Deductibility of interest payments by a foreign resident to another foreign resident where no withholding tax has been deducted from the payments

If a foreign resident (the payer) pays interest to another foreign resident, and deducts no withholding tax from the payment as the payer is not required to withhold under Subdivision 12-F of the Taxation Administration Act 1953 (ITAA 1953), will the payer be denied a deduction for that interest under section 26-25 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. Where a foreign resident pays interest to another foreign resident and deducts no withholding tax from the payment, as the payer is not required to withhold under Subdivision 12-F of the TAA, section 26-25 of the ITAA 1997 will not operate to deny the payer a deduction for the interest.

The taxpayer is a foreign resident.

The taxpayer pays interest to another foreign resident.

The taxpayer does not incur interest in carrying on a business at or through a permanent establishment in Australia.

Section 26-25 of ITAA 1997 provides that a taxpayer cannot claim a deduction for interest expenses if the taxpayer fails to withhold an amount under Subdivision 12-F of Schedule 1 to the TAA 1953 when required to do so.

Section 12-245 of Subdivision 12-F of the Schedule sets out the circumstances requiring an entity to withhold an amount from an interest payment it makes to an overseas entity.

However, section 12-300 of Subdivision 12-F of the Schedule 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.

Sub-paragraph 128B(2)(b)(ii) of the ITAA 1936 imposes withholding tax on interest paid to a non-resident by another non-resident if the interest is an outgoing incurred by the payer in carrying on a business at or through a permanent establishment in Australia.

As the taxpayer does not incur interest in carrying on a business at or through a permanent establishment in Australia, there is no withholding tax obligation under subparagraph s128B(2)(b)(ii) and no amount is required to be withheld under Subdivision 12-F of Schedule 1 to the TAA 1953.

As a result, section 26-25 will not operate to deny the payer a deduction for the interest.