Fracture at interface causes plastic deformation in the vicinity region. Conventional plastic energy dissipation theory indicates that ductile vicinity toughens the interface by absorbing plastic deformation energy. However, the microstructure in the vicinity directly affects local plastic deformability and fracture behaviour, implying a more complicated toughening mechanism. In this study, the effect of microstructure and hardness on fracture behaviour of Fe/Ni interface was investigated. By experimental approach, interfaces with and without dynamic recrystallization (DRX) were fabricated by controlling the bonding conditions. It showed that compression-induced plastic deformation is the main source of the hardening behaviour in the vicinity. Moreover, the interfaces with hardened DRX vicinities exhibited improved fracture toughness, which is inconsistent with the plastic energy dissipation theory. To clarify this observation, the crystal plasticity finite element method (CPFEM) approach was employed to distinguish the effects of plastic deformation and interfacial microstructure. The result showed that although higher plastic deformability in the vicinity absorbs more dissipated plastic energy, severe stress concentration at the interface leads to early fracture and poor toughness. On the other hand, the interfacial hardened DRXed grains disperse interfacial stress distribution and provide potential sub-crack sites. A combined result of uniform plastic deformation and fracture energy dissipation is responsible for the improved toughness at interfaces with DRXed grains.