Additional Tier 1 capital by domestic banks through foreign branches

Additional Tier 1 capital by domestic banks

Abdol Mostafavi explains the ATO's latest guidance for Australian banks issuing unfrankable non-share distributions on non-share equity interests.

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KPMG Australia

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On 5 June 2017, the Australian Taxation Office (ATO) issued Practical Compliance Guideline (PCG) 2017/10, in which the ATO has adopted a more practical and commercial approach to applying section 215-10 of the Income Tax Assessment Act 1997 than its previous interpretation.

By way of background, section 215-10 allows Australian banks to issue unfrankable non-share distributions on non-share equity interests (typically perpetual notes and certain convertible notes that constitute “Additional Tier 1 capital") which satisfy the following two conditions:

  • they must be issued “at or through a permanent establishment in a listed country” (the “issuance test”), and
  • the funds from the issuance must be raised and applied solely for permitted purposes, e.g. not expatriated to the Australian head office (the “permitted purpose test”). 

This provision effectively provides a concession for Australia’s domestic banks, removing the competitive disadvantage that they would otherwise suffer if the returns on such instruments (paid in all likelihood to non-residents) were required to be franked.

The issuance of this PCG follows a long period of lobbying and consultation by Australia’s domestic banks, following the ATO changing its previous interpretations of this section in 2008, when it began to adopt a more restrictive interpretation of the section (culminating in Taxation Determination TD 2012/19).

The banks opposed the ATO’s interpretation on technical grounds and also on the basis that it rendered section 215-10 unworkable (as evidenced by the fact that the domestic banks effectively stopped raising AT1 capital through their foreign branches after the ATO released TD 2012/19).  In response to industry concerns, the ATO withdrew TD 2012/19 on 8 October 2014. 

In PCG 2017/10, the ATO applies a risk-based approach to activities considered low, medium and high risk for the issuance test, as well as the permitted purpose test. The new approach provides additional flexibility for banks seeking to use this concession, but is expected to remain challenging to apply in practice.

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