Offshore banking unit: investment made with an offshore person or a non-resident

Where an offshore banking unit [1] (OBU) purchases investments on behalf of an offshore person, who is the entity that is referred to in the terms 'making ... with' in subsection 121D(6) of the Income Tax Assessment Act 1936 (ITAA 1936) and 'made with' in paragraph 121D(6A)(c) of the ITAA 1936?

The entity that is referred to in the terms 'making ... with' in subsection 121D(6) of the ITAA 1936 and 'made with' in paragraph 121D(6A)(c) of the ITAA 1936 is the other party (that is the counterparty) to the transaction.

An Australian OBU, which is a resident member of a multinational group, provides investment management services to a non-resident member of the group.

That group member is an offshore person as defined in section 121E of the ITAA 1936.

The OBU purchases and manages various types of investments on behalf of the offshore person. This includes purchases of shares, derivatives (including futures and options) and other securities through foreign exchanges.

Subsection 121D(6) of the ITAA 1936 states in part: For the purposes of paragraph (1)(e), an investment activity is making ... an investment with an offshore person ... (emphasis added)

Subsection 121D(6A) of the ITAA 1936 states in part: For the purposes of paragraph (1)(e), an investment activity is also the managing by an OBU of a portfolio investment ... where: ... (c) the portfolio investment was made with a non-resident (except to the extent that making the investment consisted of making a loan or purchasing an Australian thing); and ... (emphasis added)

Since subsections 121D(6) and (6A) both apply to investments, this ATO ID applies only where assets are acquired as investments. ATO ID 2004/962 discusses the distinction between assets which are acquired as investments and assets which do not amount to investments because they are acquired for other purposes.

Subsection 121D(6) of the ITAA 1936 refers to making an investment with an offshore person, while paragraph 121D(6A)(c) of the ITAA 1936 refers to an investment made with a non-resident.

This raises the question of whether the terms 'making ... with' and 'made with' refer to an entity being the previous holder of the investment, or to an entity such as the exchange through which the investment was acquired, or to the issuer of the investment, or to some other person.

'Making ... an investment with' and 'an investment made with' are not defined in the legislation. However, we consider that the terms are so similar that they both have the same meaning.

Subsection 126D(6) of the ITAA 1936 was introduced by the Taxation Laws Amendment Bill (No. 4) 1992. The Senate Replacement Explanatory Memorandum for that Bill states in part: To be an 'OB activity': ... the other party to the transaction must be an ''offshore person'' ... (emphasis added)

Subsection 121D(6A) of the ITAA 1936 was introduced by the Taxation Laws Amendment Bill (No. 2) 1996. The House of Representatives Explanatory Memorandum for that Bill says in part: 1.38,Similarly, the restriction that when making an investment on behalf of an offshore person the other party to the transaction must be a non-resident who does not have a permanent establishment in Australia is removed in new subsection 121D(6A) . OBUs will be able to purchase Australian assets from or make loans to both residents and non-residents (whether or not they have a permanent establishment in Australia). [New paragraph 121D(6A)(c)] (Emphasis added)

Hence the entity that an investment is made with, for the purpose of subsections 121D(6) and 121D(6A) of the ITAA 1936, is the other party (that is, the counterparty) to the transaction.

In the case of an investment in real property, the other party to the transaction is the vendor of the property. Hence in relation to an investment in real property, the terms 'making ... with' and 'made with' refer to the vendor.

For investments such as fixed deposits, the other party to the transaction is the bank or other entity with which the deposit is made, so the terms 'making ... with' and 'made with' refer to that entity.

In the case of loans made by an OBU, the other party to the transaction is the borrower, and 'making ... with' and 'made with' refer to the borrower.

In relation to shares or other types of securities which can be traded on an exchange, there are two distinct points at which the securities can be purchased - firstly in the primary market where securities are created and sold by the issuer, and secondly in the secondary market where investors buy and sell securities that were previously issued in the primary market.

We consider that the terms 'making ... with' and 'made with' were intended to refer to the seller of the investments, as the seller is the other party to the transaction.

In the primary market (for example, when a company undertakes an Initial Public Offering) the transaction takes place between the issuer (the company) and the investor. In this case, the issuer of the securities is the seller of the investment and the other party to the transaction. Thus, in the case of shares or other securities purchased by an OBU in the primary market, 'made with' and 'making ... with' refer to the issuer of the shares or other securities.

Where investments, including shares, debentures, units in unit trusts, futures and options etc., are traded on an exchange, the transactions are made between the buyers and sellers. Other parties may be involved in the transactions, for example, exchange participants, exchanges, and clearing houses. However, these parties act on behalf of, or as intermediaries between, the buyer and the seller.

Whenever an investment is traded on an exchange, the other party to the transaction, for the purpose of subsections 121D(6) and 121D(6A) of the ITAA 1936, is the seller or buyer on the other side of the trade.

However, in practice, a buyer (including an OBU buyer) generally does not know the identity of the seller, and so could not know whether the seller is an offshore person or a non-resident. For this reason, we will accept that when an investment is acquired through a foreign stock exchange or a foreign futures exchange or foreign options exchange, an investment is made with an offshore person for the purpose of subsection 121D(6) of the ITAA 1936 - unless either the OBU or the offshore person for whose benefit the security is purchased, is aware or might reasonably be expected to be aware, that the seller of the security is not an offshore person.

Similarly, we will accept that when an investment is acquired through a foreign exchange, an investment is made with a non-resident for the purpose of subsection 121D(6A) of the ITAA 1936 - unless either the OBU or the non-resident for whose benefit the security is purchased, is aware or might reasonably be expected to be aware, that the seller of the security is not a non-resident.

Finally, and in contrast with the exchange trading of investments, 'over-the-counter' (OTC) or 'off-exchange' trading is the negotiation and trading of such investments privately and directly between buyers and sellers, rather than through a centralised institution such an exchange. Here the terms 'making ... with' and 'made with' refer to the other party (the counterparty) to the OTC transaction.

Date of amendment Part Comment 12 October 2021 Reasons for Decision Insertion of footnote 1, to provide details regarding closure of the OBU regime to new entrants, outstanding applications for the OBU regime, and concessional tax treatment of OBUs. Date of effect 13 September 2021

Date of amendment | Part | Comment

12 October 2021 | Reasons for Decision | Insertion of footnote 1, to provide details regarding closure of the OBU regime to new entrants, outstanding applications for the OBU regime, and concessional tax treatment of OBUs. Date of effect 13 September 2021