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Ruling

Subject: Interest Withholding Tax Exemption under Tax Convention.

Question
Is FinCo entitled to the benefit of the exemption from Australian interest withholding tax under Article 11(3)(b) of the Convention between a foreign country (Country A) and Australia in respect of the discount or interest paid to FinCo on any Instruments issued by the Issuers?

Answer

Yes.

This ruling applies for the following periods:

§ Year ending 30 June 2011

§ Year ending 30 June 2012

§ Year ending 30 June 2013

§ Year ending 30 June 2014

The scheme commences on:
January 2011

Relevant facts and circumstances

FinCo

· FinCo is a corporation established under a foreign law and is domiciled in Country A. It is a resident of Country A for income tax purposes.

· FinCo is an authorised credit institution (bank) under the laws of Country A.

The Issuers

· The Issuers are special purpose companies incorporated in Australia for the purpose of issuing different series of secured Instruments.

· The Issuers issue secured Instruments and use the proceeds to invest in securitisation trusts (Trusts). The trustee of each Trust uses these proceeds to then acquire a portfolio of mortgage-backed notes.

· Each Issuer has a board of directors that are not employees of the FinCo group.

· Shares in each Issuer are held by a charitable trust with an independent trustee.

· There is no common ownership between, on the one hand, the Issuers and, on the other hand, FinCo. There is also no common ownership between, on the one hand, the originators of the securitisation program and the Issuers and, on the other hand, FinCo.

· The Issuers have not been, and are not included in the consolidated balance sheet of the FinCo group, as the Issuers are regarded as being independent of FinCo under applicable accounting standards.

Instruments Programme Information Memorandums

· The Issuers offered a series of debt instruments (Instruments) under an Information Memorandum.

· The Instruments may be issued at a discount or be interest bearing. The Instruments will be issued with a term of not more than a specified number of days.

· The Instruments are issued by competitive tender to dealers, unsolicited bids by the dealers, or by private placement.

· FinCo is one of several dealers on the dealer panel for each of the Issuers. Each of the dealers will purchase the Instruments on similar terms from the Issuers.

· FinCo's Instruments dealership is held by the FinCo X Branch in country X (FinCo X).

· As an Instruments dealer, FinCo X will subscribe for the Instruments and then on-sell the Instruments to investors. If the FinCo X branch is unable to on-sell all the Instruments to investors, FinCo X may hold the unsold Instruments and/or on-sell the Instruments to FinCo.

· FinCo and FinCo X will hold any Instruments which they purchase beneficially and for their own account, and will receive payments due to them in respect of the Instruments.

Investment Adviser and Administrative Agent to the Issuers

· A FinCo group company has been appointed by each Issuer to act as Investment Adviser and Administrative Agent.

· The Administrative Agent is responsible for providing regular reporting to, among others, the relevant Issuer, the dealers and the rating agencies.

· The Investment Adviser provides recommendations and advice to the Issuers with regard to investments, funding and operational functions of the Issuers. The Investment Adviser performs its services for the Issuers in accordance with the objectives defined in the Investment Advice Agreement (IAA).

· The Investment Adviser also manages the issuance of the Instruments and communicates with dealers to the Instruments programme. The issuance of the Instruments is made in accordance with the existing legal documentation and objectives of the Issuers and is made without providing a separate specific recommendation to the directors of the relevant Issuer.

· There will always be a meeting of the directors of the Issuer to consider any recommendation. The directors of each Issuer have sometimes requested amendments to documents provided to them by the Investment Adviser if they were not satisfied with the documents and have sometimes amended the minutes of the meetings of directors.

· The directors of each Issuer independently considers the investment and other operational recommendations put before it by the Investment Adviser and regularly ask questions before making any decision to implement the recommendation. To date, the directors of the Issuers have accepted the recommendations put to them by the Investment Adviser, although only after due consideration as to the merits of those recommendations by the directors. The recommendations made by the Investment Adviser are consistent with the defined and documented investment strategy of each Issuer.

· The IAA provides that subject to the earlier termination of the Agreement or of the appointment of a replacement Investment Adviser, the Investment Adviser's appointment continues until the assets of the Issuer have been repaid or liquidated. The Issuer may terminate the appointment of the Investment Adviser on (i)12 months' written notice in writing to the Investment Adviser or (ii) if the Investment Adviser fails to perform its obligations to the Issuer under the IAA and such failure continues for 10 business days.

Relevant legislative provisions

Convention Article 11

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

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1936 Section 128F(9)

International Tax Agreements Act 1953 Section 4

Reasons for decision

Withholding Tax

· Liability to non-resident withholding tax on interest and dividends is determined by Division 11A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

· Section 128B of the ITAA 1936 imposes withholding tax on dividends, interest and royalties generally derived by non-residents.

· In order to be subject to withholding tax, an amount must come within the definition of dividend, interest or royalty and it must not be exempt under subsection 128B(3) of the ITAA 1936.

Exemption from interest withholding tax

· Article 11(3) of the Convention provides an exemption from interest withholding tax when certain conditions are met.

· Subsection 4(1) of the International Tax Agreements Act 1953 (Agreements Act) provides that, subject to subsection 4(2) of the Agreements Act, the ITAA 1936 and the ITAA 1997 are incorporated and should be read as one with the Agreements Act. Subsection 4(2) provides that the double tax agreements prevail over the provisions of the domestic tax laws. Therefore, if international tax treaties provide a tax exemption in respect of dividends, interest and royalties, such an exemption will override Australia's domestic law.

· Article 11(3) of the Convention provides an exemption from interest withholding tax for interest derived by a financial institution that is beneficially entitled to, or beneficially owns the interest and is unrelated to and dealing wholly independently with the payer.

· However, Article 11(4) of the Convention provides that the exemption does not apply where the interest is paid as a result of an arrangement involving back-to-back loans and Article 11(6) of the Convention provides the exemption does not apply if the interest is effectively connected with a permanent establishment in Australia.

Are the conditions for the Convention exemption from interest withholding tax met?

1 The issues which are to be considered in this case are as follows.

a. Are the payments made to FinCo by the Issuers under the Instruments classed as interest for the purposes of interest withholding tax exemption under Article 11 of the Convention and Division 11A of the ITAA 1936?

b. Is FinCo considered to be a financial institution for the purposes of the Convention?

c. Are the parties to the transaction, being the Issuers and FinCo, unrelated and dealing wholly independently with the payer?

d. Is the arrangement part of an arrangement involving back-to-back loans?

e. Is the beneficial owner of the interest carrying on a business in Australia through a permanent establishment and is the interest derived through its permanent establishment and the indebtedness in respect of which the interest is paid effectively connected with that permanent establishment?

Interest Withholding Tax

A. Interest

2 Article 11(3)(b) of the Convention provides an exemption from source country tax for interest derived by a financial institution which is unrelated to, and dealing wholly independently with, the payer.

3 Interest is defined in subsection 128A(1AB) of the ITAA 1936, and includes amounts 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 the substitution of interest but does not include an amount to the extent to which it is a return on an equity interest in a company.

4 The returns on the Instruments paid by the Issuers to the Dealers will be treated as interest derived by a non-resident that consists of interest to which section 128B of the ITAA 1936 may apply. Therefore the returns on the Instruments are to be treated as interest under Article 11 of the Convention.

B. Financial Institution

5 In order to qualify for interest withholding tax exemption the interest in question has to be derived by a financial institution.

6 The term financial institution is taken to mean a bank or other enterprise substantially deriving its profits by raising debt finance in financial markets or by taking deposits at interest and using those funds in carrying on a business of providing finance.

7 For an Australian entity in order to qualify to be a bank the entity must be a body corporate that is an Authorised Deposit-taking Institution for the purposes of the Banking Act 1959: refer to section 128A(1) of the ITA 1936.

8 For a United Kingdom (UK) or United States (US) entity, Taxation Ruling TR 2005/5 (TR 2005/5) provides that the term 'bank' applies to a UK or US resident which is authorised to carry on a business of banking in their country of residency. In order to qualify as a bank, the UK or US resident must satisfy the regulatory conditions stipulated by their relevant jurisdictional authority and, in addition, satisfy any higher level capital adequacy standards that would distinguish it from other financial institutions. Based on the explanatory memorandum that accompanied the introduction of the Convention into Australian law, , similar views as expressed in TR 2005/5 will apply to the Convention for financial institutions which are residents of Country A.

9 As stated in the facts, FinCo is an authorized credit institution (bank) under the laws of Country A.

10 Therefore, FinCo satisfies the condition under article 11(3)(b) of the Convention, by reason of FinCo being authorised and regulated as a bank.

C. Unrelated to and dealing wholly independently with the payer

Unrelated

11 The term `unrelated' is not defined in the Convention.

12 TR 2005/5 sets out the guidelines on ascertaining the right to tax US and UK resident financial institutions under the US and the UK Taxation Conventions in respect of interest income arising in Australia. Based on the explanatory memorandum that accompanied the introduction of the Convention into Australian law, similar views will apply to the Convention.

13 The meaning of the term 'unrelated' is discussed in paragraph 30 of TR 2005/5 as follows:

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'

14 Furthermore, paragraphs 109 and 110 of TR 2005/5 detail that the intention of the Article is to align the treatment of interest paid to the foreign country financial institutions with the domestic interest withholding tax exemption currently available under section 128F of the ITAA 1936. Exemption from withholding tax under section 128F is disallowed where interest is paid to associates.

15 Paragraph 112 of TR 2005/5 concludes that the term 'unrelated', in Article 11(3)(b) of both the US and UK Taxation Conventions, is contextually similar to a non-associate relationship, where the relationship is not capable of affecting the dealings between the financial institution and the payer. According to the Ruling, the Commissioner considers that a financial institution will be unrelated to the payer where, in considering the level of participation in the ownership or control of either party, it can be concluded that neither party is able to exert sufficient influence over the other party.

16 The term 'sufficiently influenced' in the context of a company is defined in paragraph 318(6)(b) of the ITAA 1936 as follows:

a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts);

17 In the present case, if there is sufficient influence between the Issuers and FinCo such that FinCo is able to sufficiently influence the actions of the Issuer, it will be considered that the parties are not unrelated to each other.

The Investment Adviser

· The Investment Adviser to the Issuers is a member of the FinCo group. Members of the FinCo group are also dealers in the Instruments.

i) Relationship between Investment Adviser and Issuer

· The role of the Investment Adviser is to provide recommendations to the Issuer as set out in the IAA.

· The Issuer appoints the Investment Adviser to work in that role. The activities of the Investment Adviser are subject to the policies directions and control of the Issuer.

· The Issuer has appointed the Investment Adviser to act in the role of adviser. Although it has a role in providing recommendations to the Issuer, the Investment Adviser remains subject to the policies and directions of the Issuer.

· The directors of the Issuers are independent of the Investment Adviser, and none of the directors of the Issuer have ever been employees of the FinCo group. Should the Investment Adviser fail in its obligations, and this failure has a material effect, the directors have the power to terminate the Investment Adviser, provided that a successor is appointed by the Issuer and is approved by any holders of subordinated notes outstanding in the Issuer.

· The Investment Adviser is obliged to carry out its role in relation to the Issuer in a manner consistent with the objectives of the Issuer.

· The Issuer has a history of following the recommendations provided to it by its Investment Adviser.

· According to the submissions made in the ruling application, the directors give due consideration to the recommendations provided to them by the Investment Adviser. This is reflected in the minutes of board meetings..

· The directors of each Issuer have sometimes requested amendments to documents provided to them by the Investment Adviser if they were not satisfied with the documents and have sometimes amended the minutes of the meetings of directors.

· It is considered that the activities of the Investment Adviser are subject to the policies, directions and control of the Issuer and that within the wider context of the Arrangement, the relationship between the Issuer and FinCo is not in itself an indicator of sufficient influence being exerted by FinCo on the Issuers or that FinCo is related to the Issuers.

ii) Termination Clause

· Broadly, the Issuer may terminate the appointment of the of the Investment Adviser on 12 months notice in writing to the Investment Adviser or if the Investment Adviser fails to perform its obligations to the Company and such failure continues for 10 business days.

· In the context of the arrangement, this, of itself, is not considered to be evidence of FinCo having sufficient influence over the Issuers, or being related to the Issuers.

iii) Change in Investment Adviser

· The previous change of Investment Advisers from one member of the FinCo group to another is not considered to be an indicator of sufficient influence being exerted by FinCo over the Issuers, or to be evidence, of itself, that FinCo is related to the Issuers.

Conclusion - Unrelated to

· The Commissioner has considered the facts and circumstances of this arrangement to determine whether or not FinCo exerts sufficient influence over the Issuer which would indicate a control based relationship between FinCo and the Issuer such that the Issuer, through obligation or custom, has its affairs directed by FinCo. The Commissioner considers the payer and recipient of the interest to be unrelated to each other under Article 11 of the Convention.

Dealing wholly independently with the payer

· The term 'dealing wholly independently with the payer' is not defined in the Convention. TR 2005/5 states at paragraph 117:

· In determining whether a transaction has taken place on normal, open market commercial terms, an arm's length test is applied. The Commissioner is of the view that for the purposes of Article 11 it is also necessary to examine whether the Australian payer and the financial institution operate on an arm's length basis.

· In examining whether or not the payer and the financial institution are dealing with each other on an arm's length basis for the purposes of Article 11 of the Convention, TR 2005/5 provides at paragraph 119 that:

· The Commissioner is of the view that Taxation Ruling TR 2002/2, in particular paragraphs 4, 23 and 24, may be relied upon to determine whether parties are acting independently with each other for the purposes of Article 11.

· Taxation Ruling TR 2002/2 deals with the meaning of arm's length for the purposes of the dividend deeming provisions contained within subsection 47A(7) of the ITAA 1936. However, it also provides guidance on the meaning of dealing with each other at arm's length, especially paragraphs 4, 23 and 24.

· Paragraphs 4, 23 and 24 of TR 2002/2 provide:

4. Whether a loan satisfies the arm's length test will ultimately be determined by reference to the facts of each particular case and the outcome that might have been expected to arise between independent parties in comparable circumstances...

23. Section 47A is silent as to the criteria for determining if parties are at arm's length in relation to a loan for the purposes of paragraph 47A(7)(a). Whether parties are at arm's length in relation to a loan is a question of fact...

24. The Explanatory Memorandum relating to the Taxation Laws Amendment (Foreign Income) Act 1990, in referring to section 47A states:

· Whether the parties to a loan are at arm's length in relation to the loan is to be determined having regard to factors such as the amount of the loan, the rate of interest payable, the security for the loan, and the capacity of the borrower to repay the loan. A loan will be an arm's length loan where, having regard to these factors, the terms and conditions of the loan are those that would have been agreed between independent third parties acting at arm's length.

· In this case, the arm's length test refers to the dealings between the Issuers and FinCo with respect to the Instruments and whether the parties dealt with the Instruments on an arm's length basis. Whether or not the Issuers and FinCo are dealing with each other at arm's length is a question of fact to be determined by examining the way the parties have dealt with each other, the terms of the Instruments, the amount of interest payable on the Instruments and examining whether the terms differ to terms and amounts of interest that would be payable if the Instruments had been negotiated in similar circumstances by two independent parties.

· The Issuers and FinCo are separate and independent entities with no common ownership between the Issuers, on one hand, and FinCo, on the other hand. The directors of the Issuers have never been employees of the FinCo group and have the power to manage and direct the affairs of the Issuers. Whilst, as stated above, the FinCo group has a history of providing recommendations which have been followed by the directors of the Issuers, this, of itself, is not an indicator that FinCo is not dealing wholly independently of the Issuers. Instead, a wider view of the facts and circumstances of this arrangement must be considered.

· The Instruments are issued by competitive tender to dealers, unsolicited bids by the dealers, or by private placement. Each of the dealers will purchase the Instruments from the Issuers on similar terms as each other. Apart from FinCo X, the dealers are all independent of each other and of FinCo. Therefore, it is expected that the terms of the Instruments between the non FinCo Dealers and the Issuers will be on an arm's length basis. If FinCo receives the Instruments on similar terms as the other dealers, then it would receive the Instruments on terms which are at arm's length.

· The Commissioner is advised that the amount of discount and interest are commercially appropriate under the terms of the Instruments.

· Given the fact that the Instruments are held by several independent dealers and FinCo on similar terms, and the fact that the amount of the discount and interest are commercially appropriate, the Commissioner considers that the dealings between the Issuers and FinCo with respect to the Instruments are done at arm's length, and the payer of the interest (the Issuer) is dealing wholly independently with the recipient of the interest (FinCo).

D. Back to Back Loans

· Article 11(4) of the Convention states that interest may be taxed in the State it arises in, to a level not exceeding 10%, if it is paid as part of an arrangement involving back-to-back loans.

· Paragraph 127 of TR 2005/5 states:

· The aim of this provision is to prevent related party and other debt being structured through a financial institution to gain access to the withholding tax exemption. Due to the range of arrangements which may arise, it will be necessary to determine whether 'back to back' loans exist on a case by case basis.

· In this case, the Commissioner is advised that the Instruments will not be paid by the Issuers under a back-to-back loan or other arrangement that is economically equivalent pursuant to Article 11(4) of the Convention.

E. Is the interest derived by an Australian Permanent Establishment?

· The Commissioner is advised that the interest derived under the Instruments is not derived nor effectively connected to an Australian permanent establishment of FinCo.

Conclusion

· On the facts provided, FinCo, and the Issuers are considered to meet the criteria for interest income withholding tax exemption under of Article 11(3)(b) of the Convention due to the fact that the interest is derived by FinCo, a financial institution, which is unrelated to and dealing wholly independently with the payer of the interest (being the Issuers). The arrangement is not part of an arrangement which would be considered to be back-to back- loans, or have a similar economic effect as back-to-back loans.

· As a result, FinCo will be entitled to the benefit of the exemption from Australian interest withholding tax under Article 11(3)(b) of the Convention in respect of the discount or interest paid to FinCo on any Instruments issued to it by the Issuers.