Legislation has recently been introduced effective for
income years commencing on or after 1 July 2014 (the 30 June 2015 tax year for 30 June taxpayers) which amend the thin capitalisation rules such that:
- the maximum statutory debt limit (safe harbour debt limit) has been reduced from 3:1 to 1.5:1 (on a debt-to-equity basis) for general entities and from 20:1 to 15:1 for non-bank financial entities;
- the “outbound” worldwide gearing ratio has been reduced from 120 per cent to 100 per cent with an equivalent adjustment to the worldwide capital ratio for authorised deposit-taking institutions (ADIs) (broadly banks);
- the safe harbour capital limit for ADIs increases from 4 per cent to 6 per cent of their risk weighted Australian assets;
- the de minimis threshold increases from $250,000 to $2 million of debt deductions to minimise compliance costs for small businesses; and
- a new “inbound” worldwide gearing debt test is introduced. This test imports the commercial limits of the financial markets to gearing, and mirrors market outcomes for business that, as a whole, have naturally higher gearing levels. This will provide a further option to inward investing entities, where they do not fall within the safe harbour limit, and do not meet the arm’s length debt test. To minimise compliance costs, this test will utilise the audited consolidated financial statements that are already required to be prepared by the worldwide parent entity.
Broadly, the thin capitalisation rules apply to Australian entities which are either foreign controlled (50% or more foreign ownership) or itself controls foreign entities or has an overseas permanent establishment and the value of the foreign assets exceed 10% of the total assets of the Australian entity. Where the thin capitalisation rules apply to an Australian entity a deduction is denied for “debt deductions” (broadly interest and other borrowing costs) where the debt exceeds the relevant ratio or test applying to the entity. Where the debt limitation is exceeded a deduction is denied for the debt deductions on the excess debt.
Implications for Clients
While the changes represent a tightening of the restrictions regarding the level of debt to equity an entity is permitted to hold, the increases in the de minimus threshold will mean that many small to medium sized businesses will no longer be subject to the thin capitalisation rules. For example, the de minimus threshold of $2 million in debt deductions translates into an interest bearing debt of $20,000,000 (at a 10% interest rate) or $26,666,666 (at an interest rate of 7.5%).
If you require any further information of how this new legislation will affect you, please contact your Blaze Acumen advisor.