Edited version of private advice

Authorisation Number: 1052247630879

Date of advice: 3 May 2024

Ruling

Subject: Withholding tax - interest, foreign resident

Question

Does section 12-300 of Schedule 1 to the Taxation Administration Act 1953 (TAA) apply to you so as to reduce the amount to withhold under section 12-245 of that Schedule in respect of any interest arising under the syndicated loan facility that is, or would be otherwise capitalised at the end of Interest Period One, because there is no liability to tax for the Lenders pursuant to section 128B of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question

Does section 12-300 of Schedule 1 to the TAA apply to you so as to reduce the amount to withhold under section 12-245 of that Schedule to nil in respect of any interest arising under the syndicated loan facility that is, or would be otherwise capitalised at the end of Interest Period Two, because there is no liability to tax for the Lenders pursuant to section 128B of the ITAA 1936?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XY

The scheme commenced on:

20XW

Relevant facts and circumstances

You are the head company of a consolidated group and an Australian resident company for income tax purposes.

You entered into a syndicated loan facility agreement (the Agreement) on a date in 20XW with the Lenders.

The Lenders are foreign residents for tax purposes.

You have accepted that the Lenders would likely be in the business of money lending.

Under the terms of the Agreement, the first Interest Period started on the date in 20XW and thereafter on the last day of its preceding Interest Period. The payment of Interest A to the Lenders was on the last day of Interest Period, being a period of 3 months.

Interest B automatically capitalised and added to the outstanding principal at that same date.

There are 2 relevant Interest Periods are Interest Period One and Interest Period Two.

There were several amendments to the Agreement.

In the Deed of Amendment X, for the relevant Interest Periods, on the last day of the Interest Period, Interest A was to be capitalised and added to the amount of the loan just as the Interest B was automatically capitalised pursuant to the Agreement.

In the weeks prior to the when interest was due for Interest Period One, you and the Lenders commenced negotiations regarding a reduction in the amount to be repaid. Prior to the due date for payment of interest for Interest Period One, no agreement had been reached about the reduction in the amount of debt.

On the date interest was due for Interest Period Two, communications indicate that agreement had been reached between you and the Lenders for a reduction in the amount of the debt to $X.

Two months after the end of Interest Period Two, the parties to the Agreement entered a Side Letter to amend the Agreement:

•         the Lenders accepted the amount of $X for you to fully meet your obligations,

•         the interest amount for Interest Period One was reduced, and

•         the interest amount for Interest Period Two was reduced to nil.

Invoices for payment of the unvaried interest amounts were issued in respect of both Interest Period One and Interest Period Two. These however were automatically generated invoices and did not reflect the agreed reduction of interest.

An entry was booked to the accounts of the Lenders in respect of the Interest Period One amount, impacting the below accounts:

•         DR Loan Receivable

•         CR Interest Income

This entry did not reflect the agreed reduction.

On agreement to reverse the interest previously to be capitalised on the last day of Interest Period One, the following entry was booked in the accounts of the Lenders:

•         DR Interest Income

•         CR Loan Receivable

The Lenders did not book an amount in respect of the capitalisation of interest for Interest Period Two.

You booked an interest expense and corresponding CR to the loan payable in respect of the Interest Period One amounts. You then directly reversed this entry on entering the side letter.

You did not book an amount in respect of Interest Period Two.

Withholding tax has been remitted to the Commissioner in respect of Interest Period One.

No withholding tax has been remitted in respect of Interest Period Two.

Relevant legislative provisions

Taxation Administration Act 1953 section 11-5 of Schedule 1

Taxation Administration Act 1953 section 12-300 of Schedule 1

Taxation Administration Act 1953 section 12-245 of Schedule 1

Income Tax Assessment Act 1936 section 128A

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1936 section 128C

Reasons for decision

Questions 1 and 2

Summary

Section 12-300 of Schedule 1 to the TAA does not apply to you to reduce the amount to withhold under section 12-245 of that Schedule because the Lenders had a liability to tax pursuant to section 128B of the ITAA 1936 in respect of the interest which was capitalised on the last day of Interest Period One.

Section 12-300 of Schedule 1 to the TAA applies to SHEL so that they are not required to withhold under section 12-245 of that Schedule because the Lenders had no liability to tax pursuant to section 128B of the ITAA 1936in respect of interest which was not capitalised for Interest Period Two.

Detailed reasoning

Section 12-245 of Subdivision 12-F of Schedule 1 to the TAA sets out the circumstances requiring an entity to withhold an amount from an interest payment it makes to an overseas entity. It states:

An entity must withhold an amount from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936) it pays to an entity, or to entities jointly, if:

(a)          the recipient or any of the recipients has an address outside Australia according to any record that is in the payer's possession, or is kept or maintained on the payer's behalf, about the transaction to which the interest relates; or

(b)          the payer is authorised to pay the interest at a place outside Australia (whether to the recipient or any of the recipients or to anyone else).

Section 11-5 of Schedule 1 to the TAA provides that there has been constructive payment of any amount by an entity to another entity when the entity deals with the amount in any way on the other's behalf or as the other directs.

The Explanatory Memorandum to A New Tax System (Pay As You Go) Bill 1999 (EM) provides at paragraph 1.80 that the words in section 11-5 of Schedule 1 to the TAA were not intended to change existing administrative practice.

The predecessor to section 11-5 of the Schedule 1 to the TAA was paragraph 221YK(3)(a) of the ITAA 1936, which stated:

For the purposes of this Division: (a) interest or a royalty shall be deemed to have been paid by a person to another person although it is not actually paid over to the other person but is reinvested, accumulated, capitalized, carried to any reserve, sinking fund or insurance fund however designated, or otherwise dealt with on behalf of the other person or as the other person directs.

Even though the wording of section 11-5 of Schedule 1 to the TAA has been simplified by relying upon the higher-level expression of the concept of an entity applying or dealing with an amount in any way on another entity's behalf or as the other entity directs, the EM confirms that the broader concept encompasses the instances which were identified in its predecessor.

Additionally, in answering yes to the question in Taxation Determination TD 93/146 Income tax: should a resident deduct withholding tax from interest payable under a loan from a non-resident if there is no actual payment of the interest? (TD 93/146) provides the following example:

A is an Australian resident who borrows $250 000 on 1 July 2011 from non-resident, NR, at 10% simple interest calculated and payable annually over 5 years. By agreement between them, the annual interest is capitalised each year until the 5th year when the total amount standing to the credit of the loan account is payable.

Section 12-300 of Schedule 1 to the TAA provides that there is no requirement to withhold if no withholding tax is payable on the interest. It states:

This Subdivision does not require an entity:

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

(b)          to withhold from a dividend, from interest (within the meaning of that Division) or from a royalty more than the withholding tax payable in respect of the dividend, interest or royalty (reduced by each amount already withheld from it under this Subdivision).

Section 128B of the ITAA 1936 deals with liability to withholding tax. A non-resident is liable to pay withholding tax under subsection 128B(5) of the ITAA 1936 if the non-resident derives income that consists of interest and the requirements of subsection 128B(2) of the ITAA 1936 are satisfied in relation to that income. Subsection 128B(2) of the ITAA 1936 states that:

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.

Subsection 128A(2) of the ITAA 1936 provides that:

For the purposes of this Division, interest or a royalty shall be deemed to have been paid by a person to another person although it is not actually paid over to the other person but is reinvested, accumulated, capitalized, carried to any reserve, sinking fund or insurance fund however designated, or otherwise dealt with on behalf of the other person or as the other person directs.

The payment date of Interest A to the Lenders was the last day of each Interest Period. The relevant Interest Periods were Interest Period One and Interest Period Two.

You were required to pay Interest A on the last day of each of the Interest Period and Interest B capitalised that same day. You were required to withhold in accordance with 12-245 of Schedule 1 to the TAA on that day if the requirements of subsection 128B(2) of the ITAA 1936 were met and the Lenders became liable to pay income tax under subsection 128B(5) of the ITAA 1936.

The Lenders are non-resident and you have accepted that the Lenders would each likely be in the business of money lending.

Subsection 6-5(4) of the Income Tax Assessment Act 1997 provides:

In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

Paragraph 47 of Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings,(TR 98/1) explains that whilst the general principle is that interest is only derived, or arises, when it is received or credited, the exceptions to this general rule include:

•         interest from a business of money lending carried on by a taxpayer, and

•         interest derived by a financial institution, unless from a 'non-accrual loan'.

TR 98/1 explains in paragraphs 9 to 11, that under the 'accruals' method:

... income is derived when it is earned. The point of derivation occurs when a 'recoverable debt' is created.

The term 'recoverable debt' is used to describe the point of time at which a taxpayer is legally entitled to an ascertainable amount as the result of having performed an agreed task. A taxpayer may have a recoverable debt even though, at the time, they cannot legally enforce recovery of the debt.

Whether there is, in law, a recoverable debt is a question to be determined by reference to the contractual agreements that give rise to the legal entitlement to payment, the general law and any relevant statutory provisions.

According to paragraph 8 of Taxation Ruling TR 93/27 Income tax: basis of assessment of interest derived and incurred by financial institutions (TR 93/27) the adoption of straight-line daily accruals as the basis of tax accounting for interest derived and incurred results in 'a substantially correct reflex' of the taxable income of a financial institution.

Paragraphs 27 to 29 of TR 93/27 explain:

27. At law interest accrues day by day (that is, de die in diem) even if payable only at intervals (cf. The State of South Australia v. The Commonwealth of Australia 92 ATC 4066 at 4072; (1992) 23 ATR 10 at 19). Interest is therefore apportionable under the general law in respect of time (cf. Halsbury's Laws of England , 4th ed., Vol. 32 at para 106; Vol. 16 at para 1250; Conveyancing Act 1919 (NSW) , subsection 144(1)).

28. In F C of T v. The Myer Emporium Limited (1987) 163 CLR 199 the Full High Court restated a basic concept of interest. At page 218 it stated:

'...interest is regarded as flowing from the principal sum (Federal Wharf Co. Ltd v. DFCT (1930) 44 CLR 24 at 28) and to be compensation to the lender for being kept out of the use and enjoyment of the principal sum: Riches v. Westminster Bank Limited (1947) AC 390 at 400.'

29. Moreover, the courts have also regarded interest as a reward earned for the service of lending, the interest being earned as money is left outstanding (cf. Commissioner of Inland Revenue v. The National Bank of New Zealand 77 ATC 6001 at 6023, 6026 & 6032; (1977) 7 ATR 282 at 295, 298 & 306; Willingale (H. M. Inspector of Taxes) v. International Commercial Bank Limited ('Willingale ') (1978) 52 TC 242 at 271).

Under the terms of the Agreement the 'task performed' by the Lenders was to make available to you a loan facility. You were required to pay Interest A which accrued during the Interest Period on the last day of that period, and Interest B automatically capitalised and added to the outstanding principal.

Based on an amendment to the Agreement, for the relevant periods, on the last day of the Interest Period, Interest A was to be capitalised and added to the amount of the loan just as the Interest B was automatically capitalised pursuant to the Agreement.

In the weeks prior to the day in which interest was due for Period One, you and the Lenders commenced negotiations regarding a reduction in the amount to be repaid.

In Masters v Cameron [1954] HCA 72 (Masters case), the Court provided guidance on whether a contract has come into existence where parties who have been in negotiation reach agreement upon terms of a contractual nature and also agree that the matter of their negotiation shall be dealt with by a formal contract. In such a scenario, the case may belong to any of three classes:

•         it may be a case in which the parties have reached finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect,

•         it may be a case in which the parties have completely agreed upon all the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but have made performance of one or more of the terms provisional upon the execution of a formal document, or

•         it may be a case in which the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract.

It was held in Masters case that, in each of the first two cases there is a binding contract: in the first case a contract binding the parties at once to perform the agreed terms whether the contemplated formal document comes into existence or not, and to join (if they have so agreed) in settling and executing the formal document.

No agreement had been reached by the last day of Interest Period One, even if there may have been an expectation that there would later be a reduction in the amount of debt.

Notwithstanding that some of the debt was later forgiven/waived the fact that on the last day of Interest Period One interest was capitalised, meant that for that Interest Period the Lenders derived income by way of interest that was paid to them in accordance with subsection 128A(2) of the ITAA 1936.

On the last day of Interest Period Two, you and the Lenders had agreed to a reduction in the amount of the debt to $X.

In the Side Letter, two months later, the Lenders accepted $X as the amount to meet your obligations, and this is consistent with the amount referred to in communications on the last day of Interest Period Two.

These facts support the view that by the last day of Interest Period Two you and the Lenders had finalised negotiations and had agreed to the reduction in your debt, contemplating the formal document.

Additionally, considering that the Lenders did not book an amount in respect of the capitalisation of interest for Interest Period Two, we accept that interest for that Interest Period was not capitalised and therefore not paid.

Conclusion

Interest Period One

On the last day of Interest Period One, the requirements of subsection 128B(2) of the ITAA 1936 were met as the Lender had derived interest income for the Interest Period One and it was paid to the Lender when it was capitalised. Consequently, section 12-300 of Schedule 1 to the TAA does not apply to you to reduce the amount to withhold under section 12-245 of that Schedule because the Lenders had a liability to tax pursuant to section 128B of the ITAA 1936.

Interest Period Two

On the last day of Interest Period Two, although the Lender derived interest income for the Interest Period the other requirement of subsection 128B(2) of the ITAA 1936 was not met as that interest was not paid to the Lender as it was not capitalised. Consequently, section 12-300 of Schedule 1 to the TAA applies to you so that you are not required to withhold under section 12-245 of that Schedule because the Lenders had no liability to tax pursuant to section 128B of the ITAA 1936.