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Thin capitalisation: Have you correctly identified your debt deductions?

Have you correctly identified your debt deductions?

Jenny Wong looks at an ATO ruling affecting cross border finance confirming the commissioner's views on what types of costs are debt deductions that are subject to the thin capitalisation calculations.

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Jenny Wong

Director, Australian Tax Centre

KPMG Australia

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It is important to review what you are claiming in relation to cross border debt arrangements.

The Australian Taxation Office (ATO) has finalised another ruling affecting cross border finance confirming the ATO’s views on what types of costs are debt deductions that are subject to the thin capitalisation calculations under Division 820 of the Income Tax Assessment Act 1997 (ITAA 97).

Although interest expense is typically the largest component of debt financing that can be caught within Australia’s thin capitalisation regime, there will be other costs associated with debt financing that will be caught. TD 2019/12 released 17 July 2019, sets out the ATO’s views on this issue.

Under Australia’s thin capitalisation rules, a taxpayer (not a financial institution) generally needs to work out its ‘adjusted average debt’ and this includes all of its debt capital that gives rise to ‘debt deductions’. It then compares this adjusted average debt to the maximum allowable debt and if the adjusted average debt is greater than the maximum allowable debt then a proportion of ‘debt deductions’ are denied as a deduction. Thus, it is important to firstly work out what debt capital gives rise to ‘debt deductions’.

The provision that defines debt deductions is section 820-40 of the ITAA 97. In addition to the usual interest expenses, a debt deduction includes a cost that is:

“any amount directly incurred in obtaining or maintaining the financial benefit received, or to be received, by the entity under the scheme giving rise to a debt interest”.

TD 2019/12 provides examples of costs with this scope and includes “costs of tax advisory services giving rise to or in connection with the debt capital, including but not limited to, drafting of agreements and valuing for and/or pricing of the debt capital”. 

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