Restricting debt to prevent base erosion
Taxpayers often use debt to reduce their tax liability. Over the last decade there has been a huge loss in corporate tax revenues as companies re-finance operations using debt. In many instances with careful tax planning one is able to create a situation where the operating company obtains a tax deduction and the lender pays no (or reduced) tax. In order to curtail this practise, government has put forward the following tax proposals in the 2013 budget:
- Artificial debt: Certain debt instruments will be re-characterised as shares (meaning there is no tax deduction for interest) for example, debt instruments that will possibly not be repaid within 30 years and debt convertible into shares at the issuer’s request. Banks and insurers will be excluded.
- Connected person debt: The issue of debt by a creditor (who is exempt from income tax) to a connected person in relation to that creditor (who pays tax) can be used to reduce the connected party’s taxable income. The imposition of limits has been proposed in order to restrict the interest on this form of funding to 40% of earnings after interest on other debts has been taken into account.
- Acquisition debt: Corporate restructurings may use acquisition debt to eliminate taxable profits in future years. The interest on the excessive debt will be allowed to be rolled over for 5 years. This will replace the discretionary system currently applied to interest on discretionary debt.
Currently investors treat hedge fund investments on revenue account for income tax purposes. It is proposed that in future hedge funds will fall under the collective investment scheme legislation, however, hedge fund unit holders will still have to treat their realised earnings as being on revenue account and will not be able to treat these transactions as being on capital account (as unit holders in collective investment schemes are able to do).