Group ratio test

How the group ratio test works

An entity that is a general class investor for an income year may make a choice to apply the group ratio test in relation to that income year if it is a member of a GR group and the GR group EBITDA for the period is greater than zero.

For more information about how general class investors make a choice to apply a particular test, and the ordering of those choices, refer to procedure of choices.

As an alternative to the fixed ratio test, the group ratio test allows an entity in a sufficiently highly leveraged group to deduct more net debt deductions than the amount permitted under the fixed ratio rule, based on a ratio that relies on the group’s financial statement.

A modified definition of ‘associate entity’ also applies for the purpose of the group ratio test.

Amount of debt deductions disallowed under the group ratio test

If a choice has been made to apply the group ratio test, the amount of debt deductions disallowed for an income year is the amount by which the entity’s ‘net debt deductions’ exceed the entity’s group ratio earnings limit for the income year.

Calculating the group ratio earnings limit

• Step 1: Calculate your tax EBITDA.
• Step 2: Calculate your group ratio.
• Step 3: Multiply the result of step 2 by the result of step 1.

The calculation of an entity’s tax EBITDA for the purposes of the group ratio test is determined in the same manner as that required for the fixed ratio test.

Group ratio

An entity’s ‘group ratio’ for an income year is worked out according to the following steps:

Step 1: Work out the GR group net third party interest expense of the GR group.

Step 2: Work out the GR group EBITDA of the GR group.

Step 3: Divide the result of Step 1 by the result of Step 2. Subject to Step 4, the result of Step 3 is the entity’s group ratio for the income year.

Step 4: If the result of Step 2 is zero, the entity’s group ratio for the income year is zero.

GR Group net third party interest expense

The GR group net third party interest expense is the amount that would be the group’s financial statement net third party interest expense if the following amounts are treated as interest:

• an amount in the nature of interest
• any other amount that is economically equivalent to interest.

Financial statement net third party interest expense

The financial statement net third party interest expense of a GR group for the period is the net third party interest expense – taken from either the audited consolidated financial statements or the global financial statements (depending on whether the parent entity is a worldwide parent entity or global parent entity respectively) – reduced by the amount of a payment that is:

• relevant to working out the net third party interest expense and made to an associate entity; and
• made to a payee (entity) that is either:
  • a member of the GR group and the associate entity is not
  • not a member of the GR group and the associate entity is.

GR group EBITDA

The GR group EBITDA is relevant to calculating the group ratio earnings limit. The GR group EBITDA for a period is the sum of the GR group’s:

• net profit (disregarding tax expenses)
• adjusted net third party interest expense
• depreciation and amortisation expenses.

If a GR group member has an entity EBITDA less than zero, disregard that entity EBITDA in calculating the GR group EBITDA.

The entity EBITDA of an entity, for a period, is the sum of the entity's:

• net profit (disregarding tax expenses)
• adjusted net third party interest expense
• depreciation and amortisation expenses.

Adjusted net third party interest expense

The adjusted net third party interest expense is relevant in calculating the GR group EBITDA or an individual entity EBITDA. It is equal to the net third party interest expense of the GR group or entity, disregarding the following payments for:

• an entity, a payment that is made by
  • the entity to an associate entity of the entity
  • an associate entity of the entity to the entity
• a GR group, a payment that is made by
  • a GR group member of the GR group to an associate entity of any GR group member of the GR group
  • an associate entity of a GR group member of the GR group to any GR group member of the GR group.

In disregarding certain payments between associates, the adjusted net third party interest expense should only reflect amounts paid to third parties.

Meaning of GR group, GR group member and GR group parent

A GR group and GR group members are determined by reference to the composition of an accounting consolidated group that reports in audited consolidated financial statements or global financial statements.

If ‘audited consolidated financial statements’ have been prepared for a ‘worldwide parent entity’ for a period, the GR Group for that period will comprise of both:

• the worldwide parent entity
• each other entity that is fully consolidated on a line-by-line basis in those audited consolidated financial statements.

Each of the above entities is a GR group member for that period. The worldwide parent entity for the period is the GR group parent for the period.

An entity is a worldwide parent entity if the audited consolidated financial statements have been prepared in relation to that entity and, for the purposes of the standards in accordance with which the statements were prepared, the entity is not controlled by another entity.

If audited consolidated financial statements have not been prepared and 'global financial statements' have been prepared for a ‘global parent entity’ for a period, the GR Group for that period will comprise of both:

• the global parent entity
• each other entity that is fully consolidated on a line-by-line basis in those global financial statements.

Each of the above entities is a GR group member for that period. The global parent entity for the period is the GR Group parent for the period.

A global parent entity is an entity that is not controlled by another entity under accounting standards developed by the Australian Accounting Standards Board or otherwise in accordance with commercially accepted principles relating to accounting.

Meaning of audited consolidated financial statements

Financial statements will meet the definition of audited consolidated financial statements if they meet the following requirements:

• The statements have been prepared on a consolidated basis in relation to the entity and one or more other entities in accordance with either
  • recognised overseas accounting standards in the following foreign jurisdictions
    • the European Union
    • the United Kingdom
    • the United States of America
    • Canada
    • Japan
    • New Zealand
    • any other jurisdiction specified in a legislative instrument.
  • international financial reporting standards that are made or adopted by the International Accounting Standards Board.
• The statements have been audited in accordance with the law applicable either in the foreign jurisdictions noted above or another jurisdiction that has adopted international financial reporting standards adopted by the International Accounting Standards Board.
• One of the entities is a worldwide parent entity. An entity is a worldwide parent entity if the financial statements have been prepared in relation to that entity and, for the purposes of the standards in accordance with which the statements were prepared, the entity is not controlled by another entity.
• The statements are for the most recent period, ending no later than the end of the relevant period and no earlier than 12 months before the start of the relevant period.
• The statements show amounts relating to statement worldwide debt, statement worldwide equity and statement worldwide assets (as defined in section 820-933), however described, on a consolidated basis.

Meaning of global financial statements

Global financial statements for an entity for a period are financial statements that:

• have been prepared in accordance with accounting standards or other applicable authoritative pronouncements developed by the Australian Accounting Standards Board
• have been audited in accordance with auditing standards or other applicable authoritative pronouncements developed by the Auditing and Assurance Standards Board
• are for the most recent period ending no later than the end of the relevant period and no earlier than 12 months before the start of the relevant period.

If financial statements have not been prepared in accordance with the accounting standards and auditing standards referred to above, they can otherwise be prepared in accordance with commercially accepted principles relating to accounting and auditing that ensure that the statements give a true and fair view of the financial performance and position of the entity or that entity and the other entities on a consolidated basis.

For more information, see section 960-570 of the ITAA 1997.