Australia Thin Capitalisation Guide

Australian thin capitalisation rules. The guide covers: the thin capitalisation rules — the 'thin capitalisation rules' are the 'anti-avoidance provisions' under the 'Division 820 of the ITAA 1997' that 'limit the interest deductions' for the 'Australian entities' with the 'excessive debt' (the 'thinly capitalised entities'); the 'thin capitalisation rules' apply to: (i) the 'Australian resident entities' that 'control the foreign entities' (the 'outbound investors' — the 'Australian companies with the overseas operations'), (ii) the 'foreign entities' that 'invest in Australia' (the 'inbound investors' — the 'foreign companies with the Australian operations'), (iii) the 'Australian entities' that are 'controlled by the foreign entities'; the safe harbour debt test — the 'safe harbour test' is the 'debt to equity ratio test' — the 'maximum allowable debt' is the '1.5:1 ratio' (the 'debt to equity ratio of 1.5:1'); the 'entity meets the safe harbour test' if the 'debt amount' does NOT exceed the '1.5 times the equity amount' (the 'adjusted equity' of the 'Australian entity'); the 'interest deductions' are 'denied' if the 'debt exceeds the safe harbour ratio' — the 'excess interest is NOT deductible'; the arm's length debt test — the 'arm's length debt test' allows the 'entity to have the 'higher debt' if the 'entity can demonstrate that the 'debt amount is the 'arm's length amount' — the 'amount that would have been borrowed from the third party in the 'arm's length transaction''; the 'arm's length debt test' is the 'alternative test' — the 'entity that fails the safe harbour test may 'pass the arm's length debt test' if the 'debt is commercially justified'; the 'entity must provide the 'transfer pricing documentation' and the 'financial analysis' to 'support the arm's length debt claim'; the worldwide gearing ratio — the 'worldwide gearing ratio' is the 'alternative gearing test' for the 'Australian entities that are the 'part of the multinational group''; the 'worldwide gearing ratio' compares the 'Australian entity's debt to equity ratio' to the 'worldwide group's debt to equity ratio'; the 'Australian entity's debt' is 'allowable' if the 'Australian gearing ratio does NOT exceed the 'worldwide gearing ratio' by the 'margin' (the 'de minimis margin'); the ATO compliance — the 'ATO' is 'active in the thin capitalisation compliance' and may 'review the entity's debt structure' in the 'ATO compliance program'; the 'entity must 'lodge the 'thin capitalisation schedule' (the 'Section 820 schedule') with the 'annual tax return'; the 'entity with the 'total debt above $2 million' must 'lodge the thin capitalisation schedule'; the 'penalties for the non-compliance' include the 'denial of the interest deductions' and the 'GIC (the General Interest Charge)'.

Safe Harbour Debt Test

1.5:1 debt to equity ratio: The 'maximum allowable debt' is 1.5 times the 'equity'. The 'interest on the excess debt' is 'denied'.
Equity calculation: The 'adjusted equity' is the 'net assets' plus the 'adjustments' (the 'equity interests' and the 'retained earnings').
Inbound vs outbound: The 'inbound investors' are 'subject to the same 1.5:1 ratio' as the 'outbound investors'.

For the transfer pricing rules and the arm's length principle, see our Transfer Pricing Guide →.

Arm's Length & Worldwide Tests

Arm's length debt test: The 'entity can have the 'higher debt' if the 'debt is the arm's length amount'. The 'entity must provide the 'documentation'.
Worldwide gearing ratio: The 'Australian entity's gearing' must NOT 'exceed the worldwide group's gearing'.

For the cross-border tax and the international finance, see our Cross-Border Tax Guide →.

Compliance & Reporting

Thin capitalisation schedule: The 'entity with the 'total debt above $2 million' must 'lodge the schedule'.
Interest deduction denial: The 'interest on the excessive debt' is 'denied' (the 'non-deductible interest').

For the corporate tax returns and the annual tax reporting, see our Corporate Tax Guide →.