Senate

Replacement Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P)

Chapter 6 Offshore Banking - Anti-avoidance provisions

It should be noted that since each amount of assessable OB income and each amount of allowable OB deductions is included in assessable income or allowed as an income tax deduction in the normal way (after being factored down), the general anti-avoidance provisions, including Division 13 and Part IVA, apply to offshore banking activities.

OBU resident-owner money

Without the inclusion of a specific anti-avoidance provision, it would be possible to avoid tax by using borrowed funds to capitalise an OBU subsidiary. For example, the parent company could borrow funds for which it obtains an interest deduction at the 39% tax rate, inject those funds into the OBU by way of equity and the OBU could then on-lend the funds and pay tax on its interest income at 10%.

Since money is fungible (that it, it loses its identify when mixed in a pool of funds) it would be difficult to trace which funds provided to an OBU subsidiary have actually been borrowed.

The legislation assumes that 90% of any funds provided by way of share capital to an OBU subsidiary by a resident parent (known as OBU resident-owner money) have come from borrowings for which tax deductions for interest expense are available. Since this will be the case only where the provider of funds to the OBU is a resident, a non-resident owner is excluded from the assumption.

The legislation goes on to provide that 90% of the money provided is to be regarded as a loan at 2% above the 90 day bank accepted bill rate. This notional interest is then included in the assessable income of the owner and a deduction allowed to the OBU for the deemed interest.

Because an OBU will be taxed at an effective tax rate of 10%, the deduction for the deemed interest will also have a tax effect of 10%.

90% has been set as the percentage of an OBU subsidiary's share capital to be regarded as a loan on the basis that the funds of the subsidiary OBU should be regarded as having the same proportion of debt and equity as the pool of funds out of which the amount was made available. The Reserve Bank of Australia's (RBA) 8% minimum for capital adequacy has been taken as a benchmark and increased to take account of the fact that some banks operate with a capital adequacy ratio higher than the RBA requirement. [Section 121EK]

OBU resident-owner money is defined as money paid by a resident parent to the OBU by way of capital subscription, except where:

•

the shares are redeemable preference shares; or

•

the amount paid is a share premium.

Since redeemable preference shares have many of the characteristics of loans they have been excluded. Share premiums have also been excluded in order to limit tax avoidance opportunities. [Section 121EC]

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 of the company. Each associate will be the beneficial owner of so much of the shares of the company in which that associate has a beneficial interest. [Section 121C]

Loss of special treatment were excessive use of non-OB money

The Bill also contains anti-avoidance provisions to prevent an OBU taking undue advantage of a full deduction for losses where any income would have been effectively taxed at 10%. [Section 121EH]

For example, during an accounting year, an OBU may be able to forecast a loss in relation to its OB activities for that year. It would then arrange to 'fail' the test for availability of the OBU concessions. This could be done by obtaining non-OB money and using those funds to derive more than 10% of its assessable OB income. This would result, in the absence of anti-avoidance provisions, in the OBU losses being available in full to reduce other income.

The Bill provides, in effect, that where an OBU fails the test for the availability of tax concessions because of the 10% of assessable OB income test, its 'losses' will continue to be reduced to 10/39 of the losses. This is done by reducing each deduction, to the extent that it exceeds a specific limit, to 10/39 of the amount of the deduction.

The limit on each deduction is provided by the formula:

allowable OB deduction * (assessable OB income / sum of allowable OB deductions)


Example

Facts:

Assessable OB income derived from non-OB money (taxable at 39%)	$50M
Assessable OB income derived from OB activities (normally taxable at 10%, however, now taxable at 39% because more than 10% of the assessable OB income has been derived from the use of non-OB money)	$240M
Exclusive OB deductions made up of two separate amounts - one of $120M and one of $840M - Total	$960M
(Note: The full amount of an exclusive OB deduction is an "allowable OB deduction" for the purposes of the formula).
Exclusive deduction relating to assessable OB income derived from the use of non-OB money (taxable at 30%)	$5M

Calculation 1:

120 * (240/960) = 30


That is, $30M of the exclusive OB deduction of $120M is allowable at 39% and $90M will be carried forward as a prior-year loss allowable at a taxable value of 10%.

Calculation 2:

840 * (240/960) = 210


That is, $210M of the exclusive OB deduction of $840M is allowable at 39% and $630M will be carried forward as a prior-year loss allowable at a taxable value of 10%.

[Section 121EH]