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Need More Funding? Avoid Costly Tax Pitfalls

In the current economy, companies are evaluating their funding needs, whether for managing their ongoing cash position, finding cash for potential acquisition opportunities, taking advantage of the soon-to-expire Instant Asset Write-off provisions announced in the Federal Budget, or supporting distressed subsidiaries.

If a firm needs a capital to get through this difficult period, it can do so through a variety of means, most typically through a loan (from a bank or a connected party) or equity.

There are many factors to consider if one is to avoid onerous tax implications when attempting to augment the cash position through either loans or equity. 


Why would issuing shares pose a tax difficulty if the firm wishes to raise funds?

The first concern occurs from a tax standpoint if the group or company is carrying forward tax losses from earlier years. Your ability to use tax losses carried forward to minimise a future taxable profit is contingent upon satisfying the Continuity of Ownership Test (COT) or, if COT is not met, the Same Business Test (SBT) ought to be satisfied. In some instances, issuing new shares to both new and current investors might have a negative impact on the ability to meet the COT.

Prior to issuing capital, tax advice should be sought if a group has carried forward losses and a capital raising or purchase will be funded using script rather than cash.

As the problem of certain debt interests and secondary share classes may be disregarded from a COT standpoint, it is possible to pass COT.

Even if there are no tax losses carried forward by the corporation, the COT laws can impair the ability to claim a deduction, particularly bad debt deductions.

Extax Capital Injection

There are a variety of reasons why you may want to get financing directly for a subsidiary as opposed to the parent firm. The primary concern from a tax standpoint is that the issuance of tax equity shares would often result in the subsidiary being deconsolidated from the tax consolidated group. If the funds were not raised through the issuance of shares, but rather a convertible note, for instance, depending on the provisions of the note, the tax group may not be deconsolidated.


In addition to being cautious about incurring new debt, businesses must also be aware of the impact that a weakened balance sheet and the recession may have on on the current debt and ability to claim tax deductions on the interest, especially if the Thin Capitalisation requirements apply to the group.

For instance, the group may have overstated the accounting worth of its assets which under the current climate, would require write-downs. These impairments diminish the group's thin capitalisation safe harbour capacity. In other words, the decrease in the accounting asset base would affect the deductibility of interest and other debt charges on current debt.

This is worsened by prior year limits on revaluations for thin capitalisation, which oblige taxpayers to depend only on the asset, liability, and equity balances in financial statements.

If it is difficult to meet the Safe Harbour test, businesses must either accept the disallowance of part or all interest deductions or depend on the arm's-length debt test (ALDT).

In the present climate, it is projected that the number of taxpayers depending on ALDT would expand dramatically. The  ATO frequently refers to two main ALDT-related publications in this regard. More recently,   TR 2020/4 Income tax: Thin Capitalisation the arm's length loan test; and a Practical Compliance Guideline PCG 2002/7 ATO compliance methodology.

Advancing funds through Loans without interest

It is usual for groups to offer interest-free loans to related partiers, especially when there is financial difficulty. From a tax viewpoint, interest-free loans can be highly complex and difficult, producing additional tax complications. They pose a number of questions that may significantly affect the tax outcome depending on whether  the interest-free loan considered equity for tax reasons, is it at arm's length, is it a capital injection that might affect losses, could the injection of money produce a shift in value, and/or could a transfer pricing issue arise?

In Draft Schedule 3 to PCG 2017/4, the ATO is evaluating interest-free loans granted by Australian taxpayers to non-residents. It does not examine incoming loans, but one would expect them to be lower risk given that Australia does not claim interest deductions. In addition to this,  Transfer Pricing, Withholding Tax, and Value Shifting might still be a source of concern.

Regardless of the funding option businesses pick to stay afloat or offer assistance over the next periods, which experts predict will be another roller coaster, we will need to examine if each choice is tax-efficient given each company's unique circumstances, and consider how to reduce any adverse tax implications.

Contact us to know more.

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