Developers still in dark about thin cap legislation changes – but it’s not too early to get on front foot

18 October 2023

Property developers don’t yet know the format of retrospective legislation that will impact how they
finance their assets and business operations, but seeking guidance now can help mitigate risks and get
the best outcomes, Adam Crowley, National Leader Property and Construction at RSM Australia, says.

The proposed thin capitalisation rules, designed to prevent companies from using excessive debt financing and to
limit the amount of interest expenses they can claim as tax deductions, will fundamentally impact how financiers
look at property developments.

This makes planning for the changes critical. Mr Crowley said two camps of developers were emerging: those
pro-actively talking to tax professionals to ensure their affairs comply and to look for opportunities to optimise their
capital structure, and those who are “waiting for this to be imposed on them in their year-end tax compliance”.

“While the old rule book on thin capitalisation treatment has been thrown out the window, and the proposed rules
are being debated in the Senate but not finalised, the rules will most likely be retrospective from income years
commencing on or after 1 July 2023,” he said.

“That’s why it’s important to engage early, to ensure you optimise your position to get a better long-term outcome.
The impact of delay is you’ll be on the back foot dealing with the consequences of the changes.”

How legislation is shaping up

Broadly speaking, the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and
Transparency) Bill 2023 wants to make existing rules more effective by introducing Thin Capitalisation Interest
Limitation (TCIL) provisions.

At this stage, the Bill is on the Senate list for this week, but there will need to be amendments to the Bill given
Treasury’s own admission regarding unintended consequences of some of the changes that has been set out
since, and the Opposition’s stated position, which may delay this further.

The bill will fundamentally change how thin cap rules operate in Australia.

Under the Bill, which as passed through the House and is now before the Senate, default earnings-based tests for
‘general class investors’ will apply, being a fixed ratio test that replaces the existing safe harbour test. An entity
may elect to apply a group ratio test to replace the existing worldwide gearing test. The draft legislation also
introduces an external third-party debt test for general class investors and financial entities who are not
Authorised Deposit-taking Institutions (ADIs). This RSM article explores the initial exposure draft relating to the
proposed thin capitalisation rules in detail.

“The property development sector relies heavily on debt finance and this makes it particularly vulnerable to the
thin cap changes,” Mr Crowley said.

“It could increase costs as developers will no longer be able to claim as much interest as tax deductions . It risks
causing a property investment drain by making Australia less attractive for foreign investors.”

Plan now, rather than wait for legislation to pass

RSM Australia’s International Tax and Transfer Pricing Leader Liam Delahunty said because the proposed
legislation abandons a safe harbour, the new “default” position could be quite punitive.

“You may not have the opportunity to restructure arrangements once the legislation is finalised, so it’s advisable
to see your trusted tax advisors now to work out how to get on the front foot,” Mr Delahunty said.

He said it would be wise to look beyond the immediate impact of the thin cap changes.

“With these rules, once you make your bed in terms of the thin cap method you apply, you’ll have to lie in it, so
this first decision you make will be critical,” he said.

“Historically this has been looked at in isolation on a year-by-year basis – this will no longer be the case.”