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  • Worked example of calculations for a non-ADI financial inward investment vehicle

    There are six steps a non-ADI financial inward investment vehicle needs to take to calculate if they have met the thin capitalisation rules:

    • Step 1: Calculate the adjusted average debt
    • Steps 2 and 3: Calculate the safe harbour debt amount
    • Step 4: Calculate the arm's length debt amount
    • Step 5: Calculate the worldwide gearing debt amount
    • Step 6: Calculate debt deductions disallowed.

    The following worked example for a fictional company 'Aust Fin' demonstrates each of these steps.

    See also:

    Worked example

    Worked example: Aust Fin and Ozzie Co

    Aust Fin is a financial entity. It is wholly owned by a foreign company, Foreign Parent Co. This makes Aust Fin an inward investment vehicle.

    Aust Fin owns 75% of the equity in an Australian company (Ozzie Co), which is a general entity. Foreign Parent Co owns the remaining 25% equity in Ozzie Co.

    Aust Fin has:

    • borrowed $19,000,000 from its foreign parent
    • borrowed $40,000,000 from unrelated financial institutions
    • non-debt liabilities of $3,000,000
    • lent $45,000,000 to unrelated third parties – $3,000,000 of this is a 0% risk-weighted loan
    • invested $7,500,000 equity in Ozzie Co and lent it $1,000,000. The $7,500,000 invested as equity represents a third party payment it made for 75% of the equity in Ozzie Co.

    Neither Aust Fin nor Ozzie Co has any overseas permanent establishments.

    All loans are interest-bearing and at commercial interest rates.

    A consolidated group cannot be formed as there is no resident entity that is 100% owned.

    Aust Fin is the only entity being tested under the thin capitalisation rules for this example. The test year is the 2014–15 income year.

    Diagram of the above facts for Aust Fin and Ozzie Co

    Diagram illustrating the relevant financial information for Aust Fin and Ozzie Co.

    End of example

    Aust Fin's financial position for 2014–15

    The following tables show Aust Fin's financial position for the 2014–15 income year. These are average values using the opening and closing balances method.

    Aust Fin balance sheet 2014–15

    Assets

    Current

    $2,000,000

    Loans receivable, including low risk-weighted loan of $3,000,000

    $46,000,000

    Equity in Ozzie Co*

    $7,500,000

    Other assets

    $10,500,000

    Total assets

    $66,000,000

    Liabilities

    Non-debt liabilities

    $3,000,000

    Loan payable

    $59,000,000

    Total liabilities

    $62,000,000

    Equity capital

    Equity

    $4,000,000

    Total equity capital

    $4,000,000

    Total equity capital plus total liabilities

    $66,000,000

    * Assume the equity investment in Ozzie Co remains valued at $7,500,000 at all times throughout the income year.

    Deductions

    Aust Fin has debt deductions worth $2,700,000 in the 2014–15 income year and fails the debt deduction de-minimus test. Because Aust Fin is foreign controlled, it cannot apply the asset de-minimus test.

    Ozzie Co's balance sheet as at 1 July 2014

    Assets

    Current

    $4,000,000

    Non-current

    $8,500,000

    Total assets

    $12,500,000

    Liabilities

    Non-debt liabilities

    $500,000

    Loan payable

    $1,000,000

    Total liabilities

    $1,500,000

    Equity capital

    Equity

    $10,000,000

    Retained earnings

    $1,000,000

    Total equity capital

    $11,000,000

    Total equity capital plus total liabilities

    $12,500,000

    Ozzie Co's balance sheet as at 30 June 2015

    Assets

    Current

    $3,500,000

    Non-current

    $8,500,000

    Total assets

    $12,000,000

    Liabilities

    Non-debt liabilities

    $500,000

    Loan payable

    $1,000,000

    Total liabilities

    $1,500,000

    Equity capital

    Equity

    $10,000,000

    Retained earnings

    $500,000

    Total equity capital

    $10,500,000

    Total equity capital plus total liabilities

    $12,000,000

    Step 1: Calculate Aust Fin's adjusted average debt

    Worksheet 1: Aust Fin's Step 1

    Steps

    Label

    Label description

    Amount

    Step 1.1: The average value of all Aust Fin's debt capital that gives rise to debt deductions is $59,000,000

    (A)

    Average debt capital

    $59,000,000

    Step 1.2: Aust Fin's associate entity debt is the $1,000,000 debt interest issued by Ozzie Co

    (B)

    Average associate entity debt

    $1,000,000

    Step 1.3: Aust Fin does not have any borrowed securities amounts

    (C)

    Average borrowed securities amounts

    $0

    Step 1.4: All Aust Fin's debt capital gives rise to debt deductions

    (D)

    Average cost-free debt capital

    $0

    Step 1.5: Aust Fin's adjusted average debt is $58,000,000

    =

    Adjusted average debt (A - B + C + D)

    $58,000,000

    Aust Fin's adjusted average debt is $58,000,000. This is now compared to Aust Fin's maximum allowable debt, which is the greater of its:

    • safe harbour debt amount, which is the lesser of the total debt amount and the adjusted on-lent amount
    • arm's length debt amount
    • worldwide gearing debt amount.

    Aust Fin can calculate the amounts in any order it chooses and does not necessarily have to calculate all amounts.

    Step 2: Calculate Aust Fin's total debt amount

    Worksheet 2: Aust Fin's Step 2

    Steps

    Label

     Label description

    Amount

    Step 2.1: The average value of Aust Fin's assets is $66,000,000

    (E)

    Average assets

    $66,000,000

    Step 2.1A: None of the equity interests issued by Aust Fin are excluded equity interests

    (MM)

    Average excluded equity interest

    $0

    Step 2.2: The average value of Aust Fin's associate entity debt is $1,000,000

    (B)

    Average associate entity debt from B in Worksheet 1

    $1,000,000

    Step 2.3: The average value of Aust Fin's associate entity equity is the $7,500,000 invested in Ozzie Co

    (F)

    Average associate entity equity

    $7,500,000

    Step 2.4: The average value of Aust Fin's non-debt liabilities is $3,000,000

    (G)

    Average non-debt liabilities

    $3,000,000

    Step 2.5: The average value of Aust Fin's zero-capital amount is $3,000,000. The only zero-capital amount Aust Fin has is the low risk-weighted loan to the unrelated company

    (ZC)

    Average zero-capital amount

    $3,000,000

    Step 2.6: Reduce Aust Fin's average assets by the amounts at MM, B, F, G & ZC

    (H)

    E - MM - B - F - G - ZC

    $51,500,000

    Step 2.7: Multiply the result at H by 15/16

    (J)

    H * 15/16

    $48,281,250

    Step 2.8: The average value of Aust Fin's zero-capital amount is $3,000,000 – see Step 2.5

    (ZC)

    Average zero-capital amount

    $3,000,000

    Step 2.9: The average value of Aust Fin's associate entity excess amount is $4,537,500 – see Worksheet 2A

    (K)

    Average associate entity excess amount from K on Worksheet 2A

    $4,537,500

    Step 2.10: Aust Fin's total debt amount is $55,818,750

    =

    Total debt amount
    (J + ZC + K)

    $55,818,750

    Step 2A: Calculate Aust Fin's average associate entity excess amount for the total debt amount

    Aust Fin's associate entity excess amount is calculated on each of its measurement days. Aust Fin uses the opening and closing balances method so its measurement days are 1 July 2014 – the first day of the period – and 30 June 2015 – the last day of the period.

    Worksheet 2A: Aust Fin's Step 2A

     Steps

    Label

    Label description

    Amount as at 1 July 2014

    Amount as at 30 June 2015

    Step 2A.1: Aust Fin's associate entity equity on both measurement days is the $7,500,000 invested in Ozzie Co

    (L)

    Aust Fin's associate entity equity on a measurement day

    $7,500,000

    $7,500,000

    Step 2A.2: The value of Ozzie Co's equity capital attributable to Aust Fin (75%) is $8,250,000 on 1 July 2014 and $7,875,000 on 30 June 2015

    (M)

    Ozzie Co's equity capital attributable to Aust Co on a measurement day

    $8,250,000

    $7,875,000

    Step 2A.3: Aust Fin's premium excess amount is calculated by deducting from the amount at L the amount at M and multiplying the result by 15/16. This result is negative, and is taken to be nil

    (N)

    (L - M) * 15/16

    $0

    $0

    Step 2A.4: Ozzie Co's safe harbour debt amount on a measurement day – calculated using Step 2 and Worksheet 2 of this guide – is its assets less non-debt liabilities multiplied by 3/5

    (P)

    Ozzie Co's safe harbour debt amount on a measurement day

    $7,200,000

    $6,900,000

    Step 2A.5: Ozzie Co's adjusted average debt – calculated using Step 1 and Worksheet 1 of this guide – is the $1,000,000 it has borrowed from Aust Fin

    (Q)

    Ozzie Co's adjusted average debt on a measurement day

    $1,000,000

    $1,000,000

    Step 2A.6: Ozzie Co's excess borrowing capacity is calculated by reducing its safe harbour debt amount by its adjusted average debt

    (R)

    P - Q

    $6,200,000

    $5,900,000

    Step 2A.7: The value of Ozzie Co's equity capital attributable to Aust Fin (75%) is the same as M

    (S)

    Value of equity capital attributable to Aust Fin on a measurement day

    $8,250,000

    $7,875,000

    Step 2A.8: Ozzie Co's total equity capital is $11,000,000 on 1 July 2014 and $10,500,000 on 30 June 2015

    (T)

    Value of Ozzie Co's total equity capital

    $11,000,000

    $10,500,000

    Step 2A.9: The proportion of Ozzie Co's equity capital held by Aust Fin on both measurement days is 75%

    (U)

    S / T

    0.75

    0.75

    Step 2A.10: The attributable safe harbour excess amount is the proportion of equity held by Aust Fin (75%) multiplied by Ozzie Co's excess borrowing capacity (Q)

    (V)

    R * U

    $4,650,000

    $4,425,000

    Step 2A.11: The associate entity excess amount is the sum of the premium excess amount and the attributable safe harbour excess amount

    (W)

    N + V

    $4,650,000

    $4,425,000

    Step 2A.12: Associate entity excess amount on a measurement day for all associate entities. Aust Fin has only one associate entity so X is the same as W.

    Step 2A.13 - X is calculated for the other measurement day for all associate entities. For this exercise, this has been done in the fifth column

    (X)

    Transfer from W

    $4,650,000

    $4,425,000

    Step 2A.14: the average associate entity excess amount is calculated by adding the results at X - $4,650,000 and $4,425,000 - and dividing by 2 - the number of measurement days

    (K)

    ($4,650,000 + $4,425,000) / 2

    $4,537,500

    (transfer to K on Worksheet 2)

    Aust Fin's total debt amount is $55,818,750. It must now calculate its adjusted on-lent amount. The lesser of these two amounts is its safe harbour debt amount.

    Step 3: Calculate Aust Fin's adjusted on-lent amount

    Worksheet 3: Aust Fin's Step 3

     Steps

    Label

    Label description

    Amount

    Step 3.1: The average value of Aust Fin's assets is $66,000,000

    (E)

    Average assets

    $66,000,000

    Step 3.2: None of the equity interests issued by Aust Fin are excluded equity interests

    (MM)

    Average excluded equity interests

    $0

    Step 3.3: The average value of Aust Fin's associate entity equity is $7,500,000

    (F)

    Average associate entity equity

    $7,500,000

    Step 3.4: The average value of Aust Fin's non-debt liabilities is $3,000,000

    (G)

    Average non-debt liabilities

    $3,000,000

    Step 3.5: The average value of Aust Fin's on-lent amount is $46,000,000; that is, a $42,000,000 loan to unrelated third parties, a $3,000,000 low-risk weighted loan and a $1,000,000 loan to Ozzie Co, its associate entity

    (OA)

    Average on-lent amount

    $46,000,000

    Step 3.6: Reduce Aust Fin's assets by the amounts at MM, F, G, & OA

    (Y)

    E - MM - F - G - OA

    $9,500,000

    Step 3.7: Multiply the result at Y by 3/5

    (Z)

    Y * 3/5

    $5,700,000

    Step 3.8: The average value of Aust Fin's on-lent amount is $46,000,000 – see Step 3.5

    (OA)

    Average on-lent amount

    $46,000,000

    Step 3.9: The average value of Aust Fin's associate entity debt is $1,000,000

    (B)

    Average associate entity debt

    $1,000,000

    Step 3.10: The average value of Aust Fin's associate entity excess is $4,537,500 – see Worksheet 3A

    (AA)

    Average associate entity excess from AA on Worksheet 3A

    $4,537,500

    Step 3.11: Aust Fin's adjusted on-lent amount is $55,237,500

    =

    Adjusted on-lent amount
    (Z + OA - B + AA)

    $55,237,500

    Step 3A: Calculate Aust Fin's average associate entity excess amount for the adjusted on-lent amount

    Worksheet 3A: Aust Fin's step 3A

    Steps

    Label

    Label description

    Amount as at 1 July 2014

    Amount as at 30 June 2015

    Step 3A.1: The value of Aust Fin's associate entity equity on both measurement days is $7,500,000

    (L)

    Aust Fin's associate entity equity on a measurement day

    $7,500,000

    $7,500,000

    Step 3A.2: The value of Ozzie Co's equity capital attributable to Aust Fin is $8,250,000 on 1 July 2014 and $7,875,000 on 30 June 2015

    (M)

    Ozzie Co's equity capital on a measurement day

    $8,250,000

    $7,875,000

    Step 3A.3: Aust Fin's premium excess amount is calculated by reducing the amount at L by the amount at M and multiplying the result by 3/5. This result is negative, and is taken to be nil

    (BB)

    (L - M) * 3/5

    $0

    $0

    Step 3A.4: The attributable safe harbour excess amount has already been worked out at V in Worksheet 2A

    (V)

    Attributable safe harbour excess amount from V on Worksheet 2A

    $4,650,000

    $4,425,000

    Step 3A.5: The associate entity excess amount is the sum of the premium excess amount and the attributable safe harbour excess amount

    (CC)

    BB + V

    $4,650,000

    $4,425,000

    Step 3A.6: Associate entity excess amount for each associate entity. Aust Fin has only one associate entity so DD is the same as CC.

    Step 3A.7 - DD is calculated for the other measurement day for all associate entities. For this example, this has been done in the right-hand column

    (DD)

    Transfer from CC

    $4,650,000

    $4,425,000

    Step 3A.8: The average associate entity excess amount is calculated by adding results at DD – $4,650,000 and $4,425,000 – and dividing by 2 – the number of measurement days

    (AA)

    (4,650,000 + $4,425,000) / 2

    $4,537,500

    Transfer to AA on Worksheet 3

    The safe harbour debt amount is the lesser of the total debt amount ($55,718,750) and the adjusted on-lent amount ($55,237,500). Therefore, the safe harbour debt amount for Aust Fin is the adjusted on-lent amount of $55,237,500. Aust Fin's adjusted average debt ($58,000,000) is more than this amount.

    Aust Fin's maximum allowable debt is the highest of its safe harbour debt amount, arm's length debt amount and worldwide gearing debt amount. Aust Fin has the option to calculate an alternative amount under the arm's length debt test or the worldwide gearing debt test. Aust Fin can also choose to use the safe harbour debt amount as its maximum allowable debt.

    Step 4: Calculate Aust Fin's arm's length debt amount

    For the purposes of this exercise, assume Aust Fin chooses not to calculate an arm's length debt amount.

    See also:

    • Taxation ruling TR 2003/1 Income tax: thin capitalisation - applying the arm's length debt test

    Step 5: Calculate Aust Fin's worldwide gearing debt amount

    For the purposes of this exercise, assume Aust Fin chooses not to calculate a worldwide gearing debt amount.

    See also:

    Step 6: Calculate Aust Fin's debt deductions disallowed

    Aust Fin's maximum allowable debt is $55,237,500 – the safe harbour debt amount, being the lesser of the total debt amount and the adjusted on-lent amount. As Aust Fin's adjusted debt ($58,000,000) is more than its maximum allowable debt, a proportion of its debt deductions will be disallowed.

    Aust Fin's debt deductions are $2,700,000.

    Worksheet 6: Aust Fin's debt deductions disallowed

    Steps

    Label

    Label description

    Amount

    Step 5.1: Aust Fin's adjusted average debt is $58,000,000 and its maximum allowable debt is $55,237,500

    (EE)

    Excess debt
    $58,000,000 - $55,237,500

    $2,762,500

    Step 5.2: Aust Fin's average debt capital is $59,000,000. This includes the $1,000,000 loan to its associate entity

    (FF)

    Average debt

    $59,000,000

    Step 5.3: Divide the amount at EE by the amount at FF to get the proportion to be applied to Aust Fin's debt deductions

    (GG)

    EE / FF
    $2,762,500 / $59,000,000

    0.046822

    Step 5.4: Calculate Aust Fin's debt deductions for the income year

    (HH)

    Debt deductions

    $2,700,000

    Step 5.5: The debt deductions disallowed is calculated by multiplying the amount at GG by the amount at HH

    =

    GG * HH
    0.046822 * $2,700,000

    $126,419

    Aust Fin is disallowed $126,419 of its debt deductions.

      Last modified: 24 Aug 2017QC 48413