Treasury has released exposure draft legislation to overhaul the thin capitalisation rules for non-financial entities. 

The Treasury Laws Amendment (Measures for Future Bills) Bill 2023: Thin capitalisation interest limitation has been released for comment until 13 April 2023.draft legislation released regarding thin cap changes

This includes provisions that substantially rewrite the thin capitalisation regime for non-financial taxpayers, which are aimed at preventing entities from using excessive debt financing and interest deductions to reduce their taxable income.  

This was foreshadowed in Treasury’s consultation paper entitled ‘Government election commitments: Multinational tax integrity and enhanced tax transparency’, which preceded the October 2022 Federal Budget and was summarised in our earlier brief, noting that exposure draft legislation was anticipated to be released in advance of the proposed start date - which is income years commencing on or after 1 July 2023.

The exposure draft is open for public comment until 13 April 2023, leaving very little time for 30 June year-ends to digest and apply the final form of these rules.

Separate exposure draft legislation has been released in relation to a tax transparency measure. From 1 July 2023, Australian public companies (both listed and unlisted) must disclose further information about subsidiaries in their financial reports.

Key Observations – Thin Capitalisation Legislation

Our key observations regarding what the draft legislation provides are as follows:


  • The ‘general class investor’ definition is proposed to be introduced. The definition is a consolidation of the previous general classes of entities which included ‘outward investor (general)’, ‘inward investment vehicle (general)’, or ‘inward investor (general)’.
  • As expected, financial entities are not brought under the ambit of the new rules and continue to be dealt with under the existing regime.
  • Unfortunately, there are no carveouts provided for asset-intensive and/or highly geared industry sectors such as property, infrastructure, or mining (for instance the UK rules carve-out funds invested in long-term infrastructure for the public benefit, whereas the Canadian rules carve out third-party financing on public-private partnerships involved in infrastructure projects).


  • Application of test: The fixed ratio test allows an entity to claim net debt deductions up to 30 percent of its ‘tax EBITDA’, which is broadly, the entity’s taxable income or tax loss adding back deductions for interest, a decline in value, capital works and prior year tax losses (if the amount is less than or equal to zero the entity cannot claim any debt deductions in that year).
  • Future utilisation of excess deductions: Under the fixed ratio test, a special deduction is allowed for debt deductions that were previously disallowed under the fixed ratio test if an entity has excess capacity under the fixed ratio test in a subsequent year (i.e., the entity’s net debt deductions are less than 30 percent of its ‘tax EBITDA’ for an income year). Debt deductions disallowed over the previous 15 years can be claimed under this special deduction rule. However, currently under the proposed draft rules, this is subject to three criteria which must all be satisfied:
  • 1. The deductions must have arisen in the prior 15 years;
  • 2. The entity must have used the fixed ratio test every year since the disallowed deduction arose;
  • 3. A “modified continuity of ownership” test must be satisfied (if the entity is a company).
  • Rationale: The special deduction is included as part of the fixed ratio test to address year-on-year earnings volatility concerns for businesses that limit their ability to claim debt deductions depending on their economic performance for an income year, although can only be carried forward (not backward).
  • Associate entity excess amounts: this test applies on an entity-by-entity basis and there are no longer any “associate entity excess amount” provisions, so if there is any excess capacity in another Australian entity, there is no avenue to access this capacity through this test.


  • Application of test: The group ratio test allows an entity in a highly leveraged group to potentially deduct net debt deductions in excess of the amount permitted under the fixed ratio rule, based on a relevant financial ratio of the worldwide group. If the group ratio test applies, the amount of debt deductions of an entity for an income year that is disallowed is the amount by which the entity’s net debt deductions exceed the entity’s group ratio earnings limit for the income year. However, entities within the group that have a negative EBITDA are excluded from the calculation of the group ratio.
  • Definition of group: to rely on this option, it is necessary to determine the relevant parent entity, and this entity must prepare audited consolidated financial statements, which drive the calculations for this test. This could potentially cause issues for some privately-owned or PE-owned groups, where there may be a misalignment of the parent entity and the preparation of financial statements, or the investee group may be carried at fair market value rather than consolidated.


  • Application of test: The external third-party debt test allows all debt deductions which are attributable to third-party debt (only) and that satisfy certain other conditions. This test replaces the arm’s length debt test for all entities previously subject to the arm’s length debt test.
  • Simplified approach: the Explanatory Memorandum provides some comments that may be seen as helpful when comparing this test to the existing arm's length debt test: "The external third party debt test operates effectively as a credit assessment test, in which an independent commercial lender determines the level and structure of debt finance it is prepared to provide an entity. As the debt finance is provided by an independent third party, it is assumed to satisfy arm’s length conditions...The test is therefore intended to be a simpler and more streamlined test to apply and administer than the former arm’s length debt test, which operates based on valuation metrics and the ‘hypothesised entity comparison’."
  • The all-in basis for associates: if the entity has any Australian associates that are subject to the thin capitalisation rules, then all of those associates must apply the external third-party debt test, or none of them may adopt it.
  • Related party debt deductions: if this test is chosen, then all related party debt deductions will be denied.


  • Use of approved forms: for either of the elective methods above, the draft legislation stipulates that it is necessary to make an election in the “approved form” on or before the date of lodgment of the relevant tax return. It has not yet been specified what this means.
  • De minimis exceptions retained: the existing $2 million de minimis threshold and 90% Australian asset tests are to be retained, which will be a welcome relief, particularly for groups with limited interest deductions (on an associate-inclusive basis) and with limited non-Australian assets.


An unexpected development is that the existing section 25-90 and its TOFA equivalent are to be repealed. These are the provisions that reinstate the eligibility for interest deductions where the deductions are incurred in connection with the derivation of non-assessable/non-exempt (NANE) dividends from foreign subsidiaries. Accordingly, Australian entities with borrowings and foreign subsidiaries may need to engage in a “tracing” exercise to substantiate whether or not there is a nexus between the borrowings and the acquisition of those subsidiaries.


It is also proposed that the transfer pricing rules are modified to remove an exception that gave priority to the thin capitalisation rules in restricting the quantum of debt (i.e., determining an amount of maximum allowable debt). Given that the proposed thin capitalisation rules seek to limit interest deductions under an earnings approach, the exception to limit transfer pricing rules in determining an arm’s length level of debt is no longer appropriate for entities that will seek to apply the new earnings-based earnings tests.

Therefore, general class investors will need to consider and document whether the amount of debt is consistent with transfer pricing principles (i.e., arm’s length) regardless of whether it has the debt deductions fall within the prescribed ratio tests indicated above.  

Key Observations – Tax Transparency Measures

For each financial year commencing on or after 1 July 2023, Australian public companies must provide a "consolidated entity statement" as part of their annual financial reporting obligations.

If the accounting standards require the public company to prepare financial statements in relation to a consolidated entity, the consolidated entity statement must include disclosures about entities within the consolidated entity at the end of the financial year. This includes the name, entity type, residency, incorporation location, percentage ownership, and relation in connection with any trusts.

If however, the accounting standards do not require the public company to prepare financial statements in relation to a consolidated entity, the public company must provide a statement to that effect.

Alongside these obligations, directors, CEOs, and CFOs must also declare that the consolidated entity statement is true and correct at the end of the financial year.

The Budget announced other measures in relation to tax transparency, including requiring significant global entities to prepare for public disclosure of certain tax information, including certain country-by-country information and also a statement on their “approach to taxation”, as well as certain details in connection with tendering for contracts with the Australian Government. At this stage, the draft legislation makes no reference to either of these measures.


The Treasury Budget Papers forecast that the new measures would bring in additional revenue of $370 million in the first year. This illustrates that overall, most Australian borrowers will be prejudiced by these rules – which is an intended outcome. These entities and groups will want to closely consider and model the impact of the available options.

That said, some Australian borrowers will be better off under this new regime, particularly those EBITDA-positive but have unrecognised intangible assets.

The extremely accelerated timing of this measure in advance of a 1 July 2023 start date (for income years commencing on or after that date) leaves many groups with very limited time to understand the actual impact of these rules, albeit they will have until the lodgment date for any relevant elections to be made.

If you have any questions or concerns in relation to the new thin capitalisation rules, please contact your local RSM office.

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