Edited version of your private ruling

Authorisation Number: 1012589523844

Ruling

Subject: Unpaid non-resident withholding tax & debt forgiveness

Questions and Answers

1. Are/were you able to claim deductions for interest paid or incurred (accrued) to your foreign lender when you have not withheld tax from those interest amounts?

No.

2. Where you have not paid 10% withholding amounts related to your accrued interest owing to your foreign lender, must you pay those unpaid withholding amounts to the ATO, if your foreign lender (later) forgives your accrued interest owing?

Yes.

3. Can your 10% withholding tax paid to the ATO, related to your accrued interest owing to your foreign lender, be refunded, if your foreign lender forgives your accrued interest owing?

No.

4. Must you reduce your carry forward losses by the same amount of any capitalised (accrued) interest debt forgiven?

Yes.

This ruling applies for the following periods:

Years ended 31 January 2009

Years ended 31 January 2010

Years ended 31 January 2011

Years ended 31 January 2012

The scheme commences on:

1 February 2008

Relevant facts and circumstances

You are an Australian registered company, whose principle place of business has been in Australia since your registration. Your major shareholder, a non-resident company, has loaned you money.

In the past, you have claimed deductions for interest expenses accrued but not paid to the lender. The expenses were capitalised as amounts owing to the lender in your accounts. However, you have never lodged an assessable income tax return, and only have carry forward to later financial years.

The non-resident lender is considering forgiving the capitalised interest liability. They are also negotiating with another party to acquire their shares in you, which includes the repayment of their loan capital. However, if not successful, there remains the possibility of forgiving you the entire loan amount.

The non-resident lender has lodged their income tax returns for the relevant withholding periods.

Relevant legislative provisions

Taxation Administration Act 1953 Schedule 1 Section 12-245

Taxation Administration Act 1953 Schedule 1 Section 18-65

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1997 Section 26-25

Reasons for decision

Summary

Section 26-25 of the Income Tax Assessment Act 1997 (ITAA 1997) prohibits a deduction for interest expense payable to a non-resident lender until the withholding tax for the interest is paid. In your case, as you did not remit withholding tax for much of your incurred interest, you cannot claim a deduction for those relevant interest amounts.

Section 12-245 of Schedule 1 of the Taxation Administration Act 1953 (TAA) provides you with a requirement to withhold tax if you incur interest payable to a non-resident lender. Also, your 'capitalised (interest) debt' that may be forgiven is not of the same nature as your 'interest expenses' deducted. Therefore, you must you pay those unpaid withholding amounts to the ATO, which includes if your foreign lender (later) forgives your capitalised (interest) debt owing, because the forgiven amount is unrelated to your interest expenses deducted.

Subdivision 18-B of Schedule 1 to the TAA, particularly section 18-65, contains rules that allow refunds of amounts withheld or paid to the Commissioner in error. In your case, as your previous withholding payments were not made in error, they cannot be refunded.

Section 245-115 of the ITAA 1997 provides the total net forgiven amount of a commercial debt must be applied first, to the maximum extent possible, in reduction of your tax losses. In your case, if your capitalised (interest) debt is forgiven, you must reduce your tax losses by the forgiven amount.

Since your 'capitalised (interest) debt' that may be forgiven is not of the same nature as your 'interest expenses' deducted, if you do not pay the unpaid withholding amount, you may lose your interest deductions is addition to having to offset the forgiven amount against your tax losses.

Detailed reasoning

Question 1

If a payer has failed to withhold from an interest payment and would otherwise get a tax deduction for the interest incurred, section 26-25 of the ITAA 1997 prohibits an interest deduction until the withholding tax for the interest is paid.

Taxation Determination TD 93/146 explains a resident must deduct withholding tax from interest payable under a loan from a non-resident even if there is no actual payment of the interest.

In your case, you are unable to claim deductions for interest paid or incurred when you have not withheld tax for those interest amounts.

Since you have never lodged an assessable income tax return, section 170 of the Income Tax Assessment Act 1936 (ITAA 1936) will allow the Commissioner to amend the relevant interest expenses in any income tax assessment made in the future (since those interest expenses have crystallised in your carry forward tax losses).

Question 2

Section 12-245 of Schedule 1 of the TAA provides payers of interest are required to withhold tax if:

§ the recipient has an address outside Australia, or

§ the payer is authorised to pay the interest at a place outside Australia.

Taxation Determination TD 93/146 explains a resident must deduct withholding tax from interest payable under a loan from a non-resident even if there is no actual payment of the interest.

(However, subsection 128B(2) of the 1936 provides an exemption to withholding tax where the interest is wholly incurred by the resident as an expense of carrying on a business overseas at or through a permanent establishment in that overseas country.)

In your case, under section 12-245 of Schedule 1 of the TAA, you are required to withhold tax on your non-resident interest obligations, even if those interest obligations are later forgiven.

In addition, the amount that may be forgiven will not be the forgiveness of 'interest expense'. Instead, the forgiven amount will be the forgiveness of a 'capitalised (interest) debt'. Therefore, the 'capital debt' forgiven will not be related the 'interest expense' you previously incurred and deducted. In other words, your capitalised (interest) debt being forgiven does not change your previous obligation to withhold for 'interest expense' incurred.

In addition, as explained above, under section 26-25 of the ITAA 1997, you are required to withhold for your interest to be deductible.

Question 3

Subdivision 18-B of Schedule 1 to the TAA contains the rules allowing amounts withheld or paid to the Commissioner in error, purportedly under any of the PAYG withholding provisions, to be refunded to recipients. Section 18-65, therein, is specifically about refund of withheld amounts by the payer to the recipient.

Practice Statement Law Administration PS LA 2011/11 is about the above mentioned refund provisions. Paragraph 7 explains:

The word 'error' has its ordinary, broad meaning and includes an error of fact and an error of law. An error of fact is one where an error is made by a decision maker about the existence of a particular fact. An error of law is a misinterpretation or misapplication of a principle of law, or the application of an inappropriate principle of law to an issue of fact.

Paragraph 8 includes as examples of errors: (i) withholding an amount at a much higher rate than is normally required; (ii) withholding an amount from an interest payment to a non-resident who derives it in carrying on business in Australia at or through a permanent establishment; and (iii) using the wrong exchange rate in calculating an interest payment to a non-resident and an excess amount is subsequently withheld from these payments.

In your case, your withholding payments to the Tax Office were not subject to the errors listed in Subdivision 18-B of Schedule 1 to the TAA (and PS LA 2011/11). Therefore, they cannot be refunded.

In addition, as previously stated, the amount that may be forgiven will not be the 'interest expense'. Instead, the forgiven amount will be the forgiveness of a 'capitalised (interest) debt'. In other words, your capitalised (interest) debt being forgiven does not result in the amounts you actually withheld for 'interest expense' incurred becoming amounts withheld in error.

Questions 4

Section 245-1 of the ITAA 1997 summarises the purpose of the forgiveness of commercial debts provisions. It states, when a creditor forgives a commercial debt you owe, this Division offsets the forgiven amount against amounts that could otherwise reduce your taxable income in the same or a later income year, namely:

(a) your tax losses and net capital losses; and

(b) capital allowances and some similar deductions; and

(c) the cost bases of your CGT assets.

Section 245-10 of the ITAA 1997 states Subdivisions 245-C to 245-G will apply to a commercial debt of yours if actual or possible interest payable on such a debt can be or could have been deducted by you.

Section 245-20 of the ITAA 1997 treats unpaid interest on a debt as being a separate debt. As a result, each amount of interest that accrues is a separate debt and, if it is forgiven, it is subject to the debt forgiveness rules separately from any forgiveness of the principal amount.

Section 245-115 of the ITAA 1997 provides the total net forgiven amount of a commercial debt must be applied first, to the maximum extent possible, in reduction of your tax losses.

In your case, if your 'capitalised (interest) debt' is forgiven, it will be subject to the debt forgiveness rules in Division 245-1 of the ITAA 1997. It follows you will be required to first reduce your tax losses carried forward by the capitalised (interest) debt you owe.

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