Thinly capitalised entities

A thinly capitalised entity is one whose assets are funded by a high level of debt and relatively little equity. An entity's debt-to-equity funding is sometimes expressed as a ratio. For example, a ratio of 3:1 means that for every $3 of debt, the entity is funded by $1 of equity. This is also known as 'gearing'. An entity that is highly geared has funded its assets with more debt than equity.

The thin capitalisation rules can apply to Australian entities investing overseas, their associate entities, foreign controlled Australian entities and foreign entities investing directly into Australia. Under the thin capitalisation rules, the amount of debt used to fund those Australian operations or investments is limited. They disallow the debt deductions an entity can claim against Australian assessable income when the entity's debt used to fund Australian assets exceeds certain limits.

A debt deduction is an expense an entity incurs in connection with a debt interest, such as an interest payment or a loan fee that the entity would otherwise be able to claim a deduction for in Australia. Certain expenses are excluded from being debt deductions under tax law, including rental expenses on certain leases and some foreign currency losses. A debt interest is an interest classified as debt under the debt/equity rules in Division 974. Examples of debt interests include loans, bills of exchange or promissory notes.

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Last modified: 09 Mar 2016QC 48113