Edited version of your private ruling

Authorisation Number: 1011956877927

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Ruling

Subject: Non-resident - Early repayment of loan

Questions and Answers

1. Are you assessable on X% of the refund of prepaid interest as a result of the early repayment of a capital protected equity loan?

Yes

2. Are you entitled to a deduction of X% of the other break costs as a result of the early repayment of your loan?

Yes

3. Is the prepaid interest refunded to you subject to withholding tax?

No

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You were a resident of Australia for tax purposes.

Whilst you were a resident of Australia, you invested in shares through a Protected Equity Loan (PEL), a capital protected product on date A.

The loan was drawn down on date A for a 5 year term. Interest on the loan was fixed at the rate of Y% and interest was payable yearly in advance.

You departed Australia for Country A on date B in the 2009-10 income year and ceased to be a resident of Australia,

On date C, less than 5 years from date A, you sold the shares and made an early repayment of the PEL. You were a non-resident of Australia for tax purposes.

On termination of the PEL (date C) you received a prepaid interest refund of a certain amount, being part of the interest expense you claimed in your income tax return for the 2008-09 income year.

You were also charged other break costs for early repayment of the loan.

The financial institution has indicated the other break costs were the sum of:

· Present value of future interest payments

· Refund of prepaid interest

· Recovery of expenses

· GST on brokerage

These costs were reduced by:

· Benefit of funds

· Net option value benefit

Giving net other break costs payable

The revenue component of the protected equity loan was X%, the remainder constituting a component for capital protection.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Subsection 20-20(2).

Income Tax Assessment Act 1936 Section 128B

Reasons for Decision

Subsection 20-20(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an amount you have received as a recoupment of a loss or outgoing is an assessable recoupment if:

· you received the amount by way of insurance or indemnity , and

· you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act.

Indemnity is defined in the Macquarie Dictionary, 2005, rev 4^th edn, The Macquarie Library Pty Ltd, NSW as including compensation for damage loss or sustained. The issue of whether an amount is received by way of indemnity for the purpose of the predecessor provision to subsection 20-20(2) of the ITAA 1997 (paragraph 26(j) of the Income Tax Assessment Act 1936) has been considered in a number of cases including: Federal Commissioner of Taxation v Wade (1951) 84 CLR 105; (1951) 9 ATD 337; 5 AITR 214, Robert v Collier's Bulk Transport Pty Ltd (1959) VR 280, Goldsbrough Mort & Co Ltd v FC of T (1976) 76 ATC 4343; (1976) 6 ATR 580 and Commercial banking Company of Sydney Limited v FC of T (1983) 83 ATC 4208; (1983) 14 ATR 142.

These cases make it clear that an amount received by way of indemnity is not restricted to payments received under a contract of indemnity. They also make it clear that an amount received by way of indemnity would include a receipt pursuant to an antecedent obligation (whether by virtue of a contract, statute or a breach of some common law duty of care) to make good or to compensate for a loss which arises after the obligation comes into existence.

The refund of the prepaid interest is made pursuant to antecedent obligation in the loan agreement to compensate the taxpayer's loss arising from prepaying the interest in relation to the unexpired period and, thus, is an amount received by way of indemnity.

In your case, you invested in shares through a protected equity loan (PEL), a capital protected product on date A when you were a resident of Australia. On date B you sold the shares as a non-resident and made an early repayment of the PEL. You received a prepaid interest refund of a certain amount, being part of the interest expense you claimed in your tax return for the 2008-09 income year.

As you were allowed an amount for the prepaid interest pursuant to section 8-1 of the ITAA 1997, the refund of the prepaid interest is an assessable recoupment under subsection 20-20(2) of the ITAA 1997 in the year that the amount was received. Thus you are assessable on X% of the refund of prepaid interest as a result of the early repayment of your capital protected equity loan.

Other break costs

Section 8-1 of the ITAA 1997 allows a deduction for a loss or outgoing to the extent that it is incurred in gaining or producing assessable income, except where it is a loss or outgoing of a capital, private or domestic nature.

Penalty interest payments

Taxation Ruling TR 93/7 provides guidance on whether penalty interest payments are deductible. In this Ruling the term 'penalty interest payment' refers to an amount payable by a borrower under a loan agreement in consideration for a lender agreeing to accept an early repayment of a loan. The amount payable is commonly calculated by reference to a number of months of interest payments that would have been received had the premature repayment not been made.

TR 93/7 states that a penalty interest payment is generally deductible (under section 8-1 of the ITAA 1997) if:

· the loan moneys were borrowed for the purpose of gaining or producing assessable income or for use in a business carried on for that purpose; and

· the payment is made in order to rid the taxpayer of a recurring obligation to pay interest on the loan, where such interest would itself have been deductible if incurred.

In your case you took out a loan on date A which was a five year loan. Interest on the loan was fixed and payable yearly in advance. You made an early repayment of the loan on date C. You incurred other break costs as a result of the early repayment of the loan. The financial institution has indicated the other break costs were the sum of:

· Present value of future interest payments

· Refund of prepaid interest

· Recovery of expenses

· GST on brokerage

These costs were reduced by:

· Benefit of funds

· Net option value benefit

Giving net other break costs payable

We accept that the amount of other break costs relates to items of a revenue nature. The financial institution has indicated that the costs are in the nature of interest payments. Thus we can apply Taxation Ruling TR 93/7.

The whole of the loan capital was required to be used to purchase assessable income producing shares. Therefore the other break costs are allowable as a deduction to the extent that they do not relate to capital guarantee. In your case you can claim a deduction of X% of the other break costs.

Non-resident withholding tax

As a general rule, interest and dividend income received by non-residents is subject to non-resident withholding tax. In this case, you have received a refund of interest which is a repayment of income. The repayment of income is not subject to withholding tax.