Thin capitalisation and the global financial crisis

The thin capitalisation provisions broadly limit interest deductions for inbound and outbound investors that breach certain debt/equity ratios or other tests.

The laws apply to foreign-owned companies and Australian businesses investing overseas where foreign assets are more than 10 per cent of total assets. The thin capitalisation tax rules give companies a maximum debt–to-equity ratio of 3-to-1, meaning debt can be no greater than 75 per cent of the value of a company’s net assets. Interest repayments for debt above the cap are not tax-deductible.

Tax risk management requires a review of thin capitalisation provisions prior to year-end to ensure that there is not a risk of partial non-deductibility of interest and financing expenses.

For those forced to write-down assets impaired by the current downturn there could be an adverse consequence for companies subject to the thin capitalisation tax rules.

The rapid deterioration of the A$ may also have increased liabilities where denominated in a foreign currency and this could also impact the thin capitalisation calculation.

However, there are transitional provisions that were introduced to ensure taxpayers are not disadvantaged in determining their thin capitalisation position using AIFRS from 1 January 2005. The 4 year transitional window expires in the 2008/9 income year (for late balancing taxpayers the final year is 2007-2008). In this transitional period a company can choose to use AGAAP to calculate its thin capitalisation position.

The May 2008 Budget announcement indicated amendments would be introduced to allow departure from the current AIFRS accounting treatment in relation to certain intangible assets and to exclude both deferred tax assets and liabilities and surpluses in defined benefit superannuation funds from such calculations.

Where there was the potential to revalue assets under AGAAP this adjustment can also be made provided that all assets in an asset class are revalued.

Note, the deminimus threshold of interest/financing expenses of $250,000 per annum.

Where interest is paid to a non-resident, withholding tax shall still apply even if a deduction is denied under the thin capitalisation provisions.

Debt-for-equity conversions need to consider the commercial debt forgiveness rules. Equity injections also require careful consideration of tax loss rules.

Businesses need to review the ratios and the various optional methods now, anticipating any write-downs in the financial statements. If you require assistance please contact your usual Grant Thornton advisor or:

Mark Azzopardi
National Head of Tax
T  +61 3 8663 6000
E  mark.azzopardi@au.gt.com