ATO Interpretative Decision
ATO ID 2010/133
Income Tax
Interest withholding tax: Commitment Fee payable on the undrawn balance of funds available under a credit facilityFOI status: may be released
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Is a Commitment Fee, payable on the undrawn balance of funds available under a credit facility, 'interest' or 'an amount in the nature of interest' for the purpose of subsection 128A(1AB) of the Income Tax Assessment Act 1936 (ITAA 1936)?
Decision
No, the Commitment Fee is not interest, or an amount in the nature of interest, for the purpose of subsection 128A(1AB) of the ITAA 1936 because it is not, in substance or in form, compensation or consideration payable in respect of keeping a person out of the use and enjoyment of a principal sum.
Facts
Pursuant to an overarching agreement, a resident borrower is able to borrow amounts from a non-resident lender up to a maximum aggregate amount (the Commitment).
The Commitment is, for a period of 10 years from the date of the agreement, available to be drawn down from time to time by way of separate loans.
To obtain a loan under the agreement the borrower is required to give notice to the lender requesting an advance. The lender's obligation to make each advance is subject to conditions precedent which are specified in the agreement. An arm's length rate of interest is payable by the borrower on each loan made under the agreement.
The borrower is also required to pay an arm's length fee called a 'Commitment Fee' in the agreement. The Commitment Fee is payable in exchange for the Commitment.
The Commitment Fee is computed as a percentage per annum of the daily balance of the undrawn amount of the Commitment. The Commitment Fee is payable for a 10 year period beginning on the date of the agreement, that is, the period during which the Commitment is available to be drawn down.
The lender is not required to, and does not, set aside any funds to meet the Commitment in the event that the borrower requests a loan or loans under the agreement.
Reasons for Decision
Unless otherwise stated, all legislative references are references to the ITAA 1936.
Broadly, a non-resident person is liable under Division 11A to pay withholding tax if they derive income that consists of 'interest' paid by a resident.
The question therefore arises as to whether the Commitment Fee, paid by the resident borrower and derived by the non-resident lender, constitutes interest.
Subsection 128A(1AB) provides an expanded definition of 'interest' for the purposes of Division 11A. It relevantly provides that interest includes an amount that is in the nature of interest, or an amount to the extent that it could reasonably be regarded as having being converted into a form that is in substitution for interest.
However the word 'interest' is not otherwise defined by the Act and it is therefore necessary to have regard to common law to determine whether an amount is, in the first instance, 'interest'.
There are numerous cases which consider the meaning of 'interest'. In Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium), the High Court stated (at CLR 218):
...Interest is regarded as flowing from the principal sum (Federal Wharf Co. Ltd v. DFCT (1930) 44 CLR 24 at 28) and to be compensation to the lender for being kept out of the use and enjoyment of the principal sum: Riches v. Westminster Bank Limited (1947) AC 390 at 400...
In the context of interest withholding tax, the Full Federal Court in Federal Commissioner of Taxation v. Century Yuasa Batteries Pty Ltd (1998) 82 FCR 288; 38 ATR 442; 98 ATC 4380, referred to Myer Emporium and stated (at FCR 291) that the ordinary meaning of 'interest':
...is the return, consideration or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, and that interest must be referable to a principal.
A common feature of these definitions is that in order for a payment to be interest, it must be paid in respect of keeping a person out of the use and enjoyment of a principal sum. It must be paid in respect of an amount of money which the person can require to be repaid either upon demand or at a fixed date.
Although the Commitment Fee payable by the borrower is a percentage per unit of time calculated by reference to a principal sum (namely the undrawn balance of the Commitment), it is not payable as consideration or compensation for (or calculated by reference to) amounts actually advanced and in relation to which a liability to repay exists. Rather, the Commitment Fee is a separate charge payable to keep a line of credit open. Importantly it is payable even though that credit is not being used at that particular time (and it is only payable on that part of the credit which is not being used). Furthermore the lender is not put out of the use and enjoyment of a sum of money.
Accordingly, the Commitment Fee is not payable for the actual use of any sum of money or conversely for keeping another person out of the use of any sum of money. Therefore it is not 'interest' within the ordinary meaning of that word.
As mentioned above, subsection 128A(1AB) contains an expanded definition of interest. Paragraphs 128A(1AB)(a) and (b) are potentially relevant to the Commitment Fee.
Paragraph 128A(1AB)(a) provides that interest includes an amount that is in the nature of interest. 'In the nature of' is a phrase used extensively in statute and case law. In the context of Division 11A its purpose is to give an appropriate extension to the concept of 'interest' which is critical to one of the heads of withholding tax liability. In Century Yuasa Batteries Pty Ltd v. Federal Commissioner of Taxation (1997) 73 FCR 528; 35 ATR 394; 97 ATC 4299 (at FCR 548), Cooper J said in relation to the precursor to paragraph 128A(1AB)(a):
In my view, for a payment to fall within the extended definition under s 128A(1) in the context of the withholding tax provisions of ITAA it must have the character of a return or profit to the lender for the use of money advanced to the borrower howsoever calculated or ascertained. For example, the difference between the "extended credit price" and the cash price under consideration in Re Rouse; South Australian Gas Co v Official Receiver, in my opinion would fall within the extended definition in s 128A(1) of the ITAA.
The Full Court expressly agreed with this view on appeal.
The meaning of 'in the nature of' was also considered in Federal Commissioner of Taxation v. Consolidated Press Holdings Limited (No 1) (1999) 91 FCR 524; 99 ATC 4945; 42 ATR 575. In that case the Court had to decide whether there was a scheme that was 'by way of or in the nature of dividend stripping' for the purposes of subparagraph 177E(1)(a)(i). In a joint judgment, French, Sackville and Sundberg JJ stated (at FCR 566):
The use of the words "by way of or in the nature of" suggests that variations from the paradigm will not necessarily result in the scheme being excluded from the first limb, provided it retains the central characteristics of a dividend stripping scheme.
It is considered therefore that paragraph 128A(1AB)(a) is aimed at amounts that are in substance interest but which may not otherwise fall within the ordinary meaning of interest. To be in the nature of interest an amount must have the character of compensation or consideration payable in respect of keeping a person out of the use and enjoyment of a principal sum.
The Commitment Fee is not considered to be 'in the nature of' interest because it does not possess one of the essential qualities which gives interest its character. As explained above it is not, in substance or form, compensation or consideration payable in respect of keeping a person out of the use and enjoyment of a principal sum.
Furthermore the payment cannot be reasonably regarded as having being 'converted into a form that is in substitution for interest' for the purposes of paragraph 128A(1AB)(b). There is no suggestion that the Commitment Fee is payable in substitution for an amount payable to compensate the lender for being kept out of the use and enjoyment of money. This is covered by a separate charge payable at an arm's length rate and described as 'interest' in the Credit Agreement.
Accordingly the Commitment Fee will not be interest, an amount in the nature of interest or regarded as having been converted into a form that is in substitution for interest, for the purpose of subsection 128A(1AB) of the ITAA 1936.
Date of decision: 28 June 2010Year of income: Year ended 30 June 2010
Legislative References:
Income Tax Assessment Act 1936
subsection 128A(1AB)
paragraph 128A(1AB)(a)
paragraph 128A(1AB)(b)
subsection 128B(5)
Case References:
Federal Commissioner of Taxation v The Myer Emporium Ltd
(1987) 163 CLR 199
87 ATC 4363
18 ATR 693
(1997) 73 FCR 528
35 ATR 394
97 ATC 4299 Federal Commissioner of Taxation v Century Yuasa Batteries Pty Ltd
(1998) 82 FCR 288
38 ATR 442
98 ATC 4380 Federal Commissioner of Taxation v Consolidated Press Holdings Limited (No 1)
(1999) 91 FCR 524
99 ATC 4945
42 ATR 575
Related Public Rulings (including Determinations)
Taxation Ruling TR 93/27
Taxation Ruling TR 2002/15
Taxation Ruling TR 2002/16
ATO ID 2008/153
Keywords
Withholding taxes
Interest income
Non resident entities
Non resident interest withholding tax
ISSN: 1445-2782
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