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Ruling

Subject: Interest Withholding Tax Exemption under the relevant Convention.

Question 1

Is FinCo entitled to the benefit of the exemption from Australian interest withholding tax under Article 11(3)(b) of the Convention in respect of interest paid on advances under Liquidity Facility Agreements made available by FinCo, as Liquidity Facility Provider, to the Trustee?

Answer Yes.

Question 2

Is FinCo entitled to the benefit of the exemption from Australian interest withholding tax under Article 11(3)(b) of the Convention in respect of any interest paid on advances under the Letters of Credit?

Answer Yes.

This ruling applies for the following periods:

§ Year ended 30 June 2011

§ Year ended 30 June 2012

§ Year ended 30 June 2013

§ Year ended 30 June 2014

The scheme commences on: January 2003

FinCo

1 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.

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

The Trusts

1 Some trusts have been established in Australia as securitisation trusts (together the Trusts).

2 Trustee Limited (referred to as the Trustee when acting as the trustee of the relevant Trusts) is the trustee of each of the Trusts. The Trustee is an Australian resident that carries out its relevant trustee activities in Australia. Trustee Limited is a member of the Trustee Group.

3 Each Trust has acquired a portfolio of mortgage-backed notes funded through the issuance of debt instruments by the respective conduit (the Issuers).

4 The investor units in the Trusts are legally and beneficially held by the respective Issuer.

5 The capital unit in each Trust is held by a company that is not related to FinCo.

6 There is no common ownership between, on the one hand, the Trustee and the Issuers and, on the other hand, FinCo.

Liquidity Facility Agreements

7 FinCo has entered into some Liquidity Facility Agreements (Agreements), as the Liquidity Facility Provider, with the Trustee.

8 Under the Agreements, FinCo has provided the Trustee with a facility under which loans were made available to the Trustee in relation to securities held by the Trustee.

9 The interest rate on any draw downs under the Agreements, and the other terms of the Agreements, are considered to be commercially appropriate.

Letters of Credit

10 FinCo has also issued two letters of credit (the Letters of Credit) in favour of the Trustee.

11 The Trustee is obligated to pay back any draw downs made under the Letters of Credit.

12 The terms of the Letters of Credit are commercially appropriate.

Payments under the Agreements and Letters of Credit

13 FinCo holds the loans it provides to the Trusts pursuant to the Agreements beneficially and receives interest payments under the Agreements beneficially and for its own account. Similarly, FinCo has issued Letters of Credit on its own account and is beneficially receiving payments due to it in respect of the Letters of Credit. This interest is not received through a permanent establishment in Australia.

Investment Adviser to the Trustee

14 A FinCo company has been appointed by the Trustee to act as Investment Adviser and Administrative Agent in relation to the Trusts.

15 The Investment Adviser is responsible for preparing recommendations to be submitted to the Trustee. The Investment Adviser has no general authority to bind the Trustee or the Trusts; rather it only makes recommendations for the Trustee to consider.

16 Although the Trustee places reliance on the commercial judgement of the Investment Adviser, any recommendation must be consistent with the relevant documentation for the particular Trust as determined by the Trustee.

17 To date, the Trustee has accepted the recommendations put to it by the Investment Adviser, although only after due consideration as to the merits of those recommendations by the Trustee.

18 Under the Investment Advisory Agreement (the IAA), the Trustee may terminate the appointment of the Investment Adviser on (i) 6 months written notice in writing to the Investment Adviser, or (ii) if the Investment Adviser fails to perform its obligations to the Issuer and such failure continues for 10 business days.

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

20 The Issuers each have boards of directors that are independent of FinCo, and of the Trustee. The directors are not employees of FinCo or the FinCo group. A FinCo group company has been appointed as Investment Adviser and Administrative Agent to each of the Issuers.

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

1 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).

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

3 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

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

5 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 Income Tax Assessment Act 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.

6 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.

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

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

8 The issues which are to be considered in this case are as follows:

a. Are the payments made to FinCo by the Trustee under the Agreements and Letters of Credit classed as interest for the purposes of interest withholding tax exemption under Article 11 of the Convention and Division 11 A 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 Trustee 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

9 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.

10 Article 11(5) of the Convention relevantly states:

The term "interest" in this Article includes ...interest from any other form of indebtedness, as well as income which is subjected to the same taxation treatment as income from money lent by the law of the Contracting State in which the income arises...

11 Interest is defined in subsection 128A(1AB) of the ITAA 1936, and it 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.

Liquidity Facility Agreements

12 The Agreements state the payments made by the Trustee with respect to repayments of amounts outstanding under the Agreements are referred to as interest; the interest accrues over the interest period and is related to an interest rate. This interest is paid on a principal sum lent to the Trustee under the Agreements. As per the Agreements, the payments of interest under the Agreements are considered to be interest within the general law meaning of the word and therefore interest under the Convention.

Letters of Credit

13 The Letters of Credit are considered to be a form of credit support under the Trust Deed. The draw downs of the Letters of Credit place an interest payment obligation on the Trustee, out of the available funds in the Trust. The Trustee is obliged to repay this obligation in line with the relevant Trust Deed. Therefore, any interest payments made with respect to the draw downs made according to the Trust Deed would be considered interest under Article 11 of the Convention.

b) Financial Institution

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

15 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.

16 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.

17 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.

18 As stated in the facts, FinCo is an authorised credit institution under the laws of Country A.

19 Therefore, FinCo satisfies the condition under article 11(3)(b) of the Convention, by reason that FinCo is authorised and regulated as a financial institution.

c) Unrelated to and dealing wholly independently with the payer

Unrelated

20 The term 'unrelated' is not defined in the Convention.

21 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. As stated above, the views stated in TR 2005/5 similarly apply to the Convention.

22 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'

23 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 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.

24 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.

25 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);

26 In the present case, if there is sufficient influence between FinCo and the Trustees, it will be considered that the parties are not unrelated to each other.

The Investment Adviser

27 The Investment Adviser is a member of the FinCo group. FinCo also provides credit support to the Trustee, via the Agreements and Letters of Credit issued.

i) Relationship between Investment Adviser and the Trustee

28 The Trustee is independent of the Investment Adviser. The Trustee is Trustee Limited, which a member of the Trustee Group. Prima facie, FinCo and Trustee Limited would be considered to be genuinely independent of each other. However, consideration must be given to the parties' relationship with each other with respect to this arrangement.

29 The role of the Investment Adviser is to provide recommendations to the Issuer as set out in the IAA. Under the IAA, the Trustee appoints the Investment Adviser and the Investment Adviser is subject to the overall policies directions and control of the Trustee.

30 Should the Investment Adviser fail in its obligations and this failure has an adverse material effect, the Trustee has the power to terminate the Investment Adviser, provided that a successor is appointed by the Trustee and is approved by any holders of subordinated notes outstanding in the Issuer (see Termination Clause below).

31 Related to this is the history of the Trustee following the recommendations provided to it by its Investment Adviser. The Trustee has a history of following each of the recommendations put to it by the Investment Adviser.

32 According to the submissions made in the ruling application, the Trustee gives due consideration to the recommendations provided to it by the Investment Adviser and will only follow the recommendation is consistent with the relevant documentation for the particular Trust.

33 It is considered within the facts provided, and in the wider context of the arrangement, that the relationship between the Trustee and FinCo is not in itself an indicator of sufficient influence being exerted by FinCo on the Trustee or that FinCo and the Trustee are related to each other.

ii) Termination Clause

34 Broadly, the Trustee may terminate the appointment of the of the Investment Adviser on 6 months notice in writing to the Investment Adviser or if the Investment Adviser fails to perform its obligations to the Trustee under the IAA and such failure continues for 10 business days.

35 The Commissioner does not consider the conditions of the termination and retirement of the Investment Adviser of itself and within the larger context of the arrangement, to be an indicator of sufficient influence being exerted by FinCo on the Trustee or that FinCo is related to the Trustee.

iii) Change in Investment Adviser

36 The previous change of Investment Adviser 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.

Conclusion - Unrelated to

37 The Commissioner does not consider there to be sufficient influence by FinCo over the Trustee for the purpose of the 'associate test' under section 318 and subsection 128F(9) of the ITAA 1936. Therefore, the Commissioner considers the payer and recipient of the interest to be unrelated to each other under the Convention.

Dealing wholly independently with the payer

38 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.

39 In examining whether or not the payer of the interest 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.

40 Taxation Ruling TR 2002/2 (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.

41 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

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

43 FinCo and Trustee are separate and independent entities with no common ownership between FinCo on one hand, and the Trustee on the other hand. Prima facie, the Trustee, Trustee Limited, and FinCo would be dealing with each other on an arm's length basis.

44 The Commissioner is advised that the terms and rates of interest on any draw downs made under the Agreements and Letters of Credit are commercially appropriate.

45 Given the fact that the Trustee and FinCo are independent entities and the rates of interest payable under the Agreements and Letters of Credit are commercially appropriate, the Commissioner considers that the dealings between the Trustee and FinCo with respect to the Agreements and Letters of Credit are done at arm's length, and the payer of the interest, being the Trustee, is dealing wholly independently with the recipient of the interest, being FinCo.

Back to Back Loans

46 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.

47 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.

48 In this case, the Commissioner is advised that the funding for any draw downs under the Agreements and Letters of Credit are not sourced from a back-to-back loan or other arrangement that is economically equivalent pursuant to Article 11(4) of the Convention.

Is the interest derived by an Australian Permanent Establishment?

49 The Commissioner is advised that the interest derived by FinCo under the Agreements and Letters of Credit is not derived nor is effectively connected to an Australian permanent establishment.

Conclusion

50 On the facts provided, FinCo and the Trustee 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 Trustee. 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 and is not derived by an Australian permanent establishment of FinCo.

51 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 interest repayments made to it with respect to draw downs made on the Agreements and Letters of Credit by the Trustee.