Edited version of your written advice

Authorisation Number: 1012791140706

Ruling

Subject: Pay as you go withholding tax - Non-resident

Question 1

Are you required to deduct 10% withholding tax on interest accrued to LLC on a monthly basis?

Answer

Yes

Question 2

Are you required to pay such tax within 21 days from the month in which such interest is accrued?

Answer

Yes

Question 3

Is the interest deemed to have been paid or payable when the interest is accrued in your books?

Answer

Yes

Question 4

Should the additional payment you are required to make to LLC be considered in the nature of interest or a substitution of interest for the purpose of subsection 128A(1AB) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following periods

Year ended 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2013

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.

The scheme that is the subject of this ruling has been ascertained from:

• your private ruling application

• Convertible Note Deed Poll

You are an Australian resident company.

You have raised loan funds by issuing fully paid secured convertible notes to a limited liability company ( LLC), under a 'Deed of Agreement' executed in the 2013-14 financial year.

LLC is incorporated in a foreign country and is a foreign resident entity for Australian tax purposes.

Interest is applicable on the loan funds.

Under the Deed of Agreement, interest is accrued daily and compounded annually. Interest is payable on a note from and including the issue date of that note up to and including the date on which that note is converted or redeemed and the amount payable on redemption is paid.

Interest accrued to the conversion date is to be capitalised but unpaid at the conversion date, and interest is added to the face value (Principal Amount) of the convertible notes for the purpose of such conversion to D class (preference) shares.

If a withholding tax deduction is required by law in respect of a payment to a noteholder in respect of the notes, you shall pay an additional amount together with the payment so that after making any withholding tax, LLC receives an amount equal to the payment which would have been due if no withholding tax had been required.

The Additional Amount is expressed in the Deed of Agreement as an amount equal to the payment which would have been due if no tax deduction had been required.

If you are required to make a withholding tax deduction, you shall make that withholding tax deduction and any payment required in connection with that tax deduction within the time allowed and in the minimum amount required by law.

You shall deliver to the noteholder entitled to the payment, evidence satisfactory to that noteholder within 30 days of making any payment required in connection with that withholding tax deduction as per the Deed of Agreement. The noteholder must pay you the amount up to the tax credit to which it is entitled if it determines that the tax credit entitlement will leave it in the same tax position as it would have been had the additional payment had not been made by you.

The amount you withhold under the PAYG system is between $25,000 and $1 million per year.

Relevant legislative provisions

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

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1936 Subsection 128B(2)

Income Tax Assessment Act 1936 Subsection 128B(2A)

Income Tax Assessment Act 1936 Subsection 128C(1)

Taxation Administration Act 1953 Section 12-245 of Schedule 1

Taxation Administration Act 1953 Paragraph 12-300(a) of Schedule 1

Income Tax Assessment Act 1997 Section 26-25

Reasons for decision

Summary

In your case, under section 12-245 of Schedule 1 of the TAA, you are required to withhold tax on your non-resident interest obligations, even if those interest obligations are later forgiven. However, you are not required to withhold tax on the additional 'gross-up' amount equivalent to the tax withheld.

As a medium withholder, you must pay the withheld amounts to the Commissioner monthly. The rate of interest withholding tax payable on the interest is 10%, payable at the expiration of 21 days after the end of the month in which the interest was derived by LLC.

In addition, under section 26-25 of the ITAA 1997, you are required to withhold for your interest to be deductible.

Detailed reasoning

Obligation to withhold

Section 12-245 of Schedule 1 of the Taxation Administration Act 1953 (TAA 1953) imposes an obligation to withhold on entities that pay interest to an entity which provides a postal address outside Australia or if the interest is to be paid outside Australia.

However, paragraph 12-300(a) of Schedule 1 to the TAA 1953 provides that an entity is not required to withhold an amount from an interest payment if no withholding tax is payable in respect of the interest.

You will therefore be required to withhold an amount from any interest paid to the non-resident lender under the Convertible Note Deed Poll (Deed of Agreement) unless no withholding tax is payable in respect of those interest payments.

Interest withholding tax liability

Withholding tax liability is dealt with under section 128B of the ITAA 1936.

Subsection 128B(2) of the ITAA 1936 imposes a liability to interest withholding tax where the interest is derived by a non-resident that is either:

(i) paid to the non-resident by an Australian resident and is not an outgoing wholly incurred by the Australian resident in carrying on business in a country outside Australia at or through a permanent establishment of that person in that country; or

(ii) paid to the non-resident by a non-resident and is, or is in part, an outgoing incurred by that person or those persons in carrying on business in Australia at or through a permanent establishment of that person or those persons in Australia.

However, subsection 128B(2) of the 1936 provides an exemption to withholding tax where the interest is wholly incurred by the resident as an expense of carrying on a business overseas at or through a permanent establishment in that overseas country.

In the facts provided, you are not carrying on business outside of Australia through a permanent establishment. Therefore, the exemption (to withholding tax) in subsection 128B(2A) of the ITAA 1936 is not applicable to the interest payment from you to LLC.

Taxation Determination TD 93/146 explains a resident must deduct withholding tax from interest payable under a loan from a non-resident even if there is no actual payment of the interest.

Rate of Interest withholding tax

The general rate of interest withholding tax is 10% of the gross interest. However, if the interest is paid to a resident of a country with which Australia has a tax treaty stipulating a lesser tax rate on the interest, the withholding rate is that rate.

In your case, in accordance with the ITAA 1953 read together with Article 11 of the Convention between the Government of Australia and the Government of the overseas country for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income [1983] ATS 16 (DTA) the rate of interest withholding tax is 10%.

Payment and recovery of withholding tax

The method of notification and payment will vary depending on the size of the payer ('withholder').

A medium withholder, that is. an entity that withholds under the PAYG system between $25,000 and $1 million per year, must pay withheld amounts to the Commissioner monthly.

Subsection 128C(1) of the ITAA 1936 provides that withholding tax is due and payable at the expiration of 21 days after the end of the month in which the interest was derived by the person.

Additional 'gross up' amount

The Full Federal Court in FC of T v. Century Yuasa Batteries Pty Ltd (1998) 82 FCR 288; (1998) 38 ATR 442; 98 ATC 4380 (Century Yuasa) held that an amount is not in the nature of interest if it was not calculated by reference to a principal sum and that the 'gross-up amount' (that is, an additional payment to cover the withholding tax liability) was neither interest nor an amount in the nature of interest and was therefore not subject to withholding tax.

Similarly, in your case, the Deed of Agreement contains a 'gross-up' clause where in the event of withholding tax being applied LLC will be indemnified for the tax withheld, to ensure that LLC is not economically worse off and receives the full amount of interest payable.

In your case, the additional 'gross up' payment is not called or characterised as 'interest' under the terms of the Deed of Agreement and does not come within the extended meaning of interest for the purposes of subsection 128A(1AB) of the ITAA 1936 as it is not an amount that is calculated by reference to a principal sum and by reference to time.

Therefore, the additional 'gross up' payment payable to LLC by the foreign resident company is not subject to withholding tax under section 128B of the ITAA 1936.