PCG 2018/1 – Thin cap rules for outward investing Australian bank’s – calculating their ‘adjusted average equity capital’

The Commissioner released Practical Compliance Guideline PCG 2018/1, on Wed 24.1.2018. It explains how the ATO will administer s820-300(3) of the ITAA 1997 (this is the thin capitalisation rule for outward investing banks/ADI’s and sits within Subdiv 820-D, which is the thin cap rules for outward investing entities).

This section (reproduced below):

1. Applies to outward investing banks (Authorised Deposit taking Institutions).
2. And denies Australian ‘debt deductions’ (viz: not ‘attributable’ to a foreign Permanent Establishment, where they would be counted towards its profit);
3. If it’s ‘adjusted average equity capital’ (see below) is less than the ‘minimum capital amount’ (as defined in s820-305).
4. The amount denied is determined by s820-325.

The definition of the ADI’s ‘adjusted average equity capital’, is define in ss(3) as, broadly

• The ADI’s ‘equity capital’ minus the ‘controlled foreign entity equity’.
• These are to be calculated as ‘averages’ under Subdiv 820-G.
• They also exclude exclude capital/equity attributed to foreign permanent establishments.

The ATO’s guidelines focus on 2 components of this formula:

• ADI equity capital attributable to an overseas PE; and
• controlled foreign entity equity attributable to an overseas PE.

The key feature of PCG 2018/1 is a “suggested proxy” for each attribution.

DATE OF EFFECT: income years commencing after 24 January 2018.

PCG 2018/1 was not previously released as a draft (although the ATO had earlier indicated that it would be).

28 January 2018

[ATO site: PCG 2018/1; LTN 16, 24/1/18; Tax Month January 2018]

SECT 820.300 – Thin capitalisation rule for outward investing entities (ADI)

Thin capitalisation rule

(1)  This subsection disallows all or a part of each * debt deduction of an entity for an income year (to the extent that it is not attributable to an * overseas permanent establishment of the entity) if, for that year:

         (a)  the entity is an * outward investing entity (ADI) (see subsection (2)); and

         (b)  the entity’s * adjusted average equity capital (see subsection (3)) is less than the entity’s * minimum capital amount (see section 820-305).

Note 1:       This Subdivision does not apply if the total debt deductions of that entity and all its associate entities for that year are $2 million or less, see section 820-35.

Note 2:       To work out the amount to be disallowed, see section 820-325.

Note 3:       For the rules that apply to an entity that is an outward investing entity (ADI) for only part of an income year, see section 820-330 in conjunction with subsection (2) of this section.

Note 4:       A consolidated group or MEC group may be an outward investing entity (ADI) to which this Subdivision applies: see Subdivisions 820-FA and 820-FB.

Outward investing entity (ADI)

(2)  The entity is an outward investing entity (ADI) for a period that is all or a part of an income year if, and only if, throughout that period, the entity is an * ADI to which at least one of the following paragraphs applies:

       (a)  the entity is an * Australian controller of at least one * Australian controlled foreign entity (not necessarily the same Australian controlled foreign entity throughout that period);

       (b)  the entity is an * Australian entity that carries on a * business at or through at least one * overseas permanent establishment (not necessarily the same permanent establishment throughout that period);

         (c)  the entity is:

                 (i)  an Australian entity; and

                 (ii)  an * associate entity of another entity that is an * outward investing entity (non-ADI) or an * outward investing entity (ADI) for that period.

Note:          To determine whether an entity is an Australian controller of an Australian controlled foreign entity, see Subdivision 820-H.

Adjusted average equity capital

(3)  The entity’s adjusted average equity capital for an income year is:

        (a)  the average value, for that year, of all the * ADI equity capital of the entity (other than ADI equity capital attributable to its * overseas permanent establishments); minus

         (b)  the average value, for that year, of all the * controlled foreign entity equity of the entity (other than controlled foreign entity equity attributable to its overseas permanent establishments).

Note:          To calculate an average value for the purposes of this Division, see Subdivision 820-G.

(4)  For the purposes of paragraph (3)(a), treat treasury shares (within the meaning of * accounting standard AASB 132) in the entity as included in the * ADI equity capital of the entity, to the extent that those shares are part of the entity’s eligible tier 1 capital (within the meaning of the * prudential standards).