Debt and Equity Financing: obligation to withhold tax on a return on a debt interest under Division 974

Does the obligation to withhold tax in respect of a dividend, on redeemable preference shares which are classed as a debt interest under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997), arise at the time the dividend is paid, or is applied or dealt with in any way on behalf of the recipient or as the recipient directs?

Yes. For non-resident withholding tax purposes, dividends on redeemable preference shares which are classed as a debt interest are treated as interest. The obligation to withhold tax therefore arises at the time the dividend is paid, or is applied or dealt with in any way on behalf of the recipient or as the recipient directs.

The taxpayer is an Australian resident company. During 2002, the taxpayer company declared dividends on redeemable preference shares ('RPS). The recipient of these dividends is a non-resident investor.

The RPS constitute a debt interest under Division 974 of the ITAA 1997 and are therefore, non-equity shares for income tax purposes.

For the purposes of Division 11A of the Income Tax Assessment Act 1936 (ITAA 1936), 'interest' is defined to include 'an amount...that is a dividend paid in respect of a non-equity share' (paragraph 128A(1AB)(d) of the ITAA 1936).

Consequently, the RPS dividends will be treated as income derived by a non-resident that consists of interest to which section 128B of the ITAA 1936 applies.

The taxpayer company's obligation to withhold is therefore determined by section 12-245 of Schedule 1 to the Taxation Administration Act 1953 (TAA). Section 12-245 imposes an obligation to withhold tax on interest (within the meaning of Division 11A of Part III of the ITAA 1936) it pays to a recipient who has an address outside Australia.

The obligation to withhold is timed to payment, which has an extended meaning for withholding tax collection purposes (section 11-5 of Schedule 1 to the TAA). The taxpayer company is therefore obliged to withhold tax on a RPS dividend that has not been paid (in the ordinary sense) to the non-resident company but has been reinvested, accumulated, capitalised, carried to any reserve, sinking fund or insurance fund however designated, or otherwise dealt with on behalf of the non-resident company or as the non-resident company directs (subsection 128A(2) of the ITAA 1936).

Therefore, for non-resident withholding tax purposes, dividends on redeemable preference shares which are classed as a debt interest are treated as interest and the obligation to withhold tax therefore, arises at the time the dividend is paid.