Guide A: Guide to thin capitalisation

Cost-free debt capital

Debt interests issued by an entity that do not give rise to any debt deductions are generally treated as neither debt nor non-debt liabilities. This means that such debt interests are generally not included in adjusted average debt and do not reduce assets when calculating the safe harbour debt amount. However, as an integrity measure, these debt interests may be included in a non-ADI's adjusted average debt where the arrangement contains features that make it possible to manipulate the debt and asset levels to the advantage of either or both of the lender and borrower. To this end, debt interests will be included in adjusted average debt if they are 'cost-free debt capital'.

An entity (the borrower) can have a cost-free debt capital amount if both of the following apply:

it is a

non-ADI outward investor
non-ADI inward investment vehicle, or
non-ADI inward investor that holds assets attributable to its Australian permanent establishment or other assets held for the purposes of producing its Australian assessable income

it is not

an exempt entity, and
excepted from the thin capitalisation rules by either the debt deduction threshold or asset threshold rules, or because of section 820-39, which exempts certain special purpose vehicles.

The asset threshold only applies to entities that are outward investing entities (non-ADI or ADI) not inward investing entities (non-ADI or ADI).

The borrower's cost-free debt capital is then the total value of all the debt interests issued by it that:

remain on issue, and
do not give rise to a cost covered by paragraph 820-40(1)(a) and
if the lender (or holder of the debt interest) meets the same conditions as the borrower (see above), the measurement days used by the borrower to measure its adjusted average debt are different to the measurements days used by the lender to measure its assets; that is, either the method used to calculate average values is different or the actual measurement days are different or both are different, or
if the lender does not meet the same conditions as the borrower; that is, the lender is not required to apply the thin capitalisation rules, the debt interest has been on issue for less than 180 days at the measurement day.

If the total period for which the interest is on issue is ultimately 180 days or more, the debt interest is not taken to be cost-free debt capital. For example, an entity with a standard income year issues a debt interest that does not give rise to any debt deductions on 1 June 2008. The holder of that interest is not subject to the thin capitalisation rules. As at 30 June 2008 the debt interest is classified as debt-free capital. On 28 December 2008, the debt interest is still on issue. As it has been on issue for more than 180 days, it will be taken not to have been cost-free debt capital on 30 June 2008.

For more information, refer to subsection 820-946(4).

If the borrower is a foreign entity, debt interests can only form part of its cost-free debt capital to the extent they are attributable to assets attributable to the foreign entity's Australian permanent establishments or to other assets held for the purposes of producing the foreign entity's Australian assessable income.

For a more detailed definition of cost-free debt capital, refer to section 820-946.

Sections within 02 Thin capitalisation concepts

Last Modified: Tuesday, 8 May 2012