Guide E: Guide to thin capitalisation calculations for ADI entities

Step 3: Calculate the arm's length capital amount - inward investing entities

If the ADI's average equity capital is less than its safe harbour capital amount, it can choose to adopt an arm's length capital amount as its minimum capital amount. It would generally do so only if the arm's length capital amount is less than the safe harbour capital amount.

The arm's length capital test focuses on the ADI's Australian business. The arm's length capital amount is determined by conducting an analysis with regard to certain factual assumptions and relevant factors. The factual assumptions include some conditions that actually exist during the income year and some conditions that replace what actually happened during that period.

The result of the analysis is a notional amount of capital that represents what would reasonably be expected to have been the ADI's minimum capital amount throughout the year in relation to its Australian business. The Australian business is treated as if it were a separate entity; independent and operating at arm's length from the other parts of the ADI.

Broadly, the assumptions are that:

• the ADI's commercial activities are those of its Australian business - Australian business has a wide meaning
• the ADI's Australian business was independent of any guarantee, security or other support provided by any of the entity's associates or by the use of the assets that are attributable to the entity's overseas permanent establishments.

Sections within Step 3: Calculate the arm's length capital amount - inward investing entities

• Relevant factors
• Instruction