Key Points

  • Only debentures, non-equity shares, syndicated loans and certain instruments prescribed by regulations will be eligible for the interest tax withholding exemption.

  • Debt instruments must be carefully drafted to ensure they fall within the exemption.

The types of financial instruments eligible for the exemption from interest withholding tax ("IWT") have been significantly narrowed by the passage of a new Act - and the changes will apply to debt instruments issued on or after 7 December 2006, making them retrospective.

On 21 June 2007, the Tax Laws Amendment (2007 Measures No 3) Act 2007 ("No.3 Act") was enacted as Act No. 79 of 2007. Under the No. 3 Act, only debentures, non-equity shares, syndicated loans and certain instruments prescribed by regulations will be eligible for the interest tax withholding exemption.

Although the enacted changes limit the scope of the IWT exemption for publicly-offered debt instruments, many common forms of publicly-offered debt, such as syndicated loan facilities, are still eligible. On the other hand, the Act introduces new requirements for drafting, so unless debt instruments are carefully drafted they might not attract the exemption.

How does the exemption work - and what's changing?

Currently, the ITAA 1936 provides that IWT is imposed at a rate of 10 percent on the gross amount of interest paid or credited by an Australian borrower to a non-resident lender or to an Australian lender operating through an offshore permanent establishment. Where an Australian resident company, or a non-resident company carrying on a business through a permanent establishment in Australia, issues a debenture or a debt interest and the issue satisfies the "public offer test", the interest is exempt from IWT. A similar exemption is available for certain unit trusts.

Legislative amendments in 2005 allowed the IWT exemption to be potentially available to all debt interests, not just debentures. The current changes were in part motivated by requests made to the Australian Taxation Office seeking exemption from withholding tax on widely offered retail bank deposits. Although such offers may have literally met the revised public offer test, they were considered to be outside the policy intent.

To narrow the 2005 expansion, the No. 3 Act provides that now only four categories of financial instruments are eligible for the IWT exemption:

  • debentures

  • non-equity shares

  • syndicated loans and

  • other instruments to be prescribed by regulation.

Debentures

The definition of "debenture" is unchanged: for the purposes of the ITAA 1936 it includes debenture stock, bonds, notes and any other securities in a company, whether constituting a charge on the assets of the company or not. Many debentures are issued in a form known as a global note, global bond or global certificate (global securities).

Non-equity shares

A "non-equity share" is a share in a company which has the legal form of equity but is characterised for tax purposes as debt based on economic substance. Accordingly, a dividend paid on the share is treated as interest and is therefore potentially subject to IWT.

Syndicated loans - new requirements

Syndicated loans were included within the IWT exemption based on the belief that this form of loan is a less costly substitute for debenture issues and important in securing large scale infrastructure capital, acquisitions and other major financings. A "syndicated loan" is defined as a loan or other form of financial accommodation that is provided under a syndicated loan facility with two or more lenders.

Further, the borrower or borrowers must have access to at least $100 million (or other amount prescribed by regulation) at the first time the loan or other form of financial accommodation is to be provided under the agreement. Where the facility has two or more borrowers, all of the borrowers must be members of the same wholly-owned group, parties to the same joint venture agreement or associates of one another. This will impact on the practice of "clubbing" where unrelated borrowers take less than $100 million each.

"Financial accommodation"

"Financial accommodation" is a financial benefit, or assistance to obtain a financial benefit, that is commonly provided by the market in lieu of a standard loan where the payments would normally be considered to be in the nature of interest. In addition to the usual advances of money, a financial accommodation can include issuing, endorsing or otherwise dealing in promissory notes, bills of exchange or securities. A fee for a bill acceptance facility would generally be considered to be in the nature of interest and so may be considered eligible for the application of the IWT exemption to syndicated loans.

"Syndicated loan facility"

A written agreement is a "syndicated loan facility" where the agreement describes itself as a syndicated loan facility or syndicated facility agreement. The purpose of this self-description requirement is to take advantage of the fact that market expectations should deter an agreement that is not truly a syndicated loan facility from describing itself as such.

If an agreement does not describe itself as a syndicated loan facility but is later amended to include this description, the public offer test must be satisfied at the time of the amendment. Any earlier purported satisfaction of the public offer test will be disregarded.

A modified public offer test applies to the invitation to become a lender under the relevant syndicated loan facility, as opposed to the specific syndicated loan.

"Two or more lenders"

The two or more lenders requirement means that if there is a period where there is only one lender under the syndicated loan facility, the loan or financial accommodation will not qualify as a syndicated loan. Under the agreement, each lender must agree to severally, but not jointly, lend money or otherwise provide financial accommodation to the borrower(s).

The two or more lenders requirement is satisfied where the agreement is between one or more borrowers and one lender but the agreement provides for the addition of additional lenders. Although the public offer test may be satisfied by the offer of the facility with only one lender, the interest is not eligible for the IWT exemption until there are at least two lenders.

This concession was designed to accommodate agreements between a borrower and a lender who acts as an arranger and seeks out other lenders to become party to the agreement, or other form of syndication. Additional lenders must be added on a several and not joint basis. The $100 million threshold still applies in the case of an initial single lender.

A change in lenders, eg. due to a novation, does not result in a requirement to re-satisfy the public offer test even though legally there may be a new agreement.

$100 million threshold

There are two key aspects to a "syndicated loan facility".

First, an agreement must enable the borrower to draw down at least $100 million in Australian dollars, or the equivalent amount in foreign currency where the loan is expressed in foreign currency, at the time the loan or other financial accommodation is initially provided.

For example, if a facility permits a borrower to access $200 million at the time the first draw down is made but the borrower in fact only draws down $50 million, the $100 million threshold is still satisfied. In contrast, a facility that permits the borrower to repeatedly draw down amounts no greater than $50 million will not qualify even though the borrower may ultimately borrow an amount greater than $100 million through successive draw-downs and repayments.

Secondly, the $100 million threshold is applied at the first time the borrower has access to the funds. Thus, if a facility permits an initial $300 million drawdown but the amount available in later years drops below $100 million, the $100 million requirement is still satisfied.

This threshold is not set in stone; if market practice suggests the $100 million threshold is not appropriate, the Government will change it.

Other instruments prescribed by regulation

This regulatory power is anticipated to be used only to prescribe financial instruments that are close substitutes for debentures. A relevant factor in deciding whether to prescribe a particular financial instrument will be the extent to which denial of an IWT exemption would limit access to capital for Australian borrowers.

Effective date of changes

The amendments take effect for debt instruments issued on or after 7 December 2006, notwithstanding that for the period to 10 May 2007 the specific requirements of the enacted legislation were unknown. Thus, interest on a syndicated loan issued past 7 December 2006 which has been offered in accordance with the current public offer requirements will not be exempt if the loan document does not describe itself as a syndicated loan.

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.