Member’s Report
In this week’s TaxVine, Cameron Blackwood, ATI, Head of Tax and Partner at Corrs Chambers Westgarth, and member of The Tax Institute’s National Large Business & International Technical Committee considers the Board of Taxation’s (the Board’s) statutory review of Australia’s thin capitalisation reforms (the Review).
Board of Taxation review
In February 2026, the Board commenced its mandated review of Australia’s reformed thin capitalisation and debt deduction creation rules (DDCR). This Review is intended to assess whether the thin capitalisation changes are operating as intended, and to this end the Board will run a public consultation process to inform its report.
For tax advisers, corporates, infrastructure and property groups, and inbound investors, this Review is more than procedural — it is a critical opportunity to address significant practical concerns that have emerged since the regime’s overhaul.
The reforms, enacted through the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share—Integrity and Transparency) Act 2024, fundamentally reshaped Australia’s interest limitation framework. While the policy objective — protecting the tax base from excessive related-party debt — was clear, the operation of the new regime has generated complexity, uncertainty and unintended outcomes.
Put simply, there is a clear need for a better balance between the policy goals of preventing multinational ‘debt dumping’ and accommodating genuine commercial financing arrangements involving both foreign and domestic capital and treasury operations.
How did we get here?
Australia’s thin capitalisation rules in Division 820 of the Income Tax Assessment Act 1997 (ITAA 1997) have operated since 1 July 2001 as a core integrity measure. Historically, taxpayers relied on:
- a safe harbour debt-to-equity ratio; or
- an arm’s length debt test.
Following the Organisation for Economic Co-operation and Development’s (OECD’s) Base Erosion and Profit Shifting (BEPS) Action 4 recommendations, the Government replaced this framework for ‘general class investors’ with an earnings-based approach and the third-party debt test.
For income years commencing on or after 1 July 2023, taxpayers must apply one of three tests:
- Fixed Ratio Test — limits net debt deductions to 30% of tax EBITDA.
- Group Ratio Test — allows a higher cap where justified by worldwide group leverage.
- Third Party Debt Test — permits full deduction for certain genuine third-party debt.
In addition, from 1 July 2024, the unannounced DDCR apply to deny deductions for certain related-party debt used in connection with specified intra-group transactions.
The reforms were passed by the Parliament following two reviews by the Senate Economics Legislation Committee. Despite extensive stakeholder submissions (including a joint submission from The Tax Institute and Chartered Accountants Australia and New Zealand) raising workability concerns, the drafting of the legislation was rushed, and only limited amendments to reflect stakeholder concerns were made. The inclusion of a legislated post-implementation review, which is now underway, was therefore intended to be a significant safeguard.
Key issues and challenges
Fixed Ratio Test
The Fixed Ratio Test (FRT) operates as the default test. Conceptually simple, it limits net debt deductions to 30% of tax earnings before interest, taxes, depreciation, and amortisation (EBITDA), with limited carry-forward of denied amounts.
However, stakeholders have identified practical issues including structural distortions for asset-rich, cashflow-constrained sectors (e.g. infrastructure and real property) and challenges for non-consolidated or trust structures, where upstream debt and downstream asset ownership can produce mismatches.
While earnings-based limitations align with OECD recommendations, the FRT may produce outcomes disconnected from commercial leverage norms, particularly in capital-intensive sectors.
Group Ratio Test
The Group Ratio Test (GRT) was intended to preserve flexibility where a multinational group is genuinely highly leveraged.
In practice, concerns include heavy reliance on consolidated financial statements, followed by extensive tax adjustments.
For many groups, the compliance burden may outweigh its practical accessibility.
Third party debt test
The Third Party Debt Test (TPDT) replaced the former arm’s length debt test and was widely viewed as critical for infrastructure and property sectors, where third-party debt funding is central.
However, the TPDT imposes detailed and prescriptive conditions. Key concerns raised by practitioners include:
- All-or-nothing denial — failure to meet a condition can deny deductions entirely for the relevant instrument.
- Commercial activities condition — interpretive uncertainty regarding whether the use of debt to fund the payment of certain distributions affects eligibility for the debt instrument to pass the TPDT.
- Credit support right restrictions — broad prohibitions that may capture ordinary commercial performance guarantees that do not appear to actually support the borrower’s credit.
- Permitted recourse to minor or insignificant assets — uncertainty around what constitutes ‘minor or insignificant’ assets.
- Conduit financing and hedging costs — uncertainty around the use of swaps or other hedging instruments in conduit financing structures.
The legislative requirements to satisfy the TPDT impose onerous conditions that are viewed by many stakeholders as overly prescriptive and uncertain, such that many common, market standard financing arrangements may not comply with the TPDT conditions. This has been further exacerbated by the ATO’s interpretation of many of the new provisions.
Debt Deduction Creation Rules
The DDCR, effective from 1 July 2024, operate in priority to the thin capitalisation tests (unless the TPDT is chosen, in which case the DDCR do not apply).
Broadly, the DDCR deny deductions for related-party debt used to:
- acquire certain assets or obligations from associates; or
- fund, directly or indirectly, certain payments or distributions to associates.
Concerns expressed in submissions and professional forums include:
- The absence of a purpose test — the rules apply regardless of whether there is a base erosion motive.
- Application to existing structures — while prospective in operation, the DDCR can deny deductions on ongoing related-party debt connected to historical transactions undertaken long before the introduction of the DDCR.
- Tracing complexity — particularly in cash pool environments, where it is difficult if not impossible to determine whether funds drawn from a cash pool may have been historically used to fund ‘prohibited’ transactions.
- Potential overreach — risk of capturing ordinary commercial transactions (e.g. internal asset reorganisations).
Given their breadth, the DDCR have become one of the most controversial elements of the thin capitalisation reform package. The DDCR provisions are extraordinarily broad in their reach and have given rise to widespread concern that they capture ordinary commercial transactions that involve no base erosion motive whatsoever.
Why this Review matters
The Board’s Review is not a routine consultation. It is a statutory review required to commence by 1 February 2026, with a report due by 1 February 2027.
The Board’s Review is therefore a unique opportunity for stakeholders to highlight the shortcomings of the thin capitalisation amendments and to advocate for the legislative changes needed to make these rules more practical in their real-world application. Submissions should therefore provide:
- real-world case studies;
- impacts that the thin capitalisation amendments have on compliance costs;
- examples of commercial financing structures that fail the TPDT conditions despite genuine third-party involvement;
- examples of unintended outcomes; and
- suggestions for any legislative changes that may be necessary to achieve a more practical administration of the laws.
Competitiveness and capital attraction
Australia remains reliant on inbound foreign capital, particularly in the infrastructure, energy transition and property sectors.
Interest limitation regimes must strike a balance — protecting the tax base without discouraging legitimate commercial lending arrangements.
New Zealand’s Inland Revenue Department released a consultation paper in May 2025 on the thin capitalisation settings for infrastructure, which noted that:
‘it is important to ensure that the tax settings do not unduly disincentivise investment in infrastructure compared to other assets’
Australia’s regime should likewise ensure that integrity measures do not unintentionally impair competitiveness.
A model for future reform
The legislated requirement for post-implementation review is a positive development. Complex tax reforms often operate differently in practice than in theory.
Statutorily mandated reviews should:
- test legislative intent against operational reality;
- provide a structured pathway for amendment; and
- enhance accountability in major tax reform.
Embedding similar review mechanisms in future significant tax measures would strengthen Australia’s tax policy process.
Closing comments
The thin capitalisation and DDCR reforms represent one of the most significant restructurings of Australia’s international tax framework in two decades.
The Board has yet to open for public consultation. When the Board calls for stakeholder submissions, those affected should engage thoughtfully, provide detailed examples, and contribute to shaping a regime that is both pragmatic and workable.
The next iteration of Australia’s thin capitalisation framework will be influenced by the evidence put forward now. So, the importance of informed stakeholder engagement cannot be emphasised enough.
Join the conversation and share your thoughts and ideas on what the Board’s Review means for you and your clients. You can provide your feedback here.
Kind regards,
Cameron Blackwood, ATI
Corrs Chambers Westgarth