Replacement Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P)Chapter 4 Offshore Banking - The Concessional Tax Regime
The Concessional Tax Regime
The income from the offshore banking (OB) activities of an OBU will, generally, be taxed at a rate of tax of 10%. In the explanations that follow, the assessable income from OB activities of an OBU will be referred to as assessable OB income. The meaning of 'OB activities' is explained in Chapter 5.
Where a separate company is set up for offshore banking activities
An OBU will be required to keep accounts for its OB activities. [Clause 18]
In broad terms, the income from OB activities of an OBU will be taxed at a rate of tax of 10%. As explained in Chapter 2, rather than providing a special rate of tax for this purpose, the assessable income and allowable deductions are adjusted downwards to achieve the same result. Where the assessable income has been adjusted downwards, the amount remaining will not be considered to be exempt income. Any prior year losses, therefore, will not be offset against the remaining amount. [section 121EG to be inserted by Clause 15]
(Editor's Note: **Amended during passage through Parliament**
This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 28])
Each amount of income derived by the OBU from its OB activities and each amount of allowable deduction in relation to those activities is to be reduced by a fraction referred to as the 'eligible fraction'. The fraction is as follows:
10 / the general company tax rate applicable to the year of income
As the company rate is currently 39% the fraction is effectively 10/39.
An exception is provided where the accounts kept by the OBU for its OB activities show that more than 10% of the assessable income of the OBU from those activities was derived by using non-OB money. [New section 121EH]
In this event, all the income from the OB activities of the OBU will be subject to the general rate of company tax (ie the tax concession for OB income will be lost).
Where a company carries on offshore banking activities and other activities
The company will be required to keep accounts separately for its OB activities. The concessional tax treatment will apply to the transactions for which separate accounts are kept as though those transactions were undertaken by a separate company.
The company will have two classes of assessable income - offshore banking income taxed at an effective rate of 10% and other income taxed at 39% - provided that the OB activities are accounted for separately. If this is not done, all of the income will be subject to tax at the general company rate of 39%.
As in the case of a separate company set up to carry on only offshore banking activities, the tax concession will not be available if the accounts kept for the offshore banking activities show that more than 10% of the assessable income of the OBU from those activities was derived by using non-OB money.
Although the overall tax concession will still be available where less than 10% of assessable income was derived by using non-OB money, any income derived from the use of non-OB money will be taxed at the normal rate of tax.
Where a company carries on OB activities and other business and the OB activities are accounted for separately, there will be two classes of assessable income:
- •
- OB income taxed at an effective rate of 10 per cent;
- •
- other income taxed at 39 per cent;
If separate accounts are not kept for the OB activities, all of the income of the company will be subject to the general company tax rate of 39 per cent.
Where a company has more than one permanent establishment
Proposed subsection 121EB(1) introduces a concept of separate entities for branches of the same entity. This concept applies for the purposes of proposed sections 121D to 121EA (inclusive).
An OBU may consist of:
- (a)
- one or more permanent establishment in Australia through which qualifying offshore banking activities are carried out; and
- (b)
- other permanent establishments whether in or out of Australia.
In this case the permanent establishments in Australia referred to in (a) are to be treated as one person. The other permanent establishments are to be treated as separate persons. [Section 121EB]
The definition of 'permanent establishment' in subsection 6(1) of the ITAA applies equally to residents and non-residents. The term has been used in this context to denote branches of both resident and non-resident companies.
By treating permanent establishments as different persons, domestic banking is separated from offshore banking.
This notion is necessary for the concept of 'offshore person' as it applies to a bank. When conducting OB activities, it enables an OBU to deal with an offshore permanent establishment of the same bank as a separate person. Without this provision, Australian law would require intra-entity transactions to be ignored.
The anti-avoidance provisions also make use of the treatment of permanent establishments as separate persons in relation to:
- •
- the concept of non-OB money (eg where a domestic banking branch provides funds to an offshore banking branch);
- •
- OB activity (eg there are limitations in certain provisions to dealings with offshore persons and in others to non-residents, for example, investment activity).
Non-OB Money
Non-OB money is all the money an OBU receives other than money:
- •
- derived from the OB activities of the OBU; or
- •
- OBU resident-owner money. [New section 121C]
OBU resident-owner money applies only to money paid by a resident parent to the OBU by way of capital subscription. Any other moneys made available to the OBU by its parent will be non-OB money. [New section 121EC]
(Editors Note: **Amended during passage through Parliament**
This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 5])
The term 'owner' is defined, in relation to a company, to mean a person who, alone or together with an associate or associates, is the beneficial owner of all of the shares in the company. [New section 121C]
Non - OB money cannot be used to derive concessionally-taxed income.
Source of Income
The source of an item of income is a practical, hard matter of fact to be determined separately in each case. The source of business profits, including OB income, would generally be the country where the business activities are performed. The tax concessions are provided to OBUs on the basis that the business activities of the OBUs will be carried on in Australia. Moreover, it is internationally accepted practice in Double Tax Treaties to treat the presence of a permanent establishment (branch) in a country as sufficient economic connection with that country to give rise to a taxing right to that country on the basis of source.
To make this clear, however, the Bill will deem the offshore banking income of Australian OBUs to have an Australian source. [Section 121EJ]
Capital Gains
Capital gains will not to be taxed at the concessional rate. They will not be considered as attributable to non-OB activities for purposes of the 10 per cent of gross income test for the OBU. [Subsection 121EE(2)]
Allocation of expenses between OB and non-OB activity
Where a company carries on both offshore banking (OB) and non-OB activity, it will be necessary to allocate expenses between these two types of activity. This will be done by allowing three classes of deductions from the income generated by OB activity:
- •
- exclusive OB deductions;
- •
- general OB deductions; and
- •
- apportionable OB deductions. [Section 121EF]
Exclusive OB deductions are any deductions, other than carry forward losses, that relate exclusively to assessable OB income, eg interest payments on borrowings from a non-resident which are on-lent to a non-resident.
These deductions relate to both OB and non-OB activities, but do not carry forward losses. For example, rent on a building used for both offshore banking and normal domestic banking. These are apportioned between OB and non-OB activities using the following formula [Subsection 121EF(4)]:
deduction * (adjusted assessable OB income / adjusted total assessable income)
where:
The reason for taking interest expenses into account and using adjusted OB income and adjusted total income is that OBU business generally has large volume and low profit margin. If the approach to expense allocation used assessable income, the large volume in the OBU activity would have distorted the allocation of expenses.
Including discounts in the nature of interest will result in a fairer allocation of expenses given that a significant amount of commercial borrowing and lending is done through the issue and purchase of discounted bills of exchange.
(Editor's Note: **Amended during passage through Parliament**
This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 25-26])
Apportionable OB deductions are amounts allowed without having any connection with the production of assessable income (these are defined in subsection 6(1) of the Assessment Act and would mainly relate to gifts). These deductions have to be apportioned in accordance with the following formula [subsection 121EF(5)]:
apportionable deductions * assessable OB income - [sum of exclusive OB deductions and general OB deductions]/sum of the OBU's taxable income and apportionable deductions
where:
Treatment of Losses
Losses will be adjusted to reflect the concessional tax rate applicable to offshore banking income. Thus, if the loss was calculated as for any other business, only 10/39ths should be recoupable against income subject to the normal 39% rate of tax.
Because of the way the legislation is structured, the reduction of the loss occurs automatically as each item of the assessable OB income and allowable OB deductions is reduced by the fraction 10/39. [Section 121EG]
Where more than 10% of the total assessable income comes from the use of non-OB money a special formula will, in broad terms, have the effect that any losses from OB activities in that financial year will have a tax value of 10%. This is to prevent manipulation in cases where the OBU knows it will make a loss and seeks to breach the 10% "purity test" to give the loss a tax effect of 39%.
Treatment of Foreign Tax
Under the foreign tax credit system (FTCS), a foreign tax credit is available only to residents for foreign tax paid on foreign income.
A foreign tax credit, therefore, will not be available for offset against Australian tax payable on OB income because that income is deemed to have an Australian source.
Instead, a tax deduction will be available in a year of income for the amount of foreign tax paid in that year of income. This deduction will also be available to non-residents. [Section 121EI]
As in the case of other expenses, the amount of the foreign tax paid will be reduced by the proportion 10/39.
Activities Giving Rise to Non-Concessional Income
To ensure that OBUs will engage principally in the business activities for which they are licensed, they will lose the tax concession (resulting in tax at 39% on all income) where more than 10% of the assessable OB income of the OBU is derived from the use of non-OB money. The test will apply to an OBU established as a separate company as well as where offshore banking is only part of a more comprehensive banking or financial business conducted by an entity. [Section 121EH]