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Inbound investments have implications for Australian tax. Here is what they are.
Inbound Investments
When you receive an inbound investment from overseas – be it debt or equity – what do you need to look out for? What are the tax implications of inbound investments? This is the question Clint Harding of Arnold Bloch Leibler in Sydney discusses with you in this episode.
Here is what we learned but please listen in since Clint Harding explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Inbound Investments
In practice, structuring an inbound investment into Australia is usually a combination of what works in Australia and then also what the foreign investor is looking for giving their tax regime rules.
Debt or Equity
There are two ways of getting money into Australia, either equity or debt. To determine whether an instrument is debt or equity, you look at s974 ITAA97.
For equity tax is paid in Australia (corporate tax if a company or the trustee is assessed if a trust) and then the money leaves Australia tax-free as a franked dividend or after-tax trust distribution.
For debt, there is no tax on the interest income in Australia as such but then you have withholding tax (WHT). And you need to look out for transfer pricing (Chevron case) and Thin Cap issues.
So two very different approaches to how the income from an inbound investment is taxed in Australia depending on whether it is debt or equity.
Inbound Equity
For equity, you either have a unit trust or a company. The resulting tax issues are all about dividends and trust distributions leaving Australia with very different tax outcomes.
DTAs are often quite complicated around equity.
Unit Trusts
Discretionary trusts rarely play a role for inbound investments, since they don’t give the investor an interest in the underlying asset, hence the preference for unit trusts.
Unit trusts are common for managed investment trusts. For example, real estate trusts – often specifically designed for foreign investors – have a flat WHT of 15% or even down to 10% for ‘green’ buildings. A lot better than the usual 30% corporate tax rate that applies to companies holding passive assets.
Trusts are not well understood in foreign jurisdictions, which makes it harder to attract foreign investments. So they are not that user-friendly for investors from outside of Australia.
Div 6 ITAA36
Div 6 ITAA36 governs the taxation of trust distributions to non-residents in Australia. Under Div 6 the trustee gets taxed on the share of income at special tax rates. The foreign resident then lodges a tax return in Australia and gets a credit for the Australian income tax paid by the trustee.
The good thing is that the foreign resident can claim deductions in his Australian tax return. The bad thing is that the foreign resident gets caught by Australia’s high tax rates.
If the beneficiary is an individual, they pay the top marginal tax rate of 45% for income exceeding $180,000 like any other Australian with that sort of income.
If the non-resident beneficiary is a company, then the tax rate for the trustee is usually 30%.
The non-resident beneficiary gets a refund for any excess tax paid by the trustee.
WHT is done on a gross basis without taking deductions into account. So the ability to claim deductions in an Australian tax return might be of interest.
If Non-Taxable Australian real property is being held in a fixed trust, then you can avail yourself of the CGT exemption for non-residents in s855 ITAA97. Look at the Greensill decision. At the moment you can’t apply s855 to non-resident beneficiaries of a discretionary trust. It has to be a fixed trust per s855 -40.
Companies
Companies are less confusing to foreign investors than Australian trusts. The disadvantage of investing through a company is that you don’t get a foreign tax credit for Australian corporate tax paid. If that is an issue, you are back looking at trusts.
There are some countries that might allow a foreign tax credit for Australian tax paid, but there are not many.
If the Australian company pays a franked dividend, there is no WHT.
If it is an unfranked dividend, then you have a WHT of either 30% if no DTA or 15% with a DTA. Always start with the domestic WHT of 30% and then look at the DTA. Some jurisdictions like Hongkong don’t have a DTA with Australia, hence the WHT is 30%.
Inbound Debt
Inbound debt is all about the tax deduction you claim in Australia and the WHT that might apply.
Always look at the domestic rate first and then check the DTA. WHT on interest is generally 10% but there are exemptions, for example for publicly offered large debt raising.
Under Australia’s more modern treaties – after 2017 – there is an exemption for interest paid to financial institutions. So if you borrow from a foreign bank, there is usually no WHT. The older treaties don’t, so it varies from treaty to treaty.
If the interest you pay is over AUD 2m, then you have to worry about the Thin Cap rules. And if your interest is not at arms-length, then you have to worry about Transfer Pricing.
And remember that there is no WHT on the repayment of principal.
Chevron
The Chevron case was about transfer pricing (not about Thin Cap) and descended into a battle of experts. A lot of discussions was around parent guarantees. What is an arms-length interest rate when you consider parent guarantees? The case shows that you do need support and evidence to back up your pricing of debt.
PE
Having a bank account in Australia won’t be sufficient to create a PE. So just because you transfer an amount to an Australian bank account doesn’t mean it is a PE and hence free from WHT. An ABN will probably get you off the hook and you can assume that it is a PE.
This is a short summary of what we learned in this episode but please listen in since Clint Harding explains all this much better than we ever could.
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 25 October 2021
Tax Talks spoke to Clint Harding - Tax Partner at Arnold Bloch Leibler - for more details.
