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On 8 April 2024, the Treasury Law Amendment (Making Multinationals Pay Their Fair Share - Integrity and Transparency) Act 2024 was enacted. The amendments apply to assessments for income years commencing on or after 1 July 2023, with the exception of new integrity rules (debt deduction creation rules) which apply in relation to assessments for income years starting on or after 1 July 2024. Under the new thin capitalisation rules:
ADIs, securitisation vehicles and certain special purpose entities are excluded from the debt deduction creation rules. Entities that are Australian plantation forestry entities are excluded from the new rules. For these entities, the previous rules will continue to apply. |
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
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)
Assets |
$m |
Liabilities |
$m |
|---|---|---|---|
Current assets Building and plant |
4 13 |
Debt capital Non-debt liabilities |
12 5 |
|
17 |
|
17 |
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
Steps |
$m |
||
|---|---|---|---|
Step 1.1: The average value of all for Co's debt capital that gives rise to debt deductions is $32m ($12m attributable to the Australian permanent establishment and $20m funding the Australian block of flats). The debt capital used by For Co on its foreign business would not give rise to deductible expenses in Australia |
Average debt capital |
(A) |
32 |
Step 1.2: For Co does not have any associate entity debt attributable to its Australian permanent establishment |
Average associate entity debt |
(B) |
0 |
Step 1.3: For Co does not have any cost-free debt capital |
Average cost-free debt capital |
(C) |
0 |
Step 1.4: For Co's adjusted average debt is $32m |
Adjusted average debt (A–B+C) |
= |
32 |
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
Steps |
$m |
||
|---|---|---|---|
Step 2.1: The average value of For Co's Australian assets is $42m (Aust PE's assets of $17m and the block of flats worth $25m). The shares held in the Australian public companies are not Australian assets because they do not produce any assessable income |
Average assets |
(D) |
42 |
Step 2.1A: For Co does not have any excluded equity interests |
Average excluded equity interest |
(JJ) |
0 |
Step 2.2: For Co does not have any associate entity debt attributable to its Australian permanent establishment |
Average associate entity debt (from B on worksheet 1) |
(B) |
0 |
Step 2.3: For Co does not have any associate entity equity attributable to its Australian permanent establishment |
Average associate entity equity |
(E) |
0 |
Step 2.4: The average value of For Co's non-debt liabilities is the $5m that have arisen because of Aust PE |
Average non-debt liabilities |
(F) |
5 |
Step 2.5: Reduce For Co's average assets by the amounts at JJ, B, E & F |
D – JJ – B – E – F |
(G) |
37 |
Step 2.6: Multiply the result at G by 3/5 |
G x 3/5 |
(H) |
22.2 |
Step 2.7: For Co does not have any associate entities and so does not have an associate entity excess amount |
Average associate entity excess amount |
(J) |
0 |
Step 2.8: For Co's safe harbour debt amount is calculated by adding the amounts at H and J |
Safe harbour debt amount = (H + J) |
= |
22.2 |
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
Steps |
|||
|---|---|---|---|
Step 4.1: For Co's worldwide debt is $100m |
Worldwide debt |
(Z) |
$100m |
Step 4.2: For Co's worldwide equity is $40m |
Worldwide equity |
(AA) |
$40m |
Step 4.3: For Co's worldwide gearing ratio is calculated by dividing its worldwide debt by its worldwide equity |
Z AA |
(BB) |
2.5 |
Step 4.4: Insert the amount of BB at CC |
BB |
(CC) |
2.5 |
Step 4.5: Add 1 (one) to the amount at CC |
CC + 1 |
(DD) |
3.5 |
Step 4.6: Divide the amount at CC by the amount at DD |
CC / DD |
(EE) |
.7148587 |
Step 4.7: The gearing ratio is applied to For Co's net assets G from Worksheet 2 |
EE $37m |
(FF) |
$26.44 |
Step 4.8: The average value of For Co's associate entity excess amount is $0 as there are no associated entities |
|
(GG) |
$0 |
Step 4.9: For Co's worldwide gearing debt amount is calculated by adding the amounts at FF and GG |
Worldwide gearing debt amount |
$26,440,000 |
|
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
Steps |
|||
|---|---|---|---|
Step 5.1: For Co's average debt is $32m and its maximum allowable debt is $26.44 |
Excess debt |
(X) |
$5.56m |
Step 5.2: For Co's average debt capital is $32m; that is only $32m gives rise to debt deductions |
Average debt capital |
(Y) |
$32m |
Step 5.3: Divide the amount at X by the amount at Y |
X / Y |
(Z) |
0.17375 |
Step 5.4: Calculate For Co's debt deductions for the income year |
Debt deductions |
(AA) |
$2.1m |
Step 5.5: Multiply the amount at Z by the amount at AA. This is the total debt deductions disallowed to For Co |
Z x AA |
= |
$364,875 |
For Co cannot deduct $364,875 of its debt deductions.
The steps a non-ADI general inward investor takes to calculate if they have met thin capitalisation rules.