Edited version of private ruling

Authorisation Number: 1011593155655

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Ruling

Subject: Withholding tax

1. Do the payments made by Company X constitute 'interest' for the purposes of the withholding tax provisions in Division 11A of the Income Tax Assessment Act 1936 (ITAA 1936)?

No.

2. Are the payments made by Company X assessable in Australia?

Yes.

This ruling applies for the following period

Year ended 30 June 2010

Year ending 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts and circumstances

The following description of the scheme is based on information provided by you.

The following documents form part of the scheme under consideration:

· Your private ruling application.

· The Product disclosure statement.

You are a resident of Country A.

You do not have a permanent establishment in Australia.

You intend to invest in Units which are financial products structured as a Deferred Purchase Agreement (DPA).

You may derive income in the form of payments.

The amount of each payment will be computed per annum but only for each day where the Performance condition is satisfied.

For each day where this condition is satisfied you will be entitled to a payment.

Upon maturity, the final value of the DPA will be the issue price, unless the At-Risk condition is satisfied.

The payments will be paid to you by the Australian branch of Company X, a foreign resident of Australia with a permanent establishment in Australia.

The payments will represent income derived by you.

Australia has a tax treaty with Country A.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 11A

Income Tax Assessment Act 1936 Subsection 128A(1AB)

Income Tax Assessment Act 1936 Subsection 128A(1A)

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1997 Subsection 6-5(3)

International Tax Agreements Act 1953

Reasons for decision

Summary

The payments do not constitute interest for the purposes of the withholding tax provisions in Division 11A of the ITAA 1936.

The payments are considered income and are assessable under subsection 6-5(3) of the ITAA 1997.

You are a resident of Country A and the income you derive in the form of payments may be subject to income tax in Australia and Country A.

Detailed reasoning

Broadly, a foreign resident is liable to pay withholding tax under Division 11A of the ITAA 1936 if they derived income that consists of 'interest' paid by a resident.

Subsection 128A(1AB) of the ITAA 1936 relevantly provides that interest includes an amount:

· that is in the nature of interest; or

· to the extent that it could reasonably be regarded as having been converted into a form that is in substitution for interest.

The payments would be interest if it is interest in the ordinary sense or interest in the expanded sense as defined in subsection 128A(1A) of the ITAA 1936.

Interest

The term 'interest' is not otherwise defined by the Act. Guidance must be therefore be sought from other sources.

In Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139, it was stated that "interest is ordinarily a recurrent or periodic payment which secures … the use of borrowed money during the term of the loan" (at 148).

One feature of a loan is the use of funds for a temporary period. Another feature of a loan is the requirement to repay those funds at the end of that period or on demand (see Taxation Ruling TR 2002/16 at paragraph 88). Further, a loan requires the existence of a debtor-creditor relationship underpinned by the obligation to repay the principal sum lent (see Taxation Ruling TR 2002/15 at paragraph 61).

The Units do not exhibit either of the features identified in TR 2002/16. They also do not create a debtor-creditor relationship underpinned by the obligation to repay the principal sum lent. The subscription price paid by you is not for a temporary period and there is no requirement for Company A to repay those funds on the maturity date. Instead, the arrangement is a DPA between you and Company A under which you agree to purchase the delivery parcel from Company A on a deferred basis. On maturity date, the final value of the Unit is applied towards the purchase of the delivery parcel.

There is no mechanism by which you can demand repayment of those funds. Whilst the buyback mechanism enables you to request Company A to buy back its Units, with the buyback price to be determined by Company A, whether the buyback arrangement is accepted remains a decision to be made by Company A. Similarly, under the Agency Sale Arrangement, you are able to procure a sale of the delivery parcel. However, such arrangement is merely an avenue by which you are able to sell the delivery parcel, rather than an avenue for which you obtain a repayment of the subscription price. Further, if a kick-in event arises, the final value of the Units may be less than the subscription price.

Accordingly, under the terms and conditions of the issue, the DPA does not exhibit the features of a loan nor does it create a debtor-creditor relationship.

The payments under the arrangement would not be considered interest in the ordinary sense. It is therefore necessary to consider whether the payments are regarded as interest in the expanded sense as defined in subsection 128A(1AB) of the ITAA 1936.

In the nature of interest; in substitution for interest

For an amount to be in the nature of interest, the 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 (see ATO ID 2010/133).

For a payment to be in substitution for interest, it must have been possible for 'interest', in the ordinary sense of the word, to have been paid (see ATO ID 2009/154).

The payments are not considered to be in the nature of nor in substitution for interest as they are not compensation in respect of keeping you out of the use and enjoyment of a principal sum. In addition, as the payments do not constitute interest, they would also not be regarded as in substitution of interest as it is not possible for 'interest', in the ordinary sense of the word, to have been paid under the arrangement.

Accordingly, the payments do not constitute interest for the purposes of the withholding tax provisions in Division 11A of the ITAA 1936.

Assessable income

Subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a foreign resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources during the income year and other ordinary income included by a provision on a basis other than having an Australian source.

The payments are considered income and are assessable under subsection 6-5(3) of the ITAA 1997.

In determining the liability to Australian tax on Australian sourced income received by a foreign resident, it is necessary to consider not only the income tax laws but also any applicable tax treaty 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 ITAA 1997, so those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except in some limited situations).

The Agreements Act contains the tax treaty between Australia and Country A (the Country A Agreement). The Country A Agreement operates to avoid the double taxation of income received by residents of Australia and Country A.

The Country A Agreement provides that items of income of a resident of Country A not dealt with in the foregoing articles of the Agreement from sources in Australia may also be taxed in Australia. 

In your case, you are a resident of Country A and the income you derive in the form of payments may be subject to income tax in Australia and Country A.