Australia: Important Interest Withholding Tax Developments

Debt interests issued on or after 7 December 2006 will only qualify for an interest withholding tax exemption where there has been a public offer of:

• a debenture
• non-equity shares that are debt interests
• a debt interest that is prescribed by regulation.

A debenture may be excluded from the withholding tax exemption where it is prescribed by regulation.

In Taxation Laws Amendment (2006 Measures No. 7) Bill 2006, the Government has proposed to narrow the range of debt interests that qualify for interest withholding tax exemption under the public offer test to those financial instruments and arrangements that are consistent with the 'original policy intent'.

This means that debt interests generally will no longer qualify for interest withholding tax exemption.

Policy intent behind exemption from interest withholding tax

The Explanatory Memorandum to the Bill states that the objective of an interest withholding tax exemption was to ensure that Australian businesses did not bear the higher costs of capital arising from the imposition of interest withholding tax from offshore borrowings. The exemption is targeted at arm's-length capital raisings for business activities, and excludes transactions between related parties and individually negotiated loans.

Initially the interest withholding tax exemption was limited to debentures that satisfied the public offer test and certain other conditions. In 2005, legislative amendments were introduced to extend the exemption to debentures or a debt interest to reflect the changes in Australia's debt/equity rules. These latest amendments will limit the debt interests that are eligible for exemption and allow for some 'debentures' to be excluded by regulation.

The public offer test – overview and reminder

An issue of debentures or an eligible debt interest will satisfy the public offer test if the issue results from such instruments being offered in one of the following five ways:

• to 10 or more unrelated financiers or securities dealers
• to 100 or more investors
• by being listed debt securities
• as a result of publicly available information sources used by financial markets or
• to dealers who offer to sell the debt securities within 30 days according to any of the preceding methods.

The public offer test may also be satisfied if the debenture issued is a 'global bond'.

A public offer of a debenture

Debentures are defined for these tax purposes to include a debenture stock, bonds, notes and other securities and promissory notes and bills of exchange. Although the definition of a debenture at common law is somewhat uncertain, a relevant definition is a transferable document that either creates or acknowledges a debt (rather than merely evidencing it). Although promissory notes and bills of exchange are not customarily debentures under common law, they are for these tax purposes. Therefore it will be necessary to include note or other 'debenture' language in the drafting of a facility where it is intended that the public offer exemption apply.

We expect that this power is available to allow financial instruments that are styled as debentures legally but which are not traditionally regarded as debentures to be excluded. Examples would include savings accounts, transaction or current accounts, term deposits and non-transferable certificates of deposit.

The Explanatory Memorandum notes that 'It is intended that this power will not be used to depart from what is the current market view as to what constitutes a debenture. … The power is expected to address the circumstances where the definition has been broadened to include non-negotiable, routinely available, wholesale and retail financial instruments or products.'

It is not clear in what other circumstances the Government would attempt to exclude (by regulation) a debenture from the interest withholding tax exemption.

A public offer of a debt interest

Debt interests are defined within the debt/equity provisions of the Income Tax Assessment Act 1997 to include financial instruments and financing arrangements which include a non-contingent obligation on the borrower to pay an amount to the holder of the debt interest, at least equal to the issue price, in the future.

The amendments provide that debt interests that are non-equity shares will be eligible for interest withholding tax exemption. A debt interest may also qualify for exemption where it is prescribed by regulation. The inclusion of the regulation-making power with respect to debt interests is to allow hybrid instruments (not yet developed) to qualify for interest withholding tax exemption provided that they have a capital raising role that is similar to eligible debentures and debt interests.

Debentures issued by certain unit trusts

The interest withholding tax exemption will also be restricted to debentures and debt interests that are non-equity shares or are debt interests prescribed by regulation issued by unit trusts that are taxed as companies. A public unit trust is a unit trust that is listed for quotation on a stock exchange, is offered to the public or is held by 50 or more persons.

Date of effect

The amendments which seek to limit eligible debt interests to debt interests that are prescribed by regulations will apply to debt interests that are issued on or after the day on which the Bill was introduced into the House of Representatives (7 December 2006).

The amendments in relation to the regulation-making powers will have effect from the date of Royal Assent.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.