Use Appendix 6 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 deductions (called debt deductions) incurred in obtaining and servicing debt if the debt used to finance the Australian operations of a company exceeds the limits set out in Division 820 of the ITAA 1997. These rules ensure that entities fund their Australian operations with an appropriate amount of equity.
The rules apply to a range of situations. Where in a given year, you are not affected by the rules, answer no at item 29 Thin capitalisation.
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 overseas at or through a PE, or
- 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 in Australia.
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 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 resident entity that is neither an inward investing entity nor an outward investor
- a foreign entity that has no investment or presence in Australia
- an outward investor that is not also foreign controlled and meets the assets threshold test. This is explained further in section 820-37.
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.
- At least 50% of its assets are funded by debt interests.
- 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.
Where several large entities are taken to be a single, notional entity, any one of those entities can still meet this exception provided that all the entities taken together 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 if the thin capitalisation rules affect you this year?
If the thin capitalisation rules affect you, print Y for yes at item 29. Thin capitalisation. In addition, complete the International dealings schedule 2023.
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.
What if the thin capitalisation rules are breached?
If the thin capitalisation 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.
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