The ATO released Taxpayer Alert in December 2018 dealing with the interaction between a deduction that is being claimed for accruing interest owed to non-residents and is currently triggering the interest withholding tax 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 Taxpayer Alert are definitely not new territory. Nevertheless, the ATO has decided that now is the time to venture into this.
The Taxpayer Alert says the ATO is concerned about the structuring to produce a current deduction but deferral of withholding tax [or the] payment is not expected to trigger a withholding tax liability. Below are the four aspects to look out for.
If you are a payer:
- 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)
- Is the payer required to collect an amount toward the non-resident’s Australian tax liability.
If you are a lender:
- Does the non-resident lender have an Australian tax liability, most commonly a liability to Interest withholding tax
- Does the lender have a foreign tax liability.
Whether and how the absence of a payment affects the payer’s collection obligations and the non-resident’s interest withholding tax 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 interest withholding tax can be triggered where a payment occurs. There are also other indications that a non-resident can in some situations be liable to Australian interest withholding tax on amounts merely accruing to it.
First, in the ABB Australia Pty Ltd v FC of T 2007 ATC 4765 case, the Federal Court held that a non-resident shareholder derived income consisting of the dividend when it was declared. 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 Taxpayer Alert does not mention the ABB case above, 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”.
- • 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 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 the other person as directed
In many cases, interests will be accruing on a loan but not actually be reinvested, accumulated or capitalised.
So what can be done:
- 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.
- Eliminating the Interest Withholding Tax: it seems that some situations have arisen where the interest withholding tax is not simply deferred until the termination of the instrument, but rather no amounts of interest withholding tax has been paid at any stage.
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.