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Ruling

Subject: Cross border lease arrangement - Deduction for notional interest, deduction for decline in value and withholding tax

Issue 1

Will the Lessee be entitled to a a deduction pursuant to section 240-50 of the Income Tax Assessment Act 1997 (ITAA 1997) for the 'notional interest' calculated under Subdivision 240-E of the ITAA 1997?

Answer

Yes, the Lessee will be entitled to a deduction for the "notional interest' for an income year to the extent that the Lessee would, apart from Division 240 of the ITAA 1997, have been entitled to deduct arrangement payments for that income year if no part of those payments were capital in nature.

Issue 2

Will the Lessee be entitled to claim a deduction under section 40-25 of the ITAA 1997 for the decline in value of substantial equipment that is subject to the Lease between the Lessor and Lessee?
Answer

Yes.

Issue 3

Question 1

Will the Lessee have an obligation to withhold an amount from the interest component in respect to the lease rentals paid to the Lessor under section 12-245 of schedule 1 to the Taxation Administration Act 1953 (TAA 1953)?
Answer

No.

Question 2

Will the Lessee have an obligation to withhold an amount from the lease rentals paid to the Lessor under section 12-280 of schedule 1 to the TAA 1953?

Answer

No.

This ruling applies for the following periods:

Income year ending 30 June 2012 until completion of the lease arrangement

The scheme commences on:

Income year ending 30 June 2012

Relevant facts and circumstances

The transaction relates to the proposed Lease and financing arrangements for substantial equipment (the Transaction).

Pursuant to the Sale Agreement, the Lessor will acquire the substantial equipment from the Lessee. The Lessor will finance the acquisition of the substantial equipment through a combination of debt finance and equity. The majority of the funding will be obtained through a traditional loan from the Lenders, who are a syndicate of banks (Loan). Under the Loan, the Lessor has an effectively non-contingent obligation as defined in section 974-135 of the ITAA 1997 to repay the debt with interest that is not contingent on any event, condition or situation, other than the ability of willingness of the Lessor to meet the obligation.

The Lessor and Lessee will then enter into the Lease Agreement for the lease of the substantial equipment (Lease) for the Lease Term. The Lease Agreement is entered into on commercially agreed terms and negotiated on arm's length basis.

The Lease Agreement contains an option to purchase the substantial equipment before the end of the Lease Term. The Lessee intends to exercise the option to purchase the substantial equipment. It is the common practice of the Lessee to exercise the purchase options under similar arrangements.

During the term of the Lease, the Lessee is required to make rental payments in arrears to the Lessor.

The sum of the total rental payments and amounts payable on exercise of the option to purchase the equipment (Option Amount) exceed the purchase price of the substantial equipment. The residual value of the substantial equipment will be equal to the Option Amount.

During the term of the Lease, the Lessee will have exclusive possession of the substantial equipment. Title to the substantial equipment will remain with the Lessor until the option to purchase is exercised by the Lessee.

The Lessee will use the substantial equipment for the purpose of producing its assessable income.

The Lessee is a resident of Australia for income tax purposes.

There is and will not be any direct or indirect common ownership between the Lessor and Lessee. The Lessor, its associated companies or directors, does not have any control of or ability to sufficiently influence the Lessee, and vice versa.

The Lessor is a company incorporated under the laws of a foreign country (the Foreign Country) and is a wholly owned subsidiary of a non-resident company.

The Lessor is a resident of the Foreign Country for the purpose of the applicable tax treaty between Australia and the Foreign Country (the Convention) and its central management and control and voting power is exercised by non-residents who reside outside Australia.

The Lessor does not have a permanent establishment in Australia and it does not have a person acting on its behalf in Australia which has the authority to negotiate or conclude contracts on its behalf.

The Lessor carries on business in the Foreign Country and is liable to tax in the Foreign Country. The Lessor's business is limited to the Lease and other activities related to the Lease of the substantial equipment. The Lessor merely leases the substantial equipment and there is no active use of the substantial equipment.

For the purpose of the Interest Article of the Convention:

· the Lessor is a financial institution.

· the Lessor beneficially owns the rental payments.

· the Lessor is unrelated to and dealing wholly independently with the payer of the interest.

· the rental payments paid by the Lessee to the Lessor are not paid as part of an arrangement involving back-to-back loans.

The Lessor is a qualified person for the purpose of the Limitation of Benefits Article of the Convention.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 Division 240

Income Tax Assessment Act 1997 subsection 240-17(1)

Income Tax Assessment Act 1997 subsection 240-17(2)

Income Tax Assessment Act 1997 section 240-50

Income Tax Assessment Act 1997 subsection 240-50(1)

Income Tax Assessment Act 1997 section 240-55

Income Tax Assessment Act 1997 section 240-60

Income Tax Assessment Act 1997 section 240-65

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

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 Division 11A

Income Tax Assessment Act 1936 section 128AC

Income Tax Assessment Act 1936 paragraph 128B(2B)(b)

Income Tax Assessment Act 1936 subsection 128B(5A)

International Tax Agreements Act 1953 section 3AAA

International Tax Agreements Act 1953 section 3AAB

International Tax Agreements Act 1953 subsection 4(2)

Taxation Administration Act 1953 section 12-245 to schedule 1

Taxation Administration Act 1953 section 12-280 to schedule 1

Taxation Administration Act 1953 section 12-300 to schedule 1

Reasons for decision

Issue 1 Question 1

Division 240 of the ITAA 1997 applies to a hire purchase agreement (as defined in subsection 995-1(1) of the ITAA 1997) entered into after 27 February 1998. The broad scheme of the Division is to treat such hire purchase agreements as a sale of the relevant goods to the hirer (notional buyer) combined with a loan from the supplier (notional seller) to the notional buyer.

Among other things, the Division treats the notional buyer as the owner of the goods for certain purposes and treats as interest the payments made by the notional buyer (including amounts payable on termination of the arrangement) to the extent they exceed the notional loan principal.

On the facts, the Lease Agreement between the Lessor and Lessee is a hire purchase agreement (as defined in subsection 995-1(1) of the ITAA 1997) for the purposes of Division 240 of the ITAA 1997. Accordingly, the Lease will be treated as a notional sale of substantial equipment to the Lessee (notional buyer under subsection 240-17(2) of the ITAA 1997) with a notional loan from the Lessor (notional seller under subsection 240-17(1) of the ITAA 1997) to the Lessee.

Section 240-55 of the ITAA 1997 provides that a notional buyer cannot deduct arrangement payments (as defined in section 240-65 of the ITAA 1997) that the notional buyer makes under the arrangement, but those payments are taken into account in calculating notional interest that may be deducted under section 240-50 of the ITAA 1997.

Subsection 240-50(1) of the ITAA 1997 provides that a notional buyer is only entitled to deduct notional interest (as calculated under section 240-60 of the ITAA 1997) for an income year to the extent that the notional buyer would, apart from Division 240 of the ITAA 1997, have been entitled to deduct arrangement payments for that income year if no part of those payments were capital in nature.

Accordingly, the Lessee, as the notional buyer under the hire purchase agreement to which Division 240 of the ITAA 1997 applies, will be entitled to deduct 'notional interest', calculated as prescribed by section 240-60 of the ITAA 1997, for an income year to the extent that it would, apart from Division 240, have been entitled to deduct arrangement payments for that income year if no part of those payments were capital in nature.

Issue 2 Question 1

Section 40-25 of the ITAA 1997 provides a deduction for the decline in value of a depreciating asset a taxpayer holds to the extent the asset is used for a taxable purpose.

On the facts, the substantial equipment is a depreciating asset (as defined in section 40-30 of the ITAA 1997) and will be used for a taxable purpose.

The table in section 40-40 of the ITAA 1997 identifies the holder of a depreciating asset. The first nine items in the table apply to depreciating assets in different circumstances. Item 10 of the table in section 40-40 applies to any depreciating asset. As the specific items of the table apply in preference to the general item, item 10 applies as a default rule.

Item 10 of the table in section 40-40 provides that a taxpayer holds a depreciating asset if they are the owner of the asset, or the legal owner, if there is both a legal and equitable owner. However, there are other items in the table that identify a holder in various other circumstances even though they are not the asset's owner.

One of these circumstances is contained in Item 6 of the table in section 40-40 of ITAA 1997 (item 6). Broadly, item 6 applies where:

· a taxpayer has possession, or an immediate right to possession, of the asset combined with a right, the exercise of which would make it the holder (e.g. an option to acquire); and

· it is 'reasonable to expect' that the taxpayer will become the holder by exercising that right or that the asset will be disposed of at their direction and for their benefit.

Taxation Ruling TR 2005/20 sets out the Commissioner's view as to when a taxpayer who is taken to own goods under Division 240 of the ITAA 1997 will be taken to 'hold' a depreciating asset for the purpose of Division 40 of the ITAA 1997.

Based on the facts and in accordance with TR 2005/20, the Lessee will be the holder of the substantial equipment under either item 6 or item 10 of the table in section 40-40 of the ITAA 1997. Consequently, the Lessee can deduct an amount equal to the decline in value of the substantial equipment under section 40-25 of the ITAA 1997.

Issue 3 Question 1

Section 12-245 of schedule 1 to the TAA 1953 imposes an obligation to withhold tax on interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)) that an entity pays to a recipient who has an address outside Australia. However, section 12-300 of schedule 1 to the TAA 1953 provides that an entity is not required to withhold an amount if no withholding tax is payable in respect of the interest.

Under section 128AC of the ITAA 1936, interest withholding tax is payable on the interest component calculated according to the requirements of the section, paid by a resident to a non-resident entity pursuant to a 'relevant agreement' (which includes a hire-purchase agreement and certain leases).

In determining liability to Australian tax on income from Australian sources derived by a non-resident, it is necessary to also consider the applicable tax treaty or other agreement defined in section 3AAA or 3AAB of the International Tax Agreements Act 1953 (Agreements Act). Pursuant to subsection 4(2) of the Agreements Act, where inconsistency exists the provisions of the Agreements Act override the provisions contained in the ITAA 1936 and ITAA 1997 (other than Part IVA of the ITAA 1936).

Under the Interest Article of the Convention, Australia has a taxing right in respect of interest payments arising in Australia which the non-resident beneficially owns. However, such interest payments will not be taxed in Australia if the non-resident is:

· a financial institution as defined in the Article;

· unrelated to the interest payer; and

· dealing wholly independently with the payer of the interest,

· and the interest arising in Australia is:

· not paid as part of an arrangement involving 'back to back' loans; and

· is not effectively connected with a permanent establishment in Australia of the non-resident

In addition, the non-resident must satisfy the requirements of the Limitation of Benefits Article of the Convention to be entitled to treaty benefits conferred under the Interest Article of the Convention.

On the facts, the Lessor satisfies all of the above requirements. Therefore, the Lessor will not be liable to interest withholding tax in respect of the interest component of the rental payments. Accordingly, the Lessee will not be required to withhold an amount from the rental payments under section 12-245 of schedule 1 to TAA 1953 (pursuant to section 12-300 of schedule 1 to TAA 1953).

Issue 3 Question 2

Section 12-280 of schedule 1 to the TAA 1953 requires an entity to withhold an amount from a royalty it pays to a non-resident. However, no withholding is required from a royalty payment where no withholding tax is payable pursuant to Division 11A of the ITAA 1936 (section 12-300 of Schedule 1 to the TAA 1953).

Subsection 128B(5A) in Division 11A of the ITAA 1936 imposes a withholding tax liability on a non-resident who derives royalty income which is paid by a person who is a resident of Australia (paragraph 128B(2B)(b) of the ITAA 1936).

A 'royalty' is defined in subsection 6(1) of the ITAA 1936 to relevantly include any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for the use of, or right to use, any industrial, commercial or scientific equipment.

Taxation Ruling TR 98/21 sets out the Commissioner's view on the withholding tax issues that arise in cross border leasing arrangements in respect of payments made by an Australian resident to a non-resident lessor. Paragraph 7 of TR 98/21 states:

Where it is clear from the outset that the purchase or repurchase of the equipment is paramount, payments made under a cross border equipment leasing transaction are not subject to equipment royalty withholding tax under subsection 128B(5A) of the Act. …

On the facts and in accordance with TR 98/21, the Lessee is not required to withhold an amount from the rental payments payable by the Lessee to the Lessor under section 12-280 of schedule 1 to the TAA 1953 (pursuant to section 12-300 of schedule 1 to the TAA 1953).