The advent of International Accounting Standards ("IAS") issued by the International Accounting Standards Board have introduced a element of uncertainty in the calculation of amounts, the exceeding of which would trigger the application of thin capitalisation rules. The lack of convergence between accounting standards and tax rules is causing difficulty. The turbulence caused is of such degree that the Federal Government has allowed a grace period of three years during which taxpayers are permitted to use pre- January 2005 accounting standards to calculate the safe harbour debt amount.1
Thin capitalisation rules are formulated to ensure that multinational do not allocate an excessive amount of debt to one country resulting in a disproportionate amount of interest deduction and hence reduced tax liability.
The law relating to thin capitalisation in Australia is contained in Division 820 of the Income Tax Assessment Act 1997.
There are at least 4 International Accounting Standards that may have significant impact on asset values and hence on determination of the trigger amount for thin capitalisation purposes.
- IAS 32 Financial Instruments
- IAS 38 Intangible assets
- IAS 12 Income Taxes
- IAS 36 Impairment of assets
Thin capitalisation rules do not apply in Australia in the following circumstances:
- The entity has operations only in Australia;
- Total debt deductions for the year are not greater than $250,000 or
- The entity is an outward investing entity where 90% or more of the average value of its total assets are Australian assets.
TR 2002/20 (Income Tax: Thin capitalisation - Definition of assets and liabilities for the purposes of Division 820)
In Taxation Ruling 2002/20, the Australian Taxation Office I("ATO") dealt with the contextual factors affecting the terms assets and liabilities. Since Division 820 did not define "assets" and "liabilities" it was left to the ATO to clarify the 2 terms in the context of thin capitalisation.
According to the Ruling, the values to be adopted for assets and liabilities, as well as the entity's debt capital and equity capital must comply with the accounting standards.
Since Australia has adopted the IASB2 standards, a review of IAS is appropriate.
IAS 39 introduces "fair value option", according to which the entity has the option to elect to value its financial instruments at fair value. However, in the case of derivatives the entity has no option, IAS 39 requires that derivatives be disclosed at fair value.
Fair value is defined by the Standard as "the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction3.
Fair value option in IAS 39 may cause differing views in the calculation of the trigger amounts for thin capitalisation purposes.
IAS 38 contains various rules and procedures for determining values of intangible assets.
The most significant feature of the Standard is that under it internally generated goodwill is prohibited from being recognised4. Other internally generated intangible assets may be recognised.
Further internally generated brands, mastheads, publishing titles and customer lists are excluded from being recognisable under IAS 38.
On the subject of web site costs, IAS 38 identifies various phases of web site development and provide differing treatment of the costs incurred for each of these phases. Some of the costs have to be recognised as expenses and others as intangible assets.
Here again conflicting views may arise with respect to thin capitalisation rules.
The revised IAS 12 requires that deferred tax assets and liabilities be recognised where there is reasonable evidence that timing differences would not reverse for some considerable period ahead. Unlike the earlier Standard, IAS 12 expressly disallows discounting of deferred tax assets and liabilities.
The earlier Standard permitted, but did not require an entity to recognise a deferred tax liability in respect of asset revaluation. The revised IAS 12 requires an entity to recognise a deferred tax liability when an asset is revalued.
This again could have an effect on asset values used in thin capitalisation calculations.
Impairment of assets
Like the previous version of the Standard, IAS 36 requires that the recoverable amount of an asset be measured, but imposes stricter conditions:
- an intangible asset with an indefinite useful life, the measurement must be done annually, irrespective of whether there is any indication that it may be impaired;
- an intangible asset not yet available for use must be measured annually; and
- Goodwill acquired in a business combination to be tested for impairment annually.
Unlike the previous version, the revised IAS 12 prohibits the reversal of impairment losses for goodwill.
1 Federal Treasurer's Press Release of 24 January 2005
2 International Accounting Standards Board
3 para 9 of IAS 39
4 para 49 of IAS 38
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.