Azure Group's International tax specialists can help assess whether thin capitalisation is applicable to your business and plan around maximum allowable debt amounts.
Thin capitalisation is the name given to Australian tax rules that restrict the extent to which an entity can obtain a tax deduction for debt deductions (i.e. interest expenses).
The purpose of the rules is to counter the tax benefits that would otherwise arise to an entity in using debt funding instead of equity funding.
For example, if an Australian subsidiary is funded by an overseas parent using debt instead of equity, the Australian subsidiary would get a tax benefit in the form of an interest tax deduction. This is compared with a dividend, for which the subsidiary would not get a deduction. In addition, the use of interest expenses is an effective means of shifting profits out of Australia at a tax rate of 10% instead of the 30% company tax rate (reduced to 28.5% from 1 July 2015 for most companies).
How we help
Assessing whether Thin Capitalisation applies to your business
Forecasting and planning around the maximum allowable debt amounts
Ongoing monitoring and calculation of maximum allowable debt
Who does Thin Capitalisation apply to?
Inbound entities coming into Australia; and
Outbound Australian entities that control entities overseas.
Thin Capitalisation does not apply to entities with interest expenses of no more than $250,000. Note that the Government has proposed that for income years starting on or after 1 July 2014 this de-minimis threshold will be raised to $2m, which should significantly reduce the compliance burden for small-medium enterprise. The rules also do not limit the debt deductions of outbound entities with at least 90% of its worldwide assets based in Australia.
What is its impact?
When it applies, thin capitalisation limits an entity’s debt deduction to a statutory ratio or amount. The maximum debt deduction can be worked out under the following calculation methods:
Safe harbour ratio
Arms-length debt amount
Worldwide gearing debt amount
Connection with Transfer Pricing
The Australian Tax Office has confirmed that even in the event that an entity’s debt do not exceed the Thin Capitalisation limits, the Transfer Pricing rules will still potentially have application.
