How the thin capitalisation rules apply
A non-ADI inward investor must calculate the debt used in its Australian operations (adjusted average debt) and compare it to its maximum allowable debt. If the entity's adjusted average debt is more than the maximum allowable debt, it is disallowed a proportion of its debt deductions. If the entity's adjusted average debt is not more than the maximum allowable debt, it is not disallowed any debt deductions under the thin capitalisation rules.
A non-ADI inward investor's maximum allowable debt is the greater of an amount calculated using a fixed ratio or an arm's length test. The rules are slightly different depending on whether the entity is a general or a financial entity. However, the basic framework is the same. Specifically, the maximum allowable debt the entity can have before debt deductions are reduced is the greater of the following two amounts:
- a safe harbour debt amount - broadly, this is 3:1 for general entities and up to 20:1 for financial entities
- an arm's length debt amount.
For financial entities, the safe harbour debt amount is the lesser of the following two amounts:
- the total debt amount
- the adjusted on-lent amount.
You do not necessarily have to calculate both the safe harbour debt amount and the arm's length debt amount. If the entity's adjusted average debt is less than its safe harbour debt amount, you do not have to calculate the arm's length debt amount. Alternatively, if the entity's adjusted average debt is more than its safe harbour debt amount, you could choose not to calculate the arm's length debt amount. In this instance, the entity's debt deductions will be disallowed on the basis that the safe harbour debt amount is the maximum allowable debt.
The amounts can be calculated in any order. For example, you can start with the arm's length debt amount. However, this is not recommended unless the entity knows that it will fail the safe harbour debt amount.
In this guide, we calculate the safe harbour debt amount first and the arm's length debt amount second.
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Last Modified: Friday, 6 November 2009