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Cash-pooling – interest income from a cash-pooling arrangement

Banking on Tax, Issue 9


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In the article Banks and cash-pooling in issue #7, we outlined some issues associated with cash-pooling. Until recently, the ATO had published very little on cash-pooling.

In January 2013, the ATO released ATO Interpretative Decision 2013/2 (ATO ID 2013/2), Withholding tax: interest derived by an Australian resident in carrying on business at or through a permanent establishment outside Australia. ATO ID 2013/2 considers whether interest income derived by an Australian resident participating in a physical cash-pooling arrangement using funds obtained from a foreign branch, was derived in carrying on business in a country outside Australia at or through a permanent establishment (PE) of the Australian resident.

Essentially, the ATO states that the interest income would be derived in carrying on business in a country outside of Australia at or through the PE for the purpose of the withholding tax provisions. The scenario considered in ATO ID 2013/2 is slightly more complicated by the fact that the funds swept from the bank account were loaned to an Australian (presumably associated) entity. The ATO concludes in ATO ID 2013/2 that where none of the exemptions in section 128B of the Income Tax Assessment Act 1936 apply and all of the requirements of section 128B(2A) are satisfied, interest payments on the loans from the taxpayer to the Australian (presumably associated) entity would be liable to interest withholding tax.

The interpretations set out in ATO ID 2013/2 raise a number of issues around the ATO’s analysis of the source of interest income and an implied apportionment approach.

Source of interest income

The ATO essentially relies on a transfer pricing-type analysis to assert that the interest on the loans is derived in carrying on a business at or through a PE in a foreign country, on the basis that the funding for the loans was initially derived from a foreign source. The ATO does not seem to place any significance on the fact that the sweep was from an Australian bank account to an Australian entity that entered into the loan agreement in Australia.

The ATO approach raises a number of issues:

  • Firstly, the approach seems to ignore a body of authority that the source of interest is derived from the loan contract (rather than the source of the principal sum; see FC of T v Spotless Services Ltd and Anor 95 ATC 4775)

  • Secondly, the ATO ID does not say that the interest income is “foreign income”, so presumably the ATO does not think that section 23AH applies to exclude the interest income from assessable income (assuming section 23AH would have otherwise applied)

  • Thirdly, assuming that interest withholding tax is payable, section 128D may not apply to exclude the interest income from the taxpayer’s assessable income

  • Fourthly, again assuming that interest withholding tax is payable and the interest income is not excluded from assessable income under either sections 23AH or 128D, Division 770 of the Income Tax Assessment Act 1997 is not likely to apply to allow a taxpayer a foreign income tax offset, as “foreign income tax” does not include withholding tax (at least in the simple facts described in ATO ID 2013/2)

  • Lastly, it is not apparent why the ATO would not simply take the view that the interest income was Australian-sourced income of an Australian resident and, therefore, subject to tax in Australia.

Implied apportionment approach

ATO ID 2013/2 does not address the situation where the funds deposited into the Australian bank account were not exclusively from a foreign branch (i.e. what if the funds represented a mixture of Australian-sourced and PE-sourced amounts?). The ATO seems to imply that an apportionment based on the source of the funds would be necessary. This approach, if that is what is being contemplated, has the potential to give rise to significant compliance issues in trying to track the source and use of funds.

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