Thin Capitalisation Rules in Australia 2026-27: An Accountant's Guide to the New Interest Limitation Framework

Australia's thin capitalisation rules underwent their most significant overhaul in two decades when the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share — Integrity and Transparency) Act 2024 replaced the old safe harbour tests with a new interest limitation framework. For Australian businesses with cross-border financing arrangements, understanding the Fixed Ratio Test, the Group Ratio Test, and the Debt Deduction Creation Rules is now essential — and the right accountant can make the difference between a compliant position and a costly ATO audit.

Understanding Australia's New Thin Capitalisation Framework

Thin capitalisation rules limit the amount of debt deductions an entity can claim where it has cross-border related-party financing. The old regime used a safe harbour based on a debt-to-asset ratio. The new regime, which applies to income years commencing on or after 1 July 2023, replaces that approach with OECD-aligned interest limitation rules.

The new framework applies to entities with aggregated debt deductions exceeding AU$2 million. Below this threshold, entities are generally not subject to the thin capitalisation tests, though transfer pricing rules still apply to the quantum of cross-border debt.

Three tests are now available to general class investors — the Fixed Ratio Test (the default), the Group Ratio Test, and the Third-Party Debt Test. Each test has different eligibility criteria, calculation mechanics, and carry-forward provisions. Choosing the right test for your entity's circumstances is a critical planning decision that requires specialist accounting advice.

The Fixed Ratio Test: The Default Mechanism

The Fixed Ratio Test (FRT) is the default thin capitalisation test for general class investors. Under the FRT, an entity's net debt deductions are capped at 30% of its tax EBITDA — that is, 30% of its earnings before interest, taxes, depreciation, and amortisation as calculated for tax purposes.

Tax EBITDA is not the same as accounting EBITDA. It is calculated by adjusting the entity's taxable income (or tax loss) to add back net debt deductions, specific capital-related deductions such as decline in value and capital works deductions, and any excess tax EBITDA transferred from controlled entities.

Where an entity's net debt deductions exceed the 30% cap, the excess is disallowed. However, the FRT provides a valuable carry-forward mechanism: disallowed amounts can be carried forward for up to 15 years and claimed as a special deduction in future years, provided the entity continues to apply the FRT and has sufficient headroom under the fixed ratio earnings limit in those future years.

Key Advantages of the Fixed Ratio Test

• Carry-forward of denied deductions: Up to 15 years, giving entities flexibility to recover disallowed amounts in profitable future years.
• Simplicity: The 30% cap is a straightforward calculation compared to the group-level data required for the Group Ratio Test.
• No group-level data required: Entities that cannot readily access worldwide group financial data will find the FRT more practical to apply.

The Group Ratio Test and Third-Party Debt Test

The Group Ratio Test (GRT) allows an entity to deduct net interest expenses based on the ratio of the worldwide group's net third-party interest expense to its EBITDA. This test can be advantageous where the worldwide group is more highly leveraged than the 30% FRT cap would allow — for example, in capital-intensive industries such as infrastructure, energy, or real estate.

However, the GRT has a significant drawback: denied deductions cannot be carried forward. Entities that choose the GRT and have deductions denied in a given year lose those deductions permanently. This makes the GRT most suitable for entities that are confident their group ratio will consistently support their Australian debt deductions.

The Third-Party Debt Test (TPDT) limits deductions to those attributable to genuine external, third-party lenders. Related-party debt deductions are denied entirely under this test. The TPDT is most appropriate for entities that are funded exclusively or predominantly by arm's length external debt and wish to avoid the complexity of the FRT or GRT calculations. Like the GRT, the TPDT does not permit carry-forward of denied deductions.

The Debt Deduction Creation Rules: An Integrity Overlay

Separate from the three thin capitalisation tests, the Debt Deduction Creation Rules (DDCRs) apply to income years commencing on or after 1 July 2024. These rules are integrity measures that deny debt deductions for interest on debt arising from specific related-party transactions that lack genuine commercial justification.

The DDCRs target two main scenarios:

• Asset acquisitions from associates: Where an entity borrows from a related party to acquire assets from another associate, the interest on that debt may be denied under the DDCRs.
• Distributions to associates: Where debt is used to fund dividends, returns of capital, or other distributions to associates, the interest on that debt may similarly be denied.

Critically, the DDCRs take priority over the thin capitalisation tests. An entity must first determine whether any debt deductions are denied under the DDCRs before calculating its position under the FRT, GRT, or TPDT. Entities applying the Third-Party Debt Test and authorised deposit-taking institutions (ADIs) are exempt from the DDCRs.

The DDCRs can apply to arrangements that were in place before 1 July 2024, which means entities with pre-existing related-party financing structures should have reviewed their arrangements with their accountant as a matter of urgency.

Transfer Pricing Obligations Remain

Even where an entity's net debt deductions fall below the AU$2 million threshold or satisfy the Fixed Ratio Test, transfer pricing rules still apply to the quantum of cross-border related-party borrowings. Entities must self-assess whether the amount of their related-party debt is consistent with arm's length conditions.

The ATO expects taxpayers to maintain robust documentation supporting both the interest rates and the quantum of their cross-border financing arrangements. Inadequate documentation is a significant compliance risk, particularly given the ATO's increased focus on multinational tax integrity.

Australian Regulatory Context

The thin capitalisation reforms were enacted as part of the Australian Government's broader multinational tax integrity agenda, which also includes the global minimum tax (Pillar Two) rules applying from 1 January 2024 for large multinationals. The ATO has published detailed guidance on the new thin capitalisation framework, including Law Companion Rulings and practical compliance guidance.

A statutory review of the thin capitalisation amendments is underway, with the Board of Taxation having invited public submissions with a deadline of 18 May 2026. The final report is due to the Government within 12 months of the review's commencement in February 2026. Businesses should monitor the outcomes of this review, as it may result in further amendments to the framework.

The ATO has also signalled that it will use its data-matching and risk-profiling capabilities to identify entities that may be non-compliant with the new rules. Entities with significant cross-border financing arrangements should ensure their thin capitalisation position is documented and defensible before the ATO comes knocking.

Common Mistakes and Red Flags

The transition from the old safe harbour regime to the new interest limitation framework has created several common compliance pitfalls:

• Applying the old safe harbour approach: Some entities have continued to apply the old debt-to-asset safe harbour, which no longer exists. This is a fundamental error that can result in significant underpayment of tax.
• Ignoring the DDCRs: Entities that focus only on the thin capitalisation tests without considering the DDCRs may inadvertently claim deductions that are denied under the integrity rules.
• Failing to document transfer pricing positions: Even where the thin capitalisation tests are satisfied, inadequate transfer pricing documentation for the quantum of related-party debt is a significant ATO risk.
• Choosing the wrong test: Selecting the GRT or TPDT without fully understanding the carry-forward implications can result in permanently lost deductions.
• Missing the carry-forward mechanism: Entities applying the FRT that have disallowed deductions should ensure these are tracked and claimed in future years when headroom is available.

Questions to Ask Your Accountant

If your business has cross-border financing arrangements, the following questions will help you assess whether your accountant has the expertise to manage your thin capitalisation position:

• Which thin capitalisation test applies to our entity, and have you modelled the outcomes under each available test?
• Have you reviewed our related-party financing arrangements against the Debt Deduction Creation Rules?
• Do we have adequate transfer pricing documentation for the quantum of our cross-border debt?
• Are there any disallowed deductions from prior years that we should be tracking for carry-forward purposes?
• Have you reviewed the Board of Taxation's statutory review of the thin capitalisation amendments and assessed any potential impact on our position?
• Are we subject to the global minimum tax (Pillar Two) rules, and if so, how do they interact with our thin capitalisation position?

How MyMoney® Can Help

Australia's new thin capitalisation framework is technically complex and requires an accountant with specialist expertise in international tax and cross-border financing. The stakes are high: errors in applying the Fixed Ratio Test, the Group Ratio Test, or the Debt Deduction Creation Rules can result in significant tax underpayments, ATO audits, and penalties.

MyMoney® connects Australian businesses with qualified accountants who specialise in corporate tax, international tax, and thin capitalisation compliance. Whether you are a multinational subsidiary, a private company with related-party financing, or an Australian business expanding offshore, our marketplace helps you find an expert who understands the 2024 reforms and can protect your position.

Post a Brief to receive proposals from specialist accountants, or Browse Accountant Professionals to find an expert in thin capitalisation and international tax compliance.