Private ruling: Obligation to withhold tax from interest payments
Published: July 2012
Ruling period: XX/XX/XXXX to XX/XX/XXXX
Date scheme commenced: XX/XX/XXXX

Ruling: Q1: Is Company B required to withhold tax from interest payments to a Limited Liability Company ('LLC') pursuant to section 12-245 of Schedule 1 to the Taxation Administration Act 1953 ('TAA') where LLC is treated as a partnership under section 830-15 of the Income Tax Assessment Act 1997 ('ITAA 1997') and LLC's partners are Australian residents? | A1: No

Relevant facts and circumstances: Background of the company Company B is an Australian resident and the ultimate head of the Company B tax consolidated group. Company B will be assigned an asset of $XXX in return for issuing debt of $XXX. Existing arrangement Under the existing arrangement, $XXX was sourced from third party investors through a structure comprising of an Australian resident trust, the Company B Trust. The existing arrangement is as follows: · On XX/XX/XXXX, the Company B Trust was settled with the issue of a single ordinary unit with a face value of $XXX. Company B paid $XXX to the Trustee of the Company B Trust. The Company B Trust is a unit trust listed on the Australian Stock Exchange and is a public unit trust. · On XX/XX/XXXX, further units in the Company B Trust were issued to the value of $XXX. As part of the existing financing structure, a limited liability company, LLC was established under Delaware law in the United States of America. LLC is treated as transparent for United State tax purposes and has a registered office to comply with Delaware law. The registered office is at XXX which are the premises of a third party service provider. LLC's sole asset comprises a $XXX interest bearing loan to Company B. The nature of the asset is such that no active management of the asset is required. The LLC has no employees and does not own or rent any offices. As of XX/XX/XXXX, LLC has a single director. The Applicant states that the activities of the director are expected to be limited to determining whether the interest income of LLC should be distributed on the preference shares (held by the Company B Trust) or the ordinary share (held by Company B) and any other stewardship activities and directors meetings are accordingly expected to be infrequent. The Applicant states that LLC should not be considered to be carrying on business outside of Australia through a permanent establishment. The Applicant states that LLC is a foreign hybrid company pursuant to subsection 830-15(1) of the ITAA 1997. After LLC was established the Company B Trust used the $XXX proceeds to subscribe for one class of shares in LLC ('LLC Preference Shares'). LLC then used the $XXX to subscribe for subordinated loan notes ('the Notes') issued by Company C. Company C is an indirect wholly owned subsidiary of Company B. Company C used the $XXX proceeds to retire existing debt. Under the arrangement: · Company C pays interest on the Notes to LLC. · LLC receives interest income from Company C and may distribute that income as either dividends on the LLC Preference Shares or LLC Common Shares to the Company B Trust and Company B respectively. · LLC Preference Share dividends received by the Company B Trust would vest in the unit holders of the Company B Trust who would have a present entitlement to this income under the terms of the Company B Trust Deed. · Company B may then receive LLC Common Share dividends from LLC. Proposed arrangement For commercial and treasury reasons, the Company B group has proposed to restructure the Notes which are currently held by LLC that were issued by Company C. Under the proposed arrangement, prior to XX/XX/XXXX, the Notes will be sold to Company B ('the Sale'). The Sale is proposed as follows: · LLC will sell the Notes to Company B and Company B will issue New Subordinated Notes to LLC as consideration for the purchase of the Notes. The New Subordinated Notes will have an aggregate principal face value of $XXX. · Company B will then contribute the Notes to its wholly owned subsidiary in return for equity which will then use the Notes to settle other existing intercompany balances with Company C and contribute the remaining Notes to Company C in return for equity in Company C. The notes will accordingly cease to exist. As a result of the new arrangement: LLC will receive interest income from Company B. LLC will distribute the interest income as dividends at its discretion on either the LLC Common Shares or the LLC Preference Shares. As Company B holds all the voting control in LLC, Company B controls who receives the dividend distributions and may in the short term cause dividends to be paid only on the LLC Common Shares. Company B Company B will pay interest to LLC. Company B may receive dividends from LLC on the LLC Common Shares that it holds. Company B is expected to, or may, receive dividend income from Company C after the Sale. Company B Trust The Company B Trust may receive dividends from LLC on the LLC Preference Shares that it holds.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 128B, | Income Tax Assessment Act 1936 subsection 128B(2), | Income Tax Assessment Act 1936 subsection 128B(2A), | Income Tax Assessment Act 1936 subsection 128B(5), | Income Tax Assessment Act 1936 subparagraph 128B(2)(b)(i), | Income Tax Assessment Act 1936 Division 830, | Income Tax Assessment Act 1997 section 830-1, | Income Tax Assessment Act 1997 section 830-20, | Income Tax Assessment Act 1997 section 830-15, | Income Tax Assessment Act 1997 subsection 830-15(1), | Income Tax Assessment Act 1997 section 830-20, | Income Tax Assessment Act 1997 section 830-25, | Income Tax Assessment Act 1997 section 830-30, | Income Tax Assessment Act 1997 section 995-1, | Taxation Administration Act 1953 Subdivision 12-F of Schedule 1 | Taxation Administration Act 1953 section 12-245 of Schedule 1 and | Taxation Administration Act 1953 section 12-300 of Schedule 1.

Reasons for decision: Summary: Under section 128B of the ITAA 1936 LLC is not liable for withholding tax in relation to interest LLC received from Company B. Consequently, section 12-300 of Schedule 1 to the TAA does not apply to the interest payment. Therefore, Company B has no obligation under section 12-245 of Schedule 1 to the TAA to withhold tax from its interest payments to LLC. | Detailed Reasoning - Obligation to withhold: Section 12-245 of Schedule 1 to the TAA provides that an entity must withhold an amount from interest that it pays to an entity if any of the recipients have an address outside of Australia. Section 12-245 of Schedule 1 to the TAA 1953 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 12-300 of Schedule 1 to the TAA provides Subdivision 12-F of the TAA (including section 12-245 of Schedule 1 to the TAA) does not require an entity to withhold from interest if no withholding tax is payable in respect of the interest. | Detailed Reasoning - Liability for withholding tax: Liability for withholding tax is covered by section 128B of the ITAA 1936. In relation to interest income, subsection 128B(5) of the ITAA 1936 states: A person who derives income to which this section applies that consists of interest is, subject to subsections (6) and (7), liable to pay income tax upon that income at the rate declared by Parliament in respect of income to which this subsection applies. Subparagraph 128B(2)(b)(i) of the ITAA 1936 states that section 128B of the ITAA 1936 will apply to income derived by a non-resident that consists of interest and that interest: is paid to the non-resident by a person to whom this section applies and is not an outgoing incurred by that person in carrying on business in a country outside Australia at or through a permanent establishment of that person in Australia. Subsection 12B(2A) of the ITAA 1936 provides: Subject to subsection (3), where income: (a) is, or has, after 2 July 1973, been, derived, or derived in part, by a person to whom this section applies in carrying on business in a country outside Australia at or through a permanent establishment of the person in that country; and (b) consists of interest that: (i) is or has been paid to the person by another person to whom this section applies and is not an outgoing wholly incurred by that other person in carrying on business in a country outside Australia at or through a permanent establishment of that other person in that country; or (ii) is or has been paid to the first-mentioned person by a person who is, or by persons each of whom is, not a resident and is, or is in part, an outgoing incurred by that last-mentioned person or those last-mentioned persons in carrying on business in Australia at or through a permanent establishment of that last-mentioned person or those last-mentioned persons in Australia; this section also applies to that income or to the part of that income so derived, as the case may be. In the facts provided, the Applicant states that the LLC is not considered to be carrying on business outside of Australia through a permanent establishment. Therefore, subsection 128B(2A) of the ITAA 1936 does not apply to the interest payment from Company B to LLC. A requirement of subparagraph 128B(2)(b)(i) of the ITAA 1936 is that the interest is derived by a non-resident. There are no other provisions of section 128B of the ITAA 1936 that could result in LLC being liable for income tax under section 128B of the ITAA 1936 for income tax on the interest payment unless the interest is derived by a non-resident. | Detailed Reasoning - Division 830 ITAA 1997: Foreign Hybrids: Division 830 of the ITAA 1997 provides for foreign hybrids, which would otherwise be treated as companies for Australian income tax purposes, are to be treated as partnerships for the purposes of the Acts (section 830-1 of the ITAA 1997). The Applicant advises that LLC has satisfied the requirements to be a foreign hybrid company pursuant to subsection 830-15(1) of the ITAA 1997. Section 830-20 of the ITAA 1936 states: If a company is a foreign hybrid company in relation to an income year, the foreign hybrid tax provisions apply as if the company were a partnership, and for that purpose the following provisions of this Subdivision have effect. Subsection 995-1(1) of the ITAA 1997 defines 'foreign hybrid tax provisions' to include all of the ITAA 1936 except for Division 5A of Part III which relates to income of certain limited partnerships. Section 830-25 of the ITAA 1997 states: The partners in the partnership are the shareholders in the company. Division 830 of the ITAA 1997 was introduced by the Taxation Laws Amendment Bill (No. 1) 2004. The Explanatory Memorandum to that Bill explains the effect of subsection 830-25 of the ITAA 1997 as follows: 9.41 A reference in the income tax law to a partner in a partnership includes a reference to a shareholder in a foreign hybrid company. Based on the broad meaning of 'share' in the ITAA 1997, shareholder includes a member of a US LLC. Apart from a company listed in the regulations, a US LLC is the only type of company that can qualify as a foreign hybrid company. A US LLC is owned by its members and may not in fact issue shares. However, the members are equivalent to stockholders of a corporation. Such an interest-holder will fall within the definition of a 'shareholder' and be treated as partners in a partnership. A partnership is defined in subsection 995-1(1) of the ITTA 1997 as: (a) an association of persons (other than a company or a limited partnership) carrying on a business as partners or in receipt of 'ordinary income or statutory income jointly; or (b) a limited partnership Subsection 995-1(1) of the ITAA 1997 treats partnerships as an association of persons carrying on business or receiving income jointly. Consequently, when a partnership is paid or derives income under the tax legislation it is treated as if the income is paid to or derived by the partners jointly. In relation to foreign hybrid companies, section 830-30 of the ITAA 1997 explains the meaning of 'the individual interest of the partner in the net income of the partnership' in terms of the percentage that the partner could expect to receive if the profits of the foreign hybrid company were distributed. Section 830-30 states: The individual interest of a partner in the net income or partnership loss of the partnership of the income year is equal to the percentage that, if the profits of the company for the income year were distributed at the end of the income year to its shareholders: (a) if paragraph (b) does not apply - as dividends; or (b) if the company's constitution or other rules provide for the distribution of profits other than as dividends - in accordance with the constitution or those rules; the partner, as a shareholder, could reasonably be expected to receive of the total distribution. Through its common share voting and management rights, Company B controls who receives the dividend distributions of LLC and may in the short term cause dividends to be paid only on the LLC Common Shares, that is, only to Company Bas the holder of the LLC Common Shares. Hence the entities which will have an interest in the net income of LLC, and be treated as deriving the interest received by LLC, will be both Company B and the Company B Trust, or only Company B. | Detailed Reasoning - Interaction between Division 830 and section 128B of the ITAA 1936: In relation to interest, section 128B of the ITAA 1936 applies only where the interest is derived by a non-resident of Australia. Section 830-20 of the ITAA 1997 states: If a company is a foreign hybrid company in relation to an income year, the foreign hybrid tax provisions apply as if the company were a partnership, and for that purpose the following provisions of this Subdivision have effect. Paragraph 128B(2)(i) of the ITAA 1936 concerns income 'paid to the non-resident'. Although LLC is a company, it is a foreign hybrid and pursuant to section 830-20 of the ITAA 1997 section 128B applies to LLC as if it were a partnership. Therefore, interest paid to LLC is treated as paid to or derived by the partners of the partnership as established above. As the interest paid by Company B to LLC will be treated as if it was derived by Company B or by Company B and the Company B Trust, both residents of Australia, there is no liability for withholding tax on the interest under section 128B of the ITAA 1936. Section 12-300 of Schedule 1 to the TAA has the effect that an entity is not required to withhold from interest if no withholding tax is payable in respect of the interest. This means that Company B is not required to withhold from the interest it pays to LLC. However, it should be noted that the interest income may be assessable under other provisions of the ITAA 1936 or the ITAA 1997. Consequently, section 12-300 of Schedule 1 to the TAA does not apply to the interest paid by Company B as there is no withholding payable under section 128B of the ITAA 1936. Therefore, Company B is not obligated under section 12-245 of Schedule 1 to the TAA to withhold from its interest payments to LLC.

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