Case Studies

Compliance Case Study: How Thin Capitalisation & Debt Deduction Rules Can Bite Small Groups

Even privately owned businesses aren't immune: new thin capitalisation and debt deduction creation rules require careful planning to avoid surprise non-deductible interest expenses.

By NomadicTax Research Team • 5-8 min read • November 22, 2025

## Overview Australia has introduced stricter rules around **thin capitalisation** and **Debt Deduction Creation Rules (DDCR)**. These aim to limit interest deductions, especially when entities fund business via internal loans or related party debt. Small and mid-sized private groups must now act deliberately to stay compliant and protect tax outcomes. ([ato.gov.au](https://www.ato.gov.au/businesses-and-organisations/international-tax-for-business/private-wealth-international-program/new-international-tax-measures-affecting-private-groups?utm_source=openai)) ## What Has Changed - **New thin capitalisation rules**: From income years starting 1 July 2023, many private groups (multinational or foreign controlled) must comply with stricter is debt to equity rules. ([ato.gov.au](https://www.ato.gov.au/businesses-and-organisations/international-tax-for-business/private-wealth-international-program/new-international-tax-measures-affecting-private-groups?utm_source=openai)) - **Debt Deduction Creation Rules (DDCR)**: From 1 July 2024, rules deny deductions for debt created through related party loans used to fund asset acquisitions or prescribed payments. These apply even if the arrangement is domestic—impacting trusts, companies, or groups with internal financing. ([ato.gov.au](https://www.ato.gov.au/businesses-and-organisations/international-tax-for-business/private-wealth-international-program/new-international-tax-measures-affecting-private-groups?utm_source=openai)) ## Case Study: Small Family Group Operating an Outbound Holding Company *Family Foods Pty Ltd* owns assets in Australia and holds a related entity overseas, through which it borrows funds to expand operations. Under new rules: - If the debt is to a related party and used to acquire Australian assets (e.g. machinery, property), part of the interest may be **denied deduction** under DDCR. - If the total debt-deductions (inclusive of associates) exceed the **de minimis** threshold of **AUD 2 million**, thin capitalisation rules can apply. Even though the group is private, the thresholds or foreign control may make them in scope. ([ato.gov.au](https://www.ato.gov.au/businesses-and-organisations/international-tax-for-business/private-wealth-international-program/new-international-tax-measures-affecting-private-groups?utm_source=openai)) ## Strategic Implications and Risk Points - Overlapping rules: Entities may qualify under DDCR and thin capitalisation, meaning careful structuring of loans and intercompany financing is crucial. - Transfer pricing scrutiny: If terms of related party loans aren’t at arm’s length, these may attract ATO review or penalties. - Documentation and valuation: Must show genuine use of debt, record keeping of use of funds for allowed purposes, keep evidence when loans serve multiple purposes. ## Actionable Steps to Stay Compliant - Conduct a full **finance structure audit** similar to what a tax agent or accountant would do: map internal loan flows, categorize purposes (asset funding, dividend, etc.). - Stay under the **de minimis AUD 2 million** debt deductions rule where possible; if not, ensure compliance with documentation and thin capital rules. - Consider shifting some debt to equity, or using external commercial borrowing for major asset purchasing rather than related party lending. - For prescribed payments (distributions, returns of capital): ensure they are accounted for separately and avoid being caught up in DDCR. ## Example: Real Numbers Suppose Group X has AUD 10 million debt to related party, uses AUD 4 million for Australian asset acquisitions, AUD 3 million for distribution payments, AUD 3 million for operating expenses. Under DDCR: - AUD 4 million + AUD 3 million = **AUD 7 million** might be non-deductible debt; only AUD 3 million could be considered where allowed (operating expense) if compliant. - If overall debt deductions exceed AUD 2 million, thin capitalisation ratio (which could limit many deductions) kicks in. ## Conclusion The tightening of debt-based deductions and new thin capitalisation regimes mean that groups—especially private, family, or related-entity groups—must rethink how they finance operations and structure loans. Incremental planning today can avoid costly denials of deductions and penalties tomorrow.