THIN CAPITALISATION

Thin Capitalisation is the excessive use of debt finance compared to equity finance. For example, if an organisation were to have a debt to equity ratio 3:1 for every $3 of debt the entity is funded by $1 of equity.

The intention of Division 820 in the ITAA97 is to prevent multinational entities from shifting profits outside of Australia by funding their Australian operations with a high amount of debt finance in order to reduce their Australian tax liability.

The thin capitalisation rules act to limit the amount of debt deductions that an entity can otherwise deduct from their assessable income where the debt to equity ratios exceed the prescribed limits i.e. the entity is “thinly capitalised”.

Division 820 applies to foreign controlled Australian entities, Australian entities that operate internationally and foreign entities that operate in Australia.

Please note this Division does not apply to assets or non-debt liabilities that are held wholly or principally for private or domestic use.

A debt deduction is a cost incurred in connection with a debt that would otherwise be deductible (e.g. interest expense and borrowing costs), this specifically excludes salary or wages, rental expenses and foreign currency losses.

Debt deductions will be allowed if the total debt deductions for an entity and its associated entities does not exceed $2 million in an income year (from 1 July 2014, the previous threshold was $250,000).

The thin capitalisation rules will also not apply to outward investing Australian entities if at least 90% of their assets (including those of their associates) are Australian assets.

The application of the rules varies depending on the type of entity and whether they are inwards or outwards investors of Australia.

For a non-authorised deposit-taking institution (ADI) general entity, the following tests (among others) are available to determine the amount an entity’s debt deductions will need to be reduced by:

• Safe Harbour Debt Test

The amount of debt used to finance the Australian investments will be treated as excessive when it is greater than a debt to equity ratio of 1.5:1 or 3/5 (commencing from 1 July 2014).

•  Arm’s Length Debt Test

This is determined by analysing the entity’s activities and funding to determine the amount the entity could reasonably expect to borrow on arm’s length terms from a third party.

If you think you may be affected by the Thin Capitalisation rules and wish to discuss further, please contact our office.

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Q & A – EMPLOYEE TERMINATION PAYMENTS – THE TAX IMPLICATIONS OF REDUNDANCY

What is an Employee Termination Payment?

An Employee Termination Payment (ETP) is a lump sum payment made because your employment has finished with your employer. These payments have special tax treatments and can include the following:

• Payments for unused rostered days off;
• Payments in lieu of notice;
• A gratuity or ‘golden handshake’;
• Compensation payments i.e. for loss of job, personal injury, ill health.

However, for tax purposes, the following payments received will not be included in your termination payment as they will be included in your PAYG Payment Summary and taxed at your individual income tax rate:

• Lump sum payments for unused Annual or Long Service Leave
• Any salary or wages owing for work already completed
• The tax free part of any genuine redundancy payment

How are Employee Termination Payments Taxed?

ETP’s are taxed in special ways depending on the type of payment that has been received. The two different caps that apply to ETP’s are the ETP Cap and the Whole-of-Income Cap.

The ETP Cap

The ETP Cap is only used for ‘excluded payments’ (reasonably required payments by employers) that have been received which can include the following:

• Genuine Redundancy
• Early Retirement scheme’s
• Compensation Payments i.e. for injury, unfair dismissal, harassment.

ETP’s are taxed at a lower rate up to a certain limit which is called the cap. The cap increases every year and for the 2016-2017 financial year the ETP Cap is $195,000. The following rates apply:

The Whole-of-Income Cap

The Whole-of-Income Cap only applies to ‘non-excluded payments’ (unrequired payments received by employers) that include the following:

• Payments that do not meet genuine redundancy rules;
• Gratuities or Golden Handshakes;
• Payments for rostered days off or unused sick leave.

The Whole-of-Income Cap is $180,000 and is then further reduced by any taxable income received for the financial year. The following rates apply:

What happens to any accrued leave that I haven’t used yet?

If your employment is terminated and you have unused annual or long service leave, this may receive concessional tax treatment and be taxed at rates up to 32%. Depending on the type of termination, you may have to include any accrued leave payments in your Salary & Wages when completing your return. See the below table on how to treat any leave payments received:

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