Contributed by Julian Pinson, Director, and Professor Graeme Cooper, Consultant, Greenwoods & Herbert Smith Freehills
The ATO released Taxpayer Alert TA 2018/4 in December 2018 (the “TA”) dealing with the interaction between the deduction being claimed for accruing (but unpaid) interest owed to non-residents and triggering the interest withholding tax (IWT) regime. Even though Taxpayer Alerts are meant to give early warning about, “new or emerging higher risk tax … arrangements or issues”, some aspects of the situation dealt with in the TA are definitely not new territory. Nevertheless, the ATO has decided the time is ripe to venture into this space with a generic “shot-across-the-bows” in the form of a TA.
The TA says the ATO is concerned about, “structuring to produce a current deduction but deferral of withholding tax [or the] payment is not expected to trigger a withholding tax liability …”. There are basically four tax aspects to any cross-border interest flow.
For the payer
- (1) Is the payer entitled to a deduction (a conclusion which will be governed by the ordinary rules about interest deductibility not to mention the anti-hybrid rules, rules dealing with the payer’s collection responsibilities, thin capitalisation rules, transfer pricing rules and so on), and
- (2) is the payer required to collect an amount toward the non-resident’s Australian tax liability.
For the lender
- (3) Does the non-resident lender have an Australian tax liability, most commonly a liability to Australian IWT, and
- (4) does the lender have a (current) foreign tax liability (which might be reduced by a tax credit for the Australian IWT collected)?
In the most ambitious structures:
- (1) the Australian resident would be claiming an allowable deduction for the accruing interest, whether under s 8-1 or more typically the TOFA regime,
- (2) the Australian resident would not be collecting an amount toward the non-resident’s IWT liability on the basis that the payer’s collection obligations in the Taxation Administration Act 1953 have not (yet) been triggered,
- (3) the non-resident would not pay Australian IWT itself on the basis that it does not (yet) owe Australian IWT, and
- (4) the non-resident might be treating the amount as not (yet) assessable in the foreign country.
Asymmetric treatment: immediate deduction but future IWT payment
Whether and how the absence of a payment affects the payer’s collection obligations and the non-resident’s IWT liability is one of the old chestnuts in tax law. While the payer’s collection obligation is more clearly only enlivened if, “an entity … pays [interest] to an entity …” it is not so clear that the recipient’s liability to Australian IWT can only be triggered where a payment occurs. Section 128B is equivocal: at one point it refers to, “income … derived … by a non-resident [that] consists of interest …”; at another point it refers to, “interest … paid to the non-resident by a [resident]”. But s 128C reinforces the impression that payment is not necessary to trigger the non-resident’s liability by insisting that the “withholding tax is due and payable by the person … at the expiration of 21 days after the end of the month in which the income … was derived …”. And there are other indications that a non-resident can in some situations be liable to Australian IWT on amounts merely accruing to it.
First, in the ABB case (ABB Australia Pty Ltd v FC of T 2007 ATC 4765) the Federal Court held that a non-resident shareholder, “derived income consisting of the dividend when it was declared by [the Australian subsidiary]” rather than when the dividend was subsequently paid. It is worth noting that the analysis in the case focuses entirely on the meaning to be given to the word “derived” in the context of this shareholder.
The TA does not mention ABB, but it does mention another reason why payment might be irrelevant to the non-resident’s situation. Section 128A(2) deems an amount to be paid to the non-resident if it is, “reinvested, accumulated, capitalised, carried to any reserve, sinking fund or insurance fund however designated, or otherwise dealt with on behalf of the other person or as the other person directs”. The TA says some arrangements where interest has been accruing may have ”the same effect as capitalisation …”.
- if the borrower treats the unpaid amount as a new loan or as increasing the principal of an existing loan, the unpaid interest may have been ”reinvested”,
- if the borrower applies the unpaid amount to pay (or reduce) the lender’s debt owed to someone else, the unpaid interest may have been “dealt with on behalf of the other person”, or
- if the lender agrees to allow the unpaid interest to remain outstanding, the interest has been “dealt with … as the other person directs”.
In short, because of s 128A(2), it may prove more than a little difficult to avoid triggering the non-resident’s IWT liability if the documents provide, or both parties agree, to allow the interest to remain unpaid, or even if the borrower acts unilaterally.
However, in many cases, interest will be accruing on a loan but not actually be reinvested, accumulated or capitalised. The TA does not seem especially concerned about the potential resulting asymmetry per se:
We are not concerned with the mere fact that a deduction is claimed on an accruals basis under Division 230 while the … withholding tax is paid when the entitlement becomes due.
Instead, the TA says the ATO will only consider a situation to be high risk if:
- the taxpayer cannot “convincingly demonstrate, with evidence, that deferral of the entitlement to interest is driven by commercial non-tax factors”, and
- IWT is eventually paid when the entitlement to the interest arises.
Refinements to the model
So it may be that the impetus for the TA is not a desire to clarify the chestnut but rather a response to three new developments which are alluded to in the document:
- debt restructuring: the ATO alludes to situations where “the terms of a loan may be varied such that there is no obligation to repay the principal or the return, or the arrangement becomes an equity interest …”. If this is the ATO’s concern, it is more an issue about deductibility than it is about IWT (and probably should not be buried in a TA on IWT) — was the taxpayer correctly claiming a deduction for the interest (or did the restructuring trigger debt forgiveness or balancing adjustments consequences)? The TA takes the position that if the “variation … was under serious contemplation from the commencement of the arrangement …” the ATO may take the view that the law should be applied to the re-arranged structure from the outset of the transactions,
- IWT elimination: it seems that some situations have arisen where the IWT is not simply deferred until the termination of the instrument; rather no IWT is paid at any stage. The document refers to arrangements under which “the return [when] paid, it is not expected to trigger a withholding tax liability …”, and
- marketing: it seems that some advisers are actively marketing structures based on deferring or eliminating IWT liability; the TA reminds readers, “the promoter penalty laws [may] apply to promoters of this arrangement …”.
Like all taxpayer alerts, this one is not fully reasoned. It is a warning, not an analysis, and so it is deliberately left rather vague. The TA does foreshadow that the ATO is, “developing our technical position on the facts and circumstances of each arrangement”. We may get some clarity — on the chestnut and more — once those technical positions start to see the light of day.