Federal Budget announcements on banking tax reforms
Banking on Tax, Issue 7
While the federal Budget contained very little from a tax perspective, we summarise below three Budget announcements that affect tax reform in the banking industry:
- Further regulations to enable tier 2 capital instruments to be debt for income tax purposes
- Deferring the reduction of interest withholding tax paid by financial institutions
- Scrapping the previously proposed 50% discount on interest.
Tier 2 regulatory capital
In Banking on Tax #5 (November 2011, in the article titled, “Tax considerations arising from APRA’s discussion paper on Basel III”), we considered that APRA’s proposal to require the terms of Additional Tier 1 and Tier 2 capital instruments to include a permanent write off of the instruments or conversion to common equity where the bank would otherwise not be viable, would result in a risk that interest on Tier 2 subordinated debt would not be tax deductible under Australian tax law. The obligations to pay interest and principal on the subordinated debt may be regarded as contingent obligations for tax purposes, so the subordinated debt would not meet the test in Division 974 of the Income Tax Assessment Act 1997 for debt treatment.
The Government announced in the Budget that it will ensure that, on commencement of Basel III regulatory reforms on 1 January 2013, certain Tier 2 regulatory capital instruments can be treated as debt for income tax purposes. The mechanism for this was not identified in the Budget announcement, but these changes could be implemented by way of expanding current regulations to clarify that a non-viability clause in the terms of the Tier 2 regulatory capital instruments will be disregarded in considering whether principal and interest obligations in relation to Tier 2 subordinated debt are effectively non-contingent obligations.
Tax discount on interest
In Banking on Tax #4 (July 2011, in the article titled, “Support for tax incentives for bank funding”), we outlined the Government’s discussion paper released on 12 July 2011 about the introduction of a 50% tax discount for Australian-resident individuals on net interest income. The discount was originally announced in the 2010-11 Budget to apply to net interest income up to $500 from 1 July 2012 and up to $1,000 from 1 July 2013. Deferral of the start date to 1 July 2013 was announced on 25 November 2011.
In handing down the 2012-13 Budget, the Government announced that it will not proceed with the 50% discount for interest income as a result of the feedback received through the consultation process which raised concerns around the complexity in calculating the discount and its overall effectiveness.
Reduction of interest withholding tax
In Banking on Tax #4 (July 2011, in the article titled, “Support for tax incentives for bank funding”), we outlined the announcement which was originally made in the 2010-11 Budget to reduce interest withholding tax rates on borrowings by financial institutions from foreign financial institutions or offshore retail deposits from 10% to 7.5% from 2013-14 and 5% from 2014-15. The Government has also previously announced that in the case of Australian branches of foreign banks, withholding tax on head office funding would be reduced from 5% to 2.5% from 2013-14 and would be completely eliminated from 2014-15. On 23 November 2011, the Government announced that these dates would be deferred by one year. These reductions in interest withholding taxes are measures that were to be funded from revenue raised by the Minerals Resource Rent Tax.
In the 2012-13 Budget, the Government confirmed its intention to defer the phase down of interest withholding tax to the 2014-15 year, so that:
- The interest withholding tax rate for Australian branches of foreign banks on head office funding will be reduced from 5% to 2.5% from 2014-15 and 0% from 2015-16
- The interest withholding tax rate for borrowings by financial institutions from foreign financial institutions or offshore retail deposits will be reduced from 10% to 7.5% from 2014-15 and 5% from 2015-16.
Deferral of these interest withholding tax rate reductions will have an adverse impact on funding costs for Australian banks that source funding from certain offshore wholesale markets.