Australia: Australia's thin capitalisation rules are getting thinner

Moore Tax News
Last Updated: 8 October 2014
Article by Stephen O'Flynn

The Government has proceeded with the amendments to the thin capitalisation, foreign non-portfolio dividends and foreign residents capital gains rules with the Tax and Superannuation Laws Amendment (2014 Measures No 4) Bill 2014 passing the Senate on 25 September 2014.These measures were initially proposed in the 2013-14 Budget and are part of the Government's wider strategy around base erosion and profit shifting, more commonly referred to as BEPS. Importantly, the amendments include an integrity measure limiting the operation of the non-portfolio dividend exemption in section 23AJ, also proposed in the 2013-14 Budget. This will mean that multinational organisations' will be no longer be able to reduce their Australian tax through debt loading which previously exploited the debt / equity mismatch in the exemption.

Thin Capitalisation Reforms

Thin Capitalisation rules were first introduced in 1987 (and subsequently amended in 2001) to limit the amount of debt deductions that could be claimed for certain inbound and outbound investors. These provisions operate by denying deductions for interest expenses and borrowing costs when certain gearing thresholds are exceeded. The rules have the intended effect of limiting a multinational organisations' ability to shifting profit overseas by allocating an excessive amount of debt in their Australian operations, thereby reducing their Australian taxable income. Such entities which are highly geared are said to be 'thinly capitalised'.

Broadly, there are three ways to calculate the maximum amount of debt allowed:

  • the safe harbour debt amount;
  • the arms-length debt amount; and
  • the 'worldwide gearing debt amount'.

These rules have been amended to limit profit shifting and to reduce compliance costs and fall in line with the exposure drafts released earlier in the year. The key changes include:

  • Reduction of the safe harbour debt limit from a debt-to-equity ratio of
    • 3:1 to 1.5:1 for general entities; and
    • 20:1 to 15:1 for non-bank financial entities
  • Allowing the worldwide gearing ratio to be available to inbound investors and reducing the ratio from 120% to 100%;
  • Increasing the safe harbour capital limit for Authorised Deposit Institutions (ADIs) from 4% to 6% of their risk weighted Australian assets; and
  • Increase the De Minimis threshold from $250,000 to $2 million of debt deductions.

Potential implications

Although the Bill has just been passed, these changes apply retrospectively from 1 July 2014. Therefore, it is essential for businesses to consider the implications of these changes on their financing arrangement now.

Due to the substantial increase to the De Minimis threshold, entities with debt deductions less than $2 million will be positively impacted by these changes, and will effectively be able to disregard the thin capitalisations provisions altogether. Conversely, those entities to which the Thin Capitalisation rules do apply will be potentially worse off as the prescribed safe harbour gearing ratios have been squeezed. Given this it is now worthwhile considering strategies that could improve an entity's ability to fall within the reduced safe harbour's and limit the potential for non-deductible finance costs. These methods may include:

  • Revaluation or review of assets especially intangible assets.
  • Increasing asset levels through capital injection or other forms of restructure.
  • Repayment of debt to reduce liability levels.

These methods should be considered in order to understand the full tax implications to the company as whole. Importantly where an entity takes steps to revalue assets for the purpose of the thin capitalisation provisions it is crucial that the appropriate support for the revaluation is maintained.

Foreign Non-Portfolio Dividends

Section 23AJ of the Income Tax Assessment Act 1936 allows a non-portfolio dividend to be non-assessable non-exempt income and therefore not subject to tax. The new law, rewritten into Division 768 of the Income Tax Assessment Act 1997 (ITAA 1997), will broaden the tax exemption to be available where an Australian company (or corporate tax entity) receives a foreign non-portfolio distribution of an equity interest (e.g. a dividend) through an interposed trust or partnership.

Currently, the operation of section 23AJ is limited to direct shareholdings by Australian resident companies and does not take into account the debt / equity classification of the 'dividend' received. This means that if a dividend is paid by a foreign company to an Australian company indirectly via a fixed trust or partnership the exemption will not be available. Furthermore, the current application of section 23AJ provides tax relief for companies that received dividends paid in respect of a debt interest (e.g. certain redeemable preference shares), which can lead to arguably inappropriate tax arbitrage opportunities.

Specifically, the new Division 768 requires an Australian corporate tax entity to have a 10% 'participation interest' rather than a 10% 'voting interest' in the foreign entity which pays the distribution. The participation interest includes both direct and indirect participation interests. The result of this change is that a foreign dividend paid to an Australian corporate tax entity through a trust or partnership entity will now be classified as non-assessable non-exempt income in the hands of the Australian corporate tax entity and as a result will not be subject to income tax.

Furthermore, the new rules extend the exemption to public trading trusts, corporate unit trusts and corporate limited partnerships that are in most other respects taxed like a company. Although the new rules have a broader application, the revised rules ensure that the distribution made to the Australian company must be classified as 'equity' in accordance with Division 974 of the ITAA97. This will limit a multinational organisation's ability to reduced Australian tax by debt loading its Australian operations.

Foreign Residents Capital Gains Tax Regime

Broadly speaking foreign residents will be effectively exempt from Capital Gains Tax (CGT) if the asset is neither a direct or indirect interest in Australian real property. Whether a share in a company or an interest in a trust is an indirect interest in Australian real property depends on whether the company or trust (in which the share or interest is held) passes the Principle Asset Test.

The main changes to these provisions involve amendments to the Principal Asset Test, which can be manipulated by way of double counting of certain assets and liabilities of related parties. The new measures requires that where the assets of two or more entities are included in the Principal Asset Test, the market value of new non-TARP assets arising from certain arrangements (e.g. intercompany loans) involving those entities will be disregarded. This essentially ensures that no assets are duplicated in the Principal Asset Test.


With the previous amendments to the transfer pricing provisions and now the refinement of the thin capitalisation rules and associated measures the Government has demonstrated its commitment to the agenda for international tax reform as part of the wider BEPS strategy. Given the increasing complexity of Australia's international tax laws it is becoming increasing difficult for a business with cross border operations to successful navigate the journey alone. As such Moore Stephens international tax experts are well placed to assist your business understand these changes.

This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2014 Moore Stephens Australia Pty Limited. All rights reserved.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.