Private ruling: The application of the thin capitalisation rules to Company A
Date of advice: 30 May 2019
Published: July 2019
Ruling period: Income year ended 31 December20XX

Ruling: Q1: Does subsection 820-85(1) of the Income Tax Assessment Act 1997 (ITAA 1997) disallow any debt deductions of Company A? | A1: No | Q2: Does subsection 820-185(1) of the ITAA 1997 disallow any debt deductions of Company A? | A2: Yes

Relevant facts and circumstances: Company A is an Australian incorporated company. Company A's issued capital is held by three shareholders: · Foreign Company B - holding 40% of ordinary shares · Foreign Company C - holding 20% of ordinary shares · Trustee D - holding 40% of ordinary shares Foreign Company B and Foreign Company C together hold 60% of paid-up share capital, voting rights and rights to distributions in Company A. Neither company is a 'resident of Australia' for the purposes of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936). Company A is not: · an 'insolvency-remote special purpose entity' for the purposes of paragraph 820-39(3)(c) of the Income Tax Assessment Act 1997 (ITAA 1997); · a resident of a country other than Australia for the purpose of any of Australia's double tax agreements; · an authorised deposit taking institution (ADI) for the purposes of the Banking Act 1959 ; · a registered corporation under the Financial Sector (Collection of Data) Act 2001 ; · the 'responsible entity' of a 'managed investment scheme' registered under the Corporations Act 2001 ; or · established for the purpose of acquiring, funding and holding assets of a kind referred to in paragraph 820-942(3)(b) of the ITAA 1997. Company A is not carrying on a business of dealing in securities or derivatives. Company A does not carry on any business outside Australia and does not have any agents outside Australia. Company A also does not: · use any equipment or machinery outside Australia (including the installation of such equipment or machinery); · engage in any construction projects outside Australia; · engage in selling goods where those goods are manufactured, assembled, processed, packed or distributed in another country. Assets, liabilities and equity of Company A Company A provided facts concerning the company's assets, liabilities and equity including that: · Company A does not have any assets used, or held for use, wholly or principally for private and domestic purposes. · Company A does not have any liabilities that are wholly or principally of a private or domestic nature. Company A's rights and control in other entities Company A does not hold, and is not entitled to acquire, any of the following: · shares in any companies; · rights or interests in any companies other than shares. Company A is not entitled to a share of the income or corpus of any trusts and is not entitled to acquire such a share. Company A is not a partner of any partnerships and does not otherwise have or hold: · control of any voting power in any partnerships; · an interest in the assets or capital contributed to any partnerships; · any rights to the distribution of capital, assets or profits of a partnership; or · a right to acquire any of the abovementioned interests or rights in a partnership. There are no entities (including through directors, partners, trustees, or members of committees of management) that are accustomed to, obligated to, or otherwise might reasonably be expected to act in accordance with the directions, instructions or wishes of Company A in relation to: · The distribution or retention of that entity's profits; or · The financial policies relating to that entity's assets, debt capital or equity capital. There are no individuals that are accustomed to, obligated to, or otherwise might reasonably be expected to act in accordance with the directions, instructions or wishes of Company A in relation to their financial affairs. Rights and control that other entities have in Company A Company A and its directors are not accustomed to, obligated to, and could not reasonably be expected to act in accordance with the directions, instructions or wishes of any entity in relation to: · The distribution or retention of Company A's profits; or · The financial policies relating to Company A's assets, debt capital or equity capital No single entity holds, or is entitled to acquire, any of the following: · 50% or more of the total paid-up share capital of Company A · 50% or more of the total rights of shareholders to vote, or participate in any decision-making, concerning: o distributions of capital or profits of Company A o the constituent document of Company A, or o any variations of the share capital of Company A, or · 50% or more of the total rights to distributions of capital or profits of Company A (either as part of a winding up or otherwise) Other relevant facts Company A uses the 'opening and closing balances method' of averaging values under Subdivision 820-G of the ITAA 1997. Company A's maximum allowable debt for the income year ending 31 December 20XX under subsection 820-190(1) of the ITAA 1997 is not the arm's length debt amount or the worldwide gearing debt amount.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 6 | Income Tax Assessment Act 1936 Part X | Income Tax Assessment Act 1936 Section 317 | Income Tax Assessment Act 1936 Section 336 | Income Tax Assessment Act 1936 Section 350 | Income Tax Assessment Act 1936 Section 351 | Income Tax Assessment Act 1997 Division 820 | Income Tax Assessment Act 1997 Section 820-39 | Income Tax Assessment Act 1997 Section 820-40 | Income Tax Assessment Act 1997 Section 820-85 | Income Tax Assessment Act 1997 Section 820-185 | Income Tax Assessment Act 1997 Section 820-190 | Income Tax Assessment Act 1997 Section 820-195 | Income Tax Assessment Act 1997 Section 820-220 | Income Tax Assessment Act 1997 Section 820-583 | Income Tax Assessment Act 1997 Section 820-609 | Income Tax Assessment Act 1997 Section 820-610 | Income Tax Assessment Act 1997 Subdivision 820-G | Income Tax Assessment Act 1997 S ection 820-630 | Income Tax Assessment Act 1997 S ection 820-635 | Income Tax Assessment Act 1997 S ection 820-750 | Income Tax Assessment Act 1997 S ection 820-755 | Income Tax Assessment Act 1997 S ection 820-760 | Income Tax Assessment Act 1997 Section 820-780 | Income Tax Assessment Act 1997 Section 820-785 | Income Tax Assessment Act 1997 Section 820-790 | Income Tax Assessment Act 1997 Section 820-795 | Income Tax Assessment Act 1997 Section 820-815 | Income Tax Assessment Act 1997 Section 820-855 | Income Tax Assessment Act 1997 Section 820-860 | Income Tax Assessment Act 1997 Section 820-865 | Income Tax Assessment Act 1997 Section 820-870 | Income Tax Assessment Act 1997 Section 820-875 | Income Tax Assessment Act 1997 Section 820-905 | Income Tax Assessment Act 1997 Section 820-910 | Income Tax Assessment Act 1997 Section 820-915 | Income Tax Assessment Act 1997 Section 820-920 | Income Tax Assessment Act 1997 Section 820-942 | Income Tax Assessment Act 1997 Section 820-946 | Income Tax Assessment Act 1997 Subdivision 974-C | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Summary: No debt deductions of Company A are disallowed under subsection 820-85(1). | Detailed Reasoning - Detailed reasoning: No debt deductions of Company A will be disallowed under subsection 820-85(1) if the entity is not an 'outward investing entity (non-ADI)'. The relevant definition of the term 'outward investing entity (non-ADI)' is contained in subsection 820-85(2), which states: Outward investing entity (non-ADI) (2) The entity is an outward investing entity (non-ADI) for a period that is all or a part of an income year if, and only if, it is: (a) an *outward investor (general) for that period (as set out in items 1 and 3 of the following table); or (b) an *outward investor (financial) for that period (as set out in items 2 and 4 of that table). | Detailed Reasoning - then:: 1 the entity (the relevant entity ) is one or both of the following throughout a period that is all or a part of an income year: (a) an *Australian controller of at least one *Australian controlled foreign entity (not necessarily the same Australian controlled foreign entity throughout that period); (b) 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) the relevant entity is not a *financial entity, nor an *ADI, at any time during that period the relevant entity is an outward investor (general) for that period 2 the entity (the relevant entity ) satisfies this column in item 1 the relevant entity is a *financial entity throughout that period the relevant entity is an outward investor (financial) for that period 3 (a) the entity (the relevant entity ) is an *Australian entity throughout a period that is all or a part of an income year; and (b) throughout that period, the relevant entity is an *associate entity of another Australian entity; and (c) that other Australian entity is an *outward investing entity (non-ADI) or an *outward investing entity (ADI) for that period the relevant entity is not a *financial entity, nor an *ADI, at any time during that period the relevant entity is an outward investor (general) for that period 4 the entity (the relevant entity ) and another Australian entity satisfy this column in item 3 the relevant entity is a *financial entity throughout that period the relevant entity is an outward investor (financial) for that period Note: Sections 820-583, 820-609 and 820-610 contain other definitions of the term 'outward investing entity (non-ADI)', which are not relevant in the circumstances. Company A will therefore only be an outward investing entity (non-ADI) if it is an 'outward investor (general)' pursuant to items 1 or 3 of the table above or an 'outward investor (financial)' pursuant to items 2 or 4 of the table above. Outward investor (general): Item 1 of the table in subsection 820-85(2) In order to satisfy the criteria set out in item 1 of the table in subsection 820-85(2) for an income year, an entity must be one or both of the following in that year: (A) an 'Australian controller' of at least one 'Australian controlled foreign entity', or (B) an Australian entity that carries on a business at or through at least one 'overseas permanent establishment'. (A) Is Company A an 'Australian controller' of an 'Australian controlled foreign entity'? The term 'Australian controller' has three different definitions in sections 820-750, 820-755 and 820-760 depending on whether the entity being controlled is a 'controlled foreign company', a 'controlled foreign trust' or a 'controlled foreign corporate limited partnership'. An entity will only be an 'Australian controller' for the purposes of sections 820-750 or 820-755 if it holds a 'TC control interest' in a 'controlled foreign company' or 'controlled foreign trust' of at least 1% (the minimum is 10% in the case of paragraph (a) of section 820-750 and section 820-755). An entity will only be an 'Australian controller' for the purposes of section 820-760 if it holds a 'TC control interest' in a 'controlled foreign corporate limited partnership' of at least 10% or if it is a 'general partner' of the partnership. Relevantly, Company A is not a partner of any partnerships and so cannot be a 'general partner' for the purpose of the relevant definition of that term in subsection 995-1(1). TC control interest (section 820-815) An entity holds a 'TC control interest' in a company, trust or partnership, pursuant to subsection 820-815(1), equal to the total of the following interests: · the 'TC direct control interest' held by the entity in the company, trust or partnership (paragraph 820-815(1)(a)); · the 'TC indirect control interest' held by the entity in the company, trust or partnership (paragraph 820-815(1)(b)); and · the 'TC direct control interests' and 'TC indirect control interests' held by the entity's 'associate entities' in the company, trust or partnership (paragraph 820-815(1)(c) and paragraph 820-815(1)(d)). TC direct control interests held in companies, trusts and partnerships (paragraph 820-815(1)(a)) The term 'TC direct control interest' has three different definitions in sections 820-855, 820-860 and 820-865 depending on whether the interest is in a company, trust or partnership. Sections 820-855 and 820-860 provide that the 'TC direct control interest' an entity holds in a company or a trust is the percentage of the 'direct control interest' which that entity holds in the company or trust under modified provisions of Part X of the Income Tax Assessment Act 1936 (ITAA 1936). The relevant definitions of 'direct control interest' in Part X of the ITAA 1936 are contained in section 350 of the ITAA 1936 (for companies) and section 351 of the ITAA 1936 (for trusts). In the present circumstances the modifications of sections 820-855 and 820-860 include that subsections 350(6), 350(7), 351(3) and 351(4) of the ITAA 1936 do not apply. Company A does not hold, and is not entitled to acquire, any shares, rights or interests in any companies. As such, Company A does not hold a 'direct control interest' pursuant to section 350 of the ITAA 1936 in any companies. Company A is not entitled to, and is not entitled to acquire, a share of the income or corpus of any trusts. As such, Company A does not hold a 'direct control interest' pursuant to section 351 of the ITAA 1936 in any trusts. Consequently, Company A does not hold a 'TC direct control interest' under section 820-855 or section 820-860 in any companies or trusts. Section 820-865 determines whether an entity will hold a 'TC direct control interest' in a partnership. Company A is not a partner of any partnerships and does not otherwise have or hold: · control of any voting power in any partnerships; · an interest in the assets or capital contributed to any partnerships; · any rights to the distribution of capital, assets or profits of a partnership; or · a right to acquire any of the abovementioned interests or rights in a partnership. As such, Company A does not hold a 'TC direct control interest' under section 820-865 in any partnerships. TC indirect control interest in companies, trusts and partnerships (paragraph 820-815(1)(b)) The definition of the term 'TC indirect control interest' is contained in section 820-870. Pursuant to subsection 820-870(1), Company A will only hold a TC indirect control interest in a company, trust or partnership if there is one or more 'interposed entity' between Company A and the relevant company, trust or partnership. The term 'interposed entity' is not a defined term in the ITAA 1997. However, subsection 820-870(2) provides that a middle entity will be 'interposed' between 2 other entities if 'the first of those 2 entities' holds a 'TC control tracing interest' in that middle entity. In the present context, Company A is 'the first of those 2 entities' referred to in paragraph 820-870(2)(a) as its TC indirect control interests in companies, trusts and partnerships are being tested. Consequently, Company A will only hold a TC indirect control interest in an entity if it also holds a 'TC control tracing interest' in an interposed entity. TC control tracing interest (section 820-875) The term 'TC control tracing interest' is defined by section 820-875. As concluded above, Company A does not hold a TC direct control interest under sections 820-855, 820-860 or 820-865 in any companies, trusts or partnerships. Consequently, Company A does not hold any TC control tracing interest pursuant to subsection 820-875(1). Subsection 820-875(2) can also deem a TC control tracing interest in a company, trust or partnership in certain circumstances. In order to determine whether Company A has any TC control tracing interests under subsection 820-875(2), the following things must be considered: · Whether the total of TC direct control interests held by Company A and its 'associate entities' in any company, trust or partnership is more than 40% (or 50% for paragraph 820-875(2)(a)) · Whether Company A and its associate entities control any company, trust or partnership. There are no entities that might reasonably be expected to act in accordance with the instructions or wishes of Company A in relation to their financial policies (e.g. concerning profits, assets, debt capital or equity capital). As such, the Commissioner is satisfied that Company A will only hold a TC control tracing interest if it does so in connection with 'associate entities'. Interests held by associate entities (subsection 820-875(2)) The relevant definitions of 'associate entity' are contained in subsections 820-905(1), 820-905(2), 820-905(2A), 820-905(3A) and 820-905(3B). The definitions rely on the concept of holding an 'associate interest' which is also defined in section 820-905. Subsections 820-905(4), 820-905(5), 820-905(6) and 820-905(7) provide that the 'associate interest' an entity holds in a company or a trust is the percentage of the 'direct control interest' which that entity holds in the company or trust under modified provisions of Part X of the ITAA 1936. Company A does not hold an associate interest in any companies or trusts as it does not have a direct control interest in any company or trust (for the reasons provided above). Subsection 820-905(8) determines whether an entity will hold an 'associate interest' in a partnership. Company A does not hold an associate interest in any partnerships as it is not a partner of any partnerships and does not otherwise have or hold: · control of any voting power in any partnerships; · an interest in the assets or capital contributed to any partnerships; · any rights to the distribution of capital, assets or profits of a partnership; or · a right to acquire any of the abovementioned interests or rights in a partnership. Does Company A have any associate entities under subsection 820-905(1)? As established above, Company A does not have an associate interest in any other entities. There are also no entities (including through directors, partners, trustees, or members of committees of management) that are accustomed to, obligated to, or otherwise might reasonably be expected to act in accordance with the directions, instructions or wishes of Company A in relation to the relevant financial policies of that entity (including concerning the entity's profits, assets, debt and equity). Consequently, Company A does not have any associate entities under subsection 820-905(1). Does Company A have any associate entities under subsection 820-905(2)? There are no individuals that are accustomed to, obligated to, or otherwise might reasonably be expected to act in accordance with the directions, instructions or wishes of Company A in relation to their financial affairs. Consequently, Company A does not have any associate entities under subsection 820-905(2). Does Company A have any associate entities under subsection 820-905(2A)? As established above, Company A does not have an associate interest in any other entities. Consequently, Company A does not have any associate entities under subsection 820-905(2A). Does Company A have any associate entities under subsections 820-905(3A) or 820-905(3B)? Relevantly, Company A will only have associate entities under subsections 820-905(3A) and 820-905(3B) if it itself is an associate entity (of another entity) through the application of subsections 820-905(1), 820-905(2) or 820-905(2A). In respect of paragraph (a) of subsection 820-905(1), no single entity holds, or is entitled to acquire, 50% or more of: · Company A's paid-up share capital; · Company A's relevant decision-making rights (referred to in paragraph 350(1)(b) of the ITAA 1936), or · Company A's rights to distribution of capital or profits. Accordingly, there is no single entity holding a 'direct control interest' of 50% or more in Company A pursuant to the modified provisions of Part X of ITAA 1936 or an 'associate interest' of 50% or more in Company A for the purposes of paragraph 820-905(1)(a) and subsection 820-905(4). In respect of paragraph (b) of subsection 820-905(1), Company A and its directors are not accustomed to, obligated to, and could not reasonably be expected to act in accordance with the directions, instructions or wishes of any entity in relation to its financial policies (concerning its profits, assets, debt and equity). Accordingly, paragraph 820-905(1)(b) and subsection 820-905(1) do not apply. Company A is not an associate entity of any other entity under subsection 820-905(2) as it is not an individual. Company A is also not an associate entity of any other entity under subsection 820-905(2A) as it is not the 'responsible entity' of a 'registered scheme (being a 'managed investment scheme' registered under the Corporations Act 2001). Consequently, Company A will have no associate entities under subsections 820-905(3A) and 820-905(3B) as it is not an associate entity of any other entity under subsections 820-905(1), 820-905(2) or 820-905(2A). Conclusions on sections 820-905, 820-875 and 820-870 Company A has no 'associate entities' under the various definitions of that term in section 820-905. As such, Company A does not hold any 'TC control tracing interests' in other entities pursuant to section 820-875. This, in turn, means that Company A does not have a 'TC indirect control interest' in any entities for the purposes of section 820-870 due to absence of an 'interposed entity'. Conclusions on section 820-815 and whether Company A is an Australian controller Company A does not hold any TC direct control interests or TC indirect control interests in other entities. Company A also does not have any associate entities. Consequently, Company A does not hold any TC control interests in any other entity for the purposes of section 820-815. As Company A does not hold any TC control interests in other entities, it is not the 'Australian controller' of any entities for the purposes of sections 820-750, 820-755 and 820-760. (B) Does Company A carry on a business at or through at least one 'overseas permanent establishment'? The term 'overseas permanent establishment' is defined in subsection 995-1(1) to be a 'permanent establishment' of an entity that is in a country other than Australia. The relevant definition of 'permanent establishment' is contained in subsection 6(1) of the ITAA 1936. Company A does not carry on any business outside Australia and does not have any agents outside Australia. Company A also does not: · use any equipment or machinery outside Australia (including the installation of such equipment or machinery); · engage in any construction projects outside Australia; · engage in selling goods where those goods are manufactured, assembled, processed, packed or distributed in another country. As such, Company A does carry on a business at or through any 'permanent establishments' in a country other than Australia, or 'overseas permanent establishments', for the purposes of the definitions of those two terms in subsection 6(1) of the ITAA 1936 and subsection 995-1(1). Conclusion on Item 1 of the table in subsection 820-85(2) Company A is not an Australian controller of any Australian controlled foreign entity and does not carry on a business at or through any overseas permanent establishments. As such, Company A is not an 'outward investor (general)' under item 1 of the table in subsection 820-85(2). Outward investor (general): Item 3 of the table in subsection 820-85(2) As established above, Company A is not the associate entity of any other entity, and does not have any associate entities of its own, under subsections 820-905(1), 820-905(2) or 820-905(2A). As a result, Company A will not be the associate entity of any other entity under subsections 820-905(3A) and 820-905(3B). Company A will not be an 'outward investor (general)' under item 3 of the table in subsection 820-85(2) as it is not an 'associate entity' of any other entity. Outward investor (financial): Items 2 and 4 of the table in subsection 820-85(2) Items 2 and 4 of the table in subsection 820-85(2) have the same requirements (in the second column of that table) as Items 1 and 3 respectively. For the same reasons as given above, Company A will not be an outward investor (financial) under items 2 or 4 of the table in subsection 820-85(2). Conclusion Company A is neither an outward investor (general) nor an outward investor (financial). As such, Company A is not an 'outward investing entity (non-ADI)' for the purposes of subsection 820-85(2) and Division 820. No debt deductions of Company A are disallowed under subsection 820-85(1) as the company is not an outward investing entity (non-ADI). | Summary: Debt deductions of Company A are disallowed by subsection 820-185(1) as it is an inward investing entity (non-ADI) and the company's adjusted average debt exceeds its maximum allowable debt. | Detailed Reasoning - Detailed reasoning: Subsection 820-185(1) states: 820 - 185 Thin capitalisation rule for inward investing entities (non - ADI) Thin capitalisation rule (1) This subsection disallows all or a part of each *debt deduction of an entity for an income year if: (a) the entity is an *inward investing entity (non-ADI) for that year (see subsection (2)), but is not also an *outward investing entity (non-ADI) (see section 820-85) for all or any part of that year; and (b) for that year, the entity's *adjusted average debt (see subsection (3)) exceeds its *maximum allowable debt (see section 820-190). Debt deductions of Company A will therefore be disallowed if both paragraph 820-185(1)(a) and paragraph 820-185(1)(b) are satisfied. Paragraph 820-185(1)(a) The term 'inward investing entity (non-ADI)' is defined in subsection 820-185(2). Company A will only be an inward investing entity (non-ADI) if it is falls into one of the four classes of entity in that subsection, being: · inward investment vehicle (general) under item 1 of the table in subsection 820-185(2) · inward investment vehicle (financial) under item 2 of the table in subsection 820-185(2) · inward investor (general) under item 3 of the table in subsection 820-185(2) · inward investor (financial) under item 4 of the table in subsection 820-185(2) Inward investment vehicle (general): Item 1 of the table in subsection 820-185(2) In order to be an inward investment vehicle (general), an entity must be a 'foreign controlled Australian entity' that is neither a 'financial entity' nor an 'ADI'. Foreign controlled Australian entity The term 'foreign controlled Australian entity' is defined by section 820-780 to mean an entity that is a 'foreign controlled Australian company', a 'foreign controlled Australian trust' or a 'foreign controlled Australian partnership'. Only the definition of 'foreign controlled Australian company' is relevant as Company A is neither a trust nor a partnership (as required in section 820-790 and section 820-795 respectively). The relevant definition is contained in subsection 820-785(1), which states: 820 - 785 What is a foreign controlled Australian company? (1) A company (except a *corporate limited partnership) is a foreign controlled Australian company (or an FCAC ) at a particular time if, and only if, at that time, it is an *Australian entity to which at least one of the following paragraphs applies: (a) not more than 5 *foreign entities (each of which holds a *TC control interest in the company that is at least 1%) hold a total of TC control interests in the company that is 50% or more; (b) a foreign entity holds a TC control interest in the company that is 40% or more, and no other entity or entities (except an *associate entity of the foreign entity or entities including the foreign entity or its associate entities) control the company; (c) not more than 5 foreign entities control the company (whether or not with associate entities and whether or not any associate entity is a foreign entity). The term 'Australian entity' is defined in section 336 of the ITAA 1936 to include a 'Part X Australian resident'. In broad terms, the phrase 'Part X Australia resident' is defined by subsection 317(1) of the ITAA 1936 to be a 'resident' (for the purpose of section 6 of the ITAA 1936) that is not also treated solely as a resident of another country for the purposes of one of Australia's double tax agreements. Company A is a 'resident' within the meaning of section 6 of the ITAA 1936 as it is 'a company which is incorporated in Australia'. In addition, Company A is not resident of a country other than Australia for the purpose of any of Australia's double tax agreements. Consequently, Company A is both a 'Part X Australia resident' and an 'Australian entity'. The term 'foreign entity', as used in subsection 820-785(1), is defined by subsection 995-1(1) as an entity that is not an 'Australian entity'. Company A's issued capital is made up of 1,000 ordinary shares and held by three shareholders: · Foreign Company B - holding 40% of ordinary shares · Foreign Company C - holding 20% of ordinary shares · Trustee D - holding 40% of ordinary shares Foreign Company B and Foreign Company C are both companies that are not 'residents' for the purposes of section 6 of the ITAA 1936. Consequently, these two shareholders will not be Part X Australian residents under subsection 317(1) of the ITAA 1936 and will not be Australian entities under section 336 of the ITAA 1936. Instead, both Foreign Company B and Foreign Company C are foreign entities. In respect of paragraph 820-785(1)(a), Foreign Company B and Foreign Company C hold a 'direct control interest' in the same proportion as their shareholding consistent with paragraph 350(1)(a) of the ITAA 1936. Consequently, the two companies hold a 'TC direct control interest' and a 'TC control interest' in those same proportions for the purposes of sections 820-855 and section 820-815 respectively. Company A is therefore a foreign controlled Australian company pursuant to subsection 820-785(1) as it is an Australian entity in which two foreign entities (Foreign Company B and Foreign Company C) hold a total of TC control interests of 60%. In addition, the exception in subsection 820-785(2) does not apply as the two relevant shareholders of Company A hold TC direct control interests rather than holding a TC control interest pursuant to subsection 820-875(2). Financial entity or ADI The definition of 'financial entity' is contained in subsection 995-1(1). For the purposes of that definition, Company A is not: · a 'registered corporation' pursuant to the Financial Sector (Collection of Data) Act 2001 · a 'securitisation vehicle' pursuant to subsection 820-942(2) (as it was not established for the purpose of acquiring, funding and holding assets referred to in paragraph 820-942(3)(b)) · an entity that '...carries on a business of dealing in securities...' · an entity that '...carries on a business of dealing in ... derivatives...' Consequently, Company A is not a financial entity. Company A is also not an 'ADI' (being an 'authorised deposit taking institution' for the purposes of the Banking Act 1959 ). Conclusion: Paragraph 820-185(1)(a) Company A is a foreign controlled Australia entity that is neither a 'financial entity' nor an 'ADI'. Consequently, Company A is both an inward investment vehicle (general) and an inward investing entity (non-ADI) under subsection 820-185(2). Consistent with the analysis in Question 1, Company A is not also an outward investing entity (non-ADI) for its income year ended 31 December 20XX. As Company A is an inward investing entity (non-ADI) but not also an outward investing entity (non-ADI) for its income year ended 31 December 20XX, paragraph 820-185(1)(a) is satisfied. Paragraph 820-185(1)(b) Paragraph 820-185(1)(b) will be satisfied, for Company A's income year ended 31 December 20XX, if the company's 'adjusted average debt' (under subsection 820-185(3)) exceeds it's 'maximum allowable debt' (under section 820-190). Under subsection 820-190(1), the 'maximum allowable debt' of an entity is the greatest of the relevant 'safe harbour debt amount', 'arm's length debt amount' and 'worldwide gearing debt amount'. In this case, Company A's maximum allowable debt for the income year ending 31 December 20XX is neither the 'arm's length debt amount' nor the 'worldwide gearing debt amount'. As such, Company A's maximum allowable debt for that income year is equal to the 'safe harbour debt amount'. The 'safe harbour debt amount' for Company A, being an inward investment vehicle (general), is given by section 820-195. Valuation under Division 820 (Subdivision 820-G) The definitions of 'adjusted average debt' under subsection 820-185(3) and 'safe harbour debt amount' in section 820-195 refer to the 'average value' of certain matters. Average values are calculated under Subdivision 820-G for the purposes of Division 820. There are three methods for averaging values set out by Subdivision 820-G. Company A uses the 'opening and closing balances method' of averaging values pursuant to sections 820-630 and 820-635. Section 820-635 states: 820 - 635 The opening and closing balances method An entity that uses the opening and closing balances method for a period must apply the following method statement to calculate the average value of a matter for that period. Method statement Step 1. Work out the value of the particular matter as at the first day of that period. Step 2. Work out the value of the particular matter as at the last day of that period. Step 3. Add the results of steps 1 and 2. Step 4. Divide the result of step 3 by 2. The result of this step is the average value. Consequently, Company A must determine the average values of particular matters for the year ended 31 December 20XX by adding the value of that matter on the first day of the income year to the value of that matter on 31 December 20XX and dividing by 2. Adjusted average debt The relevant definition of 'adjusted average debt' is contained in subsection 820-185(3), which states: Adjusted average debt (3) The entity's adjusted average debt for an income year is the result of applying the method statement in this subsection. Method statement Step 1. Work out the average value, for that year (the relevant year ), of all the *debt capital of the entity that gives rise to *debt deductions of the entity for that or any other income year. Step 2. Reduce the result of step 1 by the average value, for the relevant year, of: (a) if the entity is an *inward investment vehicle (general) or an *inward investment vehicle (financial) for that year-all the *associate entity debt of the entity; or (b) if the entity is an *inward investor (general) or an *inward investor (financial) for that year-all the associate entity debt of the entity, to the extent that it is attributable to the entity's *Australian permanent establishments. Step 3. If the entity is a *financial entity throughout the relevant year, add to the result of step 2 the average value, for the relevant year, of the entity's *borrowed securities amount. Step 4. Add to the result of step 3 the average value, for the relevant year, of the *cost-free debt capital of the entity. The result of this step is the adjusted average debt . Note: To calculate an average value for the purposes of this Division, see Subdivision 820-G. In relation to step 1, all of the non-current liabilities of Company A are 'debt capital' as defined under subsection 995-1(1) and give rise to 'debt deductions' for the purposes of section 820-40. Company A has no other 'debt capital' as defined under subsection 995-1(1). In relation to step 2, an entity will only have 'associate entity debt' under the definition of that term in section 820-910 if that entity has one or more 'associate entities'. As Company A does not have any associate entities (see the reasoning above), it does not have any associate entity debt. Step 3 does not apply in this case as Company A is not a 'financial entity' for the reasons given above. In relation to step 4, an entity will only have 'cost-free debt capital' under the definition of that term in section 820-946 if that entity has issued debt interests that do not give rise to any cost, at any time, that is covered by paragraph 820-40(1)(a). In this case, all of Company A's debt capital (being debt interests issued by Company A that are still on issue) give rise to 'debt deductions' for the purposes of section 820-40 and so will necessarily involve costs covered by paragraph 820-40(1)(a). As such, Company A does not have any cost-free debt capital. Safe harbour debt amount Section 820-195 states: 820 - 195 Safe harbour debt amount-inward investment vehicle (general) If the entity is an *inward investment vehicle (general) for the income year, the safe harbour debt amount is the result of applying the method statement in this section. Method statement Step 1. Work out the average value, for the income year, of all the assets of the entity. Step 1A. Reduce the result of step 1 by the average value, for that year, of all the *excluded equity interests in the entity. Step 2. Reduce the result of step 1A by the average value, for that year, of all the *associate entity debt of the entity. Step 3. Reduce the result of step 2 by the average value, for that year, of all the *associate entity equity of the entity. Step 4. Reduce the result of step 3 by the average value, for that year, of all the *non-debt liabilities of the entity. If the result of this step is a negative amount, it is taken to be nil. Step 5. Multiply the result of step 4 by 3/5. Step 6. Add to the result of step 5 the average value, for that year, of the entity's *associate entity excess amount. The result of this step is the safe harbour debt amount . In relation to step 1A, an equity interest will be taken not to be an 'excluded equity interest' in an entity under the definition of that term in section 820-946 if the total period for which that equity interest remains on issue is 180 days or more. In this case, there were no changes to the 'equity interests' (as defined by Subdivision 974-C) issued by Company A between xx xx 20XX and 1 January 20XX. As such, none of the equity interests issued by Company A were excluded equity interests at the beginning or the end of the income year as all interests had remained on issue for at least 180 days at those two dates. In relation to step 2, Company A does not have any associate entity debt for the reasons given above. In relation to step 3, an entity will only have 'associate entity equity' under the definition of that term in section 820-915 if that entity has one or more 'associate entities'. As Company A does not have any associate entities (see the reasoning above), it does not have any associate entity equity. In relation to step 4, Company A's current liabilities balance is Company A's 'non-debt liabilities' as defined by subsection 995-1(1) in this case. In relation to step 6, an entity will only have an 'associate entity excess amount' under the definition of that term in section 820-920 if that entity has one or more 'associate entities'. As Company A does not have any associate entities (see the reasoning above), it does not have any associate entity excess amount. Conclusion: Paragraph 820-185(1)(b) Company A's adjusted average debt exceeds the maximum allowable debt (being the safe harbour debt amount) for the income year ended 31 December 20XX. Consequently, paragraph 820-185(1)(b) is satisfied in respect of Company A's income year ended 31 December 20XX. Conclusion Debt deductions of Company A are disallowed by subsection 820-185(1) as both paragraph 820-185(1)(a) and paragraph 820-185(1)(b) are satisfied.

Reasons for decision: All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise noted.