Funding costs on certain capital instruments will be tax
deductible under reforms announced in the Federal
Under the accelerated implementation timeframe previously
announced by the Australian Prudential Regulatory Authority, the
Basel III capital reforms applicable to authorised deposit-taking
institutions will progressively come into effect from 1 January
2013. These reforms aim to increase the amount and quality of
capital held by ADIs. The government has now confirmed that, on
commencement of the Basel III reforms, certain capital instruments
issued by ADIs under the reforms will be treated as debt rather
than equity for income tax purposes, thereby allowing the funding
costs of those instruments to be tax deductible.
The government has indicated that the change will apply to
certain Tier 2 regulatory capital instruments issued by ADIs and
other similar entities regulated by APRA. The change should apply
to Tier 2 subordinated debt which, under the non-viability
requirements to be applied by APRA, may be required to be
written-off or converted to equity if APRA makes such a
determination. Without the change, these instruments would be
considered to be equity under current tax law for income tax
purposes and their funding costs would not be deductible.
The market has seen a flurry of bank subordinated debt issuance.
This clarification may encourage further issuance of that type, as
the tax treatment of these capital instruments was left open
following APRA's Response to Submissions: Implementing Basel
III capital reforms in Australia (30 March 2012).
Limited recourse debt - amended definition
The government has also stated that it will amend the definition
of "limited recourse debt" for the purposes of
Australia's taxation legislation. The amendments will clarify
that "limited recourse debt" includes arrangements where
the creditor's right to recover the debt is effectively limited
to the financed asset or property over which security is provided
for the debt.
The government's rationale for making the amendment is
to ensure that tax deductions are only available for capital
expenditure on assets that have been financed by limited recourse
debt where the relevant taxpayer is effectively at risk for the
expenditure and makes an economic loss.
The amendment clarifies the intent behind the phrase and moves
away from the decision in Commissioner of Taxation v BHP Billiton
Limited  HCA 17 (1 June 2011), in which the High Court
expounded a narrow view of the phrase "limited recourse
debt", as defined in section 243-20 of the Income Tax
Assessment Act 1997. The amendment is relevant to a wide range of
project, infrastructure and other asset or structured financings
where the debt is secured solely against the financed asset,
commodity or project company and may encourage financiers to expand
capex financing, rather than turning to export credit agencies for
the financing of that type of expenditure.
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.
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