Supplementary Explanatory Memorandum
Amendments and New Clauses to be Moved on Behalf of the Government(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)CHAPTER 5 - AMENDMENTS 14 to 30 - TAXATION OF AUSTRALIAN BRANCHES OF FOREIGN BANKS
Overview
These amendments will make a number of technical corrections to proposed Part IIIB which contains new measures for the taxation of Australian branches of foreign banks. The amendments clarify the operation of the proposed Part, and in particular its interaction with Australia's double tax agreements, to ensure that the measures have the intended effect.
Explanation of the amendments
Amendment 14: Object and Application of Part IIIB
Purpose of Part IIIB
5.1 This amendment will insert new section 160ZZVA into the Income Tax Assessment Act (the Act). Broadly speaking, the new section explains that the object of the new Part is to treat Australian branches of foreign banks as though they were separate entities in order, firstly, to recognise certain intra-bank transactions so as to assist in calculating the taxable income of the branch and secondly, to ensure that withholding tax will be payable in respect of notional interest treated as paid by the branch to the bank.
5.2 The section also confirms that the separate legal entity fiction will only apply where specifically provided for in the Part. [Clause 114]
Application of Part IIIB
5.3 The second part of this amendment [new section 160ZZVB] clarifies the interaction between Australia's double taxation agreement obligations (DTAs) and the new Part.
5.4 The new Part assists a foreign bank in calculating the taxable income from its Australian branch by identifying certain amounts of income and expenditure that are properly to be regarded as attributable to the branch. If, however, a DTA is applicable in relation to the bank and if in relation to the calculation of the taxable income of the bank for a particular year of income the outcome for the bank would be more favourable under the DTA than if the Part taken overall applied, then the bank will be free to choose that the new Part not apply in respect of the calculation of its taxable income for that year.
5.5 Although a bank may choose not to apply proposed Part IIIB in calculating its taxable income, the proposed new section makes it clear that withholding tax will nevertheless apply to interest which is taken by the Part to have been paid by the branch to the bank.
Amendment 15: Definition of Accounting Records
5.6 Proposed section 160ZZV of the Bill, as originally introduced, defined "accounting records" by reference to their meaning in the Corporations Law. To assist readers so they will not have to refer to another statute, this amendment will now include in new Part IIIB a specific definition of "accounting records".
5.7 The amendment will also make it clear that the accounting records referred to are those basic records in which transactions are originally recorded and from which accounts are prepared.
Amendments 16 and 18: Branch is a wholly owned subsidiary
5.8 Proposed subsection 160ZZW(3) of the Bill provides that the branch is to be taken to be a separate company which is a "wholly-owned subsidiary" of the bank. As introduced, the Bill defined the term "wholly-owned subsidiary" by reference to the meaning of that term in the Corporations Law.
5.9 To assist readers, proposed subsection 160ZZW(3) will now refer directly to the ownership of the share capital instead of requiring reference to another statute.
Amendments 17 and 19: Treating an Australian branch as if it were a separate legal person
5.10 These amendments to proposed section 160ZZW , which are of a technical nature, will confirm that where, for the purposed outlined in proposed Part 11B, the AUstralian branch is streated as a separate company it must also be treated as a non-resident which is not a permanent establishment of the bank in Australia.
Amendment 20: Deduction for foreign tax
5.11 Under the foreign tax credit system, a foreign tax credit is available only to residents for foreign tax paid on foreign income. However, for the purposes of the Act and new Part IIIB, the branch is a non-resident of Australia. Moreover, the new Part provides that all the income derived by the bank through the branch is to be treated as having an Australian source. Accordingly, a foreign tax credit will be not be available for offset against Australian tax payable in relation to income attributable to the branch.
5.12 Instead, as a measure of double tax relief, a tax deduction will be available in a year of income for the amount of foreign tax paid in that year of income. This amendment to proposed section 160ZZY will ensure, however, that the deduction will be restricted to foreign tax on interest income.
Amendment 21: Intra-bank loans
5.13 Proposed section 160ZZZ recognises, by way of legal fiction, borrowings by the Australian branch from the foreign bank which are recorded in the branch's accounting records as having been provided by the bank to the branch.
5.14 This amendment, which inserts new subsection 160ZZZ(2), simply ensures that a repayment of the borrowings, together with any foreign exchange gain or loss on repayment, is recognised when the transaction occurred.
Amendments 22, 23, 24, and 25: Technical amendments
5.15 The first three amendments, which are of a minor technical nature, will change the way proposed paragraph 160ZZZA(1)(c) is drafted to ensure that it has its intended effect. The provision, in simple terms, restricts the intra-bank interest which is recognised under the new Part to an amount of interest calculated using the interest London inter-bank offer rate (LIBOR). That means that if intra-banks funds are provided at a rate that is in excess of LIBOR the branch will be denied a deduction for the excess. In addition, interest withholding tax will not apply to the excess.
5.16 Amendment 23 will omit a reference to a paragraph in proposed section 160ZZZB which is no longer required.
Amendment 26: Thin capitalisation
5.17 Thin capitalisation is a term that refers to companies that are funded by an excessive amount of debt or borrowings and very little share or equity capital. The thin capitalisation rules contained in the Act are, essentially, an anti-avoidance measure. The rules impose, in relation to related parties, a foreign debt to equity ratio.
5.18 Proposed section 160ZZZD, as introduced, provides the foreign bank with an exemption from the thin capitalisation rules in relation to foreign debt provided to the Australian branch by non-resident associates of the bank.
5.19 This amendment will ensure that the exemption from the thin capitalisation rules is restricted to branches of the bank which are engaged in banking business.
Amendment 27: Notional derivative and foreign exchange transactions between branch and bank
5.20 Proposed section 160ZZZE recognises, for Australian taxation purposes, derivative product transactions between a foreign bank and its Australian branch. Proposed section 160ZZZF is a mirror provision which recognises foreign exchange transactions between the bank and the branch.
5.21 Both sections have been redrafted to ensure that only amounts which are shown in the branch's accounting records as payments or receipts in respect of the notional transactions are treated as if they were payments or receipts between separate entities. Payments and receipts thus recognised will be subject to the same tax accounting rules for the recognition of income and deductions which apply when similar amounts are paid and received by the branch in respect of derivative and foreign exchange transactions entered into with third parties.
Amendments 28 and 29: Withholding tax on interest paid by an Australian branch of a foreign bank to the foreign bank
5.22 These two amendments will correct a drafting oversight by including a reference to section 221YL in proposed subsections 160ZZZJ(1) and (2).
5.23 Proposed section 160ZZZJ sets out the method for determining the amount of interest withholding tax payable in respect of interest that is treated as paid by the Australian branch of the foreign bank to the bank.
5.24 The Bill, as introduced, correctly makes reference to section 128B, which is an operative provision which sets out the general rules relating to liability to withholding tax. However, a reference to section 221YL, which sets out the general rules relating to the collection of withholding tax, is also required.
5.25 These amendments will give the relevant provision its intended effect.
Amendment 30: Payment of insufficient or excess withholding tax
5.26 Proposed subsection 160ZZZJ(4) was originally included in the Bill to assist with the withholding tax reconciliation process at year's end when the branch's accounts were finalised. It provided a mechanism for dealing with discrepancies.
5.27 Because the general withholding tax collection provisions deal quite adequately with the reconciliation process and provision already exists for the payment of insufficient or excess withholding tax the proposed new provision is not needed.
5.28 This amendment will, therefore, omit the subsection as originally introduced.