Conditions For Interest Withholding Tax
Withholding tax must be paid on interest income under certain conditions:
- If the interest is earned by someone who is not a resident for tax purposes.
- If the interest is paid by either:
- A resident, except when the interest is entirely related to a business conducted overseas through a permanent establishment (like a branch).
- A non-resident, and the interest represents an expense partially or wholly incurred by the non-resident while conducting business in Australia through a permanent establishment within Australia.
It’s important to note that withholding tax applies not only when interest is actually given to a non-resident but also when the interest is due and has been managed on behalf of or as directed by the non-resident, which includes reinvestment activities.
If the interest is paid in a foreign currency, it should be converted into Australian currency at the time of payment for withholding tax calculations.
What is Interest?
For the purpose of interest withholding tax provisions, the term “interest” is expansively defined to include several categories:
- Amounts that qualify as “interest” in the conventional sense.
- Amounts that share the characteristics of interest.
- Amounts that can be seen as substitutes for interest.
- Amounts that can reasonably be considered as received within the context of a “washing arrangement.”
- Dividends paid concerning non-equity shares.
- Payments made on upper tier 2 capital instruments that are designated as debt interests
Interest Withholding Tax Rates
Withholding tax on interest is typically applied at a flat rate of 10% on the gross interest amount. This rate is not significantly affected by Australia’s double taxation agreements (DTAs), except in certain cases.
Special Rate for Certain Bearer Debentures
- A special withholding tax rate of 45% is applied to interest that does not fall under the regular withholding tax provisions. This applies specifically to interest paid concerning certain bearer debentures when the company fails to disclose the names and addresses of the debenture holders to the tax authorities.
- In this context, the “holder” of the debenture is the person in possession of it.
Concessional Rate for Interest to Foreign Banks
A reduced withholding tax rate is applied to the interest payments made by an Australian branch of a foreign bank.
The reduced withholding tax rate is typically equal to half of the standard withholding tax rate that would apply to interest payments.
Since in most cases, the standard withholding tax rate for interest is 10%. Therefore, the concessional rate provided under this ruling is usually 5%.
Taxation of Various Financial Transactions
Specific financial transactions like forward exchange transactions, forward rate agreements, swaps, and reciprocal purchase agreements are typically exempt from the application of interest withholding tax provisions.
This exemption arises because these transactions do not entail the provision of financial funds or resources.
Building Society Share Accounts Income
In most cases, income earned by non-residents on building society share accounts is classified as interest income, not dividends, and is thus subject to interest withholding tax.
Tax-Exempt Bodies and Withholding Tax
If one or more tax-exempt entities are situated between an Australian resident payer and a non-resident recipient of interest, withholding tax must be paid as if the interest had been directly paid to the non-resident recipient.
This means withholding tax is applicable unless the non-resident recipient is also tax-exempt.
Discounted and Deferred Interest Securities
Withholding tax may apply to certain deferred and discounted interest securities. When certain qualifying securities are transferred, and the transfer price exceeds the issue price, the excess is deemed to be interest and is subject to interest withholding tax.
This rule also applies when a security has been partially redeemed, and the transfer price exceeds the reduced issue price. However, this rule does not apply to debentures that meet the “public offer” criteria.
Hire Purchase and Similar Arrangements
The withholding tax provisions extend to hire purchase and similar arrangements involving Australian entities purchasing plant and equipment from non-residents.
In these cases, withholding tax applies to the “interest” component, which is the excess of the total payments made under the arrangements over the cost price of the goods.
Moreover, when cross-border equipment lease payments include an implicit interest component, that interest is subject to interest withholding tax.
Bill of Exchange and Promissory Notes
Withholding tax is also applicable to the discount element of a bill of exchange when a resident indemnifies or reimburses a non-resident acceptor for the face value of the bill at maturity.
Any amount constituting the discount or interest component under the bill falls within the withholding tax provisions. A similar provision applies to promissory notes as well.
Exemptions From Interest Withholding Tax
As per the Australian tax laws, there are several specific exemptions from interest withholding tax. These exemptions include:
1. Interest from Non-Resident Businesses
Interest earned by a non-resident who conducts business in Australia through a permanent establishment is exempt from withholding tax.
You must also keep in mind that the rule deeming certain non-resident beneficiaries to operate in Australia through a branch does not apply in this context.
2. Interest on Publicly Offered Debentures
Interest on specific publicly offered debentures is exempt from withholding tax.
3. Interest for Certain Charitable and Non-Profit Entities
Interest payments made to certain foreign charitable institutions, public hospitals, and non-profit cultural, sporting, and friendly societies are exempt from withholding tax, provided their income is exempt from both Australian and their home country’s taxes. This exemption follows similar restrictions as dividends paid to such entities.
4. Interest for Offshore Testamentary Charitable Trusts
Interest paid to certain offshore testamentary charitable trusts established before July 1, 1997, is exempt.
5. Interest for Foreign Non-Profit Associations
Interest paid to specific foreign non-profit aviation, tourism, agricultural, and manufacturing associations is exempt.
Other exemptions include:
- Gold fees paid by an Offshore Banking Unit (OBU) in relation to offshore gold borrowings are treated as interest and exempt from withholding tax (as per TR 92/5).
- Certain interest derived by a trust estate is exempt when the trustee is liable to be assessed.
- Interest related to infrastructure borrowings is exempt.
- Interest derived by non-resident foreign superannuation funds is exempt if it’s also exempt in the fund’s home country.
- Interest on which family trust distribution tax has been paid is exempt.
- Interest paid to non-residents from specific “nostro” accounts held by banks and financial institutions conducting banking business is exempt.
- Certain interest paid to overseas charitable institutions by an OBU or a trust managed or controlled by an OBU is exempt.
- A non-share dividend is exempt to the extent that it constitutes a return on an equity interest.
- Interest paid by “temporary residents” is exempt.
Exemptions for US and UK Resident Financial Institutions
Interest payments to US and UK resident financial institutions are exempt when they are not taxable in Australia under the relevant DTAs due to their lack of effective connection with an Australian branch.
Exemptions for Government Bonds and Debentures
Interest payments made after certain dates on state and territory government bonds issued in Australia and on debentures and debt interests issued in Australia by the Commonwealth Government or its authorities may qualify for an exemption from interest withholding tax.
To be eligible for this exemption, it’s important to meet the criteria of the “public offer test” where applicable.
This test ensures that the bonds or debentures are made available to the public in a manner that satisfies the established regulations.
If the public offer test conditions are met, the interest paid on these financial instruments can be exempt from interest withholding tax.
Collection of Interest Withholding Tax
The rules governing the withholding of tax from non-resident interest payments are integrated into the PAYG (Pay As You Go) withholding system.
In most cases, withholding tax acts as a final tax. This means that income subjected to withholding tax is excluded from assessable income.
Consequences of Inadequate Withholding
When the correct amount of withholding tax is not appropriately deducted and paid, the payer responsible for the interest is obligated to cover the unpaid tax amount.
Additionally, they may incur the general interest charge (GIC) on the outstanding amount. Furthermore, failing to deduct withholding tax is considered an offense and can lead to a maximum fine of 10 penalty units.
Deemed Income for Non-Resident Beneficiaries
If non-resident beneficiaries have a legal right to a share of interest income that is part of the overall income distributed from an Australian trust estate, they are treated as if they earned that interest income themselves.
As a result of this treatment, they may be held responsible for paying withholding tax on that interest income. The timing of when this rule applies is when the beneficiary’s legal right to the interest income, known as their “present entitlement,” is established.
Exception for "Grossing-Up" Clauses
Payments made under a “grossing-up” clause are exempt from withholding tax. These clauses are typically found in loan agreements and involve borrowers agreeing to cover the interest withholding tax that foreign lenders would normally be liable to pay.
From a tax perspective, these payments are not categorized as interest or anything similar to interest. Instead, they serve as indemnities. In other words, they act as a form of protection for the foreign lender against their liability to pay withholding tax.
Despite the exemption from withholding tax, it’s important to note that tax laws generally view such payments as income for the lender. Therefore, if the source of these payments is within Australia, they may be subject to taxation as assessable income for the lender.
Credit for Withheld Interest Tax
A non-resident who earns income that includes interest on which withholding tax has been deducted is eligible to receive a credit against their withholding tax liability. In many cases, this credit is equivalent to the withholding tax liability, effectively nullifying the tax liability.
However, it’s essential to note that no deductions are permitted for an interest amount unless the withholding obligations have been properly fulfilled.
In other words, taxpayers cannot claim deductions for interest expenses unless the required withholding tax has been deducted and paid.
Tax File Number and Investment Bodies
Investment bodies, such as financial institutions, are responsible for withholding tax from any income they are required to pay to investors in connection with specific investments.
This withholding obligation comes into play when investors have not provided their TFN. However, there is an exemption for non-resident investors from the requirement to provide a TFN.
Moreover, this exemption is applicable as long as the investment body fulfills its obligation to withhold tax from the relevant interest payments.
In simpler terms, non-resident investors are not obligated to provide their TFN when investing, but this exemption is contingent on the investment body performing its duty to withhold tax from the relevant interest payments.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.