Real assets and the new interest limitation rules

17 March 2023 

In brief

On 16 March 2023, the Australian Treasury released for comment draft legislation (Exposure Draft) to introduce the previously announced changes to Australia’s interest limitation rules i.e. the thin capitalisation rules. New earnings based tests will replace the existing thin capitalisation asset-based safe harbour and worldwide gearing tests for income years commencing on or after 1 July 2023. The arm’s length debt test will also be replaced with a more restrictive external third-party debt test.

Property and infrastructure investors (whose borrowings are asset backed) and which are typically held in trust structures often with associated finance companies may be subject to permanent interest denials under the new rules. The Exposure Draft does not reflect industry submissions made during the post-Budget period in respect of both how the rules will apply to trusts and the on-lending via finance entities. In addition, the announced changes do not provide any carve outs for these types of investors.

Feasibility of new projects will need to be reconsidered and modelling updated to ascertain whether a permanent interest denial or the 15 year carry forward of these denied deductions will impact the projects’ economic viability. Affected entities are urged to engage early to test the impact of the new rules under their current debt position and consider both making submissions and/or restructuring, if necessary prior to the start of the rules. 

The Exposure Draft legislation is open for consultation until 13 April 2023.

In detail

Under the proposed new interest limitation rules, an entity’s net debt-related deductions will be limited to 30% of tax EBITDA (earnings before interest, taxes, depreciation and amortisation). This will replace the existing safe harbour test (asset to debt ratio test). This is in line with the Organisation for Economic Cooperation and Development (OECD)’s recommended approach under Action 4 of the Base Erosion and Profit Shifting (BEPS) Action Plan. In most cases, financial entities will continue to be subject to the existing thin capitalisation rules. A high level summary is outlined below:

Old law New law

Safe Harbour Debt Test (SHDT)

Gross debt deductions are limited to 60% of the average value of an entity’s Australian assets.

Fixed Ratio Test (FRT)

New “general class” investor’s net debt deductions will be limited to 30% of tax EBITDA (earnings before interest, taxes, depreciation and amortisation). Denied deductions may be carried forward for up to 15 years subject to certain conditions.

Worldwide gearing ratio test

Allows an entity’s Australian operations to be geared up to the level of the entity’s worldwide group gearing.


Group Ratio test (GRT)

Allows an entity in a group to claim debt-related deductions up to the level of the worldwide group’s net interest expense as a share of earnings. No carry forward is available for denied deductions.

Arm’s length Debt Test (ALDT)

Allows an entity’s debt deductions to the extent that the existing debt is not greater than what would have been allowed, if the borrower was an external third party with similar operations.


External third-party debt test (ETPDT)

Allows debt deductions where those amounts are attributable to genuine third party debt (with some exceptions for financing entities) which is used wholly to fund Australian business operations with recourse only to the assets of the entity. No carry forward is available for denied deductions.

For a detailed breakdown of the Exposure Draft, please refer to our analysis here.

Practical Implications for the Infrastructure and Real Estate Sectors

Fixed Ratio Test

The example below shows that even with modest gearing levels, the FRT may not provide deductions for interest incurred.

Simplified example to illustrate the operation of FRT (vs SHDT)

Asset Cost







Interest rate 5%
Interest expense $25
Net debt deductions

$25 (assuming nil interest income)

Thin Capitalisation Tests Safe Harbour Test FRT
Thin Capitalisation Limit $600 (i.e. 60% X 1000) debt $18 (i.e. 30% X 60) net debt deductions
Interest denials Nil $7

Trust structures: no effective grouping

Depending on the nature of a particular fund structure and the level at which the relevant debt is issued, the move to a FRT will lead to different tax consequences. For example, where gearing in a fund structure is pooled at the head trust level or if the pooling entity level has cross collateral, then the head trust’s tax EBITDA would generally only include taxable distributions from the sub trusts (which is net of tax depreciation at the sub trust level). This erodes the fund’s thin capitalisation capacity under the proposed new rules. In these circumstances, the head trust would be unable to rely on the ETPDT (if the lender’s took security over the underlying assets), and if the FRT and GRT are not favourable, these entities may need to consider restructuring to move the pooled debt at the head trust level to asset trust levels. This will result in similar economic structures having substantially different tax outcomes which seem not warranted by the intent of the new rules. 

For completeness, we note that there do not appear to be any proposed amendments to exclude restructures as a result of these new provisions from the scope of the general anti-avoidance rules (Part IVA of the Income Tax Assessment Act 1936).  

A simplified numerical example to illustrate this issue is below:

Lending pooled at head trust level
Entity Head Trust Asset Trust 1 Asset Trust 2
Taxable Income* $52 $50 $50
Depreciation $0 $30 $30
Interest Expense $48 N/A N/A
Tax EBITDA $100 $80 $80
FRT Limit $30 $24 $24
Interest denials $18 Nil Nil
Restructuring to lending at asset trust level
Entity Head Trust Asset Trust 1 Asset Trust 2
Taxable Income* $52 $26 $26
Depreciation $0 $30 $30
Interest Expense Nil $24 $24
Tax EBITDA $52 $80 $80
FRT Limit $16 $24 $24
Interest denials Nil $0 $0

*Assuming no interest denial

For the purposes of GRT, for most Australian fund structures, it is likely that the group will generally consist of the head trusts and its sub-trusts (i.e. they are generally not consolidated with their investors). As a result, the application of the GRT should be relatively straightforward for Australian structures. Given most fund structures have high levels of gearing, GRT could potentially be the optimal test for these structures. Where the Australian entities are part of a broader global group (for example an Asia Pacific Fund), the global ratios will be more complex.

Trusts and carry forward amounts

Additionally with respect to trusts, the rules as they are currently drafted do not require satisfaction of the current trust loss tests to carry forward denied debt deductions. This is different from proposed rules for a company, where denials are subject to a modified continuity of ownership test. As such, trust loss testing should not be required to carry forward these amounts. It should be noted, however, that an entity will effectively forfeit its “FRT disallowed amounts” (i.e. debt deductions denied in previous years) if it chooses to use an alternative method (either the GRT or the new ETPDT) in a subsequent year. That is, entities must continue to use the FRT every income year to maintain access to their carried forward FRT disallowed amounts. 

Important exclusions

We note that complying superannuation funds are carved out in a proposed amendment to the definition of “associate entity”. Where a real estate fund or infrastructure project was previously subject to the thin capitalisation rules purely due to its nature as an associate entity of a complying superannuation fund (that was itself an outward investor), the real estate fund or infrastructure project would now no longer be considered an outward investor under the new rules.

External third party debt test

Based on the current Exposure Draft, all associate entities (i.e. broadly with 10% or greater interest) would also need to elect into the same test. This will be extremely difficult and likely rule out most funds (especially club-style fund structures) to be able to use the ETPDT unless all associates also choose the same test. We expect that this will be a key issue that is flagged as part of the consultation process. 

In a stapled structure context, each side of a staple structure may not be considered an associate entity. If debt is guaranteed by both sides of a staple structure, the ETPDT may not be available due to the carve out which requires all the security to be from borrowers.

The inability to revoke these elections also creates uncertainty on changes of ownership and group composition. 

Financing entities and on-lending 

The Explanatory Memorandum to the Exposure Draft acknowledges that “conduit financier” arrangements are generally implemented to streamline the borrowing process of a group by allowing one entity in a group to raise funds on behalf of other entities in the group. Structures that utilise a financing special purpose vehicle (Finco) with simple terms should not be adversely impacted by the changes. As such, where the debt can be clearly traced to an external third party (i.e. there are simple back-to-back terms), the ETPDT can still be utilised for these arrangements. However, a Finco in a structure with multiple on-lending is unlikely to pass the additional conditions to apply the ETPDT as the on-lending terms will not be identical. Below are some examples where the terms may differ:

  1. Finco will be providing security over all of its assets and those of the property trusts whereas each trust borrower is only giving security over its own individual asset 

  2. FinCo will always rank behind the external debt and will usually not be secured, and

  3. There may be differences in the currency of funds in the context of multinational groups.

The conditions of the ETPDT seem to have been drafted under the assumption of a simple arrangement (one loan from the bank which is lent to a FinCo). Practically, the infrastructure and real estate sectors are more likely to have the multiple on-lending and direct tracing would be difficult to achieve in order to satisfy the ETPDT conditions. 

Forecasting becomes critical

The infrastructure and real estate sectors may be subject to permanent denials of interest deductions under the proposed changes (unless ETPDT applies). Higher levels of gearing are common in these sectors and therefore there is a high likelihood that there would be denials of interest, especially in the greenfield / development phase of an asset’s life cycle. 

Modelling the outcomes (either under the FRT or GRT) will therefore become more important as there may be a benefit to some deferral (under the FRT) as long as the deferred deductions can be ultimately utilised within the 15 year window. Accurate modelling in the infrastructure and real estate sectors is generally possible due to typical long-term contracted cashflows or regulated cashflows that are reasonably predictable. Note also that there was a consequential amendment to the transfer pricing rules which means that debt quantum must also be arms length.

A range of variables in these modelling exercises, such as the income profile of a fund or the phase of a fund’s lifecycle (i.e. development assets versus stabilised assets) and property revaluations may influence management decisions on whether a group ratio may enhance or detract capacity from the relevant entities. 

In particular, the GRT as currently drafted appears to be only beneficial for entities with interest to EBITDA ratios that are below the average for the group. The practical implication is that specific entities within the group may have denials. e.g. Entity A has a 10% interest to EBITDA ratio and Entity B has a 40% interest to EBITDA ratio. Assuming that both of the entities have the same size, then the average interest to EBITDA ratio is 25%, however Entity B will still have interest denials. Accordingly, FRT may be optimal or ETPDT (if available).

In addition, the new group ratio rule adopts interest expense and EBITDA based on accounting concepts. As such, these values could significantly vary to the tax values (including recognition for revaluations in EBITDA). In particular, this feature could be either beneficial or detrimental depending on property revaluations, i.e. revaluations upwards will depress the group ratio whereas revaluations downwards will enhance the ratio. This is an unusual outcome which results in a decrease in GRT as the values of the assets increase. This also means that for funds with development assets with minimal rent, the GRT could be materially higher than the 30% FRT rate.

The Takeaway

Investment structures may have historically assumed they were subject to thin capitalisation rules on the basis that it was prudent to do so (e.g. in cases where it was unclear whether they were an inward or an outward investor) and the 60% safe harbour test was in any case satisfied. The same taxpayers should consider revisiting some of these assumptions as funds will need to definitely conclude on their thin capitalisation position now that the 60% safe harbour test has been replaced with the 30% EBITDA test where interest deductions may be denied and taking into account the changes for complying superannuation funds. 

As these new rules are required to be considered on a case-by-case basis, taxpayers should begin modelling the impact of the new rules. They should also consider whether any transaction documentation needs revisiting, such as shareholders agreements, and the impact on agreed positions on tax elections etc. Affected taxpayers should also consider whether restructuring debt arrangements (potentially as early as 1 July 2023) if necessary, and if so, the consequential impacts of doing so. 

Nick Rogaris

Partner, Corporate Tax, Real Estate and Infrastructure, Sydney, PwC Australia

+61 2 8266 1155


Josh Cardwell

Partner, Head of Real Estate Tax, Sydney, PwC Australia

+61 438 129 187


Steve Ford

Partner, Sydney, PwC Australia

+61 (2) 8266 3433


Luke Bugden

Infrastructure Leader, Sydney, PwC Australia

+ 61 (2) 8266 4797


Arash Azimi

Partner, Global Tax, Sydney, PwC Australia

+61 403 267 297


Christina Sahyoun

Partner, Global Tax, Sydney, PwC Australia

+61 403 658 464


Mark Edmonds

Partner, Corporate Tax, Real Estate and Infrastructure, Sydney, PwC Australia

612 8266 1339


Chris Aboud

Partner, Global Tax, Sydney, PwC Australia


Chris Colley

Partner, Sydney, PwC Australia


Andrew White

Partner, Corporate Tax, Sydney, PwC Australia


Manuel Makas

Partner, Tax, Sydney, PwC Australia

+61 421 050 630


Sue Ann Khoo

Partner, Tax, Sydney, PwC Australia

+61 447 391 056


Kirsten Arblaster

Partner, Tax, Melbourne, PwC Australia

+61 3 8603 6120


Glenn O'Connell

Partner, Tax, Sydney, PwC Australia

+61 409 000 370


Vaughan Lindfield

Partner, PwC Australia

+61 8 9238 3660