Australian tax law has strict regulations governing the debt-to-equity ratios of entities that have Australian and overseas operations. The purpose is to encourage a more equal allocation of income and debt in multinational companies and their associated entities.
Thin capitalisation refers to the shifting of debt to high tax countries to receive a tax deduction for the interest paid and minimise the assessable income of the Australian entity.
Australia’s thin capitalisation rules generally apply to:
– Australian entities investing overseas and their associate entities; and
– Foreign entities investing in Australia.
The thin capitalisation rules limit the amount of debt a multinational company can load onto their Australian operation with reference to the:
– The safe harbour debt amount. This refers to an allowable debt to equity ratio which has been tightened over the years.
– Arm’s length debt amount. This is a largely objective which applies where:
- the entity’s adjusted debt is no greater than the amount of debt that the Australian businesswould reasonably be expected to have; and
- the funds would have been provided to the Australian business as a loan (or a series of loans) by independent commercial lending institutions on arm’s length terms.
– Worldwide gearing debt amount. This applies only available to certain entities and potentially allows the Australian operations of an entity, in certain circumstances, to be geared up to 100% of the gearing of the Australian entity’s worldwide group
If your business is caught by the thin capitalisation rules it is important to optimise your strategy by considering all or some of the following:
– Exemptions, exclusions and exemptions that are available, particularly for outbound investors
– Consider other methodologies rather than relying strictly on the safe harbour rule as the rewards can be significant
– Revalue assets within the prescribed parameters to optimise the debt-equity ratio
– Refinance assets to optimise the debt-equity ratio
If you are unsure if the thin capitalisation rules apply to your business or require advice on optimising your thin capitalisation strategy please contact our team of tax lawyers and accountants at The Quinn Group on (02) 9223 9166 or submit an online enquiry form today.