Thin Capitalisation

The thin capitalisation regime is an integrity measure. The intention is to prevent cross-border profit-shifting within multinational groups which may otherwise occur through groups financing their Australian operations with uncommercially high debt levels. The thin capitalisation rules operate by setting a maximum limit on the amount of debt (and a minimum level of equity) that can be used to finance the Australian operations of a multinational business.

Broadly speaking, Australia’s thin capitalisation rules impose restrictions on the deductibility of interest based on a taxpayer’s debt to equity ratio. The thin capitalisation rules aim to prevent the allocation of excessive interest bearing, tax deductible debt to Australian operations.

The thin capitalisation provisions are contained in div 820 of ITAA 1997. The provisions operate to disallow certain “debt deductions” where an entity is thinly capitalised. Put simply, Australia has imposed a 3:1 debt to equity ratio, meaning that at least 25 per cent of an asset’s value should be financed with equity and no more than 75 per cent of that value should be financed with debt.

The thin capitalisation rules apply to “entities” which include individuals, companies, trusts and partnerships. However, in order for the thin capitalisation rules to apply, the entity must be either an inward investing or an outward investing entity. Therefore, the thin capitalisation provisions will not apply to an entity that does not fall into either of these categories.

In addition to this, there is a de minimis exception.

Where the thin capitalisation provisions would otherwise apply, there are two general exceptions:

1. Pursuant to s 820-35 the thin capitalisation provisions do not operate in relation to a taxpayer for an income year where the aggregate debt deductions of the taxpayer and all of the taxpayer’s “associate entities” for that year are $250,000 or less.
2. Provided the taxpayer is not foreign controlled, the thin capitalisation provisions will also not apply, by virtue of s 820-37, for an income year in which the average Australian assets of the taxpayer, together with those of each of the taxpayer’s associates are at least 90 per cent of the average total assets of the taxpayer together with those of each of its associates.

All representations and information on this site is general in nature and should not be relied upon as advice.  If you require specific advice please contact us.