Eligible tier 1 company
This is a tier 1 company that meets certain requirements as to the ownership of its membership interests. A company will be a tier 1 company if both of the following apply:
- It is a qualifying wholly-owned Australian resident subsidiary of the ultimate foreign holding company.
- It is not a wholly-owned subsidiary of a company that is an Australian resident which could be a member of the MEC group.
An entity includes a company, trust, partnership, any unincorporated body or association and an individual.
Broadly, an entity's equity capital includes the value of its:
- equity interest, less any unpaid amount
- general reserves and asset revaluation reserves
- retaining earnings
- current year earnings, net of any tax payable or amounts distributed
- provisions for distributions.
Equity capital is relevant to calculating the:
- associate entity excess amount – used to calculate the maximum allowable debt for non-ADIs
- worldwide equity amount – used to calculate the worldwide gearing debt amount for non-ADI investors
- ADI equity capital – used to calculate the average equity capital for ADIs.
The equity capital of an entity at a particular time means:
- the total of the following
- the issue price of each equity interest on issue, reduced by any unpaid portion of the issue price
- the entity's general reserves and asset revaluation reserves
- the entity's retained earnings
- the entity's net earnings for the current year, reduced by the amount of tax the entity expects to pay on those earnings, as well as any distributions made or declared to the entity's members that are attributable to the entity's earnings for the current year
- if the entity is a corporate tax entity, any provisions for distributions of profit
- if the entity is not a corporate tax entity, any provisions for distributions to the entity's members
- reduced by the total of the following
- the entity's negative retained earnings
- the entity's net loss for the current income year.
Division 974 of the ITAA 1997contains rules for determining whether something is debt or equity. While this division is relevant only to companies, the thin capitalisation rules extend it to trusts and partnerships with certain modifications for the purposes of applying the thin capitalisation rules only.
In relation to a company, an equity interest is an interest that is defined as an equity interest under subdivision 974-C. In relation to a trust or partnership, it is an interest that is defined as an equity interest under section 820-930.
Equity interest and the assets threshold test
Broadly, an equity interest has been issued if the interest is not a debt interest and it is any of the following:
- a share in a company, an interest of a beneficiary in a trust or an interest of a partner in a partnership
- an interest providing returns that depend on the issuer's economic performance
- an interest providing returns at the discretion of the issuer
- an interest that may or will convert into such an interest or share.
In relation to a non-ADI, excess debt is the amount by which an entity's adjusted average debt is more than its maximum allowable debt. This amount is used to calculate the proportion of debt deductions disallowed.
Excluded equity interest
Broadly, excluded equity interest is an entity's equity capital that has been on issue for a period of less than 180 days and has certain features that make it possible to manipulate asset levels so an entity artificially passes the thin capitalisation rules.
Under the debt/equity rules, some types of financial instruments that are commonly regarded as debt are now classified as equity interests. These types of interests have features that make it possible to manipulate the debt and asset levels to the advantage of either or both of the holder and issuer. To prevent entities issuing equity interests immediately before a valuation day and cancelling the interests immediately after, certain short term equity interests called 'excluded equity interests' are deducted from assets in the method statements for determining the safe harbour debt of the issuer. This reduces the maximum allowable debt of the entity.
An entity (the issuer) can have an excluded equity interest 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.
- The issuer is not an exempt entity and is not exempted 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 issuer's excluded equity interest is then the total value of all the equity interests issued by it that:
- if the holder is an associate, meet the same conditions as the issuer (see above) and the measurement days used by the issuer to measure its adjusted average debt are different to the measurements days used by the holder to measure its assets, the equity interests where the interest has been on issue for a period of less than 180 days, or
- if the holder is an associate, does not meet the same conditions as the issuer; that is, the holder is not required to apply the thin capitalisation rules, the equity interest that has been on issue for less than 180 days at the measurement day.
However, if the total period for which the equity interest is on issue is ultimately 180 days or more, the equity interest is not taken to be an excluded equity interest.
Example 17: Equity interest
An entity with a standard income year that uses quarterly measurement dates issues an equity interest on 30 September 2008. The holder of that interest is not subject to the thin capitalisation rules. As at 31 December 2008 the equity interest is classified as an excluded equity interest. On 31 March 2009, the equity interest has been on issue for more than 180 days so it will be taken not to have been an excluded equity interest on 31 December 2008.
End of example
If the issuer is a foreign entity, equity interests can only form part of its excluded equity interests 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.
Explains eligible tier 1 company, entity, equity capital, equity interest, equity interest and the relevant to assets threshold test, excess debt and excluded equity interest.