PCG 2025/2 Corporate Restructures, Thin Capitalisation and DDCR

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PCG 2025/2 Corporate Restructures, Thin Capitalisation and DDCR

Practical Compliance Guideline PCG 2025/2 sets out the Australian Taxation Office’s (“ATO”) compliance approach to restructures undertaken in response to Australia’s new thin capitalisation regime and Debt Deduction Creation Rules (“DDCR”), introduced by the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share - Integrity and Transparency) Act 2024.

The underlying law introduced:

Thin capitalisation rules in Division 820 of the Income Tax Assessment Act 1997 (“ITAA 1997”), which limit the amount of debt‑related deductions that multinational and large domestic entities can claim; and
DDCR in Subdivision 820‑EAA of the ITAA 1997, which deny interest deductions where related‑party debt is used to fund certain acquisitions or payments involving associates.

PCG 2025/2 outlines how the ATO will:

assess compliance risk,
determine when to apply compliance resources, and
consider the application of anti‑avoidance provisions to restructures undertaken in response to the new rules.

The PCG applies to restructures entered into on or after 22 June 2023, aligning with the period from which the relevant legislative changes were announced.

Summary of Schedule 1, 2, 3 and 4

Schedule 1 – Debt Deduction Creation Rules (DDCR)

Schedule 1 explains when the DDCR may apply and provides practical examples to assist taxpayers in identifying whether interest deductions may be denied.

The DDCR broadly applies to two categories of arrangements:

Type 1 – Acquisition cases
Where an entity acquires a Capital Gains Tax (“CGT”)[1] asset or a legal or equitable obligation from an associate, and the acquisition is funded (directly or indirectly) by related‑party debt. Interest deductions are denied to the extent they relate to that acquisition.

Type 2 – Payment or distribution cases
Where related‑party debt funds or facilitates certain payments to associates, such as dividends, returns of capital or royalties. Deductions are denied to the extent they relate to those payments.

Schedule 1 highlights the importance of tracing and apportionment, including indirect funding arrangements, significantly increasing evidentiary and documentation expectations for taxpayers.

[1] CGT is the tax paid on profits from disposal of assets including investments, such as property, shares and crypto assets.

https://www.ato.gov.au/individuals-and-families/investments-and-assets/capital-gains-tax/what-is-capital-gains-tax

Schedule 2 – Restructures in Response to the DDCR

Schedule 2 focuses on restructures or refinancings undertaken in response to the DDCR and introduces ATO’s risk assessment framework.

Restructures are categorised into four zones as summarise below:

ZONES	RISK	SCENARIOS
White	Low	Minimal ATO engagement No material change in arrangement
Green	Lower Compliance Risk	Covered by low-risk examples in Schedule 2 or 4 of this PCG
Yellow	Uncertain Risk	Possible ATO engagement Undertaken one or more restructures which are not covered by examples in Schedules 2 and 4 of this PCG
Red	Higher Risk	Likely attract ATO scrutiny Restructure is covered by a high-risk example in Schedules 2 and 4 of PCG A review or audit on the restructure was conducted by ATO and a high-risk rating was given

The ATO indicates that restructures that lack substantive commercial change, such as replacing one form of related‑party debt with another, are more likely to attract closer review.

Schedule 3 – Third Party Debt Test (TPDT) compliance approach

Schedule 3 sets out the ATO’s compliance approach to the Third Party Debt Test (“TPDT”), which allows interest deductions for qualifying third‑party debt under strict conditions.

Following its initial release in draft, Schedule 3 has been finalised alongside Taxation Ruling 2025/2, which was finalised and published on 1 October 2025, replacing Draft Tax Ruling 2024/D3, and is intended to be read together with Schedule 3 of PCG 2025/2, which sets out the ATO’s compliance approach to restructures involving the TPDT.

Schedule 4 – Restructures in Response to Thin Capitalisation Changes

Schedule 4 addresses restructures undertaken in response to the broader thin capitalisation changes, rather than the DDCR specifically.

The Act introduced three thin capitalisation tests for general class investors under Subdivision 820‑AA to limit debt deductions.

The Fixed Ratio Test (“FRT”) is the default test and caps net debt deductions at 30% of tax EBITDA.
The Group Ratio Test (“GRT”) is an elective alternative that limits deductions based on the worldwide group’s net interest expense to EBITDA ratio, using audited group financials.
The Third Party Debt Test (“TPDT”) is another elective test that allows deductions only for qualifying third‑party debt; related‑party debt is excluded entirely.

Impact on Transfer Pricing

While PCG 2025/2 is not a transfer pricing guideline, it has significant transfer pricing implications.

Interest deductibility is no longer determined solely by arm’s length pricing. Even where interest rates are arm’s length, deductions may be denied under the DDCR or thin capitalisation rules.

Transfer pricing documentation demonstrating the following clearly is essential:

the purpose of borrowings,
the use of funds, and
the commercial rationale for group financing structures.

Next Steps

In light of PCG 2025/2, taxpayers should:

Map all related‑party debt arrangements, including historical and indirect funding flows.
Assess DDCR exposure for both acquisition‑related and payment‑related borrowings.
Self‑assess restructures against the PCG risk framework in Schedules 2 and 4.
Review transfer pricing documentation for consistency with tracing, purpose and substance requirements.
Strengthen contemporaneous documentation, particularly for mixed‑purpose borrowings and refinancings.

Corporate Restructures, Thin Capitalisation and DDCR Specialists

Supporting MNEs with PCG 2025/2 guidelines and compliance.