Edited version of private advice

Authorisation Number: 1051789111081

Date of advice: 10 December 2020

Ruling

Subject: PAYG withholding obligation and deductibility of interest

Question 1

Did AustCo have an obligation to withhold an amount under section 12-245 of Schedule 1 to the Taxation Administration Act 1953 (TAA) from the interest paid to the Lenders of the Facility?

Answer

No.

Question 2

Is AustCo entitled to claim a deduction under subsection 230-15(2) of the Income Tax Assessment Act 1997 (ITAA 1997) for the interest paid to the Lenders of the Facility?

Answer

Yes.

This ruling applies for the following period:

31 December 20XX

The scheme commences on:

10 May 20XX

Relevant facts and circumstances

AustCo is an Australian resident for tax purposes and the head company of the AustCo income tax consolidated group. It has an aggregated turnover in excess of $XXX.

AustCo is a wholly owned subsidiary in an international group. The group operates in the services industry.

In 20XX, a member of the group entered into a facilities agreement with external financiers. The facility was made available to AustCo (the Facility).

The Lenders of the Facility are residents of Australia for tax purposes.

The Facility was used to pay the following liabilities of AustCo and its subsidiaries:

(a)  balance of principal and interest of existing loans. These loans were used to refinance another loan which was part of a funding arrangement to acquire an entity providing services and to pay amounts drawn from a revolving credit facility,

(b)  loan establishment fee in respect of the Facility, and

(c)   certain accounts payables.

AustCo satisfied various conditions to become the borrower of the Facility. As the borrower, it became liable to pay the principal and interest payable on the Facility.

Reasons for decision

Question 1

Summary

AustCo did not have an obligation to withhold an amount under section 12-245 of Schedule 1 to the TAA from the interest paid to the Lenders of the Facility.

Detailed reasoning

Section 12-245 of Schedule 1 to the TAA 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 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

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 [subparagraph 128B(2)(b)(i) of the ITAA 1936]; 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 [subparagraph128B(2)(b)(ii) of the ITAA 1936].

Accordingly, as the Lenders of the Facility are Australian residents, AustCo, also an Australian resident, did not have an obligation to withhold an amount under section 12-245 of Schedule 1 from the interest paid to the Lenders of the Facility.

Question 2

Summary

AustCo is entitled to claim a deduction under subsection 230-15(2) of the ITAA 1997 for the interest paid to the Lenders of the Facility.

Detailed reasoning

Note: All legislative references below are to the ITAA 1997 unless otherwise indicated.

As AustCo has an aggregated turnover in excess of $100 million, the taxation of financial arrangements (TOFA) provisions in Division 230 will apply to determine whether AustCo is entitled to claim tax deductions for the interest incurred in respect of the Facility.

Under subsection 230-15(2), you can deduct a loss you make from a financial arrangement, but only to the extent that you make it in gaining or producing your assessable income, or you necessarily make it in carrying on a business for the purposes of gaining or producing your assessable income.

Financial Arrangement

In order to have a financial arrangement, one or more rights to receive a financial benefit and/or one or more obligations to provide a financial benefit must be cash settlable under an arrangement (subsection 230-45(1)).

Arrangement

An arrangement is defined to be any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings (subsection 995-1(1)).

Cash Settlable

A financial benefit that is cash settlable includes a situation when the financial benefit is money or a money equivalent (paragraph 230-45(2)(a)).

Financial Benefit

The term financial benefit means anything of economic value, including property and services, even if the transaction that confers the benefit on an entity also imposes an obligation on the entity (section 974-160).

Whether the interest paid to the Lenders of the Facility is a loss AustCo makes from a financial arrangement?

AustCo satisfied certain conditions to become the borrower of the Facility. The Facility was used to repay existing liabilities of AustCo and its subsidiaries.

As the borrower, AustCo assumed the obligation to pay the principal and interest payable on the Facility.

Accordingly, the payment of interest to the Lenders of the Facility is a loss arising from a financial arrangement.

Whether interest is deductible?

Under subsection 230-15(2), you can deduct a loss made from a financial arrangement to the extent that the loss is made in gaining or producing your assessable income, or you necessarily make it in carrying on a business for the purposes of gaining or producing your assessable income.

The wording of subsection 230-15(2) mirrors that of section 8-1, which deals with general deductions. This is acknowledged at paragraph 3.72 of the explanatory memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008. It is therefore appropriate to have regard to the case law and commentary dealing with section 8-1 (and its predecessor, former section 51 of the ITAA 1936) in interpreting this provision.

The Commissioner's view on the deductibility of interest is set out in Taxation Ruling 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith (TR 95/25).

Paragraph 3 of TR 95/25 sets out general principles by which the deductibility of interest may be determined. Relevantly, the interest expense must have a sufficient connection with the operations or activities that produce the taxpayer's assessable income. This will require characterisation of the expense, which is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put, although the subjective purpose of the taxpayer may be relevant in certain situations.

Use of the Facility

The use by AustCo and its subsidiaries of the Facility can be characterised into the following broad categories:

i.          refinancing existing loans and paying those loans' accrued interest and costs,

ii.         paying the loan establishment fee, and

iii.        paying accounts payable balance.

The deductibility of interest of each category is considered below.

i.      Refinancing existing loans and paying of accrued interest and costs

Paragraph 42 of TR 95/25 provides that interest on a new loan will be deductible if the new loan is used to repay an existing loan which, at the time of the second borrowing, was being used in an assessable income producing activity or used in a business activity which is directed to the production of assessable income ( Roberts and Smith ATC at 4388; ATR at 504).

The Facility was used to refinance existing loans. These loans were used to refinance another loan which was part of a funding arrangement to acquire an entity providing services and to pay amounts drawn from a revolving credit facility.

As the Facility was used in a business activity which was directed to the production of assessable income, the interest on the Facility is deductible to AustCo.

Accrued interest and costs in relation to the refinancing of existing loans are also deductible, as the funds from the existing loans were used for income-producing purposes.

ii.     Paying loan establishment fee

Interest paid in relation to funds used for the payment of the loan establishment fee is also deductible because it is incidental to the purpose of deriving assessable income.

iii.    Paying accounts payable balance

Interest paid in relation to the funds used for the payment of an accounts payable balance owing by AustCo and its subsidiaries is also deductible because it has a sufficient connection with the operations or activities that produce AustCo's assessable income.

Conclusion

After having regard to the requirements of subsection 230-15(2), it is concluded that AustCo is entitled to claim a deduction under subsection 230-15(2) for the interest paid to the Lenders of the Facility.