March 2023 Round Up - Why is the ATO interested in Part IVA?

Part IVA is the general anti-avoidance provision that the ATO can use to attack arrangements contrived to obtain tax benefits. So why is the ATO interested in how Part IVA applies in practice? We explore the details.

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Inside this month Michael Carruthers (Tax Director), Matthew Tse (Tax Adviser) and Lisa Armstrong (MD) bring you:

• The update on the General Anti-Avoidance Rules Panel, it's role and why now? The team on the Knowledge Shop help desk have noticed a distinct uptick in enquiries on Part IVA. Could it be the Guardian Case?
• The proposed changes to the thin capitalisation rules released in exposure draft legislation Multinational tax integrity – strengthening Australia’s interest limitation (thin capitalisation) rules
  • If the exposure draft is enacted, the method used to calculate whether debt deductions are denied would fundamentally change.

Why is the ATO interested in how Part IVA applies in practice?

The ATO has released information on the panel that advises the ATO on the application of the general anti-avoidance rules (i.e., Part IVA), acknowledging that the application of general anti-avoidance rules is a serious matter that should only be applied after careful and full consideration of the facts.

The panel consists of senior ATO staff as well as independent business and professional people chosen for their ability to provide expert informed advice. While the panel is advisory in nature and does not make the decision on whether a general anti-avoidance rule will apply,  the advice provided is considered by ATO staff when making a decision on whether the rules should be applied.   

On the Knowledge Shop help desk, we've noticed an up-tick in questions on whether Part IVA might apply to particular scenarios. It's why we've been keeping a close eye on the Guardian case (FC of T v Guardian AIT Pty Ltd ATF Australian Investment Trust; FC of T v Springer [2023] FCAFC 3 ) and the ATO's successful position that if Section 100A did not apply, then Part IVA would (for one income year the arrangement did trigger Part IVA). We explore that position in the Round Up.

The significant proposed 1 July 2023 changes to the thin capitalisation provisions

Treasury has released exposure draft legislation in relation to some significant proposed changes to Australia’s thin capitalisation provisions. These provisions can place a limit on the ‘debt deductions’ (e.g., interest deductions) that can be claimed in Australia by foreign controlled resident entities and resident entities with overseas operations.

The proposed amendments are comprehensive and seek to ensure that the Australian system is aligned with the OECD’s recommendations on base erosion and profit shifting (BEPS).

One of the key points to note here is that the new rules are intended to come into effect from 1 July 2023, leaving limited time for business groups to analyse the practical application of the changes and for the ATO to provide detailed guidance on the updated rules if they end up passing through Parliament. It is yet to be seen whether a transitional approach will be implemented.

It will be essential for affected taxpayers to carefully consider the proposed changes and the interaction between these new rules and other aspects of the tax law. The two key changes to the rules involve:

• Removing the current classifications of ‘inward investor’ and ‘outward investor’ with a single category relevant for all entities other than financial entities and ADI’s (i.e., banks). This should simplify the early stages of working through the rules.
• A wholesale replacement of the applicable debt tests. The current methods of establishing whether debt deductions are allowable (the safe harbour debt test, worldwide gearing ratio test, and arm’s length debt test) will be replaced by a fixed ratio test, a group ratio test, and an external third-party debt test.

The new tests involve a change from an asset-based approach to using earnings-based tests. However, it appears that some existing exclusions from the rules, such as the $2m de minimis threshold, will be retained.

The exposure draft legislation also contains a previously unannounced measure that removes deductions previously available under section 25-90 and section 230-15(3) ITAA 1997 for interest expenses incurred in deriving certain foreign dividends that are non-assessable non-exempt income under section 768-5.

Enjoy!