The draft Guideline provides guidance to entities in applying the arm’s length debt test in Division 820 of the Income Tax Assessment Act 19972 and should be read in conjunction with draft Taxation Ruling TR 2019/D2 Income tax: thin capitalisation – the arm’s length debt test. This Guideline also provides a risk assessment framework that outlines our compliance approach to an application of the arm’s length debt test in certain circumstances that are identified as low risk. The arm’s length debt test is one of the tests available to establish an entity’s maximum allowable debt for thin capitalisation purposes. The test focuses on identifying an amount of debt a notional stand-alone Australian business would reasonably be expected to borrow, and what independent commercial lenders would reasonably be expected to lend on arm’s length terms and conditions. An entity’s debt deductions are reduced to the extent that its adjusted average debt exceeds its maximum allowable debt. The arm’s length debt test may be used to support debt deductions for commercially justifiable levels of debt. In practice, the test is typically only used when an entity is unable to satisfy the safe harbour and worldwide gearing tests (as the compliance burden of applying these tests is generally lower). It is not common for Australian businesses to gear in excess of 60% of their net assets and historically relatively few entities have applied the arm’s length debt test. We consider the choice to apply the arm’s length debt test carries with it the necessity to undertake more rigorous analysis than the safe harbour and worldwide gearing tests. While the arm’s length debt test in some respects draws upon arm’s length concepts that are broadly common to transfer pricing, the test itself is not a transfer pricing analysis, nor does it necessarily proxy an outcome consistent with the arm’s length conditions under Subdivision 815-B. Rather it requires an overlay of factual assumptions that produce a hypothetical entity against which specific factors are to be assessed. This Guideline is limited to providing guidance and a risk assessment framework relating to the application of the arm’s length debt test contained in sections 820-105 and 820-215. It does not set out our approach to reviewing other taxation issues that might arise in relation to debt deductions ...