Journal of Australian Taxation
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BRINGING OBUs ONSHORE: ASSESSING THE
CONCESSIONS
By Kerrie Sadiq
As part of the deregulation of the Australian financial market in the 1980's the Federal Government considered establishing Australia as a competitive international financial centre. To do so changes were needed in the form of tax concessions for offshore banking units ("OBUs"). To this extent a concessional tax regime has been introduced. However, problems associated with the system currently in place have been exposed. In December 1997 the Government, in response to the Mortimer report, announced a number of changes to the OBU regime in yet another attempt to increase its attractiveness.
In the context of the Federal Government's desire to establish Australia as a competitive international financial centre this article examines the current position of OBUs in Australia. Further, the changes that have been made to accommodate the present system, along with proposed changes and the likely effectiveness of the tax concessions in attracting offshore banking activities in Australia are considered.
The recent Financial System Inquiry Final Report[1], resulting from the Wallis Inquiry, recognised that taxation has a pervasive influence on the financial system.[2] It stated that one of two broad themes in the recommendations of the Inquiry on the financial regulatory framework was "... the removal or modification of regulations which inhibit the growth, development and international competitiveness of financial sector activities in Australia ...".[3] While it was beyond the scope of the inquiry to make specific taxation recommendations,[4] it did report on the effect of certain taxation policies in relation to the competitiveness
of the Australian financial system.[5] The Wallis Inquiry is the latest in a series of inquiries into the Australian financial system, all of which considered the need for competitive tax concessions in order for Australia to be internationally viable.[6] Recommendations made by these earlier inquiries have led to a concessional tax regime being implemented with regard to offshore banking units ("OBUs"). However, the present Government has indicated that a number of changes are necessary to increase the attractiveness of the tax regime for OBUs.[7]
The present Government specifically addressed the issue of tax concessions for OBUs recently when, on 8 December 1997, the Prime Minister responded to the Mortimer Report entitled "Review of Business Programs Going for Growth: Business Programs for Investment, Innovation and Export".[8] In his response, the Prime Minister stated that the OBU regime would be broadened to include fund managers and life insurance companies as eligible OBUs, along with a broadening of the range of eligible OBU activities. Further, it was indicated that changes would be made to the interest withholding tax concession, capital gains tax consequences and administration costs associated with OBUs. On 2 July of this year, the Taxation Law Amendment Bill (No. 5) 1998 was introduced into Parliament proposing amendments to the present OBU regime in line with the Government's desire to increase Australia's attractiveness as an offshore banking centre.
In light of the renewed interest in establishing Australia as a viable offshore banking centre this article considers the history of OBUs in Australia along with the tax concessions granted by Federal and State Governments. In doing so the article considers whether past and proposed future measures are enough to attract offshore banking to Australia. Further, nontax incentives are examined in determining whether Australia has an internationally competitive OBU regime. Finally, this article looks at factors contributing to successful offshore financial centres in other jurisdictions.
Since the late 1950's, a number of countries have established themselves as competitive international financial centres by granting regulatory and/or tax concessions to encourage nonresidents to carry out banking business in their country. Locations for international banking business, known as offshore banking centres, include such
tax havens as the Bahamas, Cayman Islands and Channel Islands. Offshore banking refers to "... the financial intermediation performed by a commercial bank for the benefit of borrowers and depositors who are not residents of the country in which the bank is located."[9] Comparable tax countries such as the United States, where international banking facilities have been permitted to operate since December 1981, and Japan, which began operating an offshore market in December 1986, also operate as offshore banking centres. Singapore, Hong Kong, the Philippines and Thailand have also established themselves as offshore banking centres.
In December 1983, the Australian dollar was floated and most exchange controls were suspended. Therefore, offshore banking in Australia was conceivably possible and many of the financial institutions operating in Australia developed banking business with nonresidents. However, only a small amount of this business involved pure offshore banking transactions.[10] Australia was not regarded as an international financial centre and prior to the 1980's Australia itself had not considered becoming competitive in the international financial market.
Dr John Hewson first considered establishing Australia as a competitive offshore banking centre in a 1981 report.[11] This report was commissioned by the Campbell Committee, established in 1979, with the purpose of considering many aspects of the Australian financial system.[12] The Hewson report examined the concept of an OBU, the operations of OBUs and the ramifications of trying to establish a competitive OBU regime in Australia. The most crucial point coming out of the Hewson report was the problem of competing with other offshore banking sectors, particularly our Asia Pacific neighbours, Singapore and Hong Kong.
In May 1983 the newly appointed Australian Labor Party ("ALP") Treasurer, Mr Paul Keating, announced that a group to review the Australian financial system and the findings of the Campbell Committee would be formed. This review was to take place in light of the ALP's economic and social objectives. The findings of the Committee, chaired by Mr VE Martin, tabled in the House of Representatives in February 1984,[13] dismissed the possibility of Australia establishing an OBU regime and concluded, "Australia would not be able to compete against Singapore or Hong Kong...".[14]
At the same time the Martin Committee was reviewing the Australian financial system, the Whitlam Committee was specifically considering the establishment of offshore banking activity in Australia.[15] This report concluded that it was both feasible and desirable to attract offshore banking activities. It was emphasised that in order to establish an OBU regime it would be necessary to introduce both tax and nontax measures which were conducive to offshore banking in Australia.[16]
In 1984, a working party was formed to consider issues relevant to the establishment of an OBU regime in Australia. The Government, in announcing the formation of the working party, stated that it was in favour of facilitating offshore banking in Australia, so long as potential difficulties of supervision and taxation could be resolved.[17] The working party's findings were published in August 1985[18] concluding that there should be an income withholding tax exemption for pure offshore banking transactions between nonresidents, even where they were intermediated by an Australian financial institution.[19] The working party did not conclude that there should be a corporate rate tax concession in respect of offshore banking activity.[20]
The Hewson report, the Martin report, the Whitlam report and the Working Party report, all considered the prospects of Australia establishing itself as an internationally competitive offshore banking centre. In April 1988, legislation was introduced to exempt certain interest on offshore borrowings of an OBU from interest withholding tax. It was the first sign of the Government accommodating the development of an offshore banking industry in Australia.
Since July 1986, the Federal Government has attempted to implement taxation concessions to encourage OBU operations in Australia. The first step towards granting competitive tax concessions for OBUs was taken on 1 July 1986 when the then Federal Treasurer, Mr Paul Keating, announced that certain interest on offshore borrowings of an OBU would be exempt from interest withholding tax. In April 1988, legislation giving effect to the proposal was introduced. While this exemption was encouraging, hindsight demonstrates that it was not enough to establish Australia as a competitive force in the international market as it did not match the tax concessions of our closest competitors, Singapore and Hong Kong.
Mr Keating, in 1986, had indicated that no company tax concessions would be provided to offshore banking profits. In 1992, Mr Keating, as Prime Minister, in his "One Nation" Statement, announced that favourable company tax rates for OBUs would be introduced. Amendments were made to the Income Tax Assessment Act 1936 (Cth)("ITAA36") to provide concessional taxing of the offshore banking income of an OBU, at the rate of 10 percent.
In 1992, decisive measures were taken at a State level when the Queensland Premier announced that a working group would be formed to explore the opportunities for establishing OBUs in Queensland.[21] The working group concluded that attracting OBUs to the State would be economically beneficial and recommended that the 199293 Budget create a tax environment which would encourage the establishment of OBUs in Queensland. As a result, the Queensland Government introduced the Offshore Banking Units and Regional Headquarters Act 1993 (Qld) granting debits tax, land tax, payroll tax and stamp duty concessions to OBUs.
Each of these tax concessions will be considered in turn.
On 1 July 1986, it was announced that certain interest on offshore borrowings of an OBU would be exempt from interest withholding tax. The amendments to the ITAA36, granting an interest withholding tax concession, received royal assent in April 1988.
An interest withholding tax liability can arise when an interest payment is made by an Australian resident or an Australian company to a nonresident, or where an interest payment is made by a nonresident carrying on business through a permanent establishment in Australia.[22] Section 128GB(2) provides an exemption from withholding tax, normally payable in accordance with Div 11A of Pt III, where interest is paid by a person in respect of an offshore borrowing of the person and, when the borrowing took place, the person was an OBU.[23]
An OBU is defined as a person to whom a declaration has been made by the Treasurer under s 128AE(2).[24] The definition of OBUs is limited to banks as defined by s 5(1) of the Banking Act 1959 (Cth), public authorities constituted by a law of a State, being public authorities that carry on the business of State banking, companies in which all of the shares are beneficially owned by an OBU or persons whom the Treasurer is satisfied are appropriately authorised to carry on business as a dealer in foreign exchange. Where the Treasurer has made a declaration, the exemption will only apply to offshore borrowings as defined in the ITAA36, that is, the exemption will apply to a borrowing in any currency from a nonresident who is not related to the OBU, or a borrowing in a nonAustralian currency from an Australian resident or related person.[25]
Section 128NB operates as an antiavoidance provision and is complemented by the Income Tax (Offshore Banking Units) (Withholding Tax Recoupment) Act 1988 (Cth). The effect of these antiavoidance measures is that tax will be paid at 300 percent of the "lost withholding tax amount" where funds, which attract the interest withholding tax exemption, are used by the OBU in an unintended manner".
At the same time the interest withholding tax exemption was introduced, three related amendments were made to Div 18 of Pt III of the ITAA36, dealing with foreign tax credits. First, s 160AE was amended to include a definition of offshore banking income and to treat such income as a separate class from interest and other income. The effect of this treatment is that under s 160AF(7) any foreign tax credit resulting from offshore banking income is only available for offsetting against Australian tax payable on that income. Second, s 160AFD(6) was amended to restrict an offset of certain OBU losses against certain OBU income earned in future years. This section will only allow losses incurred by an OBU in deriving offshore banking income to be offset against offshore banking profits of the OBU. Third, s 160AF(8)(b), was amended to preclude the transfer of excess foreign tax credits by a wholly owned subsidiary in a group to another company in the same group.
The interest withholding tax concession did not induce any significant amount of offshore banking activity in Australia. While the interest withholding tax concession was the first step in Australia becoming competitive, there was still a long way to go before Australia would be any threat to other offshore banking centres. The primary reason appears to be that Australia's other tax rates were still not competitive. The company tax rate at this time was 39 percent, which was uncompetitive with other countries such as Singapore where the company tax rate for OBUs was 10 percent.
The Government, in 1986, announced that no favourable company tax rates would be provided in respect of offshore banking profits. However, in its "One Nation" Statement of 26 February 1992, it announced that taxable income of an OBU that was pure offshore income would be taxed at a reduced rate. The reason for the change of mind is obvious: the Government wished to facilitate the growth of Australia as a viable offshore banking centre and the interest withholding tax concessions did not do this. In its Explanatory Memorandum to the Taxation Laws Amendment Bill (No 4) 1992 (Cth) ("TLAB92"), which contained the proposed amendments, the Government made the following statement:
Given that the existing IWT concession has not promoted any significant offshore banking activity, the Government has now decided to reduce the company income tax rate on OBUs to 10%.[26]
The "TLAB92" received royal assent on 21 December 1992, however it operated retrospectively to 1 July 1992. The concessional tax rate introduced by this Act applies to income derived after 30 June 1992, even if the offshore banking activities were entered into before this date.[27]
The amendments resulted in the introduction of Div 9A of Pt III of the ITAA36, with its stated objective being the provision for concessional taxing, at the rate of 10 percent, of the offshore banking income of an OBU. The division does not, however, provide for a special tax rate of 10 percent, but rather the assessable income and allowable deductions are adjusted to achieve an effective tax rate of 10 percent. The Explanatory Memorandum does not explain why the amendments were drafted this way, except to state that the factoring down enables any loss that results after the adjustment of the income and deductions to be offset against any other income of the taxpayer.[28]
As with the interest withholding tax concession, to attract the company tax concessional rate the OBU must be declared an OBU by the Treasurer under s 128AE(2).[29] The concession will not apply to income from offshore banking activities, which were entered into prior to the OBU being registered.[30] The OBU will only qualify for the concessional tax rate where it is carrying on offshore banking activity ("OB activity"). For a transaction to be characterised as an OB activity it must meet the "OBU requirement" in s 121EA as well as fall within the definition of "OB activity" contained in s 121D. Section 121EA imposes geographical limits on an OBU in carrying on an OB activity, the effect of which is that OBU tax concessions are only available where the OBU carries on its business activities in Australia.[31]
Section 121D(1) lists eight types of activities, which constitute OB activities, some of which are not regarded as pure offshore banking activities. In this regard the concessions extend to a wide range of activities. The activities are: certain borrowing or lending of money,[32] certain guarantee activities,[33] certain trading activities,[34] certain eligible contract activities,[35] certain investment activities,[36] certain advisory activities,[37] certain hedging activities[38] and any other activity which involves an offshore person and is an activity declared by the regulations to be an OB activity.
For a transaction to be considered an OB activity it must, in almost every situation, be entered into with an "offshore person". An offshore person, defined in s 121E, is divided into three categories: a nonresident, a resident, or another OBU. A nonresident who qualifies as an offshore person is a nonresident whose involvement in a particular activity does not occur in carrying on business in Australia at or through a permanent establishment of that person. A resident who qualifies as an offshore person is a resident whose involvement in a particular activity occurs in carrying on business outside Australia at or through a permanent establishment of that person. An OBU will qualify as an offshore person where the involvement in a particular activity involves the payment of money by the second OBU to the first OBU and the second OBU gives a statement in writing that none of the money is non-OB money of the second OBU.
Where an OBU engages in an OB activity and wishes to take advantage of the 10 percent concessional rate, separate accounts are to be kept for relevant OB activities.[39] Failure to do so will result in the loss of the 10 percent concession.[40]
The operative provision, providing for the taxation of income at an effective rate of 10 percent, is s 121EG, allowing for the adjustment of assessable OB income and allowable OB deductions to achieve this result. Section 121EG(1) provides that only an eligible fraction of the assessable OB income is assessable, while s 121EG(2) provides that only an eligible fraction of the allowable OB deductions are allowable.[41] The result is that approximately one third of the assessable OB income and allowable OB deductions are taken into account in determining the taxable OB income, which is then taxed at the ordinary company tax rate.
Assessable OB income is that income derived from OB activities of the OBU or is included in assessable income because of such activities.[42] This income is to be derived from a source in Australia.[43] Any assessable income derived from non-OB money[44] will not be included in this amount.[45] Further, if more than 10 percent of the assessable income from OB activities is derived from using non-OB money the OBU will not be eligible for concessional tax treatment.[46]
Section 121EF defines a number of terms used in determining the allowable deductions of an OBU. This section classifies allowable OB deductions into three categories: exclusive OB deductions, general OB deductions and apportionable OB deductions. Exclusive OB deductions are deductions that relate exclusively to assessable OB income,[47] general OB deductions relate to both OB and non-OB income and are apportioned between the two,[48] while apportionable OB deductions are those amounts which do not have any connection with the production of assessable income but are allowed as deductions.[49]
The company tax concession brings Australia into line with other offshore banking centres. On a pure tax concession basis Australia is competitive with such countries as Singapore and Hong Kong. These tax concessions however may not be enough to encourage offshore banking to Australia and other factors may need to be taken into consideration.
The working group established by the Queensland State Premier in April 1992 concluded that attracting OBUs to the State would be economically beneficial and recommended that the 199293 budget create a tax environment which would encourage the establishment of OBUs in Queensland. Subsequently, the 1992–93 budget included a commitment from the State Government to abolish State taxes on the activities of qualifying OBUs, for a period of ten years.[50] As a result, the Queensland Parliament passed the Offshore Banking Units and Regional Headquarters Act 1993 (Qld) ("Qld Act") on 17 December 1993, which came into force on 1 September 1994.
The Qld Act was introduced to create a tax environment conducive to the establishment of OBUs in Queensland. To date, Queensland is the only State to pass legislation specifically addressing tax concessions for OBUs.[51] This is despite the Whitlam report in 1984 stating that it would be necessary for the States and Territories to grant tax concessions to OBUs if Australia was to be competitive.
The Qld Act provides for certain concessions on State taxes where the OBU is a "QOBU", that is, the holder of a licence granted by the Minister of Finance. The Minister may only issue a licence where he is satisfied that the issuing of such a licence is likely to give an economic benefit to Queensland.[52] The intention of this requirement is to ensure that only reputable firms with a stable financial background will qualify for the tax concessions.[53] The accompanying regulations allow up to a 100 percent exemption to qualifying OBUs.[54] A QOBU is entitled to concessions in relation to debits tax,[55] land tax,[56] payroll tax[57] and stamp duty.[58]
Submissions made to the Wallis Inquiry suggest dissatisfaction with our present OBU regime. It is suggested that while the OBU legislation was "conceived with a vision to attract business to Australian financial markets, it's codification into legislation and the interpretation of that legislation positively discourages anything but specious application.".[59]
The Wallis Inquiry stated:
The administrative complexity of the OBU regime imposes large transaction costs on participants and is claimed to deter new entrants. In addition, the fact that only authorised banks, State banks, wholly owned subsidiaries of banks already registered as OBUs, and authorised foreign exchange dealers are eligible to be declared OBUs tilts offshore funds management towards banks. Market participants argued that there is a limited range of concessions available in Australia compared with other centres.[60]
The Federal Government, on 8 December 1997, responding to the Mortimer report, announced that it is "committed to making Australia a more attractive regional financial centre and to building on our existing advantages to ensure Australia's full participation in the increasing global trade in financial services."[61] To this end it is proposed that changes will be made to the present system, as outlined above, to improve Australia's OBU tax regime.
The first change will be the broadening of the eligibility category of OBUs. At present, by virtue of s 128AE(2), only banks and authorised foreign exchange dealers may be declared an eligible OBU. It is anticipated that this category will be expanded to include funds managers, defined as money market corporations subject to the Financial Corporations Act 1974 (Cth), and life insurance companies, thereby facilitating greater non-bank competition.[62] This change is in line with the recommendations of the Wallis Inquiry which stated "the changes to licencing and other regulatory arrangements proposed by this Inquiry, together with considerations of competitive neutrality between different classes of financial institutions, suggest that the range of entities eligible to be declared OBUs may need to be reconsidered."[63]
Second, the list of eligible activities in s121D(1) will be broadened to include:
▪ trading with any person in gold, and custodial services provided to nonresident "offshore persons"; and
▪ trading, hedging and other eligible contract activity in Australian dollars with an "offshore person", including another OBU.[64]
Apart from broadening both the categories for OBU eligibility and OB activities, the Government intends to address several indirectly related obstacles. In general, amendments are aimed at addressing uncertainties and administrative difficulties encountered in the present regime.
Uncertainties will be removed to ensure a comprehensive withholding tax exemption. This will include an amendment to s 128GB of the ITAA36 to exempt interest paid on offshore borrowings under "conduit" arrangements.[65] Further, the penalty for breaches relating to the interest withholding tax concession, presently excessive at 300 percent, will be reduced to bring it in line with the penalty for breaches relating to the company tax concession.
In its proposal for reform, the Government has recognised the high administrative costs associated with OBUs and proposes to remove the requirement for separate accounts for overseas transactions. Further, amendments will allow for alternative arrangements to meet the ATO audit requirements.[66] Expense allocation rules will also be simplified. Again, this is in line with Wallis Inquiry recommendations which stated "[a] further important goal is the achievement of a less complex taxation system, one that includes lower compliance costs and facilitates the provision of simple, and more readily understood, financial products."[67]
Minor changes will correct present anomalies. In particular, where a capital gains tax liability may arise where a nonresident disposes of 10 percent or greater interest in an OBU offshore investment trust, the liability for capital gains tax will be removed where the "Australian percentage" of the trust is not more than 10 percent.[68] The interaction between OBU offshore investment trust provisions[69] and general trust provisions[70] will also be clarified. Finally, OBU income will be deemed to have a foreign source for foreign tax credit purposes where the income has been subject to foreign tax and the "thick capitalisation" provisions[71] will not apply if arm's length interest is already paid in respect of 90 percent or more of the resident owner money.[72]
On 2 July of this year Taxation Law Amendment Bill (No. 5) 1998 was introduced into Parliament. Amongst other proposed amendments, changes to the current OBU regime, in line with the Government's initiatives announced in the "Australia A Regional Financial Centre" component of the Investing for Growth statement of 8 December 1997, were proposed. The Explanatory Memorandum provides that, by extending the range of eligible entities and eligible activities, Australia's attractiveness as an offshore banking centre will be increased as the compliance burden will be reduced and the concessions available will be widened.[73]
In order to facilitate greater non-bank competition the first of the proposed amendments extends OBU status beyond the entities listed in s 128AE(2). By amending s 128AE(2), OBU status will be granted to:
▪ a life insurance company registered under the Life Insurance Act 1995;
▪ a company that provides funds management services that
▪ is included in the category for money market corporations under the Financial Corporations Act 1974;
▪ holds a dealer's licence; or
▪ holds an investment adviser's licence; or
▪ a company that the Treasurer determines to be an OBU.
At present nonresident charitable institutions are taxed in the same manner as any other nonresident. To encourage both the management of their funds by OBUs and the investment in Australia by offshore charities, an exemption will be introduced where the investments are managed by an OBU and the charitable institution is exempt from tax in its resident jurisdiction.
As well as broadening the category of eligible entities, the amendments propose a broadening of eligible OBU activities.
The proposed broadening of eligible OBU activities is extensive. Firstly, the amendments propose to extend eligible activities beyond portfolio investment activity to allow custodial services, that is, to allow OBUs to make and manage investments as custodian and therefore undertake activities at the direction of their clients. Eligible custodial services include; safekeeping of assets, settlement of transactions, foreign exchange dealings, collection of income, corporate actions, securities management, reporting to advisory services, and tax reclamation.[74]
The activities of currency trading, metals trading, other trading activities and eligible contract activities, as defined, will be extended to allow transactions in Australian currency where the other party to the transaction is an "offshore person" as defined in s 121E. The proposed amendments go further with gold by both broadening the category of eligible trading parties and removing currency restrictions. OBUs will be allowed to trade with both residents and Australian branches of nonresidents where the trade is in a foreign currency and in Australian currency where the trade is with offshore persons. Finally, the restriction placed on hedging requiring the counterparty not to be a "related person" is to be removed.
In addition to the broadening of the range of eligible entities and eligible activities there are further amendments proposed to increase Australia's attractiveness as an offshore banking centre. The current anti-avoidance measures in s 128GB(3) preventing Australia being used as a conduit to channel loans to other countries will be removed.
The capital gains tax liability of nonresidents disposing of interests in "OBU offshore investment trusts" will be reduced. This measure is designed to remove the CGT liability on gains relating to underlying foreign assets held by the investment trusts. A foreign tax credit for foreign tax paid by Australian resident OBUs will be provided in all cases, irrespective of whether a Double Tax Agreement applies. This will provide greater neutrality in the treatment of OBUs, which are residents of Australia.
The current requirement to keep certain accounts for OBUs will be relaxed by removing the requirement to operate separate nostro[75] and vostro[76] accounts thereby reducing compliance costs.
Finally, amendments are also proposed to bring the penalty for dealing with funds that are subject to the withholding tax concession in a manner excluded by the legislation in line with the penalties applying to breaches of the OBU income tax concessions. The rate will be reduced from 300 percent of the amount of withholding tax that would have been paid had the concession not applied to a rate of 75 percent.[77]
There are several jurisdictions with highly successful offshore banking centres. For example, in the 1980's and 1990's, Bahrain came to the forefront as a key player in world banking and financial services. The reasons are obvious: there is no personal, corporate or withholding tax, 100 percent foreign ownership of companies is allowed, there are liberal investment and ownership laws, and the costs associated with establishing and maintaining a presence in the country are relatively low.[78] Mauritius has also established itself as a leading offshore financial centre with advantages ranging from a concessionary income tax rate of 5 percent on all offshore profits, the ability to expatriate profits freely without attracting other taxes to political stability, excellent infrastructure and advanced, efficient telecommunication facilities.[79] Increasingly, however, it is Singapore that is the draw-card in the Asia Pacific region. Singapore is reported to have over 190 licenced Asian currency units and appears to be Australia's main competitor.[80]
The fact that Singapore is Australia's main competitor for attracting OBUs is evidenced by the attention that Australian reports have devoted to the Singapore regime. Before Australia established an OBU regime, the Singapore system and its effects were being considered. Dr Hewson, in his report, devoted a chapter to the Singapore system,[81] while the Martin report concluded that Australia would not be able to compete against Singapore.[82]
Singapore's offshore banking tax regime is comparable to Australia's as it offers incentives designed to entice offshore banking. As with Australia, to qualify for the concessions, an entity carrying on offshore banking must be licensed. These entities are licenced as an Asian Currency Unit ("ACU") and have operating requirements imposed on them by the Monetary Authority of Singapore ("MAS").
The ordinary company tax rate of 27 percent will apply to income generated from Singapore activities with a Singapore source, however a concessional rate of 10 percent will apply to income generated from ACUs.[83] Both regimes also extend the definition of OB activities to a wider range of activities than ordinary banking activities. The Singapore regulations[84] currently provide for eighteen different types of activities, which are classified as OB activities. In this sense the two regimes are similar. However, there is a divergence between the two when dealing with withholding tax. Unlike Australia, Singapore only grants an interest withholding tax concession to ACUs in very limited circumstances. Only interest on those transactions that are between banks or branches of banks will be exempt from interest withholding tax. The Singapore regime does, however, grant an exemption from dividend withholding tax on any dividends paid out of concessionally taxed ACU income. Australia does not have a comparable concession.
Singapore has been highly successful in attracting offshore banking, yet the tax concessions granted have little advantage over the Australian tax concessions. There are clearly other factors that are taken into account in deciding where to conduct offshore banking activities. Factors, which may influence potential OBUs include stability, both economically and politically, availability of skilled workers, appropriate time zones, good communications network and a high standard of living. In this regard Singapore offers many of these advantages. It has also been pointed out that, with offshore banking well established in Singapore, it is easier for banks to remain, rather than relocate to another jurisdiction.[85]
Australia also offers political and economic stability, a good work force, good communications network and an appropriate time zone in the Asia-Pacific region. However, these are not unique to Australia. One advantage Australia may be able to offer is a high standard of living at a lower cost, relative to Singapore. This in itself, however, will not be enough to entice offshore banking to Australia away from Singapore.
A final factor that should not be overlooked is a country's marketing program. Part of Singapore's success is attributable to a very successful marketing campaign. If Australia, and in particular Queensland, wish to attract offshore banking activities, tax concessions will not be sufficient to do so. Non-tax advantages of conducting offshore banking in Australia must be considered and marketed to potential OBUs.
Another of Australia's Asia-Pacific neighbours providing competition in the offshore banking market is Hong Kong. The Hong Kong tax regime only taxes income that is sourced in Hong Kong, however, any interest income which is deposited in a Hong Kong financial institution will be sourced there and subject to profits tax. Income derived by the OBU will be taxed at a rate of 17.5 percent.[86] Hong Kong does not impose interest withholding tax or dividend withholding tax on residents or nonresidents.
In previous years, Hong Kong has been highly successful in attracting offshore banking. At present one of the non-tax considerations for conducting offshore banking in Hong Kong, given its recent return to Chinese rule, is its political instability. Australia's advantage of political stability, however, may have left its run too late in attracting those departing Hong Kong. Many offshore banking centres wishing to leave Hong Kong, have already done so and have chosen Singapore as the appropriate centre for their operations.
The Wallis Inquiry recognises that:
"[a] goal, and one that is difficult to attain, is the achievement of a taxation system which is consistent with competitive neutrality in an international setting. The increasing globalisation of financial markets heightens this challenge, and will require considerable further attention from government in the near term. This will be particularly desirable if Australia's full potential as a provider of financial services in a global marketplace is to be reached."[87]
Along with the economic advantages there are other sound reasons for establishing Australia as a competitive offshore banking centre. Not the least of which is establishing Australia in international financial sectors. In order to achieve this, Australia must offer incentives competitive with other offshore banking centres. Clearly, the interest withholding tax concession was only the first step in making Australia a viable offshore banking centre. The company tax concession, introduced in 1992, has brought Australia in line with other offshore banking centres in relation to tax concessions and therefore should now, at least theoretically, be competitive in the international offshore banking arena. It is suggested, however, that even if Australia offers competitive tax concessions a growth of OBUs in Australia is unlikely to happen.
Other non-tax factors will influence a decision as to where to conduct offshore banking activity. While Australia has economic and political stability which could be decisive factors in dismissing Hong Kong as a possibility, Singapore has no such problems. The non-tax advantages of Australia over Singapore are very few and in fact the advantages associated with Singapore in this regard may outweigh Australia.
The other issue that will arise is "why move?". While OBUs are being provided with comparable tax concessions in Singapore, why would they move their activities to Australia? There is no sound reason for doing so. Australia should have been an attractive alternative as an offshore banking centre for those wishing to move from Hong Kong. However, in attracting potential offshore banking, Australia left it too late.
The drafting of the ITAA36 itself does little to attract offshore banking to Australia. The relevant legislation is not easy to understand, nor is it easy to put into practice. With regard to the company tax concession, the legislation could have simply provided for a tax rate of 10 percent for OBUs, but instead it provides for the factoring down of the OB income and OB deductions. Further, the Australian Taxation Office has issued a large number of determinations relating to OBUs and will more than likely increase this number in the future.
If Australia wishes to be part of the international financial market, it will not only be necessary to have Federal tax concessions but also State participation. The only State to date to make a concerted effort to attract OB activity has been Queensland. The State tax concessions granted by the Qld Act have been a step in the right direction, however, Queensland is not considered the financial capital of Australia so is unlikely to attract OBUs in any great number.
With more changes to the present tax regime proposed, only time will tell whether Australia's attractiveness to OBUs will increase.
[1] Financial System Inquiry, Financial System Inquiry Final Report (1997) ("Wallis Inquiry").
[2] Ibid 132.
[3] Ibid 135.
[4] Ibid 708: "The Inquiry in its consideration of financial system regulation may not make recommendations on, but will take account of: (d) policies for the taxation of financial arrangements, products or institutions."
[5] Ibid 495.
[6] Committee of Inquiry into the Australian Financial System, Australian Financial System: Final Report of the Committee of Inquiry (1981); Australian Financial System Review, Australian Financial System Report of the Review Group (1983); and House of Representatives Standing Committee on Finance and Public Administration, A Pocket Full of Change, Banking and Deregulation (1991).
[7] Federal Government, Australia A Regional Financial Centre (1997).
[8] Ibid.
[9] EMA Kwaw, The Law and Practice of Offshore Banking and Finance (1st ed, 1996) 5.
[10] AFJ Brown, DMH Bell, KR Murphy, AG Pearson, ME Slaviero, MS Sullivan and JJ Van Helten, International Banking and Finance (1989) 181.
[11] J Hewson, "Offshore Banking in Australia", Australian Financial System Inquiry Commissioned Studies and Selected Papers, Part 2 (1981).
[12] Committee of Inquiry into the Australian Financial System, above n 6.
[13] Australian Financial System Review, Australian Financial System Report of the Review Group (1984) ("Martin report").
[14] Ibid 80.
[15] Committee Established by the Premier of New South Wales, Report of the Committee Established by the Premier of New South Wales to Establish Offshore Banking Activity in Australia with Particular Reference to Sydney (1984) ("Whitlam Committee").
[16] The report also considered that it was important to establish appropriate regulatory controls.
[17] The Federal Treasurer, The Federal Treasurer's Press Release (1984).
[18] The Federal Treasurer, Report of the Commonwealth/State Working Party on Offshore Banking (1985).
[19] Ibid 1.
[20] Ibid 2.
[21] The working group also considered the establishment of regional headquarters in Queensland.
[22] Income Tax Assessment Act 1936 (Cth) ("ITAA36"), s 128B.
[23] The person only needs to be an OBU when the borrowing takes place, and does not have to be an OBU when the interest is paid: ITAA36, s 128GB(1).
[24] ITAA36, s 128AE(1).
[25] ITAA36, s 128AE(1).
[26] Explanatory Memorandum to the Taxation Laws Amendment Bill (No 4) 1992 (Cth), 17.
[27] Taxation Determination TD 93/131.
[28] Explanatory Memorandum, above n 26, 22.
[29] Section 128AE(2) states: "The Treasurer may, by notice published in the Gazette, declare a person being: (a) a bank as defined by subsection 5(1) of the Banking Act 1959; or (b) a public authority constituted by a law of a State, being a public authority that carries on the business of State banking; or (ba) a company in which all of the shares are beneficially owned by an offshore banking unit (other than one to which paragraph (c) applies); or (c) a person whom the Treasurer is satisfied is appropriately authorised to carry on business as a dealer in foreign exchange; to be an offshore banking unit for the purposes of this Division".
[30] Taxation Determination TD 93/133
[31] Section 121EA states: "For a thing done by an OBU to be an OB activity, it is necessary that, when the thing is done: (a) the OBU is a resident and the thing is not done in carrying on a business in a country outside Australia at or through a permanent establishment of the OBU; or (b) the OBU is a nonresident and the thing is done in carrying on business in Australia at or through a permanent establishment of the OBU."
[32] "Borrowing or lending activity" is defined in ITAA36, s 121D(2). Included in this category is the borrowing of money from an offshore person in a foreign currency, the lending of money to an offshore person in a foreign currency, or borrowing gold from or lending to a foreign person. The definition of "borrowing or lending activity" was extended in 1994 to include the borrowing or lending of gold.
[33] "Guarantee-type activity" is defined in ITAA36, s 121D(3). Included in this category is the underwriting of a risk for an offshore person in respect of property outside Australia or an event, which can only occur outside Australia. See also Taxation Determination TD 93/129.
[34] "Trading activity" is defined in ITAA36, s 121D(4). Included in this category is trading with an offshore person in securities issued by nonresidents and in a foreign currency or trading with an offshore person in eligible contracts where the amounts are payable by nonresidents in a foreign currency.
[35] "Eligible contract activity" is defined in ITAA36, s 121D(5). Included in this category is a contract which is an eligible contact as defined in s 121C and money under it is payable in a foreign currency.
[36] "Investment activity" is defined in ITAA36, ss 121D(6) and (6A). Included in this category is an investment made with an offshore person where the currency involved is foreign currency and the purchaser is a non resident or allocated outside Australia. Section 121D(6A) was added in 1996 to extend the definition of "investment activity" to permit offshore fund managers to place up to 10 percent of their funds in Australian assets without tainting the concessional tax rate applicable to the OBU.
[37] "Advisory activity" is defined in ITAA36, s 121D(7). Included in this category is financial advice given to an offshore person in respect of the abovementioned investment activities.
[38] "Hedging activity" is defined in ITAA36, s 121D(8). Included in this category is a contract entered into with an offshore person for the sole purpose of eliminating or reducing the risk of adverse financial consequences that might result from interest rate or currency exposure in respect of borrowing or lending activities.
[39] ITAA36, s 262A.
[40] Taxation Determination TD 93/135.
[41] The eligible fraction, contained in ITAA36, s 121EG(4), is 10 divided by the general company tax rate. At present the general company tax rate is 36 percent. Therefore the eligible fraction is approximately .278 percent (10/36% = .278).
[42] ITAA36, s 121EE. Section 121EE also defines "adjusted assessable OB income" and "adjusted total assessable income" which are used in the calculation of "general OB deductions" in s 121EF(4).
[43] ITAA36, s 121EJ.
[44] Defined in ITAA36, s 121C.
[45] ITAA36, s 121EE(2).
[46] This is known as the "10 percent purity test", contained in ITAA36, s 121EH.
[47] ITAA36, s 121EF(3).
[48] ITAA36, s 121EF(4).
[49] ITAA36, s 121EF(5).
[50] Explanatory Note to the Offshore Banking Units and Regional Headquarters Bill 1994 (Qld), 2.
[51] Other States may provide for limited exemptions within tax related legislation.
[52] Qld Act, s 8(3).
[53] Explanatory Note, above n 50, 1.
[54] Offshore Banking Units and Regional Headquarters Regulation 1994 (Qld).
[55] Debits tax concession: A QOBU does not have to pay tax under the Debits Tax Act 1990 (Qld) for debits made to an account if the debits are made, and the account is used wholly for its OBU (Qld Act, s 17(1)).
[56] Land tax concession: If a QOBU owns land and uses it for carrying out its OBU activities, it has to pay tax for the land under the Land Tax Act 1915 (Qld) to the extent, only, and on the conditions prescribed in the regulations (Qld Act, s 18(1)).
[57] Payroll tax concession: Tax under the Payroll Tax Act 1971 (Qld) is payable to the extent, only, and on the conditions prescribed by the regulation for wages paid or payable to persons employed by a QOBU and engaged in the performance of its OBU activities (Qld Act, s 19).
[58] Stamp duty concession: A transaction entered into by a QOBU for its OBU activities in only liable for duty under the Stamp Act 1894 (Qld) to the extent, and on the conditions, prescribed by regulation (Qld Act, s 20(1)). It should be noted that concessions granted under this provision do not apply to a conveyance or transfer of real property in Queensland or a conveyance or transfer of shares or a right in respect of shares.
[59] Wallis Inqiry, above n 1, 495.
[60] Ibid.
[61] Federal Government, above n 7, 1.
[62] Ibid 4.
[63] Wallis Inquiry, above n 1, 495.
[64] Federal Government, above n 7, 4.
[65] Ibid.
[66] Ibid.
[67] Wallis Inquiry, above n 1, 493.
[68] This will be achieved by reducing the capital gains tax to make it proportional to the share of gain that relates only to any underlying Australian assets held by the trust.
[69] ITAA36, s 121EL.
[70] ITAA36, ss 98(3) and 98(4).
[71] "Thick capitalisation" provisions deem interest to be paid in respect of 90 percent of an OBU's "resident owner money".
[72] Federal Government, above n 7, 5.
[73] Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 1998 (Cth), 25.
[74] Ibid 27.
[75] Foreign currency denominated accounts maintained by Australian OBUs with foreign banks or the purpose of settling foreign currency transactions.
[76] Australian dollar accounts maintained by foreign banks with Australian OBUs for the purpose of setting foreign currency transactions.
[77] This amendment is to the Income Tax (Offshore Banking Units) (Withholding Tax Recoupment) Act 1988, s 7.
[78] "Offshore Financial Centres Supplement" (1992) Euromoney (May) 15.
[79] P Craig, "Mauritius, a Success Story of the 1980's, is Looking for Investors to Participate in the Next Development Stage" (1992) 113(6) BusinessAmerica 28.
[80] M Rosamund, "Asia: A Gateway to the Future" (1991) 141(784) Banker 50.
[81] Hewson, above n 11.
[82] Martin report, above n 13.
[83] Income Tax Act (Singapore), s 43A.
[84] Income Tax (Concessionary Rate of Tax for Asian Currency Unit Income) Regulations 1988 (Singapore).
[85] For a table of comparative concessional rates for offshore banking see R Fisher, "Offshore Banking Units: Australian and Overseas Concessions" (1994) 3(1) Taxation in Australia (Red Edition) 18, 29.
[86] Ibid 25.
[87] Wallis Inquiry, above n 1, 493.
Kerrie Sadiq (nee Chalmers) holds B Com LLB (Hons) and LLM degrees. Kerrie is a lecturer in Law in the Department of Commerce at the University of Queensland and a fellow of the Taxation Law and Policy Research Institute at Deakin University. Kerrie is currently undertaking a PhD at Deakin University. Kerrie has previously published in the areas of capital gains tax and international tax in both national and international journals.
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URL: http://www.austlii.edu.au/au/journals/JlATax/1998/10.html