Deductibility of interest payments that are exempt from withholding tax

If the taxpayer company pays interest on overseas borrowings and deducts no withholding tax from the payment but the payment is one to which section 128F of the Income Tax Assessment Act 1936 (ITAA 1936) applies is the taxpayer denied a deduction for that interest under section 26-25 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. Where a taxpayer company pays interest on overseas borrowings and deducts no withholding tax from the payment but the payment is one to which section 128F of ITAA 1936 applies, section 26-25 of ITAA 1997 will not operate to deny the taxpayer a deduction for the interest.

The taxpayer company is an Australian resident. It is a member of, and acts as the finance entity for, a group of companies and trusts. The group is considering the following proposal to obtain funding from a placement to lenders in the USA:

The taxpayer will issue debentures in the USA in circumstances such that the interest paid will be exempted under subsection 128F(2) from withholding tax.

The taxpayer is 100% owned by one of the group's trusts and will remain an Australian resident at all material times.

The taxpayer will lend the monies to the trust which will then use the monies to refinance the trust's existing borrowings.

Section 26-25 of the ITAA 1997 provides that a taxpayer cannot deduct interest under ITAA 1997 if the taxpayer is required to withhold an amount from the interest under subdivision 12-F of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) but fails to do so.

Sections 12-245, 12-250 and 12-255 of Subdivision 12-F of the Schedule set out the circumstances requiring an entity to withhold an amount from, respectively, • an interest payment it makes to an overseas entity, • an interest payment it receives for or on behalf of a foreign resident, or • an interest payment it makes to either an Australian resident lender or an Australian government agency and the lender or the agency notifies the borrower that the interest is or will be derived in carrying on business through an overseas permanent establishment.

However, section 12-300 provides that there is no requirement to withhold if no withholding tax is payable on the interest. Thus it is necessary to consider whether withholding tax is payable on the interest in question.

Withholding tax on interest paid to non-residents and, in certain circumstances, to residents carrying on business through an overseas permanent establishment, is imposed under section 128B of the ITAA 1936. Certain interest payments, however, are exempted, including payments to which subsection 128F(2) of the ITAA 1936 applies.

The taxpayer proposes that the interest payments it will make on the debentures proposed to be issued will be so exempt. Where interest is exempted under 128F(2) no amount will required to be withheld under subdivision 12-F of Schedule 1 to the TAA 1953, and section 26-25 of the ITAA 1997 will not operate to deny the payer of that interest a deduction for it if the payer is otherwise entitled to it.