House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Treasurer, the Hon Wayne Swan Mp

Chapter 3

Interest withholding tax - extension of eligibility for exemption to state government bonds

Outline of chapter

3.1 Schedule 3 to this Bill amends section 128F of the Income Tax Assessment Act 1936 (ITAA 1936) to allow bonds issued in Australia by state and territory central borrowing authorities to be eligible for exemption from interest withholding tax (IWT).

3.2 Unless otherwise stated, all legislative references are to the ITAA 1936.

3.3 States means the States and Territories unless otherwise indicated.

Context of amendment

3.4 IWT is imposed on the payment of interest from Australia to non-residents, at a rate of 10 per cent of the gross amount of interest. The obligation for collecting (withholding) the IWT is on the person making the payment (ie, the borrower).

3.5 Section 128F of the ITAA 1936 provides that where an Australian resident company, or a non-resident company carrying on business at or through a permanent establishment in Australia, issues a debenture or certain specified debt interests and the issue satisfies the public offer test, an exemption from IWT will apply.

3.6 In 1999, the requirement that these debentures be issued outside Australia was removed for most borrowers. However, the liberalisation was not extended to the state central borrowing authorities. As a consequence, the interest paid to non-residents on bonds issued in Australia by state central borrowing authorities is liable to IWT (unless exempt under a treaty or another arrangement).

3.7 Consequently, the state central borrowing authorities have continued to issue their bonds offshore to remove the liability to IWT and attract non-resident investors.

3.8 Reflecting state central borrowing authorities' concerns that this practice results in a segmented market, reduced liquidity and efficiency, and hampers the role the state government bond market performs in ensuring the stable operation of Australia's financial markets, the Federal Government announced its decision to extend eligibility for exemption from IWT to domestically issued state government bonds.

3.9 This is expected to result in the state central borrowing authorities unifying their bond issuances into one pool of funds, improving depth and liquidity in the market and broadening the potential investor base. Ultimately, this should lead to a lower cost of capital (and hence financing costs) for state infrastructure projects.

3.10 Further, it is anticipated that by making state government bonds more attractive to foreign investors, some of the pressures facing the Commonwealth Government Securities market will be eased.

3.11 This measure will also define 'bond' for the purposes of this amendment, to provide greater certainty to market participants as to which instruments are eligible for exemption. The intention is to ensure that a narrow, technical meaning of bond is not potentially adopted, for example, that a 'bond' must be issued by a company under its corporate seal or be labelled as a bond, that is inconsistent with the generally understood concept of a state government bond in the market place.

3.12 This amendment is principally intended to focus on the core debt issuances of state central borrowing authorities (typically issued as inscribed stock) that would be regarded as more closely duplicating the role of Commonwealth Government Securities in supporting the effective operation of Australia's financial markets.

Summary of new law

3.13 Schedule 3 removes the prohibition preventing bonds (as defined) issued in Australia by state central borrowing authorities from being eligible for the section 128F exemption from IWT. This amendment will apply to interest payments made on or after the date of Royal Assent.

Comparison of key features of new law and current law

Detailed explanation of new law

3.14 This amendment makes it clear that bonds issued in Australia by state central borrowing authorities will be eligible for the exemption from IWT under section 128F of the ITAA 1936. [Schedule 3, item 1]

3.15 However, the exemption will only be available in respect of bonds, as defined for the purposes of new subsection 128F(5B). [Schedule 3, item 1]

3.16 The requirements of the public offer test will continue to apply to bonds (as defined) issued by the state central borrowing authorities as it applies to debentures and certain specified debt interests issued by other entities that use the section 128F exemption.

3.17 Accordingly, the exemption will only arise for interest payments on current bond issues where the issue would have satisfied the public offer test when it was made.

3.18 The legislation makes no provision for deeming current bond issues to have satisfied the public offer test. This position is reinforced by the Federal Government's announcement that state government bonds will be eligible for exemption, and not simply exempt.

Definition of ' bond'

3.19 For the purposes of subsection 128F(5B) a bond , in relation to a state central borrowing authorities is defined as including debenture stock and notes. [Schedule 3, item 1]

3.20 It is intended that defining 'bond' in this manner will provide market participants with certainty around which instruments are affected by subsection 128F(5B) and, hence, eligible for exemption from IWT.

3.21 It is intended to avoid disrupting the common usage and understanding of the term for participants in the state government bond market, whilst ensuring that the changes remain consistent with the Federal Government's intention and underlying policy rationale for this amendment.

Application and transitional provisions

3.22 This amendment will apply to interest paid on or after the date of Royal Assent. [Schedule 3, item 2]