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Appendix 3: Thin capitalisation

Last updated 25 May 2022

Use Appendix 3 to help you work out if the thin capitalisation rules apply and what to do if they affect you.

What is thin capitalisation?

The thin capitalisation provisions reduce certain expenditure (called ‘debt deductions’) incurred in obtaining and servicing debt where the debt used to finance the Australian operations of a partnership exceeds the limits set out in Division 820 of the ITAA 1997. These rules ensure that taxpayers fund their Australian operations with an appropriate amount of equity.

Do the thin capitalisation rules apply?

Subject to two exclusions listed below, the thin capitalisation rules will apply to a partnership if:

  • the partnership has at least one partner which is an Australian resident (an Australian partnership) and either          
    • the partnership, or any of its associate entities, is an Australian controller of an Australian controlled foreign entity (explained below) or carries on business overseas at or through a permanent establishment, or
    • that partnership is foreign controlled, either directly or indirectly, or
  • the partnership does not have any partners that are Australian residents and the partnership carries on business in Australia at or through a permanent establishment or otherwise has assets that produce assessable income.

For more information, see Thin capitalisation.

Entities that are not affected by the rules

For any given income year, the following entities are not affected by the thin capitalisation rules:

  • an entity that does not incur debt deductions for the income year
  • 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 an inward investing entity nor an outward investing entity
  • a foreign entity that has no investments or presence in Australia
  • an outward investing entity that is not also foreign controlled and meets the assets threshold test. (This is explained more in section 820-37.)

Certain special purpose entities are also excluded: see section 820-39.


The thin capitalisation rules will not apply if:

  • the partnership’s debt deductions (combined with the debt deductions of its associate entities) do not exceed $2 million in the income year, or
  • in the case of an Australian partnership which is not foreign controlled, the combined value of the partnership’s Australian assets and the Australian assets of its associates comprise at least 90% of the value of the total assets of the partnership and those associates.


The rules measuring control take into account both direct and indirect interests that the partnership holds in the other entity (or vice-versa) and the direct and indirect interests that associate entities of the partnership hold in the other entity. This means an Australian partnership can be an Australian controller of a foreign entity even if it holds a direct interest of less than 50% in the foreign entity.

What if the thin capitalisation rules apply?

If the thin capitalisation rules apply to the partnership or you need more information, see the instructions to section D of the IDS Instructions. If the thin capitalisation rules apply, the partnership must complete the International dealings schedule 2022.

Where a return is required because the partnership had a period in the income year when it was not a member of a consolidated group or MEC group (a non-membership period) the partnership should complete an International dealings schedule 2022 where the thin capitalisation rules apply to the partnership during the non-membership period.

What if the thin capitalisation rules are breached?

If the thin capitalisation rules are breached, some of the partnership’s debt deductions may be denied. The amount denied for business income is shown at item 5 – label B Expense reconciliation adjustments. If the partnership incurred debt deductions for other types of income (for example, rental income, dividend income or foreign income) the amount of deductions shown at the relevant entries must exclude the debt deductions denied.

For more information, see:

  • TR 2020/4 Income tax: Thin capitalisation – the arm's length debt test
  • PCG 2020/7 Arm's length debt test – ATO compliance approach

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