About the rules
Under the thin capitalisation rules, the debt deductions of certain foreign entities investing into Australia, Australian entities that are foreign controlled, and Australian entities investing overseas are limited.
A debt deduction is an expense an entity incurs including interest, an amount in the nature of interest, or any other amount that is economically equivalent to interest, where the expense is otherwise deductible if the thin capitalisation rules are disregarded.
The thin capitalisation rules apply to:
- Australian entities with specified overseas investments
- Australian entities that are foreign controlled
- foreign entities with certain investments in Australia, regardless of whether they hold the investments directly or through Australian entities.
The thin capitalisation rules do not apply to an entity for an income year if:
- the total debt deductions of the entity and all its associate entities for that year are $2 million or less.
- the entity is an Australian entity with overseas operations or investments, or an associate of such an entity, that is not also foreign controlled, and meets the assets threshold test
- the entity is an insolvency-remote special purpose entity established to manage certain risks and the total value of debt interests in the entity is at least half of the total value of its assets.
Who is affected
The thin capitalisation rules affect:
- Australian entities with certain overseas operations, and their associate entities
- Australian entities that are foreign controlled
- foreign entities with operations or investments in Australia.
For income years that commence on or after 1 July 2023, affected entities that are not financial entities or authorised deposit-taking institutions for a period that is all of part of the income year, will be classified as general class investors.
The previous law continues to apply for entities that are Australian plantation forestry entities for a period that is all or part of the income year.
The thin capitalisation rules can apply to companies, trusts, partnerships, unincorporated bodies and individuals.
An Australian entity may be affected by the thin capitalisation rules if it is any of the following. An:
- Australian controller of an Australian controlled foreign entity
- entity that carries on business through an overseas permanent establishment, such as a branch
- associate entity of either of the above.
An Australian controller includes:
- an Australian entity holding a thin capitalisation control interest in an Australian controlled foreign entity of at least 10%
- an Australian entity that holds a thin capitalisation control interest of at least 1% in a controlled foreign company (except a corporate limited partnership) and is one of 5 or fewer Australian entities that, together with associate entities, control the foreign company
- an Australian entity that is a general partner of a controlled foreign corporate limited partnership.
An example of an Australian controller is an Australian company that has a 51% shareholding in a New Zealand company. See Control of your entity.
An entity may also be affected by the thin capitalisation rules if it is either of the following:
- an Australian entity controlled by a foreign entity; that is, a foreign controlled Australian entity
- a foreign entity (the thin capitalisation rules only affect those with Australian income-producing assets).
An example of the first type entity is an Australian company that is a subsidiary of a United States company. An example of the second type of entity is a foreign entity that owns a rental property located in Australia or a foreign entity that has a permanent establishment in Australia.
Associate entities
The thin capitalisation rules also affect associate entities of Australian entities with certain overseas operations. An associate entity is an entity (Entity A) that is an associate of another entity (Entity B) under section 318 of the Income Tax Assessment Act 1936 (ITAA 1936), and at least one of the following apply:
- Entity B holds an interest of 50% or more in Entity A
- Entity A (either directly or indirectly) is accustomed, under an obligation, or reasonably expected to act in accordance with the directions, instructions or wishes of Entity B in relation to whether Entity A retains or distributes its profits or its financial policies.
For more information about the meaning of associate entity, see Terms we use.
If Entity A is an associate entity of Entity B, Entity B is automatically an associate entity of Entity A. If 2 separate entities are both associate entities of the same entity, they are also associate entities of each other. An example of this is 2 companies that are subsidiaries of the same parent company. As they are both associate entities of the parent company, they are also associate entities of each other.
There are additional special rules to deal with financing arrangements between associate entities that are not grouped.
Who is not affected
For any given income year, the following entities are not affected by the thin capitalisation rules:
- an entity whose debt deductions, together with those of any associate entities, are less than the de-minimis threshold of $2 million for the income year (see section 820-35 of the ITAA 1997)
- an Australian resident entity that is neither foreign controlled nor has any overseas operations or investments (unless it is an associate of another Australian entity that does)
- a foreign entity that has no investment or presence in Australia
- an Australian entity with overseas operations or investments, or an Australian entity that is an associate of such an entity that is not also foreign controlled and that meets the Australian assets threshold test. This is explained further in section 820-37 of the ITAA 1997.
Certain special purpose entities are also excluded where all of the following apply:
- The entity is established for the purposes of managing some or all of the economic risk associated with assets, liabilities or investments.
- The total value of debt interests in the entity is at least 50% of the total value of the entity's assets.
- The entity is an insolvency remote special purpose entity according to the criteria of an internationally recognised rating agency that are applicable to the entity's circumstances. That entity does not have to have been rated by a rating agency.
For more information on special purpose entities, see section 820-39 of the ITAA 1997.
Note: Entities that are excluded from the general thin capitalisation provisions pursuant to section 820-37 of the ITAA 1997 may still be subject to the debt deduction creation rules in Subdivision 820-EAA of the ITAA 1997.
Australian asset threshold test
Section 820-37 of the ITAA 1997 provides that an entity is excluded from the thin capitalisation regime for an income year if it meets all of the following criteria:
- The entity is one of the following for all or part of the income year
- Assuming that the entity were a financial entity for all of that income year, it would be for all of that year, an outward investing financial entity (non-ADI) and not an inward investor (financial)
- an outward investing financial entity (non-ADI)
- an outward investing entity (ADI).
- The entity is not also an inward investor (financial) or an inward investing entity (ADI) for all or part of that income year.
- The sum of the entity's average Australian assets and the average Australian assets of its associates (as defined in section 318 of the ITAA 1936) represents 90% or more of the sum of its average total assets and the average total assets of its associates.
The terms 'average Australian assets' and 'average total assets' are specifically defined for the purposes of this test.
The average Australian assets of an Australian entity means all the Australian entity's assets other than:
- assets attributable to any of the Australian entity's overseas permanent establishments
- any asset to the extent it is either controlled foreign entity debt or controlled foreign entity equity
- any asset that is a debt interest or equity interest held in the Australian entity's associates.
The average Australian assets of a foreign entity for the purposes of the Australian asset threshold test:
- includes the foreign entity's assets that are
- located in Australia
- attributable to any of the foreign entity's Australian permanent establishments
- debt interests or equity interests held by the entity, to the extent they are issued by or held in an Australian entity and are not attributable to any overseas permanent establishment of the Australian entity.
- excludes the foreign entity's assets other that are
- debt interests or equity interests issued by or held in associates of the foreign entity.