Entities must consider whether their liabilities are debt or non-debt. Each impacts the thin capitalisation calculation differently.
We typically think of debt as liabilities used to finance business operations.
Trade creditors typically fail the debt test when they are settled in less than 100 days and are generally classified as non-debt liabilities.
However, some trade creditors exist for longer than 100 days. A 'clawback' rule deems trade creditors that are on issue for more than 100 days, but less than 180 days, to be treated like debt (i.e. cost-free debt capital).
But what about trade creditors that extend beyond 180 days (e.g. where there are further steps before the liability is payable)? Such arrangements are potentially treated like equity (i.e. neither a non-debt liability nor adjusted average debt). The same is true for other long-term, non-interest bearing debt.
Just as an entity will alter its thin capitalisation position if it recapitalises the business with equity, long-term non-interest bearing debt may achieve a similar outcome.
There are, of course, a number of tax issues that need to be considered (including transfer pricing). But this example is a timely reminder that when it comes to thin capitalisation, the classification of liabilities is not always as it first appears.