*Section 25-90 allows a tax deduction for borrowed funds used to finance a non-portfolio investment in a foreign subsidiary generating exempt, foreign dividend income. The borrowed funds, whether from a related or third party, are generally subject to a debt-to-equity ratio limit of 3:1 under Australia's thin capitalisation rules. Provisions for the repeal of section 25-90 (effective 1 July 2014) were included in the 2013 Budget.
A somewhat overlooked question concerns the appropriateness of the broader funding structure of the taxpayer group—particularly in the context of difficult global commercial conditions.
Inefficiencies in both commercial and tax outcomes with respect to funding subsidiaries' operations have often been identified when a review of the broader funding structure of the group has been undertaken. Commonly identified inefficiencies include the use of intercompany debt to fund the operations of loss-making subsidiaries (or subsidiaries with effective tax rates of less than 30%) and a “spider-web” of intercompany balances across international borders.
Even in a Base Erosion and Profit Shifting (BEPS) world with cross-border financing and refinancing facing heightened scrutiny / risk, the rationalisation of such inefficiencies—whether by the conversion of debt balances to equity or the repayment, offset or forgiveness of the spider-web—may be desirable, particularly given the strong commercial imperatives coming from an improved balance sheet and simplification of flows.
In undertaking any such activity, it is important to consider a range of issues including:
- The potential realisation of unrealised foreign exchange gains and losses
- Thin capitalisation
- Differences in Australian and foreign tax rates, crystallising withholding tax obligations, franking-account implications, transfer pricing, and accounting
The application of some reasonably “vanilla” techniques can result in substantial commercial benefits and tax savings.
Read a February 2014 report prepared by the KPMG member firm in Australia: Time for another look at your cross-border intercompany loans?
Contact a tax professional with KPMG's Global Transfer Pricing Services.