Foreign banks operating in Australia – liquidity charges and notional funding costs
Banking on Tax, Issue 9
The ATO has continued its focus on the foreign banking sector by recently issuing three ATO Interpretative Decisions (ATO IDs) relating to the deductibility of liquidity reserves and notional funding costs in Australian operations of global banks. All three ATO IDs conclude that these costs are not deductible in Australia. However, our analysis is that the ATO has taken quite a narrow approach to the facts and issues in these decisions and that these costs may be deductible in certain circumstances.
ATO ID 2012/90 - deductibility of notional funding costs
ATO ID 2012/90 asks whether, in determining the profits attributable to a foreign bank's Australian permanent establishment under the business profits article of a relevant tax treaty, the bank can deduct an amount it estimates would be the funding cost if assets employed in its Australian branch operations had been funded under certain terms and conditions?
The ATO concludes that the answer is no, the bank cannot deduct such estimated (or notional) funding costs. Deloitte’s view is that the ATO has reached this conclusion based on inferences it has drawn from a rather narrow set of facts, and that in some cases these costs may be deductible where it can be shown they are necessarily incurred for the business of the Australian branch.
ATO ID 2012/91 - deductibility of "net loss" or "negative spread"
ATO ID 2012/91 asks whether a "net loss" or "negative spread" can be a loss or outgoing incurred by a taxpayer within the meaning of section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) where the net amount is the excess of interest expense incurred by the taxpayer on borrowings to fund a particular asset (being a liquid reserve asset) over the income derived by the taxpayer from the asset?
The ATO states that the “net amount” cannot be the loss or outgoing incurred by the taxpayer within the meaning of section 8-1 of the ITAA 1997; rather, it is just the interest expense incurred by the foreign bank in calculating the "net loss' or "negative spread". In our view, the particular construction of what makes up income and expense would be critical to such an analysis.
ATO ID 2012/92 - deductibility of liquidity charges
ATO ID 2012/92 asks whether, in determining the profits attributable to a foreign bank's Australian permanent establishment under the business profits article of a tax treaty, interest expense incurred by the foreign bank on its borrowings that fund the bank's general reserve liquid assets, managed and controlled for use outside Australia (i.e. the liquid asset reserve is required by the home country regulator), is deductible by the bank under section 8-1 of the ITAA 1997?
Again the ATO says that the answer is no. The ATO’s analysis takes the view that the liquid reserve assets are managed and controlled for use outside Australia, deriving income and incurring interest expenses that do not have the requisite connection with the business operations carried on through the Australian branch.
Deloitte adopts a wider view of these cases and believe that the costs may be deductible in Australia, particularly where a functional analysis shows that there is a commercial benefit in Australia that justifies the allocation of expenses and revenue to or from the Australian branch operations under transfer pricing legislation. Deloitte is of the view that the ATO has (correctly) left the door open to such analysis by saying that a foreign bank could be treated as having incurred some of the interest in the course of its Australian branch operations if, for example, it funded liabilities of its Australian branch operations from the proceeds of disposal of any of the liquid reserve assets.