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Ruling

Subject: Interest deductions

Question 1

Are you required to withhold a portion of the interest payments you make to the bank in Country A?

Answer

Yes.

Question 2

Are you entitled to a deduction for the expenses you incur paying the interest component of the mortgage you have on your rental property in Country A?

Answer

Yes, provided you comply with the withholding requirements.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on:

1 July 2010

Relevant facts and circumstances

You entered Australia on a permanent visa.

You own a rental property in Country A and receive rental income from this property.

You have a mortgage on the property with a bank in Country A to which you make interest payments to.

Australia does not have a tax treaty with Country A.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1,

Income Tax Assessment Act 1997 Section 26-25,

Income Tax Assessment Act 1997 Section 960-100,

Taxation Administration Act 1953 Schedule 1 - Section 12-245,

Taxation Administration Act 1953 Schedule 1 - Section 16-70,

Taxation Administration Act 1953 Schedule 1 - Section 16-140,

Taxation Administration Act 1953 Schedule 1 - Section 16-153 and

Taxation Administration Regulations 1976 Regulation 41.

Reasons for decision

Question 1

Summary

You are required to withhold a portion of the interest payment because you are paying it to an entity outside of Australia.

Detailed reasoning

Section 12-245 of Schedule 1 of the Taxation Administration Act 1953 (TAA) provides that an entity must withhold an amount from interest that it pays to another entity if the recipient has an address outside Australia. The rate of tax on interest income, as specified in Regulation 41 of the Taxation Administration Regulations 1976, is 10%.

According to section 960-100 of the Income Tax Assessment Act 1997 (ITAA 1997), entity means any of the following:

§ an individual

§ a body corporate

§ a body politic

§ a partnership

§ any other unincorporated association or body of persons

§ a trust

§ a superannuation fund

As you are making a payment to a non-resident entity overseas you are required to:

§ withhold tax from interest paid to non-residents,

§ remit the withheld amounts to the ATO (section 16-70 of the TAA), and

§ lodge a PAYG withholding from interest, dividend and royalty payments paid to non residents annual report (NAT 7187) (section 16-153 of the TAA).

Note

The 10% non-resident withholding tax is not a tax on your income; rather it is a tax payable on the interest income earned by a non-resident (in this case, the overseas bank) from sources in Australia. However, you as the payer are required to deduct the 10% non-resident withholding tax from the interest payment you make to the non-resident and remit the amount deducted to the Tax Office. For example, if you incur an interest expense of $1,000 in relation to your overseas rental property, you would be required to deduct and remit $100 to the Tax Office, leaving $900 to be paid to the overseas bank. You may wish to contact your overseas bank to discuss this matter with them.

Under section 16-140 of the TAA, you must be registered for PAYG withholding before you withhold tax from interest, dividend or royalty payments to non-residents. If you are not already registered, you can register: 

§ at the same time as you apply for an Australian business number (ABN), using the same form

§ by phoning 13 28 66 between 8am and 6pm Monday to Friday (you will need to have your ABN or tax file number to register over the phone), or

§ by completing an Add a new business account form. 

If you need help to register, phone 13 28 66 between 8am and 6pm Monday to Friday. 

Enclosed is the fact sheet: PAYG withholding from interest, dividends and royalties to non-residents

Question 2

Summary

Provided that you comply with the withholding requirements, you are entitled to a deduction for the interest expenses incurred.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction for losses or outgoings to the extent to which they are incurred in gaining or producing assessable income. However, you cannot deduct a loss or outgoing to the extent that the losses or outgoings are of a capital, private or domestic nature or another provision of the Act prevents you from deducting it.

Interest on borrowed money may be deductible where the money is used to acquire an income producing asset, such as a rental property. On the other hand, a repayment of the money borrowed (that is, a repayment of the principal amount borrowed) is not deductible under section 8-1 because it is capital in nature.

As the rental income from your property in Country A is assessable income in Australia, the interest expenses you incur are allowable deductions under Australian income tax law.

However, section 26-25 of the ITAA 1997 specifies that interest is not deductible if the withholding tax requirements have not been met. Therefore, if you comply with the withholding requirements, the interest expense that you incur is deductible under section 8-1 of the ITAA 1997, as the interest expense has been incurred in producing your assessable income.