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 taxpayers fund their Australian operations with an appropriate amount of equity.
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 associates 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 threshold exemption or the exemption for certain special purpose entities.
The debt deduction creation rules will apply to assessments for income years starting on or after 1 July 2024.
Do the thin capitalisation rules apply?
Subject to the 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 at or through an overseas permanent establishment
- 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 a business in Australia at or through a permanent establishment or otherwise has assets that produce assessable income.
Exclusions
The thin capitalisation rules will not apply if:
- an Australian partnership is neither foreign controlled nor has any overseas operations or investments (unless it is an associate of another Australian entity that does).
- a foreign partnership that has no investments or presence in Australia
- the partnership’s debt deductions (combined with the debt deductions of its associate entities) don't exceed $2 million in the income year
- an Australian partnership with overseas operations or investments, or that is an associate of an Australian entity with such operations or investments, that is not also foreign controlled and meets the Australian assets threshold test - see section 820-37.
Certain special purpose entities are also excluded. For more information, see section 820-39.
For more information, see Thin capitalisation.
Control
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 International Dealings Schedule. If the thin capitalisation rules apply, the partnership must complete the International dealings schedule 2024.
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 2024 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 apply, 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 amounts denied.
For more information, see:
- Tax 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
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