ATO finalises guidance on new thin capitalisation and debt creation rules

On 20 August 2025, the Australian Taxation Office (ATO) released Practical Compliance Guideline (PCG) PCG 2025/2 - Restructures and the thin capitalisation and debt deduction creation rules - ATO compliance approach (Final PCG). It is the finalised version of Draft PCG 2024/D3 (Draft PCG). 

The structure of the final PCG is similar to the draft. The key change is the exclusion in the final PCG of Schedule 3 to the draft PCG. Schedule 3 covered the ATO’s compliance approach to the Third Party Debt Test. The ATO intends to finalise this together with the finalisation of Draft Taxation Ruling TR 2024/D3 Income tax: aspects of the third-party debt test in Subdivision 820-EAB of ITAA 1997 (Draft TR 2024/D3). 

The remaining schedules are:

Schedule one	Examples where the debt deduction creation rule (DDCR) will need to be considered.
Schedule two	Restructures in response to the DDCR: Covers the compliance risks arising from restructures in response to the DDCR.
Schedule four	Restructures in response to the thin capitalisation changes: Covers the compliance risks arising from restructures in response to the thin capitalisation rules.

In substance, the final PCG’s remaining schedules do not greatly deviate from the ATO’s position in the draft. A number of additional examples have been added, some of the examples in the draft have been altered, and some of the risk ratings have been amended as discussed below. 

Background: New thin capitalisation regime from 1 July 2023 

Treasury Laws Amendment (Making Multinationals Pay Their Fair Share - Integrity and Transparency) Act No 23 of 2024 was assented to on 8 April 2024. It introduces the new thin capitalisation regime that applies to most taxpayers with effect for income years commencing on or after 1 July 2023.

The aim of the thin capitalisation rules is to limit the amount of debt deductions that multinational entities can claim in an income year.

Comparisons of final PCG and Draft PCG

Apart from structural changes, the ATO’s position has not changed significantly between the draft and finalised PCG. The ATO received a significant number of submissions before finalising the draft PCG, which appear to have prompted the Commissioner to clarify and extend the guidance on the application of the new thin capitalisation and debt deduction creation rules. 

The finalised PCG introduces additional detail to the examples as well as practical guidance on how the various tracing provisions in the new rules will be applied. Significantly, it appears industry concerns expressed on the draft PCG about the ATO’s risk ratings have been acknowledged. 

This will provide some taxpayers with comfort, for example in the context of the application of the DDCR to what might be described as routine commercial transactions where existing related party debt is replaced with third party debt.

In regard to risk zones, the final PCG states that restructures for which the ATO has already conducted a review or audit and provided a ‘low-risk’ rating, will now be in the ‘white zone’ (Further risk assessment not required). In the draft PCG, such low-risk restructures were included in the ‘green zone’ (low risk).

Some of the notable changes in the examples between the draft and finalised PCG include:

Example one	Timing and the “associate pairs” condition: In the finalised example, the associate pair condition is tested at the time of acquisition. The final PCG states there is no need to test at a later point unless there are factors indicating contrivance or artificiality in relation to the timing of entering into the acquisition or the borrowing.
Example three	This is a new example being a variation of example 2 on funding capital expenditure with related party debt where the related party debt is repaid out of cash provided from business operations. The ATO is unlikely to apply compliance resources in such a situation.
Example eight	This is a new example being a variation of example 7 on funding working capital and dividends with related party debt. The variation is that the related party debt that partly financed a dividend is refinanced with further related party debt. The ATO considers the borrower would still need to consider the DDCR to the extent the refinancing funded or facilitated the previous dividend.
Example nine	Refinancing third party debt: This is a new example, and it states ATO compliance activity will probably occur to determine the correct application of the DDCR in the context of refinancing third party debt. It confirms that there are two tests - the tracing test and the refinancing test. Example 9 also says that if you refinance arm’s length debt with related party debt, the refinancing principle applies.
Examples 15, 16 and 17	These are new examples of tracing of funds and apportionment of the funding that was used for several purposes.
Example 20	Replacing related party debt with third party debt (low risk): This example confirms that repaying related party debt with arm’s length debt would, absent any scheme to which section 820-423D applies, generally exclude the operation of the DDCR. Such restructure re considered to be low risk.

These are some helpful expanded upon examples in the finalised PCG. More generally, other examples confirm that repaying related party debt in cash, via dividends and via equity injections will also not attract the DDCRs. 

Implications of finalised PCG 2025/2 

The PCG provides taxpayers with a wide range of examples which clearly are not prescriptive to individual taxpayers but are indicative of the Commissioner’s approach to interpreting what are a complex set of provisions. In this way, the finalised version is much more useful than its draft.

By setting risk ratings as either low or high, the Commissioner has attempted to provide certainty as to what will attract attention and compliance resources. However, for those arrangements that have fallen into high-risk categories, it is advisable for affected taxpayers to engage with the ATO to secure certainty.

It is important to note the PCG remains subject to further input on the third-party debt test for thin capitalisation purposes – the timing of this is contingent on the finalisation of TR 2024/D3. It might be hoped over time as further examples emerge, the PCG will be further updated with guidance as the Commissioner’s compliance approach evolves. 

The interpretation and application of the new thin capitalisation regime is complex and an emerging category of taxation regime. Taxpayers seeking clarity or who are otherwise affected should consult with one of our corporate and international tax experts.