How Australia’s new debt deduction creation rules can deny interest deductions

Broadly, the DDCR may apply to disallow debt deductions that are paid or payable in relation to loans and debts to associates in two cases:

1. Acquisition case: Where related party debt has been used to fund the acquisition of a capital gains tax (CGT) asset, or a legal or equitable obligation directly or indirectly from an associate; or 
2. Payment or distribution case: Where financial arrangements are used to fund one or more prescribed payments or distributions to an associate. 

Sample scenario and application of the DDCR:

The following example illustrates how the DDCR may disallow debt deductions of an Australian taxpayer under a payment or distribution case.

C Co runs a global computer sales business and is a tax resident of Country C. Aus Co is an Australian tax resident and a subsidiary of C Co. Aus Co carries on the multinational enterprise’s business operations in Australia and regularly pays dividends to C Co out of cash generated from the sales of computers to Australian customers.

In FY2025, Aus Co’s cash reserves are insufficient for Aus C to fund dividends and its operations. As a result, Aus Co borrows AUD 50 million from B Co, another subsidiary of C Co. The funds are used by Aus Co to pay a dividend to C Co, and also to fund its commercial operations. 

Ordinarily, Aus Co would be able to claim a deduction for the interest expense, but under the DDCR the loan from B Co is a financial arrangement that potentially funded or facilitated the funding of the dividends to C Co. If it is found that the DDCR applies, Aus Co would not be able to deduct any interest to the extent to which it used the funds to fund, or facilitate the funding of, the dividends to C Co.

Importantly, any deductions denied under the DDCR will be disregarded for the purposes of applying the thin capitalisation rules for the income year. Such debt deductions are lost permanently and cannot be recouped in future years.

Whilst the DDCR applies automatically without the need to prove a tax avoidance purpose, it also contains specific anti-avoidance provisions that apply if the Commissioner is satisfied that an entity entered into, or carried out a scheme for the principal purpose of avoiding the application of the DDCR in relation to a debt deduction. These anti-avoidance provisions allow the Commissioner to determine if the DDCR applies.

Further, the Australian Tax Office (ATO) has confirmed that the DDCR applies to arrangements entered into before 01 July 2024, if the debt deductions continue to arise from historical arrangements in income years commencing on or after 01 July 2024. Accordingly, it is important for taxpayers to review and ensure that their existing structures and financing arrangements will not trigger the DDCR.

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Tony Nunes has over 25 years’ experience in providing tax advice to clients, especially on issues affecting cross-border transactions, acquisitions and restructures, and on all aspects of structuring the ownership and financing of corporations and their operations. 

Isabella Chin is a qualified CA, CTA and tax lawyer. She commenced her tax career with one of the “Big 4” accounting firms. She works with a diverse range of clients. Her areas of tax expertise include small business tax concessions, restructures, capital gains tax, and tax residency.