ON Wed 1.8.2018, the ATO issued two draft Determinations to help non-ADI entities make the relevant ‘thin capitalisation’ calculations in Div 820 of the ITAA97.
At its most basic, thin capitalisation involves taking average debt and asset values for the year, to assess whether there is too much debt, so that ‘thin capitalisation’ provisions are activated, to deny a proportion of the ‘debt deductions’.
Then, one has to know what those ‘debt deductions’ are, as a proportion of them may not be deductible.
Also, these two concepts overlap, as part of the process is calculating the ‘adjusted average debt’ and that must include all of the ‘debt capital’ that gives rise to that entity’s ‘debt deductions’.
TD 2018/D4 explains how ‘debt capital’ is valued when assessing debt to equity ratios, over the relevant year.
In this draft determination, the Commissioner reminds taxpayers that s820-680(1)(b) requires an entity to comply with the accounting standards in calculating ‘the value of its liabilities (including its *debt capital)’.
The problem is that thin capitalisation (and the relevant definition of ‘debt capital’) works on ‘debt interests’ issued by the taxpayer, which (under Div 974-B) can be legal form debt, equity or hybrids. The accounting standards, of course, don’t group these all under the one set of rules, creating conceptual and practical difficulties.
In this draft determination, however, the Commissioner is not relenting from having all ‘debt interests’ included and all valued under the accounting standards, whether they are legal form debt, equity or hybrids.
TD 2018/D5 considers the type of costs that are ‘debt deductions’
The meaning of ‘debt deductions’ is dealt with in s820-40 of the ITAA 1997. Subsection ss(1)(a)(i)&(ii) includes the direct cost of the financial accomodation – typically interest or a discount economic equivalent. These amounts are likely to vary with the length of the loan or other ‘debt interest’.
Subsection (1)(a)(iii) includes costs more likely to be fixed, namely: “any amount directly incurred in obtaining or maintaining the financial benefits [typically the use of money advanced] received, or to be received, by the entity under the scheme giving rise to the debt interest“.
The ATO’s preliminary view is that s 820-40(1)(a)(iii) applies to the following costs:
(a) tax advisory costs incurred in relation to the debt capital, which relate to activities including, but not limited to, agreement drafting and valuation of the debt capital;
(b) establishment fees;
(c) fees for restructuring a transaction;
(d) stamp duties;
(e) regulatory filing fees (for example Australian Securities and Investments Commission lodgement fees);
(f) legal costs of preparing documentation associated with the debt capital; and
(g) costs to maintain the right to draw down funds.
- A lot of this is not ‘rocket science’ as ss(2)(c) of s820-40 expressly includes:
a fee or charge in respect of a debt, including application fees, line fees, service fees, brokerage and stamp duty in respect of document registration or security for the debt interest.
‘Tax advisory costs’ stands out as the only one not mentioned in the Explanatory Memorandum to the Act for this provision.
The ATO also accepts that such costs can be incurred before or after the establishment of the debt capital.
PROPOSED DATE OF EFFECT: both before and the date of issue of the final Determinations.
COMMENTS are due by 31 August 2018.
FJM 19.8.18
[LTN 146, 1/8/18; KPMG, 2/8/18; PwC Article on these draft TDs; Tax Month – August 2018]
Comprehension questions (answers available)
- Are these draft determinations about ‘thin capitalisation’?
- Is ‘thin capitalisation’ about denying a proportion of ‘debt deductions’, to the extent that the average level of ‘debt capital’ exceeds one of the relevant benchmarks (as too much debt can still erode the Australian tax base – even if all transfer pricing tests were satisfied)?
- Does D4 say that in valuing ‘debt capital’, the value of ‘debt interests’ is set, by the accounting standards (under s820-680(1)(b)), but only for legal form debt?
- Does the Commissioner’s list of ss(1)(iii) fixed cost ‘debt deductions’ only include those expressly mentioned in ss(2)(c)?
