Edited version of private advice

Authorisation Number: 1051521867693

Date of advice: 5 June 2019

Ruling

Subject: Withholding tax exemption - section 128F ITAA 1936

Question 1

Will the Notes to be issued by AusCo No 2 to the non-resident lenders satisfy the definition of a 'debenture' in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

Will the Notes to be issued by AusCo No 2 satisfy the 'public offer test' in subsection 128F(3) of the ITAA 1936?

Answer

Yes.

Question 3

Is AusCo No 2 required under section 12-245 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) to withhold an amount from interest paid to non-resident lenders under the Notes?

Answer

No.

This ruling applies for the following periods:

1 July 2018 to 30 June 2028

The scheme commences on:

31 May 2019

Relevant facts and circumstances

AusCo

1.     AusCo is a trustee of a fund which invests into existing properties as well as property development

2.     AusCo is an Australian resident for taxation purposes.

3.     AusCo also provides non-discretionary mandate services to a number of its Investors for residential development.

4.     All investment decisions are made by AusCo as the trustee for the Fund.

AusCo No 2

5.     AusCo No 2 was created to raise external funds for the benefit of the Fund.

6.     AusCo No 2 will be an Australian resident company at all times, including at the time of issuing the Notes and at the time of each payment of interest and principal.

7.     AusCo No 2 is wholly owned by AusCo.

8.     AusCo No 2 will be the Issuer of the 'debentures'. The funds raised by AusCo No 2 will be lent to the Fund at the same terms as AusCo No 2 borrows on.

9.     AusCo No 2 will remain fully debt funded (other than nominal equity).

10.  The Notes Offer will be managed by appointed intermediaries

The Fund

11.  The Fund is an unlisted property fund that is a stapled entity taking the form of X unit trusts.

12.  The Fund seeks to deliver its target return to investors through the acquisition, development and long-term ownership of Australian real estate assets.

13.  The units of the Fund are held by Australian investors.

Notes Offer

14.  AusCo No 2 proposes to issue Notes in a private placement offering (the Notes).

15.  The Fund is looking to raise additional funding. To do so, it is intended that the Notes are issued to non-resident lenders (Investors).

16.  AusCo will conduct a 'Roadshow' presenting the Notes to potential investors.

17.  Potential Investors segmented into broad categories based on investment capacity (i.e. Larger Investors (>$2 bn per year) and Mid-size Investors (<$2bn per year)).

18.  The Notes will be guaranteed by the Fund.

19.  The Notes to be issued into the Investors will be governed by an agreement (the Agreement).

20.  The following is a summary of the key proposed terms that can be found as part of the Draft Term Sheet:

·        The issuer is AusCo No 2;

·        The Guarantor is the Fund;

·        AusCo No 2 will issue Notes;

·        These Notes will rank pari passu to AusCo No 2's other guaranteed senior indebtedness;

·        The funds from the Notes will be used to repay existing debt and for general corporate purposes;

·        Interest will be paid semi-annually, calculated on the basis of a 360 day year of twelve 30-day months;

·        The Notes will have bullet maturities of 10 through to 15 years. AusCo No 2 reserves the right to issue alternative maturities.

·        The key financial convenants will be:

(i)        Total Liabilities less than or equal to 25% of total assets

(ii)      ICR: Net property Income

(iii)     Net Assets

(iv)     Unit holder redemptions less than 10% of net assets in each financial year

·        If a change of control occurs, AusCo No 2 shall make pro rata offer to noteholders to prepay the Notes at par.

21.  The Agreement includes an indemnification provided by the Company to the Purchasers for any withholding of any tax required under the Notes, except where the payment is required to be made for or on account of any holder being an associate of the Company.

22.  AusCo No 2 will treat the Notes as debt interests within the meaning of Division 974 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1936 section 128F

Taxation Administration Act 1953 section 12-245 of Schedule 1

Taxation Administration Act 1953 section 12-300 of Schedule 1

Reasons for decision

Question 1

Will the Notes to be issued by AusCo No 2 to the Investors satisfy the definition of a 'debenture' in subsection 6(1) of the ITAA 1936?

Detailed reasoning

Subsection 6(1) of the ITAA 1936 defines 'debenture', in relation to a company, to include 'debenture stock, bonds, notes and any other securities of the company, whether constituting a charge on the assets of the company or not'.

The definition of 'debenture' is extended in subsection 128F(9) of the ITAA 1936 to include a promissory or a bill of exchange in addition to the instruments mentioned in the definition of debenture contained in subsection 6(1) of the ITAA 1936.

The Notes that will be sold to potential investors are unsecured loan notes. The Notes will pay interest semi-annually.

Therefore, the Notes will be considered debentures as defined by subsection 6(1) of the ITAA 1936 and for the purposes of section 128F of the ITAA 1936.

Question 2

Will the Notes to be issued by AusCo No 2 satisfy the 'public offer test' in subsection 128F(3) of the ITAA 1936?

Detailed reasoning

Public Offer Test

Paragraph 128F(1)(d) of the ITAA 1936 provides that the issue of the debenture must satisfy the public offer test set out in subsections 128F(3) or (4) of the ITAA 1936. Subsection 128F(4) of the ITAA 1936 is not relevant as it applies to global bonds. Therefore, the Notes must satisfy the requirements of subsection 128F(3) of the ITAA 1936.

Subsection 128F(3) of the ITAA 1936 contains five tests. One of these tests must be satisfied in order for the Notes to meet the public offer test.

Relevantly, at paragraph 128F(3)(a) of the ITAA 1936, the issue of a debenture by AusCo No 2 will satisfy the public offer test if the issue results from the debenture being offered for issue;

(a)   to at least 10 persons each of whom;

(i)   was carrying on a business of providing finance, or investing or dealing in securities, in the course of operating in financial markets; and

(ii)  was not known, or suspected, by the company to be an associate (see subsection (9)) of any of the other persons covered by this paragraph;

Subsection 128F(5) of the ITAA 1936 provides for situations where issues and invitations will fail the public offer test. Specifically, paragraph 128F(5)(a) of the ITAA 1936 provides that a debenture issued by a company will not satisfy the public offer test in section 128F of the ITAA 1936 if, at the time of issue, the company knew or had reasonable grounds to suspect that the debenture, or an interest in it, was being, or would be, acquired by an 'associate'.

Offered for issue

In order to satisfy the public offer test, the issue of the debenture or debt interest must have resulted from the debenture or debt interest being 'offered' for issue.

The term 'offered' is not defined in the legislation. Taxation Determination TD 1999/24: Income Tax: interest withholding tax exemption under section 128F of the Income Tax Assessment Act 1936 - how may a company satisfy the introductory requirements in paragraphs 128F(3)(a) and 128F(3)(b) that a debenture must be offered on a 'debenture by debenture' basis? (TD 1999/24) clarifies when a debenture will be considered to be offered for issue. TD 1999/24 relevantly states:

3. For the purposes of the introductory words of paragraphs 128F(3)(a) and 128F(3)(b), 'offered' is not limited to meaning 'offer' in the context of a contractual offer. Rather, the word includes invitations or inducements to potential investors to make offers. For example, the placement of an advertisement that the company wishes to issue debentures, is an attempt to induce offers from potential investors rather than an offer itself (in other words, it is an 'invitation to treat').

4. Therefore, the introductory words are satisfied where the debentures are advertised for issue or other invitations or inducements are made in accordance with their respective public offer test, giving potential investors the opportunity to make an offer to the company for the acquisition of the debenture/s.

AusCo No 2 has engaged agents, to advertise and offer the Notes for purchase by investors. During mid 2019 the agents have conducted presentations throughout the Country A. Potential investors have been provided a memorandum which provides an overview of the Fund, the purpose of the proposal and a summary of the details of the Notes. The investors have also been provided with a draft copy of the Agreement to purchase the Notes.

At the end of the Investor Roadshow the Arrangers took bids from the prospective investors which established the bid book and the size of the deal.

The above presentations, advertising and offers from the Arrangers would constitute an offer for the purposes of subsection 128F(3) of the ITAA 1936.

Offered to at least 10 persons

The Explanatory Memorandum to Taxation Laws Amendment Act (No 2) 1997 (EM), which introduced amendments to section 128F of the ITAA 1936, states that if the Australian company offers its debentures to 10 banks or pension funds operating in an overseas financial market, the public offer test will be satisfied.

AusCo No 2 has advised that it will be making an offer to at least 10 investors. All the companies identified by AusCo No 2as potential investors are in the insurance, banking, or retirement fund industries. Therefore, at least 10 investors are considered persons which either carry on a business of providing finance, or investing or dealing in securities, in the course of operating in financial markets.

Are the Investors associates of AusCo, Fund, AusCo No 2 or any other investor?

Taxation Determination TD 2001/3 Income tax: Interest Withholding Tax Exemption - for the purposes of subsection 128F(5) of the Income Tax Assessment Act 1936, when will a company be taken to have the requisite knowledge or suspicion that the debenture or an interest in the debenture was being, or would later be, acquired by an associate? (TD 2001/3) examined the question on when a company will be taken to have the requisite knowledge or suspicion that a debenture or an interest in the debenture was being or would later be acquired by an associate for the purposes of subsection 128F(5) of the ITAA 1936.

As outlined by the Commissioner in TD 2001/3, suspicion (about whether the Notes are being issued to an associate) needs to be looked at objectively in light of what is reasonable in the individual circumstances of the particular case. When subsection 128F(5) of the ITAA 1936 refers to the knowledge or suspicion of the company, knowledge or suspicion of all company personnel involved with the issue itself, and other personnel who are concerned in or take part in the overall management of the company, would be relevant. Accordingly, issuing officers will need to undertake enquiries to ensure that other officers of the company do not have such knowledge or suspicion, otherwise the subsection may operate.

A company will not be taken to have the requisite knowledge or suspicion if the company takes reasonable steps to ensure that its associates do not acquire its debentures. While every case has to be judged on its merits, one reasonable step would be to write to associates asking them not to acquire debentures (otherwise than in their capacity of a dealer, manager or underwriter in relation to the placement of the debenture). Another reasonable step would be for the debenture itself, and/or the prospectus, to contain a statement advising that the purchase of the debenture by associates could result in the entire issue failing the public offer test. A further such step could be for the issuer to instruct its manager, dealer or underwriter not to sell debentures to the issuer's associates. An issuer may, but is not obliged under subsection 128F(5) of the ITAA 1936, to obtain undertakings to this effect from its dealers, managers or underwriters.

In respect of the issue of the Notes, each prospective investor warrants in the Agreement, that they are not an associate of AusCo No 2 or the Fund, or an associate of any other investor. The agents agree not to sell the Notes to any person who has been identified by AusCo No 2 or the Fund to be an offshore associate of AusCo No 2 or the Fund.

The agents have also agreed not to offer the Notes to a financial institution who is known, or suspected, by the relevant employees of the agents (who are directly involved in the issue of the Notes) to be an associate.

Additionally in the Agreement, AusCo No 2 states that it will not cover withholding tax incurred because the Investor was an associate of AusCo No 2 or the Fund.

Therefore, given the investors are not associates of AusCo No 2 or the Fund, subparagraph 128F(3)(a)(ii) of the ITAA 1936 is satisfied. As the investors are not associates, paragraph 128F(5)(a) of the ITAA 1936 is satisfied and it is not necessary to consider the remaining paragraphs in subsection 128F(5) of the ITAA 1936.

Conclusion

Given the issue of the Notes will be made to 10 or more investors who were carrying on a business of providing finance or dealing in securities, in the course of operating in financial markets and the investors are not associates of AusCo No 2, the public offer test outlined in subsection 128F(3) of the ITAA 1936 is satisfied.

Question 3

Is AusCo No 2 required under section 12-245 of Schedule 1 to the TAA 1953 to withhold an amount from interest paid to non-resident lenders under the Notes?

Detailed reasoning

Interest payment to overseas person

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

However, subsection 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.

Interest withholding tax liability

The liability to withholding tax is dealt with under section 128B of the ITAA 1936.

Subsection 128B(2) of the ITAA 1936 imposes a liability to withholding tax where income is derived and consists of interest that is:

(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.

However, the liability to interest withholding tax will not arise for interest paid by an Australian resident to a non-resident under subparagraph 128B(2)(b)(i) of the ITAA 1936 where section 128F of the ITAA 1936 applies to the interest payment.[1]

Section 128F exemption

Subsection 128F(2) of the ITAA 1936 provides that tax is not payable under Division 11A of the ITAA 1936 in respect of interest to which section 128F of the ITAA 1936 applies. Subsection 128F(1) of the ITAA 1936 provides that section 128F of the ITAA 1936 applies to interest paid by a company in respect of certain publicly offered debentures and debt interests if:

(a)         the company was a resident of Australia when it issued the debenture or debt interest; and

(b)         the company is a resident of Australia when the interest is paid; and

(c)         (Not Relevant)

(d)         either:

(i)           the issue of the debenture or debt interest satisfies the public offer test set out in subsection (3) or (4); or

(ii)         for a syndicated loan - the invitation to become a lender under the relevant syndicated loan facility satisfies the public offer test set out in subsection 128F(3A).

Is AusCo No 2 a resident of Australia when the debenture is issued and when the interest is paid?

AusCo No 2 is incorporated in Australia. AusCo No 2 has advised that it will be an Australian resident company at all times during the issuing of the Notes and payment of the interest and principal.

Therefore AusCo No 2 is a resident of Australia and satisfies 128F(1)(a) and (b) of the ITAA 1936.

Public Offer Test

The Notes issued by AusCo No 2 satisfy the public offer test in subsection 128F(3) of the ITAA 1936 (as determined in Question 2). Therefore, subsection 128F(1)(d) is satisfied.

Subsection 128F(6)

Subsection 128F(6) of the ITAA 1936 provides that there is no exemption from liability to interest withholding tax where amounts are paid to associates of the issuing company.

As stated above in Question 2, the Notes are not being offered to associates of AusCo No 2 or the Fund. Specific clauses exist within the Agreement with the agents to prevent the sale of the Notes to associates. Therefore, this section does not apply.

Conclusion

The issue of the Notes and the payment of interest that will be accrued in respect to the Notes satisfy the withholding tax exemption pursuant to section 128F of the ITAA 1936. Accordingly, AusCo No 2 will not be required to withhold an amount from the interest paid on the Notes under section 12-245 of Schedule 1 to the TAA 1953.

[1] subparagraph 128B(3)(h)(iv) of the ITAA 1936