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Australian Court Holds Interest Income of CFC to be Reported as Derived on Accruals Basis — Orbitax Tax News & Alerts

A decision of the Federal Court of Australia has been published concerning whether interest income of a CFC should be reported as derived for tax purposes on an accruals (earnings) basis or a cash (receipts) basis. The case involves News Australia Holdings Pty Ltd. as the provisional head company of a group that included SRC Holdings Limited, a controlled foreign company in the Cayman Islands, which was wholly owned by News Limited.

Under a loan agreement between SRC and News Limited, SRC was owed interest income of approximately USD 66 million. The interest was paid in the 2011 income year, on 2 July 2010, and on 8 July 2010 SRC paid withholding tax of approximately AUD 7 million in respect of the interest. However, the Australia Taxation Office (ATO) determined that SRC was to be assessed on an accruals basis for the interest income, which as per the terms of the agreement was due to SRC on 28 June 2010, and therefore accrued and was derived for tax purposes in the 2010 income year ending 30 June 2010.

In its decision, the Court sided with the ATO. The Court found that although interest income can in general be accounted for on a cash basis, interest income can be accounted for on an accruals basis when the lending of money is an aspect of a taxpayer's business. Although SRC is not in the business of lending money, the Court accepted the position that an accruals basis should be used because the lending of money is part of SRC's business as evidenced by its income earning activities, which include the lending of money to, amongst others, its parent on commercial terms for reward. As such, the interest income should have been considered derived for tax purposes in the income year it accrued (2010).