Taxpayer Alert TA 2007/3: Income Tax: Foreign tax credit enhanced return bond investment.
Date of issue: 14 May 2007
Status: Current


Description: This alert applies to arrangements generally marketed to financial institutions that exhibit some or all of the following elements: 1. An Australian resident taxpayer (the taxpayer) establishes a wholly owned limited liability company (LLC) in an offshore jurisdiction. 2. The LLC is treated on a flow-through basis for the purposes of tax in the foreign jurisdiction and is treated as a foreign hybrid for Australian tax purposes. 3. The LLC acquires bonds (or similar instruments) issued in the United Kingdom (UK) by a UK financial institution ('the Issuer'). 4. The bonds offer an enhanced return over those of a similar grade of issuer. 5. The payment of interest on the bonds is claimed by the issuer to attract UK withholding tax at the rate applicable. 6. A securities lending arrangement is put in place within the Issuer's group that is claimed by that group to create a credit known as a 'reverse charge' tax credit. That credit is equal to the amount of the UK withholding tax liable to be paid under UK tax law. 7. A foreign tax credit is claimed by the taxpayer for the amount of UK withholding tax paid. 8. The foreign tax credit exceeds the Australian income tax payable on the net interest income from the arrangement. 9. This excess is claimed to be available for use to reduce Australian tax payable on other foreign sourced income of the taxpayer. 10. The effect of this arrangement is that the taxpayer is provided with an enhanced return funded not by the issuer but through the availability of the foreign tax credits. | 1. An Australian resident taxpayer (the taxpayer) establishes a wholly owned limited liability company (LLC) in an offshore jurisdiction. 2. The LLC is treated on a flow-through basis for the purposes of tax in the foreign jurisdiction and is treated as a foreign hybrid for Australian tax purposes. 3. The LLC acquires bonds (or similar instruments) issued in the United Kingdom (UK) by a UK financial institution ('the Issuer'). 4. The bonds offer an enhanced return over those of a similar grade of issuer. 5. The payment of interest on the bonds is claimed by the issuer to attract UK withholding tax at the rate applicable. 6. A securities lending arrangement is put in place within the Issuer's group that is claimed by that group to create a credit known as a 'reverse charge' tax credit. That credit is equal to the amount of the UK withholding tax liable to be paid under UK tax law. 7. A foreign tax credit is claimed by the taxpayer for the amount of UK withholding tax paid. 8. The foreign tax credit exceeds the Australian income tax payable on the net interest income from the arrangement. 9. This excess is claimed to be available for use to reduce Australian tax payable on other foreign sourced income of the taxpayer. 10. The effect of this arrangement is that the taxpayer is provided with an enhanced return funded not by the issuer but through the availability of the foreign tax credits. | DIAGRAM | FEATURES WHICH THE TAX OFFICE CONSIDERS GIVE RISE TO TAXATION ISSUES | The Tax Office considers that an arrangement of this type gives rise to taxation issues that include whether: (a) the withholding tax paid in the UK on the interest received by the LLC was paid 'in accordance with this convention' for the purposes of Article 22(1) of the 2003 UK Convention and Notes in Schedule 1 of the International Tax Agreements Act 1953 (UK Convention); (b) under Article 22(1) of the UK Convention and Division 18 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) a credit against Australian tax is to be allowed to the taxpayer in respect of the withholding tax paid in the UK; and (c) the general anti-avoidance provisions in Part IVA of the ITAA 1936 apply. | (a) the withholding tax paid in the UK on the interest received by the LLC was paid 'in accordance with this convention' for the purposes of Article 22(1) of the 2003 UK Convention and Notes in Schedule 1 of the International Tax Agreements Act 1953 (UK Convention); (b) under Article 22(1) of the UK Convention and Division 18 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) a credit against Australian tax is to be allowed to the taxpayer in respect of the withholding tax paid in the UK; and (c) the general anti-avoidance provisions in Part IVA of the ITAA 1936 apply. | The Australian Taxation Office is examining these arrangements. | Date of Issue: 14 May 2007 | Date of Effect: 14 May 2007 | Related Practice Statements: PS LA 2005/13 - Taxpayer Alerts | Subject References: foreign tax credits foreign hybrid international tax withholding tax | Legislative References: International Tax Agreements Act 1953 Article 22 of the 2003 UK Convention and Notes in Schedule 1 Income Tax Assessment Act 1936 Division 18 of Part III Part IVA | Contact Officer: Marie Seneviratne Business Line: Large Business & International Section: Financial Services Industry Group Phone: 03 9946 9100





Related documents: PS LA 2005/13 - Taxpayer Alerts | Part IVA

This Taxpayer Alert describes an arrangement where an Australian resident taxpayer seeks to enhance its return on a bond investment, through access to foreign tax credits for withholding tax claimed to be payable under the arrangement. The desired net effect of the arrangement is that neither the bond issuer group, nor the Australian resident taxpayer, bears the economic cost of the tax withheld.