Guide A: Guide to thin capitalisation

Associate entities

An associate entity is used to determine whether an entity is subject to the thin capitalisation rules when:

• working out whether an entity is a controlling entity or is controlled by an entity
• calculating maximum allowable debt.

The concept of an associate entity is narrower than the concept of associate in section 318 of the ITAA 1936. Broadly, one entity will be an associate entity of another if either of those entities has a sufficient influence over the other.

There are a number of situations in which an entity will be an associate entity. Under the most common situation, contained within subsection 820-905(1), an entity that is not an individual (entity B) will be an associate entity of another entity (entity A) if both of the following apply:

• entity B is an associate of entity A under section 318 of the ITAA 1936
• either
• entity A holds an associate interest of 50% or more in entity B, or
• entity B (or a director, partner, general partner, trustee or member of entity B's committee of management, as relevant) is accustomed, under an obligation, or is reasonably expected to act in accordance with the directions, instructions or wishes of entity A in relation to the distribution or retention of entity B's profits or its financial policies relating to its assets, debt capital or equity capital.

This is illustrated in the following diagram:

An individual can also be an associate entity of another entity under subsection 820-905(2). An individual is an associate entity of another entity if both of the following apply:

• the individual is an associate of the other entity under section 318 of the ITAA 1936
• the individual is accustomed, under an obligation, or is reasonably expected to act in accordance with the directions, instructions or wishes of that other entity in relation to the individual's financial affairs.

There are two additional rules, they are:

• If an entity (the first entity) is an associate entity of another entity then that other entity is also an associate entity of that first entity - see subsection 820-905(3B). In the above diagram, as entity B is an associate of entity A, entity A is automatically an associate of entity B.
• If an entity (entity B in the below example) is an associate of another entity (entity A) and a third entity (entity C) is also an associate of entity A, then entity B is also an associate entity of the entity C - see subsection 820-905(3A). This is illustrated in the example below.

Example

As both entity B and entity C are 100% controlled, they are both associates of entity A. They are also both associates of each other.

There are some special rules that apply if the entity is a responsible entity of a registered scheme. These rules are described in subsection 820-905(2A).

A registered scheme is a management investment scheme that is registered under section 601EB of the Corporations Act 2001. The responsible entity will only be an associate entity, in its capacity as responsible entity, of another entity if both of the following apply:

• the entity, in its capacity as responsible entity, is an associate of that other entity under section 318
• either
• that other entity holds an associate interest of 50% or more in the registered scheme, or
• that other entity holds an associate interest of 20% or more in the registered scheme and the responsible entity (or director, general partner, trustee or member of the responsible entity's committee or management, as relevant) is accustomed, under an obligation, or is reasonably expected to act in accordance with the directions, instructions or wishes of that other entity in relation to the distribution or retention of the schemes profits or the financial policies relating to the scheme's assets, debt capital or equity capital.

These rules only apply to make the responsible entity (in its capacity as responsible entity) and another entity become associate entities where that other entity can sufficiently influence the responsible entity in carrying out its duties.

For a more detailed definition of 'associate entity', refer to section 820-905.

Sections within 02 Thin capitalisation concepts

• ADI equity capital
• Associate entities
• Associate entity debt
• Associate entity equity
• Associate interests
• Borrowed securities amount
• Controlled foreign entity debt
• Controlled foreign entity equity
• Cost-free debt capital
• Debt deductions
• Debt interest
• Equity capital
• Equity interest
• Excluded equity interest
• Non-debt liabilities
• On-lent amount
• Zero-capital amount