Edited version of private advice

Authorisation Number: 1052369744385

Date of advice: 6 March 2025

Ruling

Subject: NANE income

Question

Pursuant to Subdivision 768-A of the ITAA 1997, is the interest income accrued on the Company B Loan from 20XX to 20XX considered non-assessable, non-exempt (NANE) income?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX - 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Company A is an Australian resident company and head of a tax consolidated group.

Company A has interests in foreign jurisdictions.

Company A holds less than 100% of the shares in Company B, a company resident in a foreign country. The government of the foreign country owns the remaining shares in Company B.

Company A has funded Company B via an overdraft known as the Company B loan, the terms of which have changed over time.

Historically, the Company B Loan was classified as a non-share equity interest in Australia and a debt interest in the foreign jurisdiction, having the characteristics of a hybrid instrument.

In 20XX - 20XX, when Company B seemingly satisfied the requirements to accrue interest expenses to Company A, Company B claimed deductions for interest expenses in the foreign jurisdiction.

Effective 1 January 2019, Australia introduced hybrid mismatch rules which, among other things, ensured that where foreign equity distributions give rise to a foreign income tax deduction, they are to be included in the assessable income of an Australian corporate tax entity (ie they are no longer NANE income - section 768-7).

Accordingly, Company A reflected the Company B loan interest income as assessable income in its Australian tax returns.

In 20XX, the foreign jurisdiction's tax authority said that the relevant tax deductions were disallowed for various reasons.

Relevant legislative provisions

Income Tax Assessment Act 1997 subdivision 768-A

Income Tax Assessment Act 1997 subsection 768-5(1)

Income Tax Assessment Act 1997 paragraph 768-5(d)

Income Tax Assessment Act 1997 section 768-7

Income Tax Assessment Act 1997 subsection 768-7(2)

Income Tax Assessment Act 1997 section 768-10

Income Tax Assessment Act 1997 section 768-15

Income Tax Assessment Act 1997 subsection 974-75(1)

Income Tax Assessment Act 1997 paragraph 960-115

Income Tax Assessment Act 1997 subsection 960-120(1)

Income Tax Assessment Act 1997 subsection 960-190(1)

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 350(1)(a)

Reasons for decision

1)  Broadly, under Subdivision 768-A, where an Australian corporate tax entity receives a foreign equity distribution from a foreign company, either directly or indirectly through one or more interposed trusts or partnerships, and the Australian corporate tax entity holds a participation interest of at least 10% in the foreign company, the distribution is non-assessable non-exempt (NANE) income for the Australian corporate tax entity.

2)  In order for the foreign equity distribution to be classified as NANE income, it must meet the requirements of subsection 768-5(1), which provides;

A * foreign equity distribution is not assessable income, and is not * exempt income, of the entity to which it is made if:

(a)          the entity is an Australian resident and a * corporate tax entity; and

(b)          at the time the distribution is made, the entity satisfies the participation test in section 768-15 in relation to the company that made the distribution; and

(c)          the entity:

(i)        does not receive the distribution in the capacity of a trustee; or

(ii)        receives the distribution in the capacity of a trustee of a * public trading trust; and

(d)          the distribution is not one to which section 768-7 (which is about foreign income tax deductions) applies.

3)  Paragraph 768-5(1)(d), and section 768-7 were introduced as part of the hybrid mismatch rules in 2018 and apply to foreign equity distributions made on or after 1 January 2019.

4)  Relevantly, section 768-7 applies to a foreign equity distribution if;

(a)          all or part of the distribution gives rise to a foreign income tax deduction; and

(b)          the exception in subsection (2) does not apply to the distribution.

5)  The exception in subsection 768-7(2) applies if:

(a)          the foreign income tax deduction arises because the company that made the distribution is recognised under the law of the foreign country in which the deduction arises as being used for collective investment; and

(b)          foreign income tax of a withholding -type tax was payable in respect of the distribution.

6)  Section 768-10 defines a 'foreign equity distribution' as:

... a *distribution or *non-share dividend made by a company that is not a Part X Australian resident (within the meaning of Part X of the Income Tax Assessment Act 1936 ) in respect of an *equity interest in the company.

7)  Section 317 of the Income Tax Assessment Act 1936 (ITAA 1936) defines a 'Part X Australian resident' as a resident within the meaning of section 6 of the ITAA 1936, but does not include an entity where:

(a)          there is a double tax agreement in force in respect of a foreign country; and

(b)          that agreement contains a provision that is expressed to apply where, apart from the provision, the entity would, for the purposes of the agreement, be both a resident of Australia and a resident of the foreign country; and

(c)          that provision has the effect that the entity is, for the purposes of the agreement, a resident solely of the foreign country.

8)  Section 974-75 sets out the basic tests for what are 'equity interests'.

9)  Item 1 of the table in subsection 960-120(1) states that a 'distribution' by a company is constituted by 'a dividend, or something that is taken to be a dividend, under this Act.'

10)  Relevantly, a dividend is defined in subsection 6(1) as any distribution made by a company to its shareholders whether in money or other property (para (a)) and any amount credited by a company to its shareholder(s) (para (b)).

11)  Section 768-15 provides that an entity satisfies the participation test in relation to another entity where the sum of the following is at least 10%:

(a)          the * direct participation interest the entity would have in the other entity if rights on winding-up were disregarded;

(b)          the * indirect participation interest the entity would have in the other entity if:

(i)        rights on winding-up were disregarded; and

(ii)        section 960-185 only applied to intermediate entities that are not * corporate tax entities.

12)  The table in subsection 960-190(1) outlines how to work out the direct participation interest one entity holds in another. Item 1 ('direct participation interest' in a company) directs the reader to the definition of 'direct control interest', which per paragraph 350(1)(a) of the ITAA 1936 includes the percentage of the total paid-up share capital of a company that an entity holds.

13)  Taxation Ruling TR 2017/3 Income tax: distributions from foreign companies - meaning of 'at the time the distribution is made' when applying the participation test states at paragraph 10:

For the purposes of section 768-5 the Commissioner considers that an entity will satisfy the participation test 'at the time the distribution is made' by the foreign company if the entity is the registered holder of at least a 10% participation interest in that company at the commencement of the day that the distribution is made.

14)  Other terms relevant to the application of subsection 768-5(1) are outlined below:

•                     'Australian resident' is defined in subsection 995-1(1) as a person who is a resident of Australia for the purposes of the ITAA 1936. Subsection 6(1) of ITAA 1936 states that a resident of Australia includes a company which is incorporated in Australia.

•                     'Corporate tax entity' is defined as including an entity which is a company in section 960-115.

Analysis

15)  Between 20XX and 20XX, interest accrued on the Company B loan provided by Company A to Company B. The accrued interest was returned as assessable income of Company A in Australia in the years it accrued.

16)  Company B is not a Part X Australian resident as it is not a resident of Australia within the meaning of section 6 of the ITAA 1936.

17) It is assumed that the Company B loan is an equity interest for Australian taxation purposes (see the assumption included above).

18)  Accordingly, the interest accrued by Company B is a foreign equity distribution under section 768-10 as it is a distribution constituted by a dividend or something taken to be a dividend, made by a company that is not a Part X Australian resident (Company B) in respect of an equity interest in Company B.

19)  The interest accrued from Company B to Company A during the relevant period (the foreign equity distribution) will be NANE income of Company A at the time the distributions are made, if they meet the requirements of subsection 768-5(1).

20)  As an Australian incorporated company, Company A is an Australian resident, per subsection 995-1(1) and subsection 6(1) of ITAA 1936. Company A is also a corporate tax entity per section 960-115 and therefore meets the requirement of paragraph 768-5(1)(a).

21)  As Company A held more than 10% of the shares in Company B at all relevant times, Company A directly holds a participation interest of at least 10% according to section 768-15, and the requirement in paragraph 768-5(1)(b) is met.

22)  As Company A does not receive the distribution in the capacity of a trust or a public trading trust, the requirement of paragraph 768-5(1)(c) is met.

23)  The final requirement in paragraph 768-5(1)(d) will be met if the distributions are not captured by section 768-7. Subsection 768-7(1) provides that section 768-7 will apply to a foreign equity distribution if, among other things, all or part of the distribution gives rise to a foreign income tax deduction.

24)  Under the foreign jurisdiction's tax law, for related party interest to be deductible to Company B, certain conditions had to be met. These conditions were not met, and accordingly section 768-7 does not apply.

25)  The tax deductions for the accrued interest on the Company B loan claimed by Company B in the foreign jurisdiction were disallowed under audit.

Conclusion

26)  The foreign equity distributions from Company B made during the relevant years are NANE income of Company A as they meet the requirements of subsection 768-5(1) and are not distributions to which section 768-7 applies.

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