Private ruling: Interest withholding tax
Published: June 2012
Ruling period: 30 April 2009 to 30 April 2013
Date scheme commenced: 30 April 2009

Ruling: Q1: Will the issuer of a deferred purchase agreement (DPA) be required to withhold tax from amounts it pays to a non-resident investor under section 12-245 of Schedule 1 to the Taxation Administration Act 1953 (TAA)? | A1: Yes.

Relevant facts and circumstances: A financial institution issued a DPA. The issue price of each unit in the DPA was $1. The final value of each unit at maturity will be $1 The DPA is 100% capital protected where investments are held to the maturity date, and no early maturity event occurs. The term of the investment is 4 years. At maturity the investor will receive ASX quoted shares equal in value to the initial investment amount. The issuer will hold only 0.00X (the 'Portion') of each share from the issue date until maturity and will be entitled to retain any distributions and voting power. The investor has an equitable interest only in the Portion held by the issuer. The investor can choose to take either physical delivery of the shares or receive the sale proceeds of the shares in cash. Interest rate payments are made every quarter over the full 4 years of the investment. In the first year the interest rate payments are fixed at a commercial rate of interest and based on the initial investment amount. In the second to fourth years the interest rate payments are made with reference to the 3 month bank bill swap rate plus a margin (determined by the issuer) and based on the initial investment amount. The issuer has the right, at the issuer's absolute discretion, to declare a call event on any call event observation date. If a call event occurs on any call event observation date, the maturity date will be deemed to be the call event observation date on which the call event occurs. The final value of each unit on the new maturity date will be $X. The investor may request to terminate their investment before the maturity date, however the issuer may in its absolute discretion, accept or reject the investor's request. If the issuer accepts it may either follow the normal maturity process, or may choose to pay a refund. If the investor requests early maturity they may receive an amount less than the initial investment amount.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 11A | Income Tax Assessment Act 1936 Subsection 128A(1AB) | Taxation Administration Act 1953 Schedule 1 Section 12-245

Reasons for decision: Summary: Section 12-245 in Sch 1 of the TAA provides that an entity must withhold an amount from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)) it pays to an entity or to entities jointly, if: · 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 · 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). The definition of interest under s 128A (1AB) in Division 11A of the ITAA 1936 includes amounts: · that are in the nature of interest; or · to the extent that they could reasonably be regarded as having been converted into a form that is in substitution for interest; or · to the extent that it could reasonably be regarded as having been received in exchange for interest in connection with a washing arrangement; · that are dividends paid in respect of a non-equity share; or · payments made in respect of banks' Upper Tier 2 capital for which regulations have been made. Upper Tier-2 capital includes asset revaluation reserves, provisions for doubtful debts and certain APRA-approved hybrid capital instruments. Although 'interest' in the withholding tax context is given an expanded definition by virtue of s 128A(1AB) the term itself in not defined in Division 11A. Halsbury's Laws of England, 4th Edition, Volume 32, paragraph 106, states that 'Interest is the return or compensation for the use or retention by one person of a sum of money belonging to or owed to another ....'. It cites the following cases in support of this proposition: Re Farm Security Act 1944 [1947] SCR 394 at 411; Dunn Trust Ltd v. Feetham [1936] 1 KB 22, CA; Bennett v. Ogston (Inspector of Taxes) (1930) 15 TC 374; Bond v. Barrow Haematite Steel Co [1902] 1 Ch 353; and Riches v. Westminster Bank Ltd [1947] AC 390, [1947] 1 All ER 469, HL. Interest was described by Rowlatt J in Bennett v. Ogston (Inspector of Taxes) (1930) 15 TC 374 at 379 as being a 'payment by time for the use of money'. It has been said that this 'definition' highlights the two requirements which must normally be satisfied for a payment to amount to interest, namely: · there must be a sum of money by reference to which the payment is to be ascertained (which might loosely be called the principal sum or the principal debt); and · that sum must be a sum which is due to the person entitled to the interest, unless the right to the interest has been assigned to a third party. ("Interest", King J.C., Taxation in Australia, Vol. XV, No. 1, July 1980 at p.3). Interest is a charge for the use or enjoyment of the principal sum for a fixed period of time because a loan is ephemeral in nature. In Australian National Hotels Limited v. FC of T 88 ATC 4627; (1988) 19 ATR 1575 at 1582 (Australian National Hotels), Bowen CJ and Burchett J said at 4633: 'If the capital is raised by loan, an investment of the borrowed moneys in a business will ordinarily remain an investment of capital, and the same consequences will follow. But there is a special feature of loan capital, which flows from the ephemeral nature of a loan ...' This passage was referred to with approval by the High Court in Steele v. FCT 99 ATC 4242 at 4248; (1999) 41 ATR 139 at 148 (' Steele '). Gleeson CJ, Gaudron and Gummow JJ described the character of interest as being a recurrent payment to secure the use for a limited term of loan funds: 'As was explained in Australian National Hotels Ltd v. FCT, interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of borrowed money during the term of the loan. A debt is moneys outstanding to be repaid at a fixed or determinable time or on demand: 'Chitty on Contracts', 27th ed. 1994, para 36-202. One feature of a loan therefore is the use of the funds for a temporary period. Another feature of a loan is the requirement to repay those funds at the end of that period or on demand. In FC of T v. Radilo Enterprises Pty Ltd 97 ATC 4151 at 4161; (1997) 34 ATR 635 at 646 (Radilo) the joint judgment of Lehane and Sackville JJ refers to Dr Pannam's description of a loan of money: 'A loan of money may be defined, in general terms, as a simple contract whereby one person ('the lender') pays or agrees to pay a sum of money in consideration of a promise by another person ('the borrower') to repay the money upon demand or at a fixed date. The promise of repayment may or may not be coupled with a promise to pay interest on the money so paid. The essence of the transaction is the promise of repayment. As Lowe J put it in a judgment delivered on behalf of himself and Gavan Duffy and Martin JJ: "Lend" in its ordinary meaning in our view imports an obligation on the borrower to repay." [Ferguson v. O'Neill [1943] VLR 30, at 32.] Without that promise, for example, the old indebitatus count of money lent would not lay. Repayment is the ingredient which links together the definitions of 'loan' to be found in the Oxford English Dictionary, the various legal dictionaries and the text books. In essence then a loan is a payment of money to or for someone on the condition that it will be repaid. CL Pannam, The Law of Money Lenders in Australia and New Zealand (1964) at 6. See also Brick and Pipe Industries Ltd v. Occidental Life Nominees Pty Ltd (1991) 9 ACLC 324, at 357-358; [1992] 2 VR 279, at 321-323, per Ormiston J.' A debt instrument generally gives the holder the right to sue for recovery of the principal sum in debt if the issuer fails to make the scheduled payment: see Charles E. Curry 43 TC 667, 686 16 (1965); Luden's Inc. v United States 196 F. Supp 526, 633 (E.D Pa. 1961). From the case law it is possible to draw the following conclusions regarding interest: · there is generally a relationship of debtor and creditor; · interest must be calculated with reference to a sum of money; · interest is payable for the use of money and is in the nature of compensation for deprivation of use of money; and · interest accrues over time. Common features of a DPA warrant are outlined in Taxation Determination TD 2008/21, which states: A DPA warrant is a listed or unlisted, transferable or non-transferable retail investment product offered by financial institutions with the following features: · an investor enters into an agreement to purchase a number of assets (Delivery Assets) from the issuer; · the value and number of Delivery Assets is determined at a specified future date (Maturity Date), typically 3 to 5 years after the date of contract; Delivery Assets comprise a number of a nominated security, which is typically a share or unit listed on the Australian Securities Exchange (ASX); · the number and value of securities that is delivered to the investor is dependant on the performance of a nominated share market index or basket of indices (Reference Indices) from the date of contract until the Maturity Date; · soon after the Maturity Date, the issuer satisfies its obligations under a DPA warrant by effecting a transfer of the Delivery Assets to the investor; · the value of the Delivery Assets is based on the DPA warrant's 'Maturity Value'; · the Maturity Value is worked out by increasing or decreasing the investor's initial investment by the percentage change in the performance of the Reference Indices from the date of contract until Maturity Date; and · the number of the securities comprising the Delivery Assets is equal to the Maturity Value divided by the market price per security at the Maturity Date or such later date stipulated in the DPA warrant. A DPA warrant may also have the following features: · a capital guarantee ensuring that at Maturity Date, the Maturity Value will be at least the initial amount invested; · the investor may receive a right under the DPA warrant to receive coupon payments during the investment period (coupon payments are assessable under section 6-5 of the Income Tax Assessment Act 1997 ); and · a facility under which, after taking delivery of the Delivery Assets, the investor can appoint the issuer to sell those assets on the investor's behalf. TD 2008/21 concludes that DPA's exhibiting the above features have insufficient 'debt like' features to constitute a 'security' as defined under section 159GP(1) of the ITAA 1936. With reference to the case law outlined above the following features of the issuer's DPA satisfy the Commissioner that the quarterly interest rates payments made in relation to each unit are payments which are interest for the purposes of Division 11A of the ITAA 1936. For the following reasons the Commissioner considers that specific features of this DPA product make it distinguishable from the terms of TD 2008/21. The maturity value of each unit is not determined by reference to any market rate or indices. Under the terms of the agreement the issue price of each unit was $X and the maturity value of each unit was predetermined to be $X. This provides the basis for the capital protection feature of the product so that in effect the investor is guaranteed to receive back the exact value originally invested. The DPA is also capital guaranteed by another party related to the issuer. On this basis the issuer has a contractual obligation to repay to the investor the exact value of the original investment amount. It is intended under the agreement that the value will be repaid to the investor by way of a transfer of property in the form of a particular ASX quoted share. However where the issuer determines that it is not possible to transfer that particular share, it may substitute any other security quoted and trading on ASX. In addition the investor also has the option to request that the shares are sold on their behalf and have the cash value of the shares and therefore the initial investment amount repaid to them. In this instance the investor is effectively receiving a cash return equivalent to their cash investment. This feature is seen as indicative that although a DPA has been described as an agreement to purchase assets, the investor may not actually be interested in ever taking full ownership of the asset, or necessarily that particular share asset, but interested more in having the value of the initial investment returned to them, one way or another. The term of the arrangement has been set at four years. During this four year period the issuer has full use of the investor's funds and there is no requirement as to how the funds must be spent by the investor. The investor is not obligated to purchase the shares at any specified time prior to the maturity date. It is not possible to determine at the outset what number of shares will eventually be required to be acquired in order to satisfy the maturity value, though a small portion (0.00X) may be held from the outset. The issuer has agreed to make quarterly interest rate payments to the investor in each year. This represents the only return the investor gets on his investment. The interest rate payment is worked out by reference to the initial investment amount contributed by the investor. This is also an indicator tending towards the character of the payment being interest. In the first year a fixed commercial rate of interest on the investment amount was paid, and in the following three years interest is determined by adding a margin to the 3 month bank bill swap rate, the margin is determined by the issuer. These commercial rates of interest also tend towards the character of the payment being interest. With respect to these specific features outlined above the Commissioner is satisfied that the quarterly interest rate payments made under the terms of the DPA are payments which are interest for the purposes of Division 11A of the ITAA 1936.

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