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The choice of fixed accounting ratios as safe harbours in thin capitalisation rules - some guidance from commercial debt contracts

Published on 01 Apr 06 by "AUSTRALIAN TAX FORUM" JOURNAL ARTICLE

Thin capitalisation rules often contain safe harbour provisions specifying the maximum allowable debt in terms of simple accounting ratios such as debt to equity ratio or earnings ratio. The choices of which accounting ratios to use and what level to specify as safe harbours are important policy decisions. This paper argues that commercial debt contracts provide a useful reference point for policy makers making these decisions because lenders often use simple accounting ratios in these commercial debt contracts to limit the borrower’s debt capacity. The evidence from debt contracts in Australia, New Zealand and the US shows that, except for the interest coverage ratio used in the US rules, the current safe harbour ratios adopted by policy makers in all three countries appear to be consistent with the debt restrictions that borrowers are required to maintain commercially.

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Shee Boon LAW

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