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# Step 2: Calculate the safe harbour capital amount

How to calculate the safe harbour capital amount if you're an outward investing entity (ADI).

Last updated 23 July 2024

The safe harbour capital amount is a level of equity capital an authorised deposit-taking institution (ADI) must allocate to its Australian operations. This amount is based on the value of net risk-weighted assets and intangible assets comprising of capitalised software expenses that are attributable to the ADI's Australian operations. The safe harbour capital amount is broadly based on the methodology of the capital adequacy requirements prescribed by prudential regulators, for example, the Australian Prudential Regulation Authority (APRA).

Table 51: outward investing entity (ADI)'s step 2 and Worksheet 43: outward investing entity (ADI)'s step 2 explain how to work out the safe harbour capital amount.

You will need copy of the prudential standards to work out the safe harbour capital amount.

Table 31: Outward investing entity (ADI)'s step 2

Steps

Step 2.1: Calculate the average value, for the income year, of all the ADI's net risk-weighted assets and intangible assets comprising of capitalised software expenses that are not:

• attributable to the ADI's overseas permanent establishments
• assets that represent equity invested in controlled foreign entities; that is, amounts shown at B in Worksheet 24: Outward investing entity (ADI)'s step 1
• assets in respect of which prudential capital deductions must be made, other than assets attributable to the ADI's overseas permanent establishments.

Insert this amount at C on Worksheet 25: outward investing entity (ADI)'s step 2.

The first step is to work out the average value of the ADI's net risk-weighted assets and intangible assets comprising of capitalised software expenses that are attributable to the ADI's Australian operations.

If the ADI is foreign controlled and there is at least one foreign entity with a TC control interest of at least 40%, the ADI's risk-weighted assets are its risk exposures determined in accordance with the prudential standards of the country in which that foreign entity is a resident. Otherwise, its risk-weighted assets are its risk exposures determined in accordance with Australian prudential standards.

To isolate the Australian assets, disregard assets attributable to overseas permanent establishments and equity invested in controlled foreign entities. Prudential capital deductions are amounts that must be deducted under the prudential standards when calculating either eligible tier 1 capital or the sum of eligible tier 1 and tier 2 capital.

Step 2.2: Multiply the amount at C by 6%.

Insert the result at D on Worksheet 25: outward investing entity (ADI)'s step 2.

The average value of Australian risk-weighted assets is then multiplied by 6%.

Step 2.3: Calculate the average value of all the ADI's tier 1 capital prudential deductions for that year, other than the value of tier 1 prudential capital deductions attributable to any of the ADI's:

• overseas permanent establishments or controlled foreign entities for which the ADI is an Australian controller
• goodwill or intangible assets relating to any excess of the net market value of an interest in a subsidiary over the net amount of the subsidiary's assets and liabilities to the extent that the excess is referrable to the value of business in force (VBIF)
• intangible assets comprising capitalised software expenses.

Insert this amount at E on Worksheet 25: outward investing entity (ADI)'s step 2.

Tier 1 capital is composed of core capital, which primarily consists of common stock and disclosed reserves or retained earnings. It may also include non-redeemable non-cumulative preferred stock.

Tier 1 prudential capital deductions are amounts that must be deducted under the prudential standards when calculating eligible tier 1 capital. Prudential capital deductions are made in respect of assets like goodwill and intangibles.

VBIF is the value of business in force at the time of acquisition of the relevant subsidiary. VBIF is taken to be nil unless the value of VBIF at the time of acquisition of the relevant subsidiary was worked out by an actuary.

Software capitalisation involves the recognition of internally-developed software as fixed assets. They are capitalised on the basis that the expenses will result in a future economic benefit to the entity.

Step 2.4: Calculate the ADI's safe harbour capital amount by adding the amounts at D and E.

The safe harbour capital amount represents 6% of the ADI's Australian risk-weighted assets and intangible assets comprising of capitalised software expenses, increased by any tier 1 capital prudential deductions.

Worksheet 25: Outward investing entity (ADI)'s step 2

Steps

\$

Step 2.1: Average Australian risk-weighted assets and intangible assets comprising capitalised software expenses

(C) _____________

Step 2.2: C × 6%

(D) _____________

Step 2.3: Average tier 1 prudential capital deductions

(E) _____________

Step 2.4: Safe harbour capital amount (E)

= ______________

This is the ADI's safe harbour capital amount.

If the ADI's adjusted average equity capital is equal to or more than the safe harbour capital amount, the ADI is not disallowed any debt deductions under the thin capitalisation rules. You do not have to complete any more calculations.

If the ADI's adjusted average equity capital is less than the safe harbour capital amount, you can choose to calculate the ADI's worldwide capital amount, but only if the ADI is not foreign controlled (see step 3) or an arm's length capital amount (see step 4). If you do not want to calculate a worldwide capital amount or an arm's length capital amount, you can use your safe harbour capital amount as your minimum capital amount and debt deductions will be disallowed on this basis (see step 5).