If you invest in bonds it’s important to understand where your custodian resides. Having bonds in safe custody with an offshore domiciled custodian may mean your bonds are subject to an additional 10% (or more) withholding tax.
Written by the FIIG Legal and Custody Teams
Tax consequences are an important consideration when evaluating prospective investments. The return on an investment can be materially affected depending upon how it is taxed. Here we focus on withholding tax and its impact on income derived from corporate bonds where the requirements of the public offer test in section 128F of the Income Tax Assessment Act are not met.
Interest withholding tax exemption
In the interest of creating an internationally accessible bond market, the ATO has granted a withholding tax exemption for Australian tax residents for qualifying bonds. In order for the exemption to apply the issuer, beneficial owner and custodian must be an Australian resident for tax purposes.
For investors buying bonds by a locally licenced issuer and custodian, no interest tax withholding, will be applied. However, for an offshore investor or an investor who holds assets with an offshore custodian, withholding tax will most likely be charged. Withholding tax is imposed by the ATO on interest payments made to foreign investors, generally at a rate of 10% (depending on the treaty with Australia).
Custodian Facilities at FIIG
FIIG has been licensed to provide Custodial Services since early 2010. As FIIG is domiciled in Australia, it is regulated by ASIC and indeed Australian law, such that adoption of FIIG’s custody arrangements would not jeopardise Australian-tax resident’s entitlements to the interest withholding tax exemption.
Other competitors in the market who provide custodial services, use foreign custodians which may impact investor’s tax liabilities.
The specifics of the withholding tax exemption and the ‘public offer test’ can be referred to in the relevant legislation; for issuers who are companies, this is section 128F of the Income Tax Assessment Act and section 128FA for issuers who are structured as a trust.
In summary, withholding tax should be considered by investors when buying Australian corporate bonds and the implication of where custodians are domiciled. Prospective investments should be assessed for their eligibility for the ATO exemption, noting that the corporate structure of the issuer and the way the bond is issued are the two relevant factors. The issue prospectus often indicates whether or not the bond satisfies the requirements for the exemption. As always, you should speak to a registered tax agent to gain a more personalised understanding of any tax consequences you may face when investing in corporate bonds.
If you have any questions regarding bonds and custody please contact your relationship manager.