AUD LIBOR discontinued ─ Can the LIBOR cap in Part IIIB still apply?
Banking on Tax, Issue 11
In a number of previous Banking on Tax articles, we have commented on Part IIIB of the Income Tax Assessment Act 1936 (Part IIIB deals with Australian branches of foreign banks) and the London Interbank Offer Rate (LIBOR) limitation on interest deductions under that part. On 1 August 2013, the ATO released a document titled, Large business income tax strategy 2013-14. In that document, the ATO identified Part IIIB for the banking and finance industry as a “matter of concern”.
LIBOR is an interest rate based on the average interest rates at which a number of banks operating in London would lend to each other. Until mid-2013, LIBOR was quoted for different maturities and for different currencies (including the Australian dollar, or AUD). At the end of May 2013, the British Bankers Association decided to discontinue fixing a LIBOR for a number of currencies, including the AUD.
The only reference to LIBOR in the Income Tax Assessment Acts is in Part IIIB. Part IIIB deems internal funding provided to an Australian branch of a foreign bank to be borrowings and deems accounting expenses related to that funding to be interest incurred. However, Part IIIB limits the deemed deduction to the amount calculated by reference to the LIBOR. In addition, withholding tax of five per cent (rather than 10 per cent) is payable on the amount of deemed interest (subject to the LIBOR limitation).
If an Australian branch of a foreign bank has borrowings in currencies for which the LIBOR is no longer quoted (such as the AUD, New Zealand dollar, Swedish krona, Danish krone and Canadian dollar), there is an argument that the limitation for deemed interest deductions in Part IIIB can no longer apply. In fact, it is our view that an interest rate cap should no longer apply (be it LIBOR or any other interest rate benchmark).
The Board of Taxation’s review of tax arrangements applying to permanent establishments (i.e. a review of Australia’s adopting the OECD’s “functionally separate entity” approach for permanent establishments) included a review of Part IIIB. In response to the discussion paper issued by the Board of Taxation, Deloitte submitted that the LIBOR cap in Part IIIB should be removed, on the basis that it caused significant issues as the LIBOR was often significantly lower than the actual cost of funds. In our view, the arm’s length principle (in conjunction with the existing thin capitalisation provisions) provides a more appropriate framework to determine the amount of interest deductible for foreign banks operating in Australia. This is consistent with the recommendation contained in The Report on Australia as a Financial Centre prepared by the Australian Financial Centre Forum.
The Board of Taxation provided its report on the taxation arrangements applying to permanent establishments to the previous Government in April 2013. To date, no response has been provided (and thus no copy of the Board of Taxation report has been made available). The announcement of taxation policy decisions to be included in the Mid-Year Economic and Fiscal Outlook is an opportunity for the Government to deliver its response and provide certainty for Australian branches of foreign banks.