industry concerns and would such an approach be sustainable given the difficulties mentioned in the description above? What modifications to this option could be adopted to address such difficulties?
Whilst grandfathering the operation of all previous AGAAP standards would provide the outcome sought by companies, it is acknowledged that over time the practicality of this may become challenging if numerous AGAAP standards remained relevant into the future. Therefore, the G100 does not support the grandfathering of the full set of AGAAP standards as is the case under the transitional arrangements. However, the G100 would support an extension of the transitional grandfathering provisions for 1-2 more years if there was any delay in deciding upon and implementing a solution to this issue.
Although the G100 does not favour indefinite grandfathering of the full suite of AGAAP standards, given the quite small number of standards that do raise concern and the fact the most material issues arise in the area of intangibles, the grandfathering of AGAAP standards on a targeted basis as suggested under the heading in Option 1 “Restrict to particular elements of AGAAP” has significant merit. This approach would be effective in eliminating the concerns of companies without unduly increasing compliance concerns in the future.
There would be very little difficulty in grandfathering the operation of AASB 1041 “Revaluation of Non-Current Assets’ as it relates to intangibles. Once the aspects of AASB 1041 that were modified by the thin capitalisation rules are taken into account the guidance in AASB 1041 is really limited to prescribing the use of “fair value” as the basis for valuing intangibles. Accordingly, there would be little difficulty in maintaining the understanding of this standard into the future.
This option has the benefit of allowing companies to continue to use the pre-AIFRS numbers booked in their accounts or used in their “tax balance sheet” for thin capitalisation purposes.
Does this approach provide an effective approach to address concerns about the interaction of AIFRS with the thin capitalisation rules? Can this proposal be implemented without introducing unwarranted additional complexity into the thin capitalisation rules?
This option would be effective in resolving taxpayer concerns and should be able to be introduced without undue complexity if done on a targeted basis having regard to the areas of concern identified through consultation and maintaining the existing valuation framework of the thin capitalisation rules.
In respect of the intangibles issue it would appear to be a straightforward process to amend the legislation to specifically allow for the use of the fair values of intangibles in calculating thin capitalisation outcomes. Alternatively, the amendment could be expressed in terms of an authorisation to ignore the “active market” requirement in AASB 138. In practice this would not be very different from grandfathering AASB 1041 in respect of intangible assets given the only valuation guidance provided by AASB 1041 is to use “fair value”.
Concerns regarding complexity could be alleviated through two measures:
(i) first, allowing companies to use the pre-AIFRS values for intangibles which were either booked in their accounts or were part of their “tax balance sheet” used for thin capitalisation purposes. The use of these valuations would of course be subject to impairment testing as they are currently under the transitional rules; and
(ii) second, where companies wish to depart from the pre-AIFRS numbers the valuation rules that currently apply in the thin capitalisation rules to those entities that wished to undertake off-balance sheet valuations for thin capitalisation purposes should be maintained for these purposes. The Government believed that the process dictated by the revaluation rules in the thin capitalisation rules provided sufficient integrity in the valuation process. There is no reason to depart from this regime and add the extra cost and complexity of requiring external valuations. Requiring external valuations would in effect reverse the amendments made to the revaluation rules in 2003.
How effective is this approach in addressing industry concerns? Is it likely to result in greater certainty for taxpayers and can it be implemented without introducing significant complexity into the thin capitalisation regime?
This option, whilst being effective in addressing the concerns of companies materially affected by these rules, is not supported by the G100. We believe that this option would introduce unnecessary complexity when, as explained above, there would appear to be far simpler avenues to address the concerns of companies.
Would modifying the arm’s length test as discussed above address industry concerns? Of the possible approaches mentioned which of the suggested changes to the arm’s length test would provide the greatest level of taxpayer certainty and minimise complexity? Are there other amendments that could be made to the arm’s length test that maintain the integrity of the thin capitalisation rules yet address the impact flowing from certain AIFRS standards?
The G100 does not support the modification of the arm’s length test as a method of resolving the impact on the safe harbour test of the introduction of AIFRS. However, the G100 supports any moves to improve the usefulness of the test as a fallback option for companies in addition to amending the safe harbour test.
The areas mentioned in the discussion paper all have merit. However, significant work is required to determine which combination of these provided a workable framework for the arm’s-length test. The G100 believes that even with amendment the arm’s-length test will continue to suffer from not being able to provide any certainty of future borrowing capacity which is critical to the planning of Australian companies.
Are there other changes to the thin capitalisation rules not mentioned in this discussion paper that should be considered in the context of the application of the accounting standards.
No comment.