Debt Deduction Creation Rules in Australia 2026: Board of Taxation Review and What Businesses Must Know

Australia's tax landscape for businesses with related-party financing arrangements has undergone a fundamental transformation since 1 July 2024. The Debt Deduction Creation Rules (DDCR) — introduced alongside the broader thin capitalisation reforms — target arrangements that artificially generate deductible interest expenses without corresponding economic substance. For Australian businesses, trustees, and their accountants, understanding these rules is now a compliance imperative, not an optional consideration.

Understanding the Debt Deduction Creation Rules

The DDCR apply to income years commencing on or after 1 July 2024. They sit alongside the new earnings-based thin capitalisation regime — which replaced the old asset-based safe harbour from 1 July 2023 — and together represent the most significant overhaul of Australia's interest deductibility framework in decades.

At their core, the DDCR deny deductions for related-party debt expenses where the debt was created to fund certain transactions with associates. The rules target two distinct types of arrangements.

Type 1 Arrangements: Acquiring Assets from Associates

Type 1 arrangements involve related-party debt deductions used to acquire capital gains tax (CGT) assets or legal and equitable obligations from an associate. The concern is that a business could borrow from a related party to purchase an asset already within the group, generating an interest deduction without any genuine external financing cost.

The ATO's risk framework, set out in PCG 2024/D3 and subsequent updates, categorises restructures as White (no further assessment required), Green (low risk), Yellow (unassessed), or Red (high risk). Arrangements that attempt to artificially change the character of costs — or that replace related-party debt with third-party debt where the associate lender subsequently provides funds to the third-party lender — are classified as Red and attract the highest scrutiny.

Type 2 Arrangements: Funding Payments to Associates

Type 2 arrangements involve related-party debt deductions used to fund payments to associates, such as dividends, royalties, or returns of capital. The concern here is that a business borrows from a related party to fund a distribution back to that same related party, creating a circular flow that generates a deduction without genuine economic cost.

Both types of arrangements are subject to the DDCR regardless of whether the entity is otherwise compliant with the thin capitalisation fixed ratio test, group ratio test, or third-party debt test.

The 2026 Board of Taxation Review

In January 2026, the Australian Government tasked the Board of Taxation with an independent review of the thin capitalisation reforms, including the DDCR. The review was commissioned in response to concerns from industry that the rules have created unintended consequences for legitimate commercial and property investment structures.

The Board of Taxation is examining whether the reforms have inadvertently captured genuine arm's-length financing arrangements — particularly in the property development and infrastructure sectors — that were never intended to be targeted by the legislation.

While the review is ongoing, the ATO has made clear that taxpayers cannot rely on anticipated future amendments to justify non-compliance with the current rules. Businesses must ensure their existing financing structures are defensible under the legislation as it stands today.

Key Considerations for Australian Businesses

The DDCR interact with the broader thin capitalisation framework in complex ways. Businesses need to assess their position across multiple dimensions simultaneously.

• Identify all related-party debt arrangements — Map every intra-group loan, guarantee, and financing arrangement to determine whether the DDCR could apply.
• Assess the purpose of each arrangement — Determine whether any related-party debt was used to acquire assets from associates or to fund payments back to associates.
• Apply the PCG risk framework — Use the ATO's colour-coded risk categories to assess the risk profile of each arrangement and prioritise remediation.
• Review restructuring history — Any restructures undertaken since 1 July 2024 should be reviewed against the DDCR to confirm they do not inadvertently trigger a denial of deductions.
• Document commercial rationale — Maintain contemporaneous documentation of the commercial reasons for each related-party financing arrangement.
• Consider the third-party debt test — The ATO's finalised guidance in TR 2025/2 clarifies that the third-party debt test is narrow and focused on genuine commercial arrangements connected to Australian business operations.

Common Mistakes and Red Flags

The ATO has identified several financing structures that are likely to attract scrutiny under the DDCR and the broader thin capitalisation framework.

One of the most common errors is assuming that compliance with the fixed ratio test (which limits net debt deductions to 30% of tax EBITDA) automatically means the DDCR do not apply. The DDCR operate independently of the thin capitalisation tests and can deny deductions even where an entity is within the fixed ratio limit.

Another frequent mistake is failing to recognise that refinancing arrangements can trigger the DDCR. Where a business replaces related-party debt with third-party debt, but the associate lender subsequently provides funds to the third-party lender, the ATO treats this as a Red-category arrangement that is likely to be denied.

• Circular financing structures — Borrowing from a related party to fund a distribution back to that same party is a classic Type 2 arrangement.
• Asset acquisitions within the group — Purchasing assets already held within the corporate group using related-party debt is a Type 1 arrangement.
• Inadequate documentation — Failing to document the commercial rationale for related-party financing arrangements leaves businesses exposed to ATO challenge.
• Relying on anticipated legislative changes — The Board of Taxation review does not suspend current compliance obligations.

Australian Regulatory Context

The DDCR were enacted as part of the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share — Integrity and Transparency) Act 2024. They form part of Australia's broader response to OECD Base Erosion and Profit Shifting (BEPS) recommendations, specifically Action 4, which addresses interest deductibility.

The Australian Taxation Office (ATO) administers the DDCR and has published extensive guidance, including PCG 2024/D3 (risk framework for restructures), TR 2025/2 (third-party debt test), and PCG 2025/2 (practical compliance guidance). The ATO has signalled that it will actively audit arrangements that fall into the Yellow and Red risk categories.

The Board of Taxation review, commissioned in January 2026, is examining the practical impact of the reforms on commercial structures. However, the review does not provide any safe harbour or moratorium on ATO enforcement activity during the review period.

Businesses with cross-border financing arrangements should also be aware that the DDCR interact with Australia's transfer pricing rules and the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936.

Questions to Ask Your Accountant

If your business has related-party financing arrangements, these are the questions you should be discussing with your accountant right now.

1. Have all of our related-party debt arrangements been reviewed against the DDCR since 1 July 2024?
2. Do any of our financing arrangements involve debt used to acquire assets from associates or to fund payments back to associates?
3. What is the ATO risk category (White, Green, Yellow, or Red) for each of our related-party financing arrangements?
4. Are we compliant with the fixed ratio test, group ratio test, or third-party debt test under the thin capitalisation framework?
5. Do we have adequate contemporaneous documentation of the commercial rationale for each related-party loan?
6. Have any restructures undertaken since 1 July 2024 been reviewed against the DDCR?
7. Should we be making a voluntary disclosure to the ATO if we have identified a potential DDCR issue?

How MyMoney® Can Help

The Debt Deduction Creation Rules represent a significant compliance challenge for Australian businesses with related-party financing arrangements. Getting the analysis wrong can result in the denial of substantial interest deductions, penalties, and interest charges.

MyMoney® connects Australian businesses with experienced accountants who specialise in corporate tax, thin capitalisation, and ATO compliance. Whether you need a comprehensive review of your related-party financing arrangements, assistance with ATO risk categorisation, or support during an ATO audit, our network of qualified professionals can help.

Post a Brief to describe your situation and receive tailored proposals from accountants with expertise in the DDCR and thin capitalisation framework. Alternatively, Browse Accountants on the MyMoney® Marketplace to find a specialist who can review your financing arrangements and ensure your business is compliant with Australia's evolving tax rules.