Foreign Controlled Australian Company
An Australian resident company is a foreign controlled Australian company if any of the following apply:
- A group of five or fewer foreign entities holds at least 50% in the Australian company.
- A single foreign entity holds at least 40% in the Australian company and no other entity (except for an associate entity) controls that Australian company.
- A group of five or fewer foreign entities, either alone or with associate entities, control the company.
If the entity is a foreign controlled Australian entity, it is subject to the thin capitalisation rules. Multinational businesses often finance their Australian business investments with large amounts of overseas debt instead of equity as it is more tax effective for the following reasons:
Subject to compliance with the thin capitalisation rules the interest expense is deductible against the Australian business’s profits. Each $1.00 of interest expense saves $0.275 or $0.30 in tax.
The interest expenses payable to non-residents is only subject to a final 10% withholding tax.
The ATO thin capitalisation rules:
- Define a thinly capitalised entity as one whose assets are funded by a high level of debt and relatively little equity. These are entities whose investments are funded by $3 of debt for every $1 of equity. Where the debt exceeds 75% of the net value of the investments, then part of the interest expense will be non-deductible.
- Exclude businesses that have foreign interest expense deductions of less than $2m per year.
- Exclude interest expenses incurred in relation to financing rental property investments. This means all rental property investments can be funded with 100% debt.
- Businesses that have foreign interest expense deductions of less than $2m per year are excluded from the thin capitalisation rules so should be financed with 100% overseas debt.
- Ensure the interest expense paid to overseas related parties is documented and arms-length.
- Foreign interest expense payments are subject to a final 10% withholding tax (which must be paid to the ATO before the foreign interest expense can be claimed as a tax deduction).
- Businesses financed with 100% overseas debt often end up with no Australian taxable income or tax liability after paying the foreign interest expense (so the ‘effective tax rate’ is 10% which is the withholding tax payable to the ATO)