On 1 October 2025, the Commissioner of Taxation (Commissioner) updated his draft guidance (Draft Guidance) on the third party debt test (TDPT) by publishing:

• finalised binding interpretative guidance on the TPDT in TR 2025/2 Income tax: aspects of the third party debt test in Subdivision 820-EAB of the Income Tax Assessment Act 1997 (TR 2025/2);[1] and
• a finalised compliance approach to the TPDT in Schedule 3 to PCG 2025/2 Restructures and the thin capitalisation and debt deduction creation rules – ATO compliance approach (PCG 2025/2).[2]

The finalised guidance products (Finalised Guidance) inform taxpayers of the Commissioner’s approach to interpreting and administering the TPDT. As background, the TPDT is a new and optional test under Australia’s revised thin capitalisation rules, which may permit a greater (maximum) quantum of debt deductions compared to the earnings-based fixed ratio test and group ratio test.

However, despite its name, the TPDT does not necessarily allow full debt deductions on all third-party debt, as strict (and in many cases commercially artificial) conditions must be met for each debt interest.

For a high-level refresher on the TPDT and a summary of our insights on the Draft Guidance, refer to our previous article, Australia’s New Thin Capitalisation Guidance – Some Roses, But Many More Thorns. 

In essence, this article echoes a similar sentiment articulated in our previous article, with a further summary of key changes from the Draft Guidance.

In Brief

The Commissioner’s views in the Finalised Guidance follow extensive stakeholder consultation on the Draft Guidance, with the Commissioner providing responses to issues raised during consultation in two separate Compendium documents.[3]

The Finalised Guidance includes additional examples and guidance to address a number of issues raised through the public consultation process; however, the Commissioner has also doubled down on a number of significant issues in the Draft Guidance that were raised by stakeholders as being problematic or uncommercial. As a result, the strict legislative requirements of the TPDT are exacerbated by the Commissioner’s highly restrictive interpretative and compliance approach in the Finalised Guidance, which in many cases reads in unlegislated requirements to the (already restrictive) legislative tests.

In practice, the TPDT and its interpretation by the Commissioner may make the TPDT unworkable for many ordinary commercial lending arrangements in the infrastructure and property sectors, particularly where foreign sponsors are involved. This is likely to force borrowers to negotiate more constrained security packages, without commercially standard group guarantees. If obtained, while these modifications may be technically effective in meeting the TPDT conditions, they may also drive increased financing costs and unintended pricing tension, added diligence costs, and structurally inefficient outcomes. Alternatively, borrowers may need to absorb the cost of non-deductible debt, resulting in higher financing costs.

Given the intended users of the TPDT, this has policy implications for Australia as a destination for foreign investment, and implications for critical sectors of our economy.

What Has Changed: Helpful Developments on the Finalised Guidance

Recourse relates only to Australian assets

A key TPDT condition is that a lender must only have “recourse” to a borrower’s Australian assets. Submissions requested further guidance on the meaning of “Australian assets,” including the classification of intangible assets.

In response, TR 2025/2 now includes:

• a series of factors that point toward an asset having a substantial connection to Australia (including physical location, place of use and the entity benefiting from such use, governing law, and production of Australian sourced income);[4]
• guidance in relation to tangible assets being “Australian assets” when they are physically situated in Australia and used exclusively in Australian operations, with the added concession that having “some limited or remote connection” to a foreign jurisdiction is not fatal to an asset being an Australian asset;[5]
• factors relevant to whether particular intangible assets (excluding membership interests) are “Australian assets”, including the location of the contracting parties, the governing and relevant laws applicable to the asset, and the asset being used or held by an Australian or foreign business or supported by Australian assets;[6] and
• additional commentary that a “membership interest” must be in an Australian entity to be an “Australian asset”, with an “Australian entity“ being identified by reference to the underlying assets held by the entity (both directly and indirectly).[7]

In response to submissions, the Commissioner’s newly inserted Example 12 in TR 2025/2 now confirms that membership interests in an entity that has “minor or insignificant” foreign assets should not preclude such membership interests from being an “Australian asset”.[8] However, the Commissioner follows on with newly inserted Example 13, which provides a contrasting outcome that the same membership interests described in Example 12 (being membership interests in the borrower entity) would fail the TPDT conditions, because recourse to Australian assets that are membership interests in the entity is not permitted if the entity has a legal or equitable interest, whether directly or directly, in any asset that is not an Australian asset (whether or not minor or insignificant).[9] These contradictory outcomes are problematic, particularly when third party lenders will invariably require security over membership interests in the borrower. It is not clear what certainty new Examples 12 and 13 add for taxpayers, other than underscoring that careful attention to the underlying assets of obligor entities will be required.

Notwithstanding the additional guidance on whether an asset is an “Australian asset”, this test still requires an assessment based on a range of factors.

Extension of transitional compliance approaches

The Draft Guidance, and specifically the draft form of PCG 2025/2, provided several transitional compliance approaches intended to facilitate taxpayers restructuring their existing arrangements to comply with the TPDT.

These included:

• a transitional compliance approach allowing taxpayers to remove recourse to foreign assets to comply with the TPDT;
• a transitional compliance approach for restructures that are undertaken to allow a taxpayer to comply with the conduit financing provisions; and
• a (narrow) transitional compliance approach allowing taxpayers with existing arrangements to maintain minor or insignificant assets that are no more than 1% of the entity’s total assets (in aggregate), individually are worth no more than $1 million, and are not credit support rights (provided by any entity).

All three of these transitional compliance approaches have been retained (unchanged) in the Finalised Guidance but, helpfully, the period during which taxpayers can rely on the compliance approaches has been extended to restructures undertaken prior to 1 January 2027 in respect of the “recourse” and conduit financing conditions concessions, and income years ending on or before 1 January 2027 in respect of the minor or insignificant assets concession (which may be further extended if required).

The Commissioner has also included an additional transitional (but very limited) compliance approach in respect of the TPDT’s “use” requirement for commercial activities in Australia. This applies to taxpayers who make reasonable efforts to trace the use of third-party debt (including refinanced third-party debt) and whose debt is currently used to fund annual trust distributions (see further detail on Example 34 below).

What Has Not Changed

TPDT conditions must be satisfied for the whole income year

As outlined in the Draft Guidance, the Commissioner holds the view that several of the TPDT conditions must be satisfied by a debt interest throughout the entire income year for the arrangement to qualify. A single failure during the year will, on this construction, result in the denial of interest deductions for the entire income year, not just the period of failure.

This generally requires taxpayers to continually test their arrangements, monitor their assets (at least those to which lenders may have recourse), and track the use of their third-party debt funding throughout every day of every income year. These requirements remain unchanged in the Finalised Guidance and impose a heavy evidentiary burden on taxpayers seeking to comply with the Commissioner’s approach.

Meaning of “minor or insignificant”

The TPDT allows taxpayers whose debt arrangements provide recourse to “minor or insignificant assets” that are not qualifying Australian assets to continue to satisfy the TPDT.

Disappointingly, the Commissioner has not taken on board vocal industry submissions that additional leeway and a more practical interpretative approach is required on when a non-Australian asset is “minor or insignificant” (and therefore permissible under the TPDT).

Instead, the Commissioner has doubled down on the approach in the Draft Guidance and maintains that “minor or insignificant” means “minimal or nominal value”.[10] More specifically, TR 2025/2 retains the various examples which interpret “minor or insignificant” as:

• a Foreign Sub Co with share capital of $2 and no other assets (Example 8 in TR 2025/2);
• not extending to foreign assets with a value of 2% of the taxpayer’s total assets where that value is more than nominal, as in the Commissioner’s view the relative value of foreign assets is not determinative (Example 9 in TR 2025/2); and
• not being dependent on the actual or hypothetical impact of assets on a taxpayer’s borrowing capacity or terms of debt (Example 10 in TR 2025/2).

As these examples form part of the Commissioner’s binding interpretive guidance, the Commissioner will be bound to apply the TPDT conditions in the same way as set out in TR 2025/2.

This means that the debt interest will not satisfy the TPDT conditions where a lender has recourse to any non-Australian assets with more than nominal value, even if the non-Australian asset is, relatively and practically to the taxpayer (by reference to that taxpayer’s arrangements), a minor or insignificant asset. This will require careful review of existing security and recourse arrangements, with restructures to be undertaken in a timely manner. As noted above, PCG 2025/2 provides narrow transitional compliance approaches that:

• deem as “minor or insignificant” non-Australian assets that make up to 1% of the total assets to which recourse is provided (provided each asset does not have a value exceeding $1 million), up to income years ending on or before 1 January 2027;[11] and
• allow restructures to remove foreign assets to comply with the TPDT’s “recourse” condition, up to 1 January 2027.[12]

Use of third-party debt for “commercial activities in connection with Australia”

Broadly, the TPDT permits taxpayers who use the proceeds of a qualifying debt interest to fund “commercial activities in connection with Australia” to satisfy the TPDT conditions.

In the Draft Guidance, the Commissioner presented a view that:

• the payment of distributions, capital returns, and other capital management activities are not "commercial activities" in connection with Australia for these purposes; and
• the “use” of funds requirement involves onerous and ongoing tracing of the use of proceeds from debt interests, including reassessing the “use” of these amounts where an initial debt-funded Australian asset is disposed of, and the proceeds are redeployed.

Extensive submissions were made rejecting these viewpoints. In response to the feedback, the Commissioner has removed the reference to “capital management activities” in TR 2025/2 and clarified that third-party debt borrowed to refinance existing debt and used to fund commercial activities in connection with Australia will satisfy the “commercial activities in connection with Australia” condition (i.e., this is not a prohibited use of funds).

However, in perhaps the most disappointing aspect of the Finalised Guidance, the Commissioner has dismissed all other concerns and chosen to reinforce his view that:

• ongoing tracing is required to demonstrate the “use” of third-party debt proceeds, even once an asset which was initially funded by third-party debt is disposed of and the proceeds redeployed; and
• third-party debt used to pay distributions, dividends or capital returns will not satisfy the TPDT conditions, based on the Commissioner’s (unsubstantiated) view that these are not “commercial activities in connection with Australia” but instead “appropriations of profit or equity.”[13]

Ultimately, this position:

• imports into the TPDT an ongoing tracing requirement that is not evident on the face of the legislation, leaving taxpayers with a heavy evidentiary burden and no guidance from the Commissioner on how to practically discharge this burden;
• is punitive by effectively aligning the requirements of the TPDT to those under the new debt deduction creation rules in Subdivision 820-EAA of the ITAA 1997 (DDCR). That is, the Commissioner’s binding interpretation in TR 2025/2 effectively creates an unlegislated DDCR for third-party debt in preventing the use of debt for distributions to investors, when Parliament’s clear intent is that taxpayers that choose to apply the TPDT are not subject to the DDCR;[14] and
• is not aligned with the commercial reality of how taxpayers who will rely on the TPDT use third party debt. In particular:
  • it is not uncommon to debt fund distributions to investors, whether as a result of re-gearing or ordinary cash flow management practices, and the Commissioner’s view here will significantly impact how returns are provided to and valued by investors; and
  • in practice, once multiple debt facilities are established and available to a taxpayer to be drawn down, the “uses” of debt funding are not necessarily tracked, so onerous tracing requirements under the TPDT mean it is imperative that internal treasury and finance functions are educated on the need to clearly document the “use” of third-party debt funds.

In some good news and as noted above, PCG 2025/2 also includes a new Example 34 which provides a very limited concession for taxpayers who use third-party debt to fund trust distributions but can demonstrate the repayment of debt prior to income years ending on or before 1 January 2027.

However, Example 34 is a very bespoke fact pattern in which annual trust distributions that are debt funded do not exceed 10% of the available balance of a debt facility. Practically, the threshold of 10% is unlikely to be sufficient (particularly where, as is common, debt facilities are used in re-gearing arrangements that were historically used to return profits or capital to investors). It is not clear whether the Commissioner is limiting the unwind of such arrangements to the 10% ratio, and if so, this “concession” will have limited application.

It is also unclear what (if any) relief will be provided to corporate taxpayers who use third-party debt to fund dividends or capital returns to shareholders. 

Permissible guarantee, security, or other credit support rights

In TR 2025/2, the Commissioner clarified his view that all credit support rights are unlikely to ever be “minor or insignificant” assets. The Commissioner has also maintained his position that equity commitment deeds and other parental support provided by a foreign associate contravene the TPDT. This view will present obvious issues where foreign sponsors are involved, particularly for greenfield real estate and infrastructure.

Despite industry submissions, the Commissioner has also declined to provide further guidance on the meaning of “other credit support”, merely maintaining the incredibly broad view that “rights that operate to reduce the risk of default by the issuer in respect of the debt interest will generally be covered.”[15]

By way of example, if a taxpayer borrows from third parties (Loan A) with no credit support rights, but subsequently borrows from third parties (Loan B) with a foreign parent company guarantee, while the guarantee is credit support only in respect of Loan B and would cause Loan B to fail the TPDT conditions, it may also, in one view, “reduce the risk of default” on Loan A.

It is inconsistent with the legislative drafting and intent for the taxpayer to fail the TPDT conditions on Loan A merely as a result of having another guaranteed borrowing. However, the Commissioner’s binding interpretative view in TR 2025/2 is wide enough to potentially encompass this type of arrangement and does not explicitly limit the meaning of “other credit support” to those legal rights that are similar in nature to guarantees and security in respect of the relevant debt interest only.

On credit support rights, newly added Example 19 in TR 2025/2 illustrates a credit support right that satisfies section 820-427A(5)(a)(i), as the credit support right provides recourse only to Australian assets. By virtue of this example, however, it could be implied that the Commissioner views a performance guarantee as a form of credit support right (this view did not appear in the Draft Guidance).

Similarly, the discussion around credit support rights in PCG 2025/2 remains largely unchanged from the draft. However, one key addition in the finalised PCG 2025/2 is Example 31 that says a taxpayer can modify the terms of a credit support agreement so that the recourse under that credit support right is restricted to the “development phase” of a project. This will allow taxpayers to access the exemption in section 820-427A(5)(a)(iii) which applies to permit credit support rights that relate wholly to the creation or development of a CGT asset that is, or is reasonably expected to be, land situated in Australia.

This compliance approach is available for restructures undertaken up to 1 January 2027 and should provide some (limited) breathing space for projects that were entered into prior to the TPDT rules.

Key Takeaways

Unfortunately, the Finalised Guidance is unlikely to provide much relief to taxpayers relying on the TPDT and does not reflect meaningful changes since the Draft Guidance.

Despite some additional transitional compliance approaches and extensions to the time allowed for complying restructures in PCG 2025/2, in general the interpretation adopted by the Commissioner remains highly restrictive and involves a reading in of policy intent that is not evident in the legislation itself. The Commissioner provides limited concessions, many of which are unlikely to reflect commercial reality for many taxpayers. In particular, the changes to the binding interpretative guidance in TR 2025/2 are minimal and indicate that the Commissioner will take a “hardline” approach to interpreting the (already narrow) TPDT.

In the absence of legislative reform, taxpayers are in limbo with the current TPDT rules, which are complex to navigate and appear to be misaligned with the original intention of the TPDT—to account for genuine commercial third party arrangements, and intended to “[operate] effectively as a credit assessment test, in which an independent commercial lender determines the level and structure of debt finance it is prepared to provide an entity.”[16]

In light of the Commissioner’s finalised positions, taxpayers should continue to review their existing financing structures and ensure any restructures undertaken comply with the Commissioner’s compliance approaches. We expect a flurry of submissions with the post implementation review of the thin capitalisation rules that Treasury is due to commence by 1 February 2026,[17] and the recently announced Red Tape Reduction Review to be undertaken by the Board of Taxation.