Edited version of private advice

Authorisation Number: 1051824430267

Date of advice: 7 April 2021

Ruling

Subject: Interest withholding tax

Question 1

Is Entity A entitled to the benefit of the exemption under Article 11(3)(b) of the Convention between Australia and the Swiss Confederation for the Avoidance of Double Taxation with respect to Taxes on Income, with Protocol [2014] ATS 33 (the Swiss Convention) such that amounts of interest income payable on debt by Entity B to Entity A are not subject to interest withholding tax under section 128B of the Income Tax Assessment Act 1936 (ITAA 1936)?

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Entity A is a company incorporated in Switzerland and is a Swiss resident for Swiss tax purposes.

Entity A is an authorised bank pursuant to Swiss Law. Entity A offers banking and financial services globally.

All relevant services conducted by Entity A for specific clients are conducted through its Branch in a third jurisdiction (referred to below as its Other Branch).

Entity A is providing relevant services to a number of funds (the Funds) managed by Entity B, an independent fund manager that is not related to Entity A.

Each Fund is constituted as a trust. These entities are Australian residents.

Agreements have been entered into with each Fund by Entity A acting through its Other Branch (the Agreements). The Agreements are open-ended and will be on foot until terminated by the parties.

Although Entity A carries on business through a permanent establishment in Australia, any financing provided under the Agreements is not connected with Entity A's permanent establishment in Australia. Entity A acting through its Australian Branch does not provide the relevant services to clients.

Each of the Agreements is structured similarly and contains the same terms.

Entity A's Other Branch may use its Affiliates to fulfil an Agreement's terms and may delegate to them to act as agents. An Affiliate is defined to mean anything with majority voting control of Entity A (and vice versa) as well as common control.

Entity A's Australian Branch does not act as sub-custodian in relation to services provided to the Funds.

Entity A's Australian Branch does not interact with the Funds or their trustees. Certain individuals employed by Entity A's Australian employing entity (for all its Australian staff) are involved in the management of the client relationships and booking flow with the Funds.

Entity A will be the beneficial owner of interest income derived from each of the Funds in respect of any financing provided to the Funds under the Agreements. Such financing will be provided as ordinary interest-bearing debt, i.e. will not incorporate any contingent, equity-like or performance-linked returns.

The Agreements under which interest will be charged are not back-to-back loans, nor are they economically equivalent to back-to-back loans.

Entity A does not participate in the management, control or decision-making of any of the Funds upon which it derives interest income.

Entity A does not have a special relationship with those payers who pay the interest income which results in the amount being paid exceeding the amount that would otherwise have been expected to have been paid had such a special relationship not been in existence.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Convention between Australia and the Swiss Confederation for the Avoidance of Double Taxation with respect to Taxes on Income, with Protocol [2014] ATS 33 Article 11

Reasons for decision

Question 1

Is Entity A entitled to the benefit of the exemption under Article 11(3)(b) of the Swiss Convention such that amounts of interest income payable on ordinary interest-bearing debt by Entity B to Entity A are not subject to interest withholding tax under section 128B of the ITAA 1936?

Detailed reasoning

A non-resident is liable to pay withholding tax under subsection 128B(5) of the ITAA 1936 if the 'non-resident' derives income that consists of interest and the requirements of subsection 128B(2) of the ITAA 1936 are satisfied in relation to that income. Subsection 128B(2) of the ITAA 1936 provides that:

Subject to subsection (3), this section... applies to income that:

(a) is derived... by a non-resident; and

(b) consists of interest that:

(i) is paid to the non-resident....

None of the exclusions listed in section 128B(3) of the ITAA 1936 apply to Entity A in relation to the relevant interest income. However, in determining liability to Australian tax on Australian source income derived by a non-resident, it is necessary to consider not only the income tax laws but also any applicable Convention or Double Taxation Agreement contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997) so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

Australia and Switzerland have entered into the Swiss Convention, which has been incorporated into domestic law.

In order for the Swiss Convention to apply, Article 1 of the Swiss Convention states:

This Convention shall apply to persons who are residents of one or both of the Contracting States.

Entity A must therefore be considered both a 'person' and a 'resident of a Contracting State' for the Swiss Convention to apply.

Person

Subparagraph 1c) of Article 3 of the Swiss Convention defines 'person' to include:

... an individual, a company, a trust and any other body of persons.

Subparagraph 1d) of Article 3 of the Swiss Convention defines a 'company' to mean:

... any body corporate or any entity which is treated as a company or body corporate for tax purposes.

Entity A is a company for tax purposes in Switzerland. Therefore, Entity A satisfies the definition of a 'company' pursuant to subparagraph 1d) of Article 3 of the Swiss Convention. It is, therefore, considered to be a 'person' in accordance with subparagraph 1c) of Article 3 of the Swiss Convention for the purposes of applying the Swiss Convention.

Resident of a Contracting State

Paragraph 1 of Article 4 of the Swiss Convention provides the following:

For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax as a resident of that State, and also includes the Government of that State and any political subdivision or local authority thereof. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State.

Entity A is a company incorporated in Switzerland and is a Swiss resident for Swiss tax purposes. As such, Entity A is a resident of a Contracting State.

Entity A meets the requirements of Article 1 of the Swiss Convention and is therefore subject to its application.

Swiss Convention - application to taxes

Paragraphs 1 and 2 of Article 2 of the Swiss Convention, in respect to taxes covered, provides the following:

1.    This Convention shall apply to taxes on income imposed on behalf of a Contracting State and, in the case of Switzerland, on behalf of its political subdivisions or local authorities, irrespective of the manner in which they are levied.

2.    There shall be regarded as taxes on income all taxes imposed on total income or on elements of income, including taxes on gains from the alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation.

In addition, subparagraph 3a) of Article 2 of the Swiss Convention provides the following:

The existing taxes to which this Convention shall apply are in particular:

a)    in Australia:

the income tax, the fringe benefits tax and resource rent taxes imposed under the federal law of Australia;

(hereinafter referred to as "Australian tax");

Based upon the above, the Swiss Convention applies to all taxes imposed on income and in particular applies to Australian income tax.

Section 128B of the ITAA 1936imposes liability to withholding tax on dividend, interest and royalty income derived by non-residents. As such, withholding tax payable in respect to interest to non-residents is considered to be an Australian income tax and is covered by the Swiss Convention.

Interest income

Article 11 of the Swiss Convention is the relevant provision in relation to interest income. The provision states the following:

1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
2. However, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the interest.
3. Notwithstanding paragraph 2, interest arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall not be taxed in the first-mentioned State if the interest is derived by:

...

b)    a financial institution which is unrelated to and dealing wholly independently with the payer. For the purposes of this Article, the term "financial institution" means a bank or other enterprise substantially deriving its profits by raising debt finance in the financial markets or by taking deposits at interest and using those funds in carrying on a business of providing finance;

For subparagraph 3b) of Article 11 of the Swiss Convention to apply to Entity A, such that interest income payable by Entity B to Entity A shall not be taxed in Australia (including under withholding tax provisions), the following conditions must be met:

•         there is interest that arises in Australia,

•         Entity A is the beneficial owner of the interest and derives the interest,

•         Entity A is a resident of Switzerland,

•         Entity A is a financial institution which is unrelated to and dealing wholly independently with the payer, and

•         Other relevant provisions of Article 11 of the Swiss Convention are satisfied.

Interest that arises in Australia

Interest income arises in Australia from the ordinary interest-bearing debt provided by Entity A to Entity B (who is an Australian tax resident).

Therefore, this condition is met.

The beneficial owner of the interest and derives the interest

Entity A is the beneficial owner of the interest income which it derives from the ordinary interest-bearing debt financing provided to Entity B under the Agreements.

Therefore, this condition is met.

Resident of Switzerland

As determined above, Entity A is a resident of Switzerland as it satisfies the definition of a 'resident of a Contracting State' and was established in Switzerland

Therefore, this condition is met.

Financial institution which is unrelated to and dealing wholly independently

Entity A is an authorised bank according to Swiss Law. Entity A offers banking and financial services globally.

In terms of being a financial institution 'unrelated to and dealing wholly independently with the payer', TR 2005/5 states:

29. For the purposes of Article 11(3)(b), the US or UK resident must be both unrelated to, and dealing wholly independently with the Australian payer.

30. The term 'unrelated' means that there is no ownership or control based relationship between the payer of the interest and the financial institution, under which one party is able to exert sufficient influence over the activities of the other party. In this regard, the term 'sufficient influence' takes its meaning from section 318 of the ITAA 1936. Essentially, an entity will be sufficiently influenced by another entity where that entity has 'influence, because of obligation or custom, over a company or its directors to direct the actions of the company either directly or through interposed entities'.

31. In determining whether the parties will be regarded as dealing wholly independently with each other, an arm's length test is applied to ascertain whether the transaction has taken place on normal, open market, commercial terms...

Entity A is independent from Entity B and the Funds themselves.

Therefore, this condition is met.

Other provisions of Article 11 of the Swiss Convention

Entity A does not meet any of the restrictions that would prevent it from being able to benefit from the exemption regarding its ordinary interest-bearing debt under Article 11, including where:

•         interest is paid as part of an arrangement involving back-to-back loans or other arrangement that is economically equivalent and intended to have a similar effect (paragraph 4 of Article 11 of the Swiss Convention). The EM to the ITAAB 2014 describes back-to-back loans:

1.160 The exemption is not available for interest paid as part of an arrangement involving back-to-back loans or other arrangement that is economically equivalent and intended to have a similar effect. The denial of the exemption for these back-to-back loan type arrangements is directed at preventing related party and other debt from being structured through financial institutions to gain access to such relief. The exemption will only be denied for interest paid on the component of a loan that is considered to be back-to-back. In such cases, the 10 per cent rate limit will apply. [Article 11, paragraph 4a)]

1.161 An example of a back-to-back arrangement would include, for instance, a transaction or series of transactions structured in such a way that:

-        a Swiss financial institution receives or is credited with an item of interest arising in Australia; and

-        the financial institution pays or credits, directly or indirectly, all or substantially all of that interest (at any time or in any form, including commensurate benefits) to another person who, if it received the interest directly from Australia, would not be entitled to similar benefits with respect to that interest.

1.162 However, a back-to-back arrangement would generally not include a loan guarantee provided by a related party to a Swiss financial institution.

The Agreements under which interest will be charged by Entity A are not back-to-back loans, nor are they economically equivalent to back-to-back loans.

•         the member of a Contracting State is operating through a permanent establishment whether or not that permanent establishment is situated in that other Contracting State (paragraph 6 of Article 11 of the Swiss Convention). This is discussed in paragraph 32 of Taxation Ruling TR 2005/5 - Income tax: ascertaining the right to tax United States (US) and United Kingdom (UK) resident financial institutions under the US and UK Taxation Conventions in respect of interest income arising in Australia (TR 2005/5):

In cases where interest is paid by an Australian borrower to a permanent establishment in Australia of the financial institution, and the indebtedness in respect of which the interest is paid is effectively connected with that permanent establishment, Article 11(6) of the Conventions specifies that the provisions of Article 7 (Business Profits) will apply. Notwithstanding that the US or UK resident may be a financial institution, the interest arising in Australia will be taxable in Australia under Article 7 of the Conventions.

The OECD Commentary on the Model Tax Conventions (OECD Commentary) may be used to interpret the meaning of paragraph 6 of Article 11. ATO Interpretive Decision ATO ID 2011/13 Income Tax Interest withholding tax: interest arising in Australia paid to a New Zealand Limited Partnership - 'beneficially owned' (ATO ID 2011/13)provides guidance in relation to the use of relevant context for interpreting Australian tax treaties and is therefore instructive in considering the application of paragraphs 6 of Article 11 of the Swiss Convention.

ATO ID 2011/13 provides the following:

Relevant context for the purposes of interpreting an Australian tax treaty includes the Commentaries on the OECD Model Tax Convention on Income and on Capital (the OECD Commentary). Paragraph 104 of Taxation Ruling TR 2001/13 states that the OECD Commentary provides important guidance on interpretation and application of the OECD Model Tax Convention and will often need to be considered as a matter of practice, in interpreting tax treaties, at least where the wording is ambiguous.

The OECD Commentary on Article 11 states at paragraphs 25 and 25.1:

It has been suggested that the paragraph could give rise to abuses through the transfer of loans to permanent establishments set up solely for that purpose in countries that offer preferential treatment to interest income. Apart from the fact that the provisions of Article 29 (and, in particular, paragraph 8 of that Article) and the principles put forward in the section on "Improper use of the Convention" in the Commentary on Article 1 will typically prevent such abusive transactions, it must be recognised that a particular location can only constitute a permanent establishment if a business is carried on therein and, as explained below, that the requirement that a debt-claim be "effectively connected" to such a location requires more than merely recording the debt-claim in the books of the permanent establishment for accounting purposes.

A debt-claim in respect of which interest is paid will be effectively connected with a permanent establishment, and will therefore form part of its business assets, if the "economic" ownership of the debt-claim is allocated to that permanent establishment under the principles developed in the Committee's report entitled Attribution of Profits to Permanent Establishments (see in particular paragraphs 72 to 97 of Part I of the report) for the purposes of the application of paragraph 2 of Article 7. In the context of that paragraph, the "economic" ownership of a debt-claim means the equivalent of ownership for income tax purposes by a separate enterprise, with the attendant benefits and burdens (e.g. the right to the interest attributable to the ownership of the debt-claim and the potential exposure to gains or losses from the appreciation or depreciation of the debt-claim).

All relevant services conducted by Entity A for specific clients are conducted by its Other Branch.

Entity A provides the relevant services to the Funds. Entity A's Other Branch may use its Affiliates to fulfil an Agreement's terms, and may delegate to them to act as agents. Entity A's Australian Branch does not act as sub-custodian in relation to services provided to the Funds.

Entity A's Australian Branch does not interact with the Funds or their trustees. Certain individuals employed by Entity A's employing entity are involved in the management of the client relationships and booking flow with the Funds.

Therefore, although Entity A carries on business through a permanent establishment in Australia (via its Australian Branch), it is considered that any financing provided under the Agreements is not effectively connected with Entity A's permanent establishment in Australia.

•         the beneficial owner of the interest participates in the management, control or decision-making of the issuer of the debt-claim (paragraph 4 of Article 11 of the Swiss Convention). Entity A does not participate in the management, control or decision-making of any of the Funds upon which it derives interest income.

•         there exists a special relationship between the payer and the person beneficially entitled to the interest which results in the amount being paid exceeding the amount that would otherwise have been expected to have been paid had such a special relationship not been in existence (paragraph 8 of Article 11 of the Swiss Convention). Entity A does not have a special relationship with those payers who pay the interest income which results in the amount being paid exceeding the amount that would otherwise have been expected to have been paid had such a special relationship not been in existence.

Consequently, the limitations prescribed in the Swiss Convention, to the availability of the exemption from income and withholding tax on interest income discussed above will not be applicable in respect of the interest income derived by the Entity A.

Protocol 1 to the Swiss Convention

The Protocol prevents those from taking advantage of the Swiss Convention. It states:

The benefits of this Convention shall not apply if it was one of the principal purposes of any person concerned with the creation or assignment of the property or right in respect of which the income is paid, or if a person has become a resident of a Contracting State, to take advantage of the provisions of the Convention by means of such creation, assignment or residence.

Paragraph 1.340 of the EM to the ITAAB 2014 states:

The inclusion of this rule will ensure that effect is given to the principle contained in paragraph 9.5 of the Commentary on Article 1 (Persons Covered) of the OECD Model; namely that the benefits of a double tax convention should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions.

Entity A is considered a genuine resident of Switzerland. Furthermore, the arrangements are arm's length transactions between unrelated parties, entered into for commercial purposes. In these circumstances, it is not considered that either party had a principal purpose of taking advantage of the provisions of the Swiss Convention.

Therefore, paragraph 1 of the Protocol should not operate to deny benefits under the Swiss Convention.

Conclusion

Entity A is entitled to the benefit of the exemption under Article 11(3)(b) of the Swiss Convention such that amounts of interest income payable on ordinary interest-bearing debt by Entity B to Entity A are not subject to interest withholding tax under section 128B of the ITAA 1936.

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