What Is Thin Capitalisation?
Thin Capitalisation refers to a corporate tax situation in which a company is financed mainly by debt, triggering national anti-abuse limits on interest deductions.
Also known as: Thin Capitalization, Thin Cap.
How Thin Capitalisation works
Thin Capitalisation describes a company funded with a high proportion of debt relative to equity, often from shareholders or related parties, and the rules responding to it restrict the deduction of interest so taxable profits are not shifted out through interest payments. Older regimes compare debt to equity, while the EU Anti-Tax Avoidance Directive caps exceeding borrowing costs at 30 percent of EBITDA, with an optional EUR 3 million threshold. Disallowed interest may be carried forward or recharacterised as a dividend, depending on local rules.
Thin Capitalisation vs Transfer Pricing
Unlike transfer pricing, which tests whether the interest rate on a related-party loan is arm's length, thin capitalisation rules test whether the overall amount of debt or interest is excessive.
Example
Illustrative example: A founder resident in Country A lends a large sum to a wholly owned company in Country B instead of subscribing for shares. The company deducts the interest, reducing taxable profit in Country B. If Country B applies an earnings-based cap, interest above the permitted share of EBITDA is disallowed for the year and taxed as profit.
Common misconception
Myth: Lending money to one's own company is a neutral way to extract profits with full interest deductions.
Reality: Thin Capitalisation and interest limitation rules can disallow interest on shareholder or related-party debt, and the receiving country may still tax the interest income.
Frequently asked questions
What is thin capitalisation?
Thin Capitalisation is a situation in which a company relies heavily on debt rather than equity, and the term also designates the anti-abuse rules limiting interest deductions on such debt under national law.
Do thin capitalisation rules apply to small companies?
Thin Capitalisation rules often include thresholds; the EU Anti-Tax Avoidance Directive allows Member States to permit exceeding borrowing costs up to EUR 3 million, so smaller companies may fall below the limit, subject to local rules.
Related terms
- Transfer Pricing — Tests the price of related-party loans
- EU Anti-Tax Avoidance Directive (ATAD) — EU source of the interest limitation rule
- Arm's Length Principle — Benchmark for related-party interest rates
- Base Erosion and Profit Shifting (BEPS) — OECD project behind earnings-based interest caps
Related guides
- Incorporation options for location-independent entrepreneurs — Company financing choices for nomad founders
- Tax management approaches: from compliance to aggressive strategies — Where debt structuring sits on the risk spectrum
Sources
Last verified: 2026-10-09. This entry is general information, not tax or legal advice; rules vary by country and change over time.
