Australia's thin capitalisation rules – finally, the amending Bill to a Bill to amend

20 minute read  20.10.2023 Adrian Varrasso, Robert Yunan, Jason Hawe, Silvino Gomes, Daniel Kornberg

We explore the new exposure draft released for public consultation which amends the proposed thin capitalisation changes and debt deduction creation rules.

Key takeouts

  • An amended related party requirement for the triggering of the debt deduction creation rules (DDCR) means deductions in respect of borrowings from an external third party should not be caught by the rules.
  • A limited transitional period for the DDCR is provided until 1 July 2024 for financial arrangements entered into before 22 June 2023 – all other financial arrangements will be subject to the DDCR from 1 July 2023.
  • Although updated recourse conditions under the third party debt test (TPDT) account for a greater variety of lending arrangements, there are still significant practical deficiencies in how this test operates.

On 18 October 2023, Treasury released an exposure draft Bill (Amending Bill) with proposed amendments to the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share—Integrity and Transparency) Bill 2023 (Original Bill) which passed the House of Representatives on 9 August 2023 and is before the Senate.

The Amending Bill has been published in response to the Senate Economics Legislation Committee (Senate Committee) Report on the Original Bill, released on 22 September 2023 (Committee Report) and includes amendments to various aspects of the thin capitalisation rules in the Original Bill to ensure the rules are 'appropriately targeted'.

In our previous update, we discussed the proposed changes to the thin capitalisation rules to be introduced by the Original Bill. In this article, we focus purely on the key changes proposed under the Amending Bill.

Amendments to the debt deduction creation rules

Ordering and application of the DDCR

The Amending Bill introduces new section 820-31 which clarifies the ordering when applying the DDCR and the new thin capitalisation provisions.

In direct response to a key issue raised in the Senate Committee, the exemption of certain special purpose entities (e.g. insolvency remote vehicles) from the thin capitalisation rules has been extended to the DDCR. Authorised deposit taking institutions and securitisation vehicles are now also excluded from the DDCR. This is a welcome change for many financiers that regularly undertake financing through an SPV, and in particular those that undertake the process wholly within the domestic market.

The exemption of certain special purpose entities (e.g. insolvency remote vehicles) from the thin capitalisation rules is extended to the DDCR. Authorised deposit taking institutions and securitisation vehicles are now also excluded from the DDCR.

Related party requirement for DDCR

To recap, the DDCR will apply to deny deductions in these two scenarios / limbs:

  • The first limb concerned asset acquisitions from associates (this applies when the conditions in subsection 820-423A(2) are satisfied). As drafted in the Bill, this limb did not require the debt to be borrowed from an associate; and
  • The second limb concerned an entity borrowing from its associate to fund a payment to that, or another, associate (this applies when the conditions in subsection 820-423A(5) are satisfied).

Both limbs of the DDCR will now only apply where the relevant entity’s debt deduction is paid or payable, directly or indirectly, to an associate pair of the entity.

This means that deductions arising from third party external debt should not be covered by the rules. The DDCR as drafted in the Original Bill was widely criticised for its broad scope and impact on ordinary funding arrangements that have no tax minimisation purpose. Accordingly, the narrower and more targeted application of the DDCR are likely to allay some of the fears outlined in submissions to, and the report published by, the Senate Committee.

Specific exclusion for first limb

The Amending Bill includes three new exceptions to the asset acquisition limb of the DDCR:

  • the acquisition of a new membership interest in an Australian entity is disregarded. Additionally, the acquisition of a new membership interest in a foreign entity that is a company is disregarded;
  • the acquisition of certain new tangible depreciating assets is disregarded. The EM indicates this exception is intended to allow an entity to bulk acquire depreciating assets on behalf of its associate pair. Interestingly, this exception only applies to certain tangible depreciating assets, a clear omission being trading stock (even though trading stock was an exception in former Division 16G of the ITAA36); and
  • the acquisition of certain debt interests is disregarded. The EM indicates this is a technical exception which ensures that mere related party lending is not caught by the rules.

However, the provisions make it clear that the DDCR may apply to prevent debt deductions in relation to the indirect acquisition by an entity of a CGT asset through an interposed entity, even if the indirect acquisition happens because of the direct acquisition by the first entity of a CGT asset covered by one of the three exceptions.

For example, this would be the case where an entity obtains related party debt funding to acquire new membership interests in a subsidiary that then uses those funds to acquire a separate CGT asset from a related party. In these circumstances, the DDCR would still apply to deny deductions in respect of that related party debt funding.

While these exceptions are welcome, particularly when coupled with the narrowing of the definition of associate pair with respect to unit trusts and the requirement for the debt to be related party debt, they are fairly narrow and there are still examples of commercial transactions which would not fall within the ambit of these exceptions.

Specific exclusion for second limb

The Amending Bill also introduces exceptions to the second limb that appear to apply where:

  • there is an on lending of debt on the same terms – however, this exception appears to apply only where the relevant taxpayer is on lending to an Australian associate entity, not a foreign entity; or
  • an existing debt is refinanced with new debt, where the existing debt would not otherwise be covered by the DDCR – that is, you can refinance a debt that was not subject to the DDCR, in which case the new borrowing will also not be subject to the DDCR. You cannot refinance a debt that would otherwise have been subject to the DDCR and have the new debt automatically excluded from the DDCR. What is not clear is how this exception would apply to a loan that had already been refinanced ahead of either implementation on 1 July 2023 or the operation of the DDCR on 1 July 2024. There is however a requirement for the lender of the repaid debt to be an Australian entity.

The death of related party debt?

In the refinancing exclusion to the payments limb of the DDCR that we list immediately above, the existing debt needs to be from a related Australian entity.

If the original debt is from a related foreign party, then any refinancing of that debt will not fit within the refinancing exception given the payment will not be made to a recipient that is an Australian entity.

This means that the DDCR will apply to deny deductibility of interest incurred on the new debt even where the existing debt from a foreign lender was not initially subject to the DDCR. You can only refinance an existing debt if it was not subject to the DDCR and it was with an Australian lender.

Accordingly, if there is a change over time of foreign related party debt owed by an Australian subsidiary (e.g. through maturity), any refinancing with new foreign related party debt will automatically fail the DDCR. This is even the case if the original financing was not caught by the DDCR, for example because it was obtained to fund tangible depreciating assets.

This seems to be directed at moving all multinationals away from using related party debt. A real problem for any Australian entities that are part of a group with an offshore treasury function that borrows centrally and on-lends to global operating subsidiaries.

Over time, will all Australian subsidiaries’ related party debt cease to be deductible? Going forward, would Australian entities have to move all debt facilities to external third party financiers? Would doing so give rise to a risk that the anti-avoidance rule in section 820-423D applies?

It is also not clear how the refinancing exception would apply to a loan that had already been refinanced. However, we would expect the exception could apply to subsequent refinancings, if each refinancing was in essence a refresh of the original debt that was not otherwise subject to the DDCR.

The above, combined with the operation of section 820-423A(5) and the breadth of the language "fund, facilitate the funding of, or increase the ability of any entity to make" would appear to mean that any related party debt from a foreign entity may have real problems under the DDCR.

Associate pairs

Pointed criticism raised in submissions made as part of the Senate Committee consultation process highlighted the inequality of exempting trustees of complying superannuation funds from the definition of 'associate entity' while allowing other types of investment funds, such as managed investment trusts and corporate collective investment vehicles, to be caught by the broad way that term is defined.

The exclusion effectively results in superannuation funds being exempted from the interest limitation rules, which the EM to the Original Bill justifies as being appropriate given superannuation funds are subject to a relatively strong regulatory regime and rarely exercise any meaningful control over their associate entities.

Perhaps other types of investment funds could also fall into this category and it would therefore seem appropriate that they too be excluded from the broad definition of 'associate entity'.

Treasury acknowledges this point to some extent in the Amending Bill given it modifies the definition of ‘associate pair’ as it applies to unit trusts by narrowing the meaning of ‘associate’ in section 318 of the Income Tax Assessment Act 1936 (Cth). However, this modification applies only in the context of the DDCR and therefore such trusts would still fall within the 'associate entity' concept, and therefore the thin capitalisation provisions, more broadly. What this amendment does do is prevent a very minor interest held by an entity in a unit trust from resulting in the parties being treated as associate pairs given a unitholder of a unit trust is ordinarily an associate of the trust by virtue merely of that minor holding.

Transitional provisions for DDCR

The Committee Report acknowledged criticism provided during the Senate Committee's consultation period on the proposed 1 July 2023 implementation date for the DDCR.

Consistent with an approach proposed in the Committee Report, a limited transitional period for the DDCR has been included in the Amending Bill regarding financial arrangements entered into before the Original Bill being introduced to parliament (i.e. 22 June 2023). This appears to be a direct response to the genuine surprise of many stakeholders at the replacement of the amendments to section 25-90 (which was, of itself, largely criticised at the time) by the much broader DDCR.

Where a financing arrangement was entered into before 22 June 2023, then the DDCR will not apply to deny deductions in respect of that financing arrangement until the income year commencing 1 July 2024 (or 1 January 2025 for early December year end balancers). Financial arrangements entered into after 22 June 2023 will be subject to the DDCR from 1 July 2023 (or 1 January 2024 for early December year end balancers).

Post 1 July 2024 (or 1 January 2025 for December year end balancers), all financial arrangements regardless of when they were entered into will be subject to the new DDCR, so the element of retrospectivity which was criticised remains (the implications are merely delayed for another income year).

Third party debt test

Recourse to assets

A major issue in the Original Bill is that the TPDT conditions require that a lender only have recourse to Australian assets held by the borrower.

The Amending Bill purports to change the TPDT conditions so that the holder of the debt interest being tested can now have recourse to the following kinds of assets without there being a failure of the TPDT conditions:

  • Australian assets held by the entity (noting that in conduit financier cases, this condition is modified to instead refer to the Australian assets of the conduit financier and borrowers);
  • Australian assets that are membership interests in the entity, unless the entity has a legal or equitable interest, directly or indirectly, in an asset that is not an Australian asset (again noting that in conduit financier cases, this condition is modified to instead refer to Australian assets that are membership interests in the conduit financier and borrowers), permitting unit/share mortgages to be given without impacting the TPDT; and
  • Australian assets held by an Australian entity that is a member of the obligor group in relation to the tested debt interest.

The EM states that the updated recourse conditions account for a greater variety of lending arrangements.

While we agree to an extent with this statement, there is still an obvious issue in how the test operates where a borrower or obligor group has both Australian and non-Australian assets (e.g. a foreign permanent establishment or foreign subsidiaries).

We expect that lenders would ordinarily seek to have recourse over all assets held by a particular entity or entities, whether or not those assets are located in Australia. Given this, the TPDT may still be unavailable to borrowers unless lenders forgo security over non-Australian assets.

We observe that the prohibition on recourse to credit support rights is maintained, subject to the limited exception where the rights relate wholly to the creation or development of a CGT asset relating to Australian real property.

The Amending Bill slightly broadens this exclusion so that it also applies to ‘moveable property’ where that moveable property is incidental to and relevant to the ownership and use of the land, and is situated on the land for the majority of its useful life.

However, the EM explains that the retention of the general prohibition on guarantees and credit support ensures that multinational groups do not have an unfettered ability to ‘debt dump’ third party debt in Australia that is recoverable against the global group.

While this may be sound policy, the retention of this prohibition with an exclusion limited to property development only will adversely affect other projects and industries. For example, start-up or small business entities can often rely on credit support or guarantees from substantive parent entities being provided. Similarly, large commercial project financing arrangements often require credit support as a condition imposed by financiers for that project financing.

Trusts and partnerships applying the TPDT

As expected, the term ‘Australian entity’ (rather than the term 'Australian resident') is now used in Subdivision 820-EAB to ensure trusts and partnerships can access the TPDT. This was a key deficiency in the Original Bill and using the term 'Australian resident' seems to have been an oversight in its drafting.

The meaning of this term is modified in relation to partnerships so that they will be covered only where Australian residents together hold at least a 50% direct participation interest in the partnership.

Conduit financing

For conduit financier cases, minor amendments are proposed to clarify that the conduit financing conditions do not require every associate entity of a conduit financier to be a ‘borrower’ and therefore subject to certain conditions.

Additionally, minor amendments clarify that not every debt interest that a borrower issues is a ‘relevant debt interest’ and therefore subject to certain conditions.

Disappointingly, the 'same terms' requirement to the extent that terms relate to costs has been retained in the conduit financing provisions. A more workable solution for this requirement may have been to require the terms relating to costs (which we expect would include terms about interest rates, maturity, repayments, gross ups and other borrowing costs) to be substantially the same, as opposed to the same.

Similarly, the Amending Bill does not propose to widen the recourse requirements for conduit financing arrangements meaning such arrangements can still only result in a lender having recourse to Australian assets.

Choices under Subdivision 820-AA


New subsection 820-47(4A) clarifies the ordering between a deemed choice to apply the TPDT and a choice to apply the group ratio test.

In relation to a single income year, if a choice to apply the TPDT is taken to have been made by the entity (e.g. because it is a member of an obligor group containing another member that has made the choice to apply the TPDT), the entity cannot subsequently make a choice to apply the group ratio test, and any choice previously made to apply the group ratio test by the entity is revoked and taken never to have been made.

Revocation of choices

The conditions for revoking certain choices under Subdivision 820-AA have been simplified. Revoking a choice no longer requires the particular entity that made the choice to always satisfy certain conditions.

However, the Commissioner must still be satisfied that it is fair and reasonable, having regard to matters the Commissioner considers relevant, to allow the entity to revoke the choice. The EM indicates that such matters may include whether the entity made the choice on a reasonable and genuine basis, and not as a part of aggressive tax planning.

We observe that the language used in this provision remains broad and vague, and the absence of any meaningful discussion in the EM about what 'fair and reasonable' means or when the discretion will be exercised results in considerable uncertainty for taxpayers. For this reason, it will be particularly important for taxpayers to model their thin capitalisation outcomes and carefully consider their positions before making any choice. We would expect ATO guidance to be released at some stage to provide further detail as to the matters that will be taken into account by the Commissioner in this context.

An entity must apply to revoke a choice in relation to an income year within four years after they lodge their income tax return for the income year (or are required to lodge their income tax return for the income year if that date is earlier). The EM indicates that this time limit provides administrative certainty and ensures that entities have a reasonable amount of time to revoke choices.

Other updates by the Amending Bill

Obligor group

The Amending Bill attempts to clarify that a creditor need not have recourse to all the assets of an entity for that entity to be an 'obligor entity', although we query whether this intention has been achieved.

Interestingly, the EM describes the amendment as resulting in it being 'sufficient for recourse to be had to one or more assets of the entity'. However, the EM does not reflect how paragraph 820-49(1)(b) is amended by the Amending Bill.

The provision as proposed to be amended will now apply where the creditor has recourse 'to assets of one or more other entities'. The replacement of the words 'the assets' with 'assets' by the Amending Bill may not be sufficiently clear to achieve Treasury's intention. It still seems open to interpretation that the provision requires a creditor to have recourse to all assets of an entity for it to be an 'obligor entity'.

Separately, the Amending Bill includes a new provision that states that where a creditor has only recourse to the assets of an entity that are membership interests in the borrower, then that entity will not be an 'obligor entity'. This is to accommodate the fact that it is common for lenders to acquire security over the interests held in a borrower.


As part of the Senate Committee consultation process, several submissions were made highlighting issues with the proposed tax EBITDA methodology. The proposed calculation methodology had detrimental impacts on particular Australian industries and asset types, particularly in the context of groups of non-consolidated entities where there was sufficient capacity at operational levels below a financing entity.

The Amending Bill attempts to address some of these concerns by making several tweaks to the concept of 'tax EBITDA' including:

  • permitting the add back of two new tax deductions in determining an entity's tax EBITDA, allowing plantation forestry entities to better apply the fixed ratio test;
  • to account for corporate tax entities' choice in deducting tax losses, embedding an assumption into the tax EBITDA calculation to assume that a corporate tax entity chooses to deduct all of its tax losses;
  • modifying tax EBITDA calculations to better cater for attribution managed investment trusts and their members, by specifically referring to AMIT related concepts;
  • requiring the subtraction from tax EBITDA of notional deductions for R&D entities to prevent them obtaining a double benefit; and
  • allowing eligible unit trusts (being unit trusts and managed investment trusts which satisfy certain eligibility conditions) to transfer excess tax EBITDA amounts to other eligible unit trusts, facilitating a greater variety of lending arrangements, but only where the higher trust has a 50% direct control interest in the transferor trust.

In respect of the excess tax EBITDA amounts for trusts, an excess amount transferred to an eligible trust will be taken into account when considering whether that trust has an excess amount itself, which can subsequently be transferred to a further eligible trust higher up the chain, but only where the 50% interest remains.

Broadly, a trust will be an eligible trust where:

  • it is a unit trust that is a resident trust for CGT purposes or a managed investment trust;
  • the trust is a general class investor and is using the fixed ratio test for the income year; and
  • the 'transferee trust' (i.e. trust receiving the excess tax EBITDA) has a direct control interest of 50% or more in the 'transferor trust' (i.e. trust transferring the excess tax EBITDA).

This change should ensure that existing tiered trust structures would not be significantly disadvantaged where debt funding and operations generating taxable income are held in different entities. However, there still appears to be an unsatisfactory outcome for investors that hold between 10% and 50% in a trust, which can be a significant issue for a variety of joint venture projects with more than one or two parties. This is because such trusts will not be permitted to transfer the excess up the chain, whereas:

  • entities that hold less than 10% of the trust should generally be permitted to include trust distributions in their tax EBITDA calculation; and
  • subject to the Amending Bill proceeding, entities that hold more than 50% of the trust should benefit from the excess tax EBITDA transfer calculation.

Interestingly, while somewhat helpful for trusts (which is a sensible and positive development – although we question the policy on the 10-49% structures), it seems that the logic has missed partnerships. They have a much greater problem where there is no excess amount transferred to partners at 50% or above. Although there are comments in the EM about trusts and partnerships being treated the same way in certain parties, and under tax law they are both generally treated as flow through, it seems that either there was no 'partnership lobby group' or there was a conscious decision to treat trusts differently.

This may have a significant impact on unincorporated joint venture projects that are tax law partnerships.

Next steps

The consultation period for comments on the Amending Bill is short with submissions due by 30 October 2023. We expect that once the Amending Bill is finalised, it will be introduced to parliament with the Original Bill returning to the House of Representatives once approved by the Senate so that the House can consider the proposed amendments.

Many taxpayers will have already considered the impact that the Original Bill will have on their position, including by undertaking relevant thin capitalisation modelling. Given the significance of some of the proposed amendments, taxpayers should reassess how the proposed provisions will apply to them, as to be amended, particularly where they intend to rely on the TPDT.

Taxpayers should also consider the updated DDCR in light of the further refinements and exceptions included in the Amending Bill. While some taxpayers may breathe a sigh of relief with the proposed narrower application of these provisions, others are likely to be left unsatisfied with the limited scope of the exceptions and broad reaching consequences particularly for multinational investors and Australian groups with overseas operations.

If you have any queries in relation to the Amending Bill or the thin capitalisation provisions and DDCR more broadly, please get in touch as we would be happy to assist you.