On 11 May 2010, the Australian Federal Government announced as part of the Budget that it will phase down Australian interest withholding tax arising in respect of interest paid by financial institutions on certain offshore borrowings, with effect from the 2013-14 income year, a move that presents some opportunities, challenges and uncertainties for debt capital raisings by financial institutions operating in Australia.
The phasing down of Australian interest withholding tax on borrowings by financial institutions is intended to support banking competition by allowing non-major banks to access cheaper funding, put downward pressure on interest rate margins and further the Government's objective of developing Australia as a leading regional financial centre.
What prompted the phase down?
The measures respond to certain recommendations contained in the Australian Financial Centre Forum's report - Australia as a Financial Centre: Building on our strengths of November 2009 (the Johnson Report) and the Henry Tax Review.
The Government recognises that where Australian interest withholding tax applies, it may be passed on to Australian borrowers through higher interest rates and may also bias the funding choices of financial institutions.
The changes will not apply to Australian businesses that are not financial institutions. They will still need to comply with the requirements of the existing section 128F exemption for publicly offered debentures and syndicated loans if interest on those borrowings is to be exempt from withholding tax. An exemption may also be available under certain tax treaties.
What did the Johnson Report and the Henry Tax Review say about Australian interest withholding tax?
In the Johnson Report, the Australian Financial Centre Forum recommended the abolition of Australian interest withholding tax in the following areas:
- Removal of Australian interest withholding tax on interest paid on foreign-raised funding by Australian banks, including offshore deposits and deposits in Australia by non-residents.
- Removal of Australian interest withholding tax on interest paid to foreign banks by their Australian branches.
- Removal of Australian interest withholding tax on financial institutions' related party borrowings.
The Henry Tax Review recommended that:
- Financial institutions operating in Australia should generally not be subject to Australian interest withholding tax on interest paid to non-residents (Recommendation 33).
- Consideration should be given to negotiating, in future tax treaties or amendments to treaties, a reduction in Australian interest withholding tax to zero so long as there are appropriate safeguards to limit tax avoidance (Recommendation 34).
Although similar to the Johnson Report, the Henry Tax Review recommendations perhaps go one step further as they do not appear to be confined to related party borrowings by financial institutions.
The Government's response in the Budget
The Federal Government announced the phasing down the Australian interest withholding tax rates applying to:
- the borrowings of local financial institutions from their overseas parents, from 10% to 7.5% in 2013-14 and to 5% from 2014-15, with an aspirational target of zero;
- the borrowings by any Australian branch of a foreign bank from its overseas head office, from the 5% to 2.5% in 2013-14 and to zero from 2014-15; and
- any financial institution that borrows offshore retail deposits which they on-lend in Australia, from 10% to 7.5% in 2013-14 and to 5% from 2014-15, with an aspirational target of zero.
As an integrity measure, the phase down will not apply to interest paid on non-resident retail deposits held in Australia.
How the phase down will work
The types of borrowings to which the phase down will apply and the expected implementation dates are:
|Type of borrowing||Current IWT||Future IWT|
|From 2013-14||From 2014-15|
|Financial institution borrows from a related foreign financial institution (where a treaty exemption is not available)||10%||7.5%||
Aspirational target to zero
|Australian branch of a foreign bank borrows from its overseas head office||5%||2.5%||Exempt|
|Financial institution borrows from offshore retail deposits (where the proceeds are used and traced to Australian operations)||10%||7.5%||
Aspirational target of zero
|Financial institution borrows through a publicly offered debenture issue, non-equity share or syndicated loan||Exempt||Exempt||Exempt|
|Offshore banking unit (borrows and on-lends offshore)||Exempt||Exempt||Exempt|
|Financial institution borrows from non-resident retail deposits in Australia||10%||10%||10%|
What does this mean for financial institutions operating in Australia?
Financial institutions operating in Australia should be mindful of the following opportunities, challenges and uncertainties in relation to the proposed phase down of Australian interest withholding tax:
- The announced measures will not apply until the 2013-14 income year.
- Not all offshore borrowings of financial institutions from a foreign financial institution will enjoy the benefit of the reduced rates from 2013-14 - only related party borrowings from foreign financial institutions. (However, non-related party borrowings may benefit from a tax treaty exemption.)
- It is yet to be seen what is meant by offshore retail deposits the proceeds of which are used and traced to Australian operations.
- The "aspirational" targets of zero are indicated for all borrowings with the exception of financial borrowings from non-resident retail deposits held in Australia.
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.