Entity Setup
Entity Setup and Tax Planning in Australia: Structuring for Thin Capitalisation and DDCR Rules
New Australian rules on thin capitalisation and debt deduction creation are forcing businesses to rethink entity setup, funding and group structuring to maintain tax effectiveness and avoid disallowed deductions.
By NomadicTax Research Team • 6 min read • November 23, 2025
## Introducing the Thin Capitalisation and DDCR Regime
Australia recently enacted **new thin capitalisation rules** and **Debt Deduction Creation Rules (DDCR)** aligned with OECD Base Erosion and Profit Shifting (BEPS) Action 4.([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)) These apply to:
- Multinational businesses operating in Australia
- Privately owned Australian entities that are foreign-controlled
- Privately owned and wealthy groups with outbound operations (i.e., global reach)([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 features of the updated rules include:
### Thin Capitalisation Tests
- **Fixed ratio test**: debt deductions limited to **30% of EBITDA**. Denied deductions can be carried forward (up to 15 years) under this method.([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))
- **Group ratio test**: based on the worldwide group’s net debt and EBITDA—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**: deductions allowed in full for external debt; however, related-party debt deductions are generally denied. Again, 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 arm’s length debt test has been **removed** altogether.([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)
These rules deny interest deductions where loans or prescribed payments are created to fund assets, distributions, or related party capital transactions. Applies both domestically and internationally. Applies from income years starting **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))
## Entity Setup Considerations
When planning entity structure, these factors now matter:
- **Where does value reside?** Entities holding intangibles or cross-border related financing are particularly vulnerable under DDCR and thin capitalisation. Example: a subsidiary paying royalties or dividends that are misclassified.
- **Negotiate inter-company financing terms carefully**: related-party loans should be evaluated under new tests. External financing favored under certain tests.
- **Test choice of test** annually: depending on global leverage, group structure, external vs internal debt, the fixed ratio test may be more favorable if external debt is high.
- **Carry forward planning**: For fixed ratio denied deductions, only that method allows carry forward for 15 years. Other methods don’t.
## Practical Example
ABC Holdings Pty Ltd has the following scenario:
- A parent in France with 2 subsidiaries in Vietnam and Singapore.
- Australian entity has both related-party debt and external debt.
- EBITDA in Australia is AUD 5 million, interest deductions from external debt are AUD 1 million; related‐party interest is AUD 2 million.
Under the fixed ratio test: deduction limited to 30% of EBITDA = AUD 1.5 million; thus AUD 1 million (external) + only AUD 0.5 million (from related party), the balance of AUD 1.5 million denied and carried forward. Under other tests, related party interest likely denied completely.
## Actionable Steps for Setup and Planning
- **Perform a debt audit**: categorize related-party vs third-party, current vs new loans.
- **Model each test** (fixed, group, third-party) to see which yields least denial.
- **Document your financing decisions**, related party agreements, and financial statements of group to survive transfer pricing and ATO scrutiny.
- If setting up new entities, favor external debt where possible if you expect to rely on third-party debt test.
- Ensure capital contributions or distributions are not structured just to generate deductible debt (DDCR covers this).
With the updated rules fully in effect, businesses must be proactive in structuring liabilities and entity setups that preserve deductions where allowed and manage downside risks where they're not.