External benchmarks are used in a number of places in the tax legislation. In recent years we have seen scenarios where the use of these benchmarks no longer reflects commercial practice or the benchmarks themselves cease to exist. This causes issues for both taxpayers and the Australian Taxation Office (ATO).
The use of London Interbank Offered Rate (LIBOR) as a limit for deductions on intra-branch borrowings in Part IIIB first ran into problems when regulatory changes forced foreign branches to manage liquidity locally and borrow funds with terms longer than 12 months (being the longest period that LIBOR is quoted). For floating rate term borrowings, the requirement to use the LIBOR rate for the (relatively short) period that the interest rate is fixed on multi-year term loans means the LIBOR cap denies the term premium built into the borrowing cost and is one reason for many taxpayers electing out of Part IIIB.
Add then the decision to cease publication of LIBOR for AUD and a number of other currencies with effect from May 2013 significantly limiting the potential relevance of the cap. This prompted the ATO to agree to an administrative solution with industry to use Bank Bill Swap (BBSW) as the replacement benchmark for intra-branch AUD denominated borrowings.
More recently, negative interest rates in various LIBOR currencies have put further pressure on the use of LIBOR as a benchmark. The ATO, to its credit, has been relatively responsive with a view that the cap cannot be a number below zero! Unfortunately for taxpayers the ATO does not seem to accept that negative interest rates can give rise to negative withholding tax!
Another example of a benchmark causing issues is the use of the Reserve Bank of Australia (RBA) indicator rate as a cap on interest deductions for capital protected borrowings. Again driven by regulatory changes, home loan lenders now have differential interest rates on owner occupied and investment property loans. In September last year this prompted the RBA to replace its Standard Variable Housing Loans indicator rate with separate rates for Owner Occupied and Investment Loans, the later rate being 25-30 basis points higher.
With the indicator rate specifically referred to in capital protected borrowing rules no longer published, the ATO issued Taxation Determination (TD) 2016/10 in June 2016 indicating that investors should use the higher Investment Loan indicator rate when calculating any limit in interest deductions on capital protected borrowings.
The use of benchmarks in tax legislation might seem like an appropriate approach, but the drafting needs to provide flexibility for future (unforeseen) changes that might impact their applicability.