Edited version of private advice

Authorisation Number: 1052331408834

Date of advice: 17 December 2024

Ruling

Subject:Withholding tax

Question 1

Does the judgment debt owed to Bank M, although being recorded as one lump sum, comprises an interest component that retains its character as interest, and that if an amount is paid to Bank M as part of the liquidation process whether as an interim distribution or a final distribution, the interest component of that payment will be subject to withholding tax under subsection 128B(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

Will the Commissioner accept for you to use the interest first approach for the calculation of the interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the Reduction Amount?

Answer

Yes.

Question 3

Will the Commissioner accept for you to use the pro-rata approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the Reduction Amount.

Answer

Not Applicable.

Question 4

Will the Commissioner accept for you to use the interest last approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the Reduction Amount?

Answer

Not Applicable.

Question 5

Will the Commissioner accept for you to use the interest first approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the lump sum or partial payments made to Bank M?

Answer

Yes.

Question 6

Will the Commissioner accept for you to use the pro-rata approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the lump sum or partial payments made to Bank M?

Answer

Not Applicable.

Question 7

Will the Commissioner accept for you to use the interest last approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the lump sum or partial payments made to Bank M?

Answer

Not Applicable.

Question 8

Are you subject to a 10% withholding tax as per section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 on the interest payment to Bank M?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Company P, as borrower entered into a Facility Agreement with Bank M. You provided us with details on the date the Facility Agreement was entered into, the amount borrowed and the term of the loan. You and Company Q were listed as guarantors.

Bank M is a foreign resident for Australian tax purposes. The loan was made at the Country N branch of Bank M which is now closed.

Bank M sued you (as guarantor) for Company P's unpaid debt. The court found in favour of Bank M for you to pay the unpaid debt.

On a specified date Bank M provided their proposed calculation for the Judgment. You provided us with details on the full amount along with the breakdown which included an interest amount.

The Judgment obtained by Bank M against you was handed down on a specified date for a specified amount, which was listed as a single amount.

Person O (the liquidator) was appointment as your liquidator on a specified date, where Bank M is a creditor. Bank M lodged a proof of debt with the liquidator for the judgment amount against you.

The liquidator intends to pay an interim dividend and further dividend to your creditors who have submitted a proof of debt.

The liquidator currently estimates that there will be insufficient funds to pay all creditors, therefore dividends paid to Bank M will be insufficient to discharge your outstanding amount with Bank M.

You provided us with the Facility Agreement which details the guarantor of the loan, when the accrued interest on the loan is payable, along with how part payments are to be allocated when received.

Clause XX of the Facility Agreement deals with partial payments. Clause XX(a) sets out the order a part payment is to be allocated. Clause XX(b) states that order can be varied if so directed by the lender.

Relevant legislative provisions

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

Income Tax Assessment Act 1936 subsection 128B(2)

Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 section 7

Reasons for decision

Detailed reasoning

Ordinary meaning of 'Interest'

'Interest' is not otherwise defined by the Income Tax Act and has been variously described at common law as:

The return, consideration or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, that must be referable to a principal: (Full Federal Court in Federal Commission of Taxation v Century Yuasa Batteries Pty Ltd (1998) 82 FCR 288; 38 ATR 442; 98 ATC 4380).

Interest is in essence compensation to a lender for being kept out of the use and enjoyment of the principal sum (Federal Commission of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199; (1987) 18 ATR 693; (1987) 87 ATC 4363).

It is an amount that is calculated by reference to a principal sum and by reference to time (Federal Wharf Co Ltd v Deputy Commissioner of Taxation (1930) 44 CLR 24 at 28).

Expanded definition of 'interest'

Subsection 128A(1AB) of the ITAA 1936 provides an expanded definition of 'interest' for the purposes of Division 11A of the ITAA 1936 as follows:

'Interest' includes 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)           ...

(d)           ...

(e)           ...

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

Paragraph 128A(1AB)(a) provides that interest includes an amount that is in the nature of interest. In the context of Division 11A the purpose of the phrase 'in the nature of' is to give an appropriate extension in the concept of 'interest' which as previously stated is critical to one of the heads of withholding tax liability. In Century Yuasa Batteries Pty Ltd v Federal Commissioner of Taxation (1997) 73 FCR 528; 35 ATR 394; 97 ATC 4299 (at FCR 548), Cooper J said in relation to the precursor to paragraph 128A(1AB)(a):

In my view, for a payment to fall within the extended definition under s 128A(1) in the context of the withholding tax provisions of ITAA it must have the character of a return or profit to the lender for the use of money advanced to the borrower howsoever calculated or ascertained...

The Full Court expressly agreed with this view on appeal.

Taxation Ruling TR 93/27 (paragraphs 24-30) and TR 2002/15 (paragraphs 53-56), which provide guidance on the nature of interest, state that the following requirements must normally be satisfied for a payment to be treated as interest:

•                     there must be a sum of money by reference to which the payment is to be ascertained (which might loosely to be called the principal sum or the principal debt)

•                     that sum must be a sum which is due to the person entitled to the interest; and

•                     the payment must be calculated by reference to time.

As explained in TD 1999/26 an amount paid by a guarantor arises from a contractual obligation to repay any amounts where there is a default payment. The interest component would fall within the 'nature of interest' as the amount is still a compensation to the lender for not having the principal for the term of the loan. Simply, it is paid by the guarantor rather than the borrower.

Interest Withholding Tax

Interest withholding tax is payable on interest derived by non-residents under subsection 128B(2) of the ITAA 1936.

Section 7 of the Income Tax (Dividends, Interest and Royalties Withholding tax) Act 1974 sets the rates of withholding tax on payments to which subsection 128B(2) of the ITAA 1936 applies. The rate of withholding tax on interest paid to non-residents is 10%. However, this liability to Australian withholding tax is subject to any applicable tax treaty provisions contained in the International Tax Agreements Act 1953 (Agreements Act).

Question 1

Does the judgment debt owed to Bank M, although being recorded as one lump sum, comprises an interest component that retains its character as interest, and that if an amount is paid to Bank M as part of the liquidation process whether as an interim distribution or a final distribution, the interest component of that payment will be subject to withholding tax under subsection 128B(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Application to your circumstances

The interest component from the judgment debt payable by your liquidator is in the nature of interest for the purposes of subsection 128(1AB) of the ITAA 1936 as:

•                     it is calculated by reference to the outstanding principal amount

•                     the amount is due to the lender under the terms of the Facility Agreement; and

•                     the amount is calculated by reference to the time the loan was in place at the date of the judgement.

Accordingly, any interest pursuant to the Facility Agreement payable to Bank M (a non-resident entity) by your liquidator will be subject to withholding tax under section 128B of the ITAA 1936.

Question 2

Will the Commissioner accept for you to use the interest first approach for the calculation of the interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the Reduction Amount?

Application to your circumstances

The Judgment obtained by Bank M did not vary the terms contained in the Facility Agreement. It also did not contain terms dealing with part payments. Therefore, based on the information provided, the Commissioner accepts the interest first approach for the calculation of interest as it is in accordance with the order set out in clause XX(a) of the Facility Agreement, unless that order has been varied by the lender as per clause XX(b).

Question 3

Will the Commissioner accept for you to use the pro-rata approach for the calculation of the interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the Reduction Amount.

Application to your circumstances

Not applicable, as at Question 2 it has been determined that the interest first approach is the appropriate method.

Question 4

Will the Commissioner accept for you to use the interest last approach for the calculation of the interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the Reduction Amount?

Application to your circumstances

Not applicable, as at Question 2 it has been determined that the interest first approach is the appropriate method.

Question 5

Will the Commissioner accept for you to use the interest first approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the lump sum or partial payments made to Bank M?

Application to your circumstances

As explained in Question 2, the Judgment obtained by Bank M did not vary the terms in the Facility Agreement nor it contained terms dealing with part payments. Therefore, the Commissioner accepts the interest first approach for the calculation of interest as it is in accordance with the order set out in clause XX(a) of the Facility Agreement, unless that order has been varied by the lender as per clause XX(b).

Question 6

Will the Commissioner accept for you to use the pro-rata approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the lump sum or partial payments made to Bank M?

Application to your circumstances

Not applicable, as at Question 5 it has been determined that the interest first approach is the appropriate method.

Question 7

Will the Commissioner accept for you to use the interest last approach for the calculation of interest (for the purpose of interest withholding tax under subsection 128B(2) of the ITAA 1936) in relation to the lump sum or partial payments made to Bank M?

Application to your circumstances

Not applicable, as at Question 5 it has been determined that the interest first approach is the appropriate method.

Question 8

Are you subject to a 10% withholding tax as per section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 on the interest payment to Bank M?

Application to your circumstances

As Australia does not have any tax treaty with Country N the general non-resident withholding tax of 10% is applicable in your situation.