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Edited version of your written advice
Authorisation Number: 1013137963424
Date of advice: 8 December 2016
Ruling
Subject: Whether certain payments constitute 'interest' for the purposes of subsection 128A(1AB) of the Income Tax Assessment Act 1936
Question 1
Do the different payments payable by the taxpayer to the Financier under the Loan Note Subscription Agreement constitute 'interest' for the purpose of subsection 128A(1AB) of the Income Tax Assessment Act 1936 (ITAA 1936)
Answer
The only payment type that constitutes interest under subsection 128A(1AB) of the ITAA 1936 is the Cash Interest Margin.
This ruling applies for the following periods:
From January 201X to January 201X
The scheme commences on:
January 201X
Relevant facts and circumstances
1. The taxpayer entered into an Agreement with the Financier as part of an arrangement to provide a bank guarantee to the lending bank. The Financier arranged for the bank guarantee to be provided by a third party bank.
2. The Applicant and the Financier are unrelated parties and the Financier is not a resident of Australia.
3. Under the Agreement, the taxpayer agreed to make a number of payments to the Financier including the Cash Interest Margin.
4. The Cash Interest Margin is only payable if the bank guarantee or any part of it is actually called upon (drawn down) by the lending bank (that is in the event of a partial or full default), and is calculated as a percentage of the amount drawn down.
5. The Cash Interest Margin is capitalised quarterly and paid at the end of the facility.
Relevant legislative provisions
Income Tax Assessment Act 1936 Subsection 128A(1AB)
Reasons for decision
The definition of “interest”
Subsection 128A(1AB) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that:
“interest” includes an amount, other than an amount referred to in subsection 26C(1):
(a) that is in the nature of interest; or
(b) to the extent that it could reasonably be regarded as having been converted into a form that is in substitution for interest; or
(c) to the extent that it could reasonably be regarded as having been received in exchange for interest in connection with a washing arrangement; or
(d) that is a dividend paid in respect of a non-equity share; or
……..
However, apart from the definition above, the term “interest” is not defined anywhere else in the Tax Acts, and we need to resort to the common law to determine if an amount constitutes “interest” under subsection 128A(1AB) of ITAA36.
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:
…. 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 ….
The Federal Court in Federal Commissioner of Taxation v Century Yuasa Batteries Pty Ltd (1998) 82 FCR 288; 38 ATR 442; 98 ATC 4380 quoted the joint judgement in Myer Emporium (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 referrable to a principal…..
The definition of 'interest' is further explained in ATO Interpretative Decision, Interest withholding tax: commitment fee payable on the undrawn balance of funds available under a credit facility (ATO ID 2010/133). It highlighted that “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.”
Cash Interest Margin
The payment of the Cash Interest Margin is different from the other payments in that it is compensation for amounts drawn down under the bank guarantee, and the interest payment is referrable to the principal amount repayable at a fixed date.
Thus, according to the discussions of the definition of “interest” above, the Cash Interest Margin does constitute “interest” under subsection 128A(1AB) of the ITAA 1936.
The other payments are required to be made irrespective of whether the bank guarantee is called upon, and are not consideration or compensation for amounts actually advanced. Further, they are payable regardless of whether any liability to make payments arises in the event that an amount is called upon by the lending bank under the bank guarantee.
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