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.
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.
What are the debt deduction creation rules?
The debt deduction creation rules disallow debt deductions paid or payable, directly or indirectly, to associate entities and created in connection with certain acquisitions from associate entities or funding certain payments or distributions to associate entities. These rules don't apply to ADIs or securitisation vehicles, or entities that are exempted from their application under the $2 million dollar threshold exemption or the exemption for certain special purpose entities.
The debt deduction creation rules will apply to all debt deductions for income years starting on or after 1 July 2024.
ADI, securitisation vehicles and certain special purpose entities are excluded from the debt deduction creation rules.
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 , 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.
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 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 2024.
For more information, see:
- Taxation Ruling TR 2020/4 Income tax: thin capitalisation – the arm's length debt test
- Practical Compliance Guideline 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.
Return to: Appendixes for the company tax return
Return to: Instructions to complete the Company tax return 2024
Continue to: Appendix 7: Taxation treatment of pooled development funds and investors