State and territory central borrowing authorities will no longer need to issue their bonds outside of Australia in order to qualify for the exemption in section 128F from interest withholding tax, following the passage last night of the Tax Laws Amendment (2008 Measures No. 5) Act 2008.
The change is expected to allow State and Territory borrowers to be able to consolidate their separate programmes for domestic and global investors and generally improve liquidity and efficiency in the Australian financial markets.
Why The Change To Section 128F Is Needed And How It Will Work
Broadly, Australian interest withholding tax is imposed on the payment of interest or amounts in the nature of interest from Australia to non-residents at a rate of 10 percent, unless an exemption applies. The obligation for collecting (withholding) the interest withholding tax is on the person making the payment.
Under section 128F of the Income Tax Assessment Act 1936, an exemption applies in respect of interest paid in respect of certain "publicly offered" debentures and debt interests, if all prescribed conditions are met.
Prior to 1999, debentures could only qualify for the section 128F interest withholding tax exemption if they were issued outside of Australia. Although this requirement was removed for most borrowers in 1999, this liberalisation was not extended to the state and territory central borrowing authorities.
State and territory central borrowing authorities seeking the benefit of the section 128F exemption have therefore been forced to issue bonds to non-resident investors under offshore programmes, meaning those bonds have been executed and delivered outside of Australia, subject to foreign law and have been administered and maintained in an offshore jurisdiction.
Reflecting their concern that this results in a segmented market and reduced liquidity and efficiency in the Australian financial markets, the Federal Government announced in May it would extend eligibility for the section 128F exemption to domestically issued state and territory government bonds.
Provided all other requirements of the section 128F interest withholding tax exemption are satisfied (including the public offer test), a new section 128F(5B) introduced by the Tax Laws Amendment (2008 Measures No. 5) Act 2008 makes it clear that bonds (including debenture stock and notes) issued by a state or territory central borrowing authority will be eligible for the section 128F exemption, notwithstanding that the bonds have been issued in Australia.
Transitional Issues
The proposed changes are intended to apply to interest paid on or after the date of Royal Assent. This means that the section 128F interest withholding tax exemption may be available from that date in respect of interest paid on bonds already issued by a state or territory central government authority in Australia and held by non-residents, as long as they satisfied the public offer test when they were made.
The proposed legislation however does not make any provision for deeming current bond issues to have satisfied the public offer test, so state and territory government bonds, wherever issued, will only be eligible for the section 128F exemption, not automatically exempt.
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