ato logo
Search Suggestion:

Amending Australia's interest limitation (thin capitalisation) rules

The Government announced it will strengthen the thin capitalisation rules.

Last updated 11 July 2023

On 25 October 2022, as part of the 2022–23 Budget, the government announced it would strengthen Australia's thin capitalisation rules. Changes will be made to align with the Organisation for Economic Co-operation and Development's (OECD) best practice approach (OECD BEPS Action 4). The changes will apply to income years commencing on or after 1 July 2023.

The amendments will apply to most multinational businesses operating in Australia currently subject to thin capitalisation with at least $2 million in debt deductions (on an associate inclusive basis).

Most multinational businesses will be 'general class entities'. General class entities will apply one of 3 new tests:

  • Fixed ratio test – an earnings-based ratio test consistent with the OECD’s best practice approach. This test will limit an entity’s net debt deductions to 30% of its tax earnings before interest, taxes, depreciation, and amortization (EBITDA). Under this new test, debt deductions exceeding the 30% EBITDA limit will be denied. Denied deductions can be carried forward and claimed in subsequent income years (subject to the 30% EBITDA limit each year), for a maximum of 15 years. This method is the default method unless a taxpayer makes a choice to use the other 2 methods.
  • Group ratio test – an earnings-based worldwide gearing ratio test consistent with the OECD’s best practice approach. This test will limit net debt deductions based on a ratio of the worldwide group’s net debt deductions and EBITDA. There is no carry forward of denied deductions under this method.
  • Third party debt test – limits an entity's debt deductions to those attributable to an entity’s external (or third party) debt deductions except for non-qualifying external debt deductions. Related party debt deductions are denied under this test. There is no carry forward of denied deductions under this method.

The current safe harbour test and worldwide gearing ratio test will be retained for entities classified as financial entities and authorised deposit-taking institutions (ADIs). The current arm’s length capital test will be retained for ADIs. Financial entities which are not ADIs can choose the new third party debt test, and the current arm’s length debt test for non-ADIs is repealed.

These rules are supported by anti-debt deduction creation rules that deny debt deductions arising in connection with relevant related party arrangements. These debt creation rules reduce the ability for multinational businesses with at least $2 million in debt deductions (on an associate inclusive basis) to create debt through internal transactions in order to utilise any additional debt deduction capacity under the above tests.

The BillExternal Link was introduced to parliament on 22 June 2023 but is not yet enacted.

For more information see:

QC70733