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Australia Consulting on Draft Ruling on Thin Capitalisation Arm's Length Debt Test and Companion Ruling on Hybrid Mismatch Targeted Integrity Rule — Orbitax Tax News & Alerts

The Australian Taxation Office (ATO) has published for consultation draft Taxation Ruling (TR) 2019/D2 and draft Law Companion Ruling (LCR) 2019/D1.

TR 2019/D2 Income tax: thin capitalisation - the arm's length debt test

This draft Ruling deals with the application of the arm's length debt test contained in the thin capitalisation rules in Division 820 of the Income Tax Assessment Act 1997 (ITAA 1997).

The thin capitalisation rules set a limit on the amount of debt that can be used to finance an entity's Australian operations. For entities that are not authorised deposit taking institutions (non-ADIs), the arm's length debt amount for the year is one amount that can be used to determine an entity's maximum allowable debt. For tax purposes, an entity's debt deductions are reduced to the extent that its adjusted average debt exceeds its maximum allowable debt.

This Ruling applies to an entity who seeks to apply the arm's length debt test contained in section 820-105 (for outward investing entities (non-ADI)) and section 820-215 (for inward investing entities (non-ADI)).

The purpose of this Ruling is to provide interpretative guidance on key technical issues that may arise in determining an entity's arm's length debt amount. This Ruling also provides interpretative guidance relating to the record-keeping requirements in section 820-980.

Comments on the draft ruling are due by 31 May 2019.

LCR 2019/D1 OECD hybrid mismatch rules - targeted integrity rule

This draft Ruling provides the Commissioner's view of particular aspects of the law in relation to the hybrid mismatch targeted integrity rule in Subdivision 832-J of the Income Tax Assessment Act 1997, legislated as part of the package of measures making up Australia's hybrid mismatch rules including Division 832.

The hybrid mismatch rules are intended to deter the use of certain hybrid arrangements that exploit differences in the tax treatment of an arrangement and/or entity under the income tax laws of two or more countries. When applicable they neutralise the effect of hybrid mismatches so that unfair tax advantages do not accrue for multinational groups as compared with domestic groups.

The hybrid mismatch rules, including the targeted integrity rule, apply to pre-existing arrangements in the same way as they apply to arrangements entered into after the application date of Division 832.

For the purposes of these rules, a hybrid mismatch arises where there is a double non-taxation benefit where a cross border dealing results in:

  • a deduction/non-inclusion (D/NI) mismatch (broadly, a deduction being received for a payment in one country, where the corresponding income is not assessable income in another country), or
  • a deduction/deduction (DD) mismatch (broadly, a deduction entitlement arising in two countries for the same payment).

In addition, the hybrid mismatch rules include the targeted integrity rule at Subdivision 832-J, which seeks to prevent offshore multinationals from otherwise circumventing the hybrid mismatch rules by routing investment or financing into Australia via an entity located in a no or low tax (10% or less) jurisdiction. Were it not for the targeted integrity rule, the interposition of such an entity would otherwise effectively replicate a D/NI mismatch but fall outside the scope of the operative provisions of Division 832 pertaining to a D/NI mismatch. Under Subdivision 832-J, where the core elements are present, the targeted integrity rule will apply to deny the deduction for a payment of interest or an amount under a derivative financial arrangement.

Comments on the draft ruling are due by 10 May 2019.