Australia’s ‘fair share’ tax reform targets multinationals

July 30, 2024

Australia’s ‘fair share’ tax reform hits multinationals after Australia’s tax system has a major shake-up. Australia’s tax system is going through much-needed reform. Critics say it simply cannot deal with multinational trade, increasing global competition for investment, the internet and the digital economy. It has also been criticised for being unfair, and one of the first areas that the government has focused on is multinational taxation.

Making Multinationals Pay Their Fair Share – Integrity and Transparency Bill 2023

On 27 March 2024, Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 completed its passage through Federal Parliament. This Bill contains the amendments to introduce a new thin capitalisation regime that will apply to most companies for income years commencing on or after 1 July 2023. It will officially become law when the Bill receives Royal Assent.  

The Bill aims to strengthen Australia’s thin capitalisation rules to combat what the government considers to be excessive debt deductions eroding the domestic tax base. It will limit the amount of debt used to fund Australian operations or investments and disallow debt deductions when debt used to fund Australian assets exceeds certain limits. It applies to most multinational businesses operating in Australia with at least AUS$ 2 million in debt deductions.

The Bill will affect Australian entities investing overseas and their associate entities; foreign entities investing in Australia; Australian entities with certain overseas operations and their associate entities; Australian entities that are foreign controlled; and foreign entities with operations or investments in Australia.

Australia’s ‘fair share’ tax deadline

Delays to the bill have meant that the new tax regime has been enacted only months prior to the income year to which it applies. Companies with a 30 June year-end had less than eight weeks to restructure their debt arrangements.

Regardless of year-end, this will create a lot of work for clients. Organisations will now have an obligation to trace and document the use of all related party loans to assess whether they are used for ineligible debt creation purposes. It may be worth restructuring debt, such as using working capital for ineligible debt creation purposes.  

Clients will also need to satisfy their auditor that their interest expense does not give rise to a permanent tax difference. All companies need to take tax advice and at a minimum build a new thin capitalisation model, as 2024 tax return forms will require disclosure of the thin capitalisation method chosen and applied. 

It cannot be underestimated how complex and challenging it will be to apply the new rules to such a wide variety of companies. It is going to require consultation with technical accounting and banking experts, and for some, the road to compliance will be a bumpy one. Some organisations may find themselves in a situation where genuine commercial arrangements result in debt deduction denials. Any uncertainty in tax positions that may require disclosures in financial accounts will have to be actioned as soon as possible.

The Bill requires the government to undertake a review of the thin capitalisation amendments to commence no later than 1 February 2026. This will provide an opportunity to assess the impact of these changes, including whether the amendments have had any effect on Australia’s ability to attract foreign investment.

Direct foreign investors

Australia is considered a very attractive option for foreign direct investment (FDI) by many companies across the globe, with a high ranking on the FDI confidence index in 2024, according to Statista.  Foreign economies had a total of $4.7 trillion invested in Australia at the end of 2023.

While mining and energy still attract the lion’s share of investment, the technology sector is booming. Treasurer Jim Chalmers has said he wants to see tech companies pay their fair share of tax, and a recent tax victory over royalties will have major implications.

Case study: PepsiCo

The Federal Court of Australia on November 30, 2023, ruled in favour of the Australian Taxation Office in a dispute with PepsiCo. The ATO argued that certain portions of the payments made in relation to bottling agreements were royalties and so were subject to royalty withholding tax. It was also ruled that diverted profits tax would apply.

This is the first time a court has considered Australia’s diverted profits tax since its introduction in 2017. Multinationals will now come under increased scrutiny of embedded royalties that arise from intellectual property use and there may be possible changes to tax treaty interpretation.

It is clear that both indigenous and foreign multinationals will have to be rigorous in their reporting and will need a lot of outside help to ensure they do not fall foul of the new tax regime. If the Australian government wants to make large corporations the villain, companies have to make sure their reporting is as transparent as possible.

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