House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 - Interest withholding tax exemption for certain unit trusts

Outline of chapter

2.1 Schedule 2 to this bill provides an IWT exemption for interest paid on certain debentures issued by (the trustees of) eligible unit trusts. In this chapter, this is referred to as an IWT exemption for these unit trusts. A similar exemption is currently available for companies.

Context of amendments

2.2 Generally, entities operating in Australia which have obtained finance abroad must withhold a proportion of their interest payments to non-residents and remit that amount to the ATO. These amounts are withheld as a final tax on interest income sourced in Australia. If entities operating in Australia fail to withhold a proportion of interest payments they will be personally liable for these amounts. Obliging Australian borrowers to withhold amounts from interest paid on debentures held by foreigners tends to shift the tax impact onto the Australian borrowers.

2.3 Companies carrying on a business in Australia are currently able to receive an exemption from IWT on interest payments in relation to widely offered debentures. Other borrowers, including unit trusts, are not similarly exempted from withholding even in relation to interest paid on similar debentures. However, they may effectively obtain the exemption by having an interposed company undertake the borrowing and paying the interest.

2.4 The Board of Taxation recommended that this exemption should be extended to the managed funds industry, which operates through unit trust structures.

Summary of new law

2.5 This bill:

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removes the requirement to withhold tax on interest paid on widely offered debentures issued by certain Australian unit trusts;

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allows certain foreign unit trusts operating at or through a permanent establishment in Australia to access the exemption for interest payments in relation to widely offered debenture issues;

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stipulates the types of unit trusts that may qualify for the exemption; and

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duplicates all the other conditions for the exemption that currently applies to companies.

2.6 All legislative references are to the ITAA 1936.

Detailed explanation of new law

The exemption

2.7 In order to access the IWT exemption, a unit trust must meet the eligibility requirements when the debenture is issued and when the interest is paid on the debenture. To apply these tests, trusts that are taken to be public unit trusts or certain other trusts for an income year are deemed to be these kinds of trusts for the whole income year. These debenture issues must also satisfy the public offer test by being widely offered [Schedule 2, item 5, subsections 128FA(1), (2) and (9)]. When these requirements are satisfied, interest paid on the debenture will be exempt from withholding tax and the trustee of the unit trust will not have to withhold tax on the interest payments [Schedule 2, item 5, subsection 128FA(3)].

2.8 All unit trusts operating in Australia that would otherwise be required to withhold tax from interest payments to non-residents may qualify for the exemption. This means that what might be termed a foreign eligible unit trust carrying on business in Australia at or through a permanent establishment will receive the IWT exemption if debentures issued by it satisfy the public offer test. This will place all qualifying unit trusts carrying on a business in Australia on an equal footing with each other and with companies in relation to the taxation of their interest payments. [Schedule 2, item 5, subsection 128FA(1)]

Eligible unit trusts

2.9 The unit trusts that may qualify for the IWT exemption are referred to as eligible unit trusts. This definition refers to unit trusts which at any time in a year of income are public unit trusts, or unit trusts which have all their issued units held by two or more listed eligible unit holders. The objective of this definition is to ensure that eligible unit trusts are directly or indirectly widely held, for integrity reasons. [Schedule 2, item 5, subsection 128FA(8)]

2.10 The public unit trust definition adopted for the purposes of this measure (section 102G) will allow trusts taxed like companies (i.e. corporate unit trusts and most public trading trusts) to receive an exemption from IWT on debentures which meet the public offer test. Not all public trading trusts will be entitled to the exemption because of concerns that some of these trusts may be closely held. [Schedule 2, item 5, subsection 128FA(8)]

2.11 In order to receive the IWT exemption, a unit trust that is not a public unit trust must have all its issued units held by two or more of the following entities:

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public unit trusts;

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complying superannuation funds with 50 or more members;

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PST;

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complying ADFs;

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life insurance companies;

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public companies; or

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other unit trusts which themselves meet this requirement.

2.12 These entities are included as permissible unit holders of eligible unit trusts on the basis that they are generally widely held. [Schedule 2, item 5, subsection 128FA(8)]

Duplication of provisions applying to companies

2.13 Many of the provisions in section 128FA mirror the existing provisions in section 128F that apply only to companies. This allows eligible unit trusts to receive the same treatment as companies in relation to the borrowing activities of some foreign subsidiary companies, associate requirements, the debenture definition, the public offer test and the issue of global bonds. [Schedule 2, item 5, subsections 128FA(4) to (7)]

2.14 In addition, section 128FA includes a provision to exempt from IWT the deemed interest component of the sale price of a qualifying debenture similar to that provided for companies. Note that this provision applies only in relation to qualifying debentures issued by eligible unit trusts. [Schedule 2, item 5, subsection 128FA(2)]

2.15 For the purposes of the associates requirements in section 128FA, eligible unit trusts are to be regarded as public unit trusts. This enables the trustee of a public unit trust to be treated as if it were a company for the operation of the 'associates' definition in section 318 [Schedule 2, item 5, subsection 128FA(8)]. In determining whether the trustee of an eligible unit trust is sufficiently influenced by another entity, regard should only be had to the influence on the trustee acting in that capacity and not in any other capacity. This principle of applying the provisions to the trustee of a unit trust in its capacity as the trustee and not in any other capacity should be adopted generally in applying section 128FA (e.g. in the definition of 'debenture' in subsection 128FA(8)).

Application and transitional provisions

2.16 The amendments in the Schedule will apply to debentures issued on or after the day of Royal Assent. [Schedule 2, item 6]

Consequential amendments

2.17 The consequential amendments to the ITAA 1936 ensure that the operation of the withholding tax provisions is not compromised. These consequential amendments ensure like treatment is provided to debentures issued by companies and eligible unit trusts. [Schedule 2, items 1 to 4, subsection 25(2), paragraph 128AAA(2)(b), subparagraph 128B(3)(h)(iv) and section 128D]