Withholding Tax Exemption: Interest in respect of debentures that are retired or cancelled

Will an Australian company be entitled to an exemption from withholding tax under subsection 128F(2) of the Income Tax Assessment Act 1936 (ITAA1936), on interest in circumstances where its foreign subsidiary, having issued debentures in terms that satisfy subsection 128F(8) of the ITAA 1936, later retires or cancels those debentures or part thereof?

No. The Australian company will not be entitled to an exemption from withholding tax under subsection 128F(2) of the ITAA 1936 on interest paid after the debentures are retired or cancelled, as the interest will not be paid 'in respect of a debenture' since the debentures will no longer exist.

An Australian company plans to make an issue of qualifying debentures through its United States of America (US) subsidiary. That subsidiary will issue commercial paper denominated in US dollars (USD) to third parties in the US. It will then convert the proceeds to Australian dollars (AUD) and on-lend the proceeds to the Australian parent.

The subsidiary will thus need to consider its foreign exchange exposure, generated by the ongoing differential between the USD borrowings and the AUD repayments. As one part of its strategy to manage the exposure of adverse currency movements, the US subsidiary proposes that it may reduce the level of commercial paper on issue. This would involve retirement or cancellation of some of the debentures, or some part thereof, in the US.

The company will satisfy the residency and public offer test requirements of subsection 128F(1) of the ITAA 1936.

The company will also satisfy the requirements of subsection 128F(8) of the ITAA 1936 for debentures issued through non-resident subsidiaries.

Section 128F of the ITAA 1936 exempts from withholding tax, interest on certain publicly offered debentures. Subsection 128F(1) of the ITAA 1936 states that withholding tax is not payable on interest paid by a company 'in respect of a debenture' if: • the company was a resident of Australia when it issued the debenture; • the company is a resident of Australia when the interest is paid; and • the issue of the debenture satisfies one of the public offer tests set out in subsections 128F(3) or 128F(4) of the ITAA 1936.

To qualify for the exemption, the interest payment must be made 'in respect of a debenture'.

Where the foreign subsidiary company retires or cancels a debenture, or part thereof, the debenture will no longer be on issue. If a debenture is no longer on issue, interest cannot be paid 'in respect of' that debenture. The relative component of the interest payable by the Australian company to its foreign subsidiary is, as a consequence of the retirement or cancellation, no longer in respect of that debenture.

Accordingly, the Australian company will not be entitled to a withholding tax exemption under subsection 128F(2) of the ITAA 1936 on interest payments where the underlying debentures have been cancelled or retired.