Worked example of calculations for a non-ADI general inward investor

The steps a non-ADI general inward investor takes to calculate if they have met the thin capitalisation rules are:

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

This worked example goes through each of these steps.

Note: The thin capitalisation rules only affect foreign entities:

• with an Australian permanent establishment or other Australian income producing assets
• that are claiming debt deductions.

See also:

• Thin capitalisation

Worked example

For Co is a foreign entity that has three types of investments in Australia. It has an Australian permanent establishment (Aust PE) through which For Co carries on a manufacturing business in Australia:

• several shareholdings in Australian public companies – these investments amount to 1% of the ordinary shares in each company
• a block of flats that it rents out to private tenants – the average value of the block of flats is $25 million.

For Co has $100 million of debt capital, of which $20 million was used to fund the acquisition of the block of flats and $12 million is attributable to Aust PE (it actually raised this debt in Australia through the PE). The remaining debt capital is used in For Co's foreign business. The shares in the Australian public companies were funded by For Co's profits. Aust PE has $5 million of non-debt liabilities and together with the block of flats has generated $2.1 million of debt deductions in Australia.

All loans are at commercial interest rates. For Co, in relation to its Australian investments, is the only entity being tested under the thin capitalisation rules. The test year is the 2014–15 income year. Below is a diagram illustrating these scenarios and the relevant financial information for Aust PE.

Table: Aust PE's assets and liabilities for year ending 30 June 2015 (average values using opening and closing balances method)

Assume For Co’s has statement worldwide debt of $100 million and statement worldwide equity of $40 million.

For Co has $2.1 million worth of debt deductions in the 2014–15 income year and fails the debt deduction de-minimus test. Because it is an inward investor, it cannot apply the asset de-minimus test.

Step 1: Calculate For Co's adjusted average debt

Worksheet 1: For Co's step 1

For Co's adjusted average debt is $32 million. This is now compared to For Co's maximum allowable debt, which is the greater of its:

• safe harbour debt amount
• arm's length debt amount
• worldwide gearing debt amount.

For Co can calculate these amounts in any order it chooses and does not necessarily have to calculate all amounts.

Step 2: Calculate For Co's safe harbour debt amount

Worksheet 2: For Co's step 2

For Co's safe harbour debt amount is $22.2 million. For Co's adjusted average debt is more than this amount. For Co can calculate an alternative amount under the arm's length debt amount test or the worldwide gearing debt amount test (though these may not be higher than the safe harbour debt amount) or can choose to use the safe harbour debt amount as its maximum allowable debt.

Step 3: Calculate For Co's arm's length debt amount

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

See also:

• Taxation ruling TR 2003/1

Step 4: Calculate For Co's worldwide gearing debt amount

An entity cannot use the worldwide gearing debt test unless the result of the following formula is greater than 0.5:

Average Australian assets of the entity / Statement worldwide assets of the entity for the income year

This threshold requires that the entity’s Australian assets represent no more than 50 per cent of the consolidated group’s worldwide assets.

For Co’s.average Australian assets for the year are $17m and statement worldwide assets is $140m. The result of applying the above formula is 0.12, therefore Aust Co is eligible to apply the new worldwide gearing debt test.

Worksheet 4: For Co's step 4

Step 5: Calculate For Co's debt deductions disallowed

For Co's maximum allowable debt is $26.44 million (the worldwide gearing debt amount). As For Co's adjusted average debt ($32 million) is more than its maximum allowable debt, a proportion of its debt deductions will be disallowed.

For Co's debt deductions are $2.1 million.

Worksheet 5: For Co's step 5

For Co cannot deduct $364,875 of its debt deductions.