What is thin capitalisation?
The thin capitalisation provisions limit the debt deductions that certain entities can claim for tax purposes based on the tests set out in Division 820 of the ITAA 1997. These rules ensure that entities fund their Australian operations with an appropriate amount of equity.
Do the thin capitalisation rules apply?
Australia’s thin capitalisation rules apply to:
- Australian entities with certain overseas operations, and their associate entities
- Australian entities that are foreign controlled
- foreign entities with operations or investments in Australia that are claiming debt deductions.
The thin capitalisation rules may apply to a company if the company:
- is an Australian resident company and either
- the company, or any of its associate entities, is an Australian controller of a foreign entity or carries on business at or through an overseas permanent establishment
- the company is foreign controlled, either directly or indirectly
- is a foreign resident company and carries on business in Australia at or through a PE or otherwise has assets that produce assessable income.
Entities that are not affected by the rules
For any given income year, the following entities are not affected by thin capitalisation rules:
- an entity whose debt deductions, together with those of any associate entities, are $2 million or less for the income year
- an Australian 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 meets the Australian assets threshold test – see, 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 as 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.
An entity is taken to meet the above conditions throughout a period if it is one of 2 or more entities that taken together to be a single, notional entity would meet the above conditions. The entity will only be exempted from the thin capitalisation rules for the period that it meets all of the above conditions.
For more information, see Thin capitalisation. This explains what certain terms mean for thin capitalisation purposes, such as control, associated entities, debt deductions and asset threshold test. For example, the rules regarding ‘control’ take into account both direct and indirect interests that the company holds in the other entity (or vice versa), and the direct and indirect interests that associate entities of the company hold in the other entity.
What are the debt deduction creation rules?
For income years that commence on or after 1 July 2024, the DDCR operates to disallow related party debt deductions for certain related party arrangements. The debt deduction creation rules apply to:
- arrangements entered into before 1 July 2024 where debt deductions continue to arise
- new arrangements entered into on or after 1 July 2024.
The DDCR applies to multinational businesses (that is, businesses operating in Australia and at least one other jurisdiction), including private businesses and privately owned groups.
Exemptions from the DDCR
The DDCR do not apply to:
- entities that, together with their associate entities, have $2 million or less of debt deductions for an income year
- authorised deposit-taking institutions (ADls)
- securitisation vehicles
- certain special purpose entities
- Australian plantation forestry entities.
Who can the DDCR apply to
The DDCR can apply to:
- an Australian resident entity that either:
- carries on business in a foreign country at or through a permanent establishment
- has a controlling interest in any offshore entity (no matter the size or turnover of that offshore entity)
- a foreign resident entity with operations or investments in Australia that is claiming debt deductions.
The DDCR disallow debt deductions for certain related party arrangements. As the rules focus on the creation of debt deductions, it does not matter whether the arrangement involves resident or non-resident entities. This means that onshore and cross-border related party arrangements can trigger the debt deduction creation rules.
The rules can apply to related party arrangements, arrangements undertaken (entirely or partially) prior to 1 July 2024. For example, the rules will apply to interest arising under a related party loan that is still on foot (or has been refinanced) where the related party loan funded a historical transaction caught by the debt deduction creation rules.
The rules broadly capture 2 types of arrangement.
Type 1: Acquisition case
The debt deduction creation rules may disallow debt deductions where an entity acquires a capital gains tax (CGT) asset or a legal or equitable obligation from an associate pair. An entity is an associate pair of another entity if the entity is an associate of the other entity or the other entity is an associate of the entity.
This applies to all such acquisitions except:
- new membership interests in an Australian entity or foreign company
- new depreciating tangible assets to be used by the acquirer for a taxable purpose in Australia within 12 months that have not previously been installed or used by the acquirer, an associate pair or the disposer for a taxable purpose
- new debt interests issued to the acquirer by an associate pair.
Debt deductions that are paid or payable (directly or indirectly) to a related party are disallowed to the extent that they're for the acquisition (or holding) of the CGT asset or legal or equitable obligation.
Type 2: Payment or distribution case
The debt deduction creation rules may disallow debt deductions where an entity uses a financial arrangement to fund, or facilitate the funding of, prescribed payments or distributions to an associate pair.
Prescribed payments and distributions include:
- dividends, distributions or non-share distributions
- distributions by a trustee or partnership
- returns of capital, including returns of capital made by a distribution or payment made by a trustee or partnership
- cancellations or redemptions of a membership interest
- royalties (or similar payments or distributions for the use of, or right to use, an asset)
- refinancing a debt interest that originally funded a prescribed payment
- payments or distributions of a similar kind to any of the above
- payment prescribed in regulations (no regulations currently exist).
Debt deductions that are paid or payable (directly or indirectly) to a related party for the financial arrangement are disallowed to the same extent that the financial arrangement was used to fund, or facilitate the funding of, one or more prescribed payments or distributions.
What if the thin capitalisation or debt deduction creation rules affect you this year?
If the thin capitalisation or debt deduction creation rules affect you, print Y for yes at item 29. Thin capitalisation. In addition, complete the International dealings schedule 2025.
For more information, see:
- Debt deduction creation rules and Division 7A
- Draft Practical Compliance Guideline PCG 2024/D3 Restructures and the thin capitalisation and debt deduction creation rules - ATO compliance approach
- Thin capitalisation rules.
What if the thin capitalisation and/or debt deduction creation rules are breached?
If the thin capitalisation and/or debt deduction creation rules are breached, some of the company’s debt deductions may be denied. Include the amount denied at item 7 – label W Non-deductible expenses.
Return to: Appendixes for the company tax return
Return to: Instructions to complete the Company tax return 2025
Continue to: Appendix 7: Taxation treatment of PDFs and investors