ATO Draft PCG 2025/D2 – A new era of cross-border debt compliance

A new era of thin capitalisation rules. On 29 May 2025, the Australian Taxation Office (ATO) released Draft PCG 2025/D2 - a practical compliance guideline that reshapes how inbound, cross-border related-party financing arrangements are assessed under Australia’s thin capitalisation and transfer pricing rules.

This follows the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share — Integrity and Transparency) Act 2024, which significantly tightens the rules around how much debt a multinational can allocate to its Australian operations.

What the draft guideline covers

The guideline provides a risk-based framework to help taxpayers determine whether their related-party debt levels are consistent with arm’s length conditions. It introduces:

• Risk zones (White, Green, Blue, Red) to classify financing arrangements.
• A focus on debt quantum, not just interest rates.
• A requirement to justify the commercial rationale for the level of related-party debt.
• Emphasis on documentation, including group policies, funding alternatives, and serviceability metrics.

What this means for Australian taxpayers

1. More scrutiny, more substance

Taxpayers can no longer rely solely on pricing benchmarks. The ATO now expects a holistic justification for the amount of debt, including:

• Why the debt is needed
• Whether equity or internal funds were viable alternatives
• How the debt aligns with group-wide policies

2. Arm’s length capital structure is key

The ATO will assess whether your capital structure—not just your interest rate—is consistent with what an independent party would agree to. This shifts the burden to taxpayers to model and defend their debt levels.

3. Risk zones drive audit focus

The color-coded risk zones help taxpayers self-assess their exposure. Falling into the Red Zone could trigger audits or adjustments. Staying in the Green or White Zones may reduce compliance risk.

4. Documentation is no longer optional

Robust, contemporaneous documentation is essential. This includes:

• Financial models
• Board papers
• Internal funding policies
• Evidence of third-party comparables

Comparison: Old Safe Harbour rules vs. PCG 2025/D2

Strategic takeaways for CFO s and business leaders

1. Reassess capital structure

Evaluate your current financing arrangements, especially if they involve related-party debt, to ensure they align with evolving compliance expectations.

2. Substance over form

Go beyond interest rates. Clearly articulate the commercial rationale for borrowing, including why debt was chosen over equity or internal funding.

3. Scenario planning

Develop and document alternative funding models to demonstrate that your capital structure reflects arm’s length conditions.

4. Proactive advisory engagement

Collaborate early with tax, legal, and financial advisors to prepare for the finalisation of PCG 2025/D2 and potential ATO scrutiny.

5. Documentation discipline

Maintain robust, contemporaneous documentation including board papers, financial models, and group funding policies to support your position.

6. Risk zone self-assessment

Use the ATO’s risk zone framework (White, Green, Blue, Red) to evaluate your exposure and take corrective action where needed.

Next steps

The draft is open for public comment until 30 June 2025. Taxpayers should consider submitting feedback, especially if the guidance creates uncertainty or compliance burdens.