Entity Setup

Entity Setup and Compliance: Navigating the New Thin Capitalisation & DDCR Rules in Australia

Entity structures with debt and cross-border financial flows are affected by new rules; here’s how entities can stay compliant and avoid denied deductions.

By NomadicTax Research Team • 5-8 min read • April 6, 2026

## What Are the New Rules and Why They Matter Australia has overhauled its interest limitation and thin capitalisation framework to align with OECD BEPS Action 4. Key changes effective for **income years from 1 July 2023**, with the **Debt Deduction Creation Rules (DDCR)** coming into force **from 1 July 2024**. ([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)) Entities (company, trust, etc.) subject to these rules are those that are **foreign controlled**, or are **privately owned** with outbound operations and cross-border interest payments or debt to related parties. The de minimis threshold still exempt where associate-inclusive debt deductions don’t exceed **AUD 2 million** in a year. ([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)) ## Key Tests Under Thin Capitalisation Each entity must apply one of three tests to ascertain allowable net interest deductions: - **Fixed ratio test**: Net debt deductions capped at **30% of EBITDA**; excess may be carried forward up to **15 years** under certain conditions. Exchange with associate debt included. ([ato.gov.au](https://www.ato.gov.au/api/public/content/0-b12d922f-3ffe-47a6-a868-289919bcf50a?utm_source=openai)) - **Group ratio test**: Uses worldwide group’s debt ratios to determine allowable net deductions—no carry forward. ([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)) - **Third-party debt test**: Only external (third party) debt allowed; related party debt deductions denied; no carry forward. ([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)) The classic **arm’s length debt test** has been removed. For DDCR: deductions related to related party loans that fund acquisitions or distributions may now be denied. ([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)) ## Action Steps for Entity Owners and Trustees 1. **Review existing debt arrangements**: Identify all related party loans, internal financing and associated terms. 2. **Assess preferred test**: Depending on your structure, one of the three tests may offer optimal deductions. 3. **Ensure systems capture EBITDA accurately** and support forecasting – to compare against fixed ratio. 4. **Monitor restructure risks**: Changes in group structure, ownership, or financing arrangements can trigger tougher treatment under these rules. 5. **Prepare for auditing and reporting**: Entities may need to provide disclosures or schedules in the tax return regarding thin capitalisation and DDCR compliance. ## Example Scenario Suppose a private Australian entity has total net debt deductions of **AUD 3 million**, including related party debt, and its calculated EBITDA is **AUD 10 million**. Under the **fixed ratio test**, deductions are capped at **$3 million** × **ratio limit** = **$3 million** actually allowable (that is 30% of EBITDA). If net debt deductions are **$4 million**, deductions above **$3 million** are denied—but may be carried forward if fixed ratio chosen. If same entity picks **third-party debt test**, it must exclude all related party debt, regardless of amount, but may allow full third-party debt if unrelated. No carry forward. ## Compliance Penalties & Timing - Legislation is already **law**. ([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)) - For income years starting **1 July 2024**, entities must ensure debt deduction creation rules are observed. Non-complying deductions can be denied altogether. - Violations may also lead to adjustments, audits, and Senior Executive penalties. ## Takeaway Entity-based structuring demands careful alignment with laws effective since 2023-24 and fully in force by 2024-25. Whether choosing fixed ratio, group ratio, or third-party test, each comes with its documentation, disclosure, and compliance burden—but also potential tax savings. Get advice, model scenarios, adjust financing as needed to retain more deductions legally.