Edited version of your written advice

Authorisation Number: 1051435392112

Date of advice: 15 April 2019

Ruling

Subject: Withholding tax - PAYG

Question 1

Is Australian Branch required to withhold an amount under subdivision 12-F of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) from interest that accrues on funds deposited in a ‘Client Segregated Account’ that is then on-paid to the client by Australian Branch?

Answer

No

Question 2

Is Australian Branch required to withhold an amount pursuant to subdivision 12-F of Schedule 1 to the TAA 1953 from interest that it receives in a ‘Client Segregated Account’ from an ‘Offshore Permissible Investment’ that is then paid to the client by Australian Branch?

Answer

No

Relevant facts and circumstances

Foreign Company – Business and Australian Branch

1. Foreign Company is resident in Foreign Country and is not a resident of Australia.

2. It carries on an investment business in Australia through a permanent establishment (Australian Branch) in Australia.

Steps of Transaction

3. A client that wishes to transact on an offshore exchange transfers a margin into a ‘Client Segregated Account’ in the name of Foreign Company.

4. These Client Segregated Accounts are offshore interest-bearing accounts with third-party banks. The third-party banks are foreign residents that do not hold amounts deposited in carrying on a business in Australia at or through an Australian permanent establishment. The particular account into which funds are transferred is dictated by the geographic location of the offshore exchange and the currencies involved.

5. Australian Branch does not have participation rights with any offshore exchange. To enable it to discharge its obligations to clients, Australian Branch contracts with non-resident affiliates or non-resident third party brokers which have full participation rights for the particular offshore exchange. The client does not contract with the affiliate or broker.

6. To effect a transaction, Australian Branch places the amount from the client in each Client Segregated Account with the affiliate or third-party broker which may choose to invest the funds on a particular offshore exchange or other offshore investment. The amount transferred may include other client funds.

7. The affiliates and third-party brokers that Foreign Company transacts with are foreign residents that do not carry on business at or through an Australian permanent establishment.

8. An investment return is paid by the offshore exchange or other offshore investment.

9. The affiliate or third-party broker pays the interest into the Client Segregated Account at the direction of Foreign Company

10. All relevant funds paid into or otherwise credited to the Client Segregated Account are taken to be held in trust by Foreign Company for the benefit of the client pursuant to section 981H of the Corporations Act 2001. This includes interest accruing in the Client Segregated Account and interest paid into the account by affiliates and third-party brokers.

11. The clients are paid from the Client Segregated Account.

12. Owing to the intermingling of client money in the client segregated accounts and the affiliate and third-party broker accounts, Foreign Company maintains systems which it uses to keep track of the amounts held for each client, including interest. Amounts due to a client are credited and distributed to the client less an administration fee.

Scope of Ruling

13. This ruling only applies where:

a) a non-resident client, who does not carry on business in Australia at or through a permanent establishment in Australia, enters into a client agreement with Australian Branch for the purposes of trading in the offshore exchange; and

b) Either:

a. ‘Interest’ (within the meaning under Part III, Division 11A of the ITAA 1936) accrues on money or property which has been placed in a segregated account in Foreign Company’s name (Client Segregated Account); or

b. Australian Branch receives ‘interest’ (within the meaning under Part III, Division 11A of the ITAA 1936) on money or property which has been placed in a Client Segregated Account and invested in ‘Offshore Permissible Investments’. ‘Offshore Permissible Investments’ are certain investments, permitted by the client agreement, offered by non-resident entities otherwise than in carrying on a business in Australia at or through a permanent establishment in Australia.

On-payment of interest

14. Under the client agreement:

a. Australian Branch must segregate all money and property deposited by the client or on behalf of the client. The client is entitled to – and Australian Branch is irrevocably bound to pass onto the client – interest earned on the money or property which has been segregated and invested. For the avoidance of doubt, no deductions, other than an administrative charge, can be made by Australian Branch in respect of that interest;

b. Australian Branch has the discretion to invest monies held as per above in Permissible Investments and if such investment is made, the client is entitled to any earnings on the Permissible Investments unless otherwise notified by Australian Branch. Australian Branch has absolute discretion to realise any Permissible Investment to meet any amounts, fees or charges owing to Australian Branch under the client agreement. If Australian Branch is to pay a client any earnings on Permissible Investments, it may deduct monies properly due and owing to it, including, without limitation, debit balances, charges, commissions, fees, Margins or any other obligations, together with any applicable interest.

15. Interest is generated with respect to the funds as follows:

a. From the Foreign Company bank accounts;

b. From the third-party brokers; and

c. From each offshore exchange.

Relevant legislative provisions

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

Income Tax Assessment Act 1936 Division 11A of Part III

Income Tax Assessment Act 1936 section 128A

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1936 subsection 128B(2)

Income Tax Assessment Act 1936 section 128AE

Income Tax Assessment Act 1936 section 128GB

Tax Administration Act 1953 subdivision 12-F to Schedule 1

Tax Administration Act 1953 section 12-245 to Schedule 1

Tax Administration Act 1953 section 12-250 to Schedule 1

Tax Administration Act 1953 section 12-300 to Schedule 1

Reasons for decision

Legislative references in this Ruling are to provisions of the ITAA 1936, or to provisions of the (Income Tax Assessment Act 1997) ITAA 1997 unless otherwise indicated.

Question 1

Summary

Interest withholding tax under section 128B does not apply to the interest accrued in the Client Segregated Account that is then on-paid to the client. Accordingly, Australian Branch is not required to withhold an amount under Subdivision 12-F of Schedule 1 to the TAA 1953 from the interest.

Detailed reasoning

An entity is not required to withhold an amount from interest under Subdivision 12-F of Schedule 1 to the TAA 1953 if no withholding tax is payable in respect of the interest. In particular, section 12-300 of Schedule 1 to the TAA 1953 says:

This Subdivision does not require an entity:

(a) to withhold an amount …, from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936) … if no *withholding tax is payable in respect of the …, interest, …; or

(b) …

Section 128B of the ITAA 1936 deals with withholding tax liability. A person who derives income to which section 128B applies that consists of interest is prima facie liable to pay income tax upon that income at the rate declared by the Parliament.

Relevantly, subsection 128B(2) provides:

Subject to subsection (3), this section also applies to income that:

(a) is derived, on or after 1 January 1968, by a non-resident; and

(b) consists of interest that:

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

(ii) is paid to the non-resident by a person who, or by persons each of whom, is not a 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.

Is income that consists of interest derived by a non-resident?

A requirement of subsection 128B(2) is that the non-resident derives income that consists of interest.

There is no exhaustive definition of ‘interest’ in the ITAA 1936, and therefore ‘interest’ takes its ordinary meaning.

In Riches v Westminster Bank Limited [1947] AC 390; [1947] 1 All ER 469, Lord Wright stated:

the essence of interest is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had had the use of the money, or conversely the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation. From that point of view it would seem immaterial whether the money was due to him under a contract express or implied or a statute or whether the money was due for any other reason in law.

Interest has also been described as 'payment by time for the use of money' (Rowlatt J in Bennett v Ogston (1930) 15 TC 374 at 379).

In addition to the ordinary meaning of ‘interest,’ subsection 128A(1AB) extends the meaning of ‘interest’ for the purposes of Division 11A of Part III (the withholding tax provisions) so as to ‘include’ an amount:

(a) that is in the nature of interest; or

(b) to the extent that it could reasonably be regarded as having been converted into a form that is in substitution for interest; or

(c) to the extent that it could reasonably be regarded as having been received in exchange for interest in connection with a washing arrangement; or

(d) that is a dividend paid in respect of a non-equity share; or

(e) if regulations under the Income Tax Assessment Act 1997 are made having the effect that instruments known as upper tier 2 capital instruments, or a class of instruments of that kind, are debt interests - that is paid on such a debt interest and is not a return of an investment;

but does not include an amount to the extent to which it is a return on an equity interest in a company.

The payment to the client by Australian Branch is not a payment of ‘interest,’ either under the ordinary or statutory meaning of ‘interest.’ In particular, the payment is not compensation for the deprivation by the client of the money. It does not represent, in form or substance, what the client might have made if they had the use of the money, or conversely the loss they suffered because they had not that use. Rather, the payment arises because of Australian Branch’s obligation under the client agreement to pass on amounts. The payment is better characterised as a trust distribution.

While the client may not directly receive interest, the client may still ‘derive’ the interest accrued in the Client Segregated Account through the operation of subsection 128A(3).

Subsection 128A(3) states:

For the purposes of this Division, a beneficiary who is presently entitled to a dividend, to interest or to a royalty included in the income of a trust estate shall be deemed to have derived income consisting of that dividend, interest or royalty at the time when he became so entitled.

Given that the money in the Client Segregated Account is held in trust by Foreign Company for the client under section 981H of the CA 2001, subsection 128A(3) will apply to treat a non-resident beneficiary who is presently entitled to interest included in the income of the trust estate as deriving the interest when the present entitlement arises.

Taxation Ruling IT 2680 Income tax: withholding tax liability of non-resident beneficiaries of Australian trusts discusses how subsection 128A(3) applies to amounts distributed to non-resident beneficiaries of Australian trust estates. As explained in paragraph 22 of IT 2680, the client beneficiary will be presently entitled to income from the trust where the following requirements are met:

● The relevant income is legally available for distribution; and

● The beneficiary has an absolutely vested beneficial interest in possession in the whole of the relevant income; and

● The beneficiary would succeed in an action to recover the income from the trustees ignoring for this point the existence of any legal disability from giving a valid discharge to the trustee (e.g. by being a minor).

It is noted that, although IT 2680 applies only to distributions from Australian trust estates, subsection 128A(3) applies to all trust estates.

‘Interest’ (within the meaning under Part III, Division 11A) in the Client Segregated Account is ‘income of a trust estate’ – specifically, the trust estate of which Foreign Company is the trustee – for the purposes of subsection 128A(3). This is because the money in the Client Segregated Account, which includes the interest referred to above, is received and held in trust by Foreign Company for the benefit of the client pursuant to section 981H of the CA 2001.

Further, the client, as beneficiary, is ‘presently entitled’ to interest that is included in the trust estate under the client agreement. The client becomes ‘presently entitled’ when Foreign Company receives the interest from the third party, such as the affiliate.

Therefore, the effect of subsection 128A(3) is that the client is deemed to have ‘derived’ income that consists of the interest that accrues in the Client Segregated Account.

Does the relevant income satisfy one of the limbs in paragraph 128B(2)(b)?

For withholding tax to apply, the income that is derived by the non-resident client must consist of interest that:

● is paid to the non-resident by a person to whom this section applies and is not an outgoing wholly incurred by that person in carrying on business in a country outside Australia at or through a permanent establishment of that person in that country; (sub-paragraph 128B(2)(b)(i)); or

● is paid to the non-resident by a person who, or by persons each of whom, is not a 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 (sub-paragraph 128B(2)(b)(ii)).

In applying these limbs, it must be determined who is the ‘payer’ of the income derived by the client. Again, the effect of subsection 128A(3), a deeming provision, is important. The approach to be taken to construing a deeming provision is the same as in construing any statute (see Newcastle Airport Ltd v Chief Commissioner of State Revenue [2014] NSWSC 1501 at [55]-[56]). The court must ascertain what parliament meant by the words that it used.

Subsection 128A(3) deems a beneficiary to have derived income consisting of ‘that interest’ included in the income of a trust estate to which the beneficiary is presently entitled. The use of the words ‘that interest’ makes it clear that the deemed state of affairs is not concerned with the derivation of interest in the abstract. Rather, it concerns the very interest that was included in the income of the trust estate and derived by the trustee. Once it is accepted that the effect of the provision is to deem the beneficiary to have derived a specific amount of interest that was derived by the trustee, and not merely an amount of interest in a general sense, it follows that the interest which the beneficiary has derived has the attributes that it in fact possesses (including the attribute of who paid the interest).

Accordingly, the relevant ‘payer’ for the purposes of the paragraph 128B(2)(b) limbs are the third party banks, the affiliates, and the third party brokers that pay the interest to Australian Branch. These entities are offshore entities in the sense that they are not resident in Australia and the interest they pay is not an outgoing incurred by them in carrying on a business through a permanent establishment in Australia. According, neither limb of 128B(2)(b) is satisfied.

Conclusion

Interest withholding tax under section 128B does not apply to the interest accrued in the Client Segregated Account that is then on-paid to the client. Accordingly, Australian Branch is not required to withhold an amount under Subdivision 12-F of Schedule 1 to the TAA 1953 from the interest.

Question 2

Summary

Interest withholding tax under section 128B does not apply to the interest received in the Client Segregated Account from the Offshore Permissible Investments that is then on-paid to the client. Accordingly, Australian Branch is not required to withhold an amount under Subdivision 12-F of Schedule 1 to the TAA 1953 from the interest.

Detailed reasoning

As stated above, an entity is not required to withhold an amount from interest under Subdivision 12-F of Schedule 1 to the TAA 1953 (which includes sections 12-245 and 12-250), if no withholding tax is payable in respect of the interest (section 12-300 of Subdivision 12-F of Schedule 1 to the TAA 1953).

Is income that consists of interest derived by a non-resident?

As stated above, on the given Facts, the payment by Australian Branch to the non-resident clients is not a payment of ‘interest.’

However, given that the money in the Client Segregated Account is held in trust by Foreign Company for the client, subsection 128A(3) treats the client as deriving the interest received by the Client Segregated Account when the present entitlement to the income of the trust arises.

The client is presently entitled to interest income received in a Client Segregated Account from an Offshore Permissible Investment under the client agreement. Accordingly, the non-resident client ‘derives’ that income.

Does the income that consists of interest satisfy paragraph 128B(2)(b)?

For the same reasons as above, the non-resident client has derived ‘that interest’ which was paid to Foreign Company. Accordingly, the ‘payers’ of this interest are the Offshore Permissible Investments rather than Foreign Company. The Offshore Permissible Investments are offered by non-resident entities otherwise than in carrying on a business in Australia at or through a permanent establishment in Australia. Accordingly, both limbs of paragraph 128B(2)(b) are not satisfied.

Conclusion on Withholding Tax under subsection 128B(2)

Interest withholding tax under section 128B does not apply to the interest received in the Client Segregated Account from the Offshore Permissible Investments that is then on-paid to the client. Accordingly, Australian Branch is not required to withhold an amount under Subdivision 12-F of Schedule 1 to the TAA 1953 from the interest.