House of Representatives

Explanatory Memorandum

(Circulated by authority of the Assistant Treasurer, Minister for Housing and Minister for Homelessness, Social and Community Housing, the Hon Michael Sukkar MP)

Chapter 2 - Offshore banking units

Outline of chapter

2.1 Schedule 2 to the Bill amends Australia's OBU regime to:

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remove the concessional tax treatment for OBUs;

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remove the interest withholding tax exemption; and

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close the regime to new entrants by removing the Minister's ability to declare or determine an entity to be an OBU.

2.2 All legislative references in this Chapter are to the Income Tax Assessment Act 1936 unless otherwise stated.

Context of amendments

2.3 The OBU regime was introduced in 1987 to assist the Australian financial services sector compete with financial services providers located in low tax jurisdictions in the Asia Pacific region. This was initially done by providing a withholding tax exemption on interest paid on eligible foreign borrowings by an OBU. When introducing the interest withholding tax exemption for OBUs in 1987, the then Treasurer stated that the exemption was 'intended to encourage offshore transactions and in particular on lending to non-residents'. ^[1]

2.4 In 1992, the regime was expanded to introduce an effective concessional tax rate in respect of taxable income derived by an OBU from eligible OB activities.

2.5 Under this regime, assessable income from eligible OB activities is effectively subject to a tax rate of 10 per cent, rather than the general corporate tax rate of 30 per cent. This is achieved by only bringing to account an 'eligible fraction' of income from OB activities and associated expenses (see section 121EG of the Act).

2.6 In October 2018, the OECD Forum for Harmful Tax Practices determined Australia's OBU regime to be a harmful preferential tax regime, on the grounds that it provides a concessional tax rate, and is ring-fenced to exclude domestic transactions from its scope (meaning the concession is only available in relation to transactions between parties that are foreign residents).

2.7 To address the Forum's concerns, the Government has taken a decision to remove the preferential tax treatment and close the regime to new entrants.

2.8 Under the rules of the OECD Forum for Harmful Tax Practices, grandfathering provisions must cease from the beginning of an OBU's 2023-24 income year.

Summary of new law

2.9 Schedule 2 to the Bill amends the tax law to remove the effective concessional tax treatment for OBUs in respect of OB activities. From the 2023-24 income year, the taxable income of an OBU on its OB activities will be subject to the relevant corporate tax rate.

2.10 Schedule 2 to the Bill also removes the withholding tax exemption for OBUs for interest paid on or after 1 January 2024.

2.11 Schedule 2 to the Bill also amends the tax law to remove the ability of the Minister to issue determinations or declarations that a person or entity is an OBU.

Comparison of key features of new law and current law

Detailed explanation of new law

Removing the concessional tax treatment for OBUs

2.12 The amendments repeal the provision of the Act which provides for a reduction of an OBU's assessable OB income, allowable OB deductions and foreign income tax paid. [Schedule 2, item 6, section 121EG]

2.13 Repealing this provision means that OBUs will not receive any special taxation arrangements and will be subject to the applicable corporate tax rate.

2.14 To ensure that OBUs engaged principally in the business activities to which the concessional tax rate applied, the Act provides they will lose the concessional tax treatment where more than 10 per cent of the assessable OB income of the OBU is derived from the use of non-OB money (see section 121EH).

2.15 Schedule 2 to the Bill repeals this provision as it is no longer relevant with the repeal of the effective concessional tax treatment for OBUs. [Schedule 2, item 7, section 121EH]

2.16 The amendments removing the concessional tax treatment for OB activities apply in relation to assessments for the 2023-24 income year, and later income years. [Schedule 2, item 13]

Withholding tax exemption

2.17 Schedule 2 to the Bill also amends the Act to provide that interest payments (including interest consisting of gold paid) paid on or after 1 January 2024 on offshore borrowings by OBUs will no longer be exempt from withholding tax. [Schedule 2, item 15, subsection 128GB(1A)]

2.18 This means for interest paid on or after 1 January 2024, OBUs will be subject to withholding tax on eligible income.

Closing the OBU regime to new entrants

2.19 The amendments remove the ability for the Minister to make a declaration or determination that a person or company is an OBU. This change applies from the day after the amendments receive Royal Assent. Schedule 2, item 14, subsection 128AE(1A)]

2.20 Australia's OBU regime has been effectively closed since October 2018. No new OBU applications have been approved since that time. Once the amendment takes effect, the power for the Minister to approve OBU applications will be removed. This means that any outstanding applications made to the Minister before the amendments apply (being the day after they received Royal Assent) are not able to be approved from that time and will, in effect, lapse. This is consistent with the intention that the OBU regime be closed to new entrants, and that the applicable grandfathering arrangement be limited to existing OBUs. To ensure that Australia addresses the OECD Forum for Harmful Tax Practices' concerns about the OBU regime, the Government does not intend that any applications be granted by the Minister before the amendments apply.

Consequential amendments

2.21 Schedule 2 to the Bill makes a number of consequential amendments to remove references to the effective concessional tax treatment for OBUs. [Schedule 2, items 2 and 8 to 12, , paragraphs 121B(3)(a) and (b), section 10-5 of the ITAA 1997 (table item headed "banking"), section 11-55 of the ITAA 1997 (table item headed "offshore banking units"), section 12-5 of the ITAA 1997 (table item headed "offshore banking units"), subsection 118-20(4) of the ITAA 1997 (note) and subsection 770-10(1) of the ITAA 1997 (note 3)]

2.22 The object of the Division relating to OBUs is also repealed, and references to this object in other provisions have been removed. [Schedule 2, items 3 to 5, paragraphs 121EAA(5)(e) and (f) and subsection 121EAA(6)]

2.23 This change reflects that the regime is primarily concerned with providing concessional tax arrangements for OBUs. This objective is no longer relevant given the removal of those arrangements.