Tax Tip 37: Withhold tax on interest you pay to overseas entities

What happens if you borrow a large sum of money from your rich uncle overseas and use the money to buy an investment property - whether in full or part. Can you claim the interest?

If the loan was properly documented then there would be no reason why the usual principles governing deductibility of interest would not apply so the interest would generally be deductible.


But when paying interest overseas the payer of the interest is required to withhold tax from that interest before it is sent off. This is to make sure the government gets its tax out of the transaction as otherwise it would have no jurisdiction to collect the tax if the non resident would not pay.


Failure with withhold tax will mean the interest will not be deductible to you.

 

At top marginal rate I assume?

 

Withholding tax is a set rate of 10% for interest. https://www.ato.gov.au/Business/PAY...ividends-and-royalties-paid-to-non-residents/

Importantly if the person is resident of a country with which Australia has a tax treaty the withholding "MAY" be exempt provided the payer reports it in the correct fashion to the ATO each year. (The theory being that the ATO shares the data with for example the IRS in the US)

The interest submenu in the above link provides more details.

 

This also applies where interest is incurred but not paid to the lender until the end of the loan term.


ATO’s example

Example:

A is an Australian resident who borrows $250 000 on 1 July 2011 from non-resident, NR, at 10% simple interest calculated and payable annually over 5 years. By agreement between them, the annual interest is capitalised each year until the 5th year when the total amount standing to the credit of the loan account is payable.

A has an annual interest liability of $25 000 payable on 30 June. Even though the interest is not actually paid over to NR each year the interest debt is to be satisfied each year by crediting it to NR's loan account. This arrangement is enough to invoke the requirements of the withholding tax provisions to deduct withholding tax from the interest credited each year. Therefore, A is required to deduct $2 500 at the time interest is credited to the loan account and remit it to the Australian Taxation Office.


Taxation Determination TD 93/146

Income tax: should a resident deduct withholding tax from interest payable under a loan from a non-resident if there is no actual payment of the interest?

TD 93/146 - Income tax: should a resident deduct withholding tax from interest payable under a loan from a non-resident if there is no actual payment of the interest? (Published on 22 March 2017)

 

Now lets assume that the lender is in HK. Hong Kong tax laws dont seek to tax investment interest income derived from overseas (Please seek personal tax advice in HK) .

BINGO ! Tax free income.......However that also means the withholding tax is lost. Its non-creditable in Hong Kong and Australian wont refund it either. So if $AUD25,000 of interest was involved the tax withheld would be $2500 so the HK resident would be paid the net amount of $22,500.

Normally if a country is a tax treaty country the foreign country will tax the gross income ($25K) and credit the withholding tax paid against the final tax. In some countries very high withholding can apply to Australian receipt of income from profits or interest and a process to claim amounts that are based on the agreed tax treaty are required. A good example of this is Switzerland....The source withholding is around 40%+ but should only be 20%. The ATO only credits the 20% but there is a complex paperwork process to claim the other 20% once you can prove it has been included in taxable income here...like a withholding tax on withholding taxes.

 

Might be best to just borrow that money interest free from your rich overseas relos.