In the first, the ATO has denied a deduction in Australia for an allocation of any portion of the cost of maintaining liquid reserve assets as required by the bank’s home country banking regulator. The liquid assets reserve comprised high quality, liquid government bonds and secured cash deposits, funded by relatively more expensive term funding resulting in an overall loss or negative spread in the liquid asset reserve.
Notwithstanding that reserve liquid assets are available to meet the liquidity requirements of the Australian branch should the need arise, the ATO has determined that no portion of the negative spread can be allocated to the Australian operations. The ATO ruling states that because the liquid reserve assets are managed and controlled by the foreign bank outside Australia, at best there is only a contingent connection between the reserve assets and the bank’s activities in Australia.
In the second ruling, the ATO has denied an internal recharge of notional funding cost. In this case the bank was funding its Australian branch with short term AUD borrowings while other jurisdictions had more expensive longer term funding. A liquidity charge (or term funding premium) was imposed on the Australian branch by head office, to reflect the higher funding costs that the Australian branch would have incurred if it had instead borrowed AUD with the average duration of the bank’s global borrowings.
These rulings highlight the issues that arise from Australia’s ‘relevant business activity approach’ to allocating actual income and expenses of a taxpayer to a permanent establishment rather than the ‘functionally separate entity’ approach adopted by the OECD.
The conclusions reached by the ATO in these rulings do not result in the Australian tax base reflecting what would have occurred if the Australian branch was a separate enterprise required to satisfy regulatory liquidity requirements in their own right (consistent with the current OECD approach).
In the weeks since the rulings were released the ATO has already targeted a number of banks seeking information about liquidity charges.
It will be interesting to see how this plays out domestically in the medium term through the work of the Board of Tax. Equally interesting will be the response of other revenue authorities around the world. Impacted taxpayers are likely to be left with little choice but to invoke the Competent Authority provisions of Australia’s Double Tax Treaties. It is one thing for the ATO to run these arguments with taxpayers, it is another for them to sit across a table from a bank’s home country revenue authority and argue that these are home country costs only.