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Australia: Thin capitalisation, correctly identifying debt deductions

Australia: Thin capitalisation, debt deductions

The Australian Taxation Office (ATO) 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).

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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. The ATO ruling—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.” The taxpayer 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 critical to determine 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.”

The ruling (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.”
 

Read a July 2019 report prepared by the KPMG member firm in Australia

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