The ATO released TD 2016/6 on 13.4.2016 – ruling that interest costs incurred by an Australian resident company, in acquiring foreign source dividend income, through a foreign branch, is not deductible under s25-90 of the Income Tax Assessment Act 1997 (‘ITAA97‘).
Section 25-90 allows deductions for losses and outgoings that would not, otherwise, be not allowed under the general deduction provision: s8-1(2)(c) of the ITAA97, because they were incurred in gaining or producing income that was ‘non-assessable non-exempt’ (‘NANE‘). Or at least, s25-90 remedies this problem for many, but not all classes of NANE income – according to this determination issued by the Commissioner.
Section 25-90 allows such deductions where the foreign source income is NANE by virtue of s23AI (payments from CFC attribution accounts); s23AK (payments from attributed FIF income); and s768-5 (a ‘participation exemption’ for ‘foreign equity distribution’ from a direct or indirect participation interest of at least 10%). Until 2009, s25-90 covered dividend income on foreign company shares, with a ‘non-portfolio’ interest of at least 10%. But this was replaced with the ‘participation’ exemption in s768-5, so that the deductions were only available in relation to deriving ‘equity distributions’ on ‘equity interests’ (not ‘dividends’ on ‘shares’).
Notable by its absence is foreign source income that is NANE under s23AH, which relates to income from foreign branches. Section 25-90 does not offer deductions incurred to derived income from a foreign branch. That much is clear.
So a deduction is available when a resident company incurs losses or outgoings to acquire a stake of at least 10% of the shares (‘equity interests’) in a foreign company (made NANE under s768-5), but the question is whether similar deductions also available to a taxpayer who makes the acquisition, but as part of carrying on business through a foreign branch?
The Commissioner says: ‘no’ – s25-90 deductions are not available in those circumstances. Relying on a version of ‘purposive’ construction of the law, he notes that s25-90 was introduced at the same time as the ‘thin capitalisation’ provisions (in Div 820 of the ITAA97). At par 26 of the Determination, he notes that the ‘thin capitalisation’ debt restrictions only applied to Australian operations and not foreign branches.
26. The thin capitalisation rules were only intended to limit the debt deductions available to an Australian entity in respect of its Australian operations.[19] As a consequence, Division 820 of the ITAA 1997 does not impose limits on debt deductions to the extent that the cost is attributable to an overseas permanent establishment of an outward investing entity (including banks).[20] This includes debt deductions incurred in earning income that is non-assessable non-exempt under section 23AH of the ITAA 1936.[21] This treatment of the overseas permanent establishments of an Australian entity is consistent throughout Division 820 of the ITAA 1997, as the Australian entity’s overseas permanent establishments are also excluded in determining the Australian entity’s maximum allowable debt or minimum capital amount.[22]
Footnote [19]: See paragraph 1.18 of the Explanatory Memorandum to the New Business Tax System (Thin Capitalisation) Bill 2001.
Footnote [20]: See sections 820-1, 820-85 and 820-300 of the ITAA 1997.
Footnote [21]: See sections 820-95, 820-100, 820-105, 820-310, 820-315 and 820-320 of the ITAA 1997.
Footnote [22]: As subsection 23AH(2) of the ITAA 1936 applies to ‘income derived at or through a PE’ and sections 820-85 and 820-300 of the ITAA 1997 only apply to a debt deduction ‘to the extent that it is not attributable to an overseas permanent establishment’, subject to exceptions to these primary rules, it is likely that costs incurred in deriving income that is subject to section 23AH of the ITAA 1936 will also be subject to the exceptions in either section 820-85 or 820-300 of the ITAA 1997.
And the Commissioner continues to expand the link between the scope of the thin capitalisation provisions and the scope of s25-90 in paras 30 and 31 of his determination.
30. A policy approach could have been adopted under which the general rule in Division 820 of the ITAA 1997 extended to all debt deductions, including those attributable to overseas permanent establishments. However, a deliberate decision was made to make an exception for debt deductions attributable to overseas permanent establishments. Fundamentally, these deductions differ from other deductions covered by section 25-90 of the ITAA 1997 because they fall for consideration as to deductibility in the country of the permanent establishment. Were these deductions also subject to section 25-90, there would likely be significant ‘double deductions’ for the same financing costs.
31. As such, debt deductions attributable to overseas permanent establishments are treated fundamentally differently from other debt deductions relating to offshore non-assessable non-exempt income: they are not within section 25-90 of the ITAA 1997 (so no deduction is available to the extent the relevant branch income is exempt under section 23AH of the ITAA 1936) but also they are not included in the calculation of debt that is subject to Division 820 of the ITAA 1997 limitations.
[TT summary] [LTN 69, 13/4/16]