How Australia’s New Debt Deduction Creation Rules Can Deny Interest Deductions

The new Debt Deduction Creation Rules (“DDCR”) operate to disallow debt deductions (e.g. interest expenses) arising on certain related party arrangements for income years starting on or after 1 July 2024. 

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:

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 $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. Still, 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 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 that the DDCR applies. 

Further, the ATO has confirmed that the DDCR applies to arrangements entered into before 1 July 2024 if the debt deductions continue to arise from these historical arrangements in income years commencing on or after 1 July 2024.  Accordingly, it is important for taxpayers to review and ensure that their existing structures and financing arrangements would not trigger the DDCR.