Negative interest rates
Tax & AccountingMay 10, 2021

Negative interest rates… another Y2K for the financial sector?

Contributed by Cindy Chan, Senior Content Management Analyst, Wolters Kluwer

Are our current tax laws well equipped to deal with negative interest rates that might arise in the current economic environment? Mr Julian Humphrey, CTA and KPMG Australia partner, discussed the potential impact of negative interest rates on the classification of financial arrangements and its implications for interest payments and receipts, at the Tax Institute’s 2021 Financial Services Taxation Conference in April 2021.1The following article highlights some key issues he discussed.

Negative interest rates?

Broadly speaking, the central bank cash rate is what a central bank (such as the Reserve Bank of Australia (the RBA)) is willing to pay banks for money or reserves they keep on deposit with it. A negative central bank cash rate would effectively penalise banks for holdings reserves with the central bank. The mechanism could be used as an expansionary measure to encourage banks to deploy those reserves to stimulate the economy. Generally, it is unlikely that negative interest rates would flow through to the wholesale or retail markets, though we have seen low and zero rates paid on wholesale or retail deposits.

Given the current low interest rate environment, APRA recently wrote to regulating entities regarding their preparedness for zero or negative interest rates, noting that RBA statements do not preclude the possibility of negative interest rates in the future. For the financial sector, Mr Humphrey argued that the negative interest rates have the potential to be like the “Y2K” problem. Relevant implications noted in APRA’s letter included the regulated entities’ risk management, hedging, operational processes, contracts, product disclosure documents, information technology and accounting systems.

Borrowing with negative interest rate unlikely to satisfy debt test

Notably, Mr Humphrey argued that a borrowing that is subject to a negative interest rate would be unlikely to satisfy the debt test in Subdiv 974-B of ITAA 1997. To satisfy the debt test, essentially one needs to demonstrate that it is substantially more likely than not that the value to be provided under an arrangement is at least equal to the value received. In the case of a negative interest rate applying to an ordinary borrowing, it is not reasonably likely that the financial benefit provided would be at least equal to the financial benefits received.

Meanwhile, it is likely that other provisions dealing with dept-type arrangements would operate as intended when it comes to the classification of arrangements that are subject to negative interest rates. They include provisions dealing with taxation of financial arrangements (also known as TOFA), traditional securities and commercial debt forgiveness.

Borrowers in receipt of negative interest amounts

In the commercial context, a borrowing corporate entity could receive either (a) an amount from the lender (ie a cash payment of negative interest) or (b) a reduction in the amount payable or the principal amount.

A payment from the lender would likely be treated as income according to ordinary concepts under relevant case law (eg FC of T v Dixon (1952) 10 ATD 82; (1952) 86 CLR 540; [1952] HCA 65). However, the position is less clear with respect to the reduction in the principal amount. This could arguably be considered akin to a debt defeasance type gain. Mr Humphrey pointed out that the majority in FC of T v Orica Ltd (formerly ICI Australia Ltd) 98 ATC 4494; (1998) 194 CLR 500; [1998] HCA 33 said that a debt defeasance gain could not be considered ordinary income. Therefore, there might be an argument that a reduction in the principal to be repaid would not be income according to ordinary concepts. Accordingly, it might be important to pay attention to how particular arrangements are structured to give effect to the negative interest rate.

In the private or domestic context, a property buyer who used a mortgage to purchase a residential property might receive incentives, similar to some cash back arrangements currently being used by Australian banks. Mr Humphrey noted relevant ATO guidance including Taxation Ruling TR 1999/6 on flight rewards, Taxation Determination TD 1999/34 and Practice Statement Law Administration PS LA 2004/4 (GA) for consumer loyalty programs. The latter guidance provides that where there is a monetary benefit, it must be “received as part of an income earning activity”, and there must be a “business relationship” between the recipient and provider of the reward. In the present case, it would be clear that the benefit would not be received as part of an incoming producing activity. It would also be unlikely that negative interest amounts arising on a loan used for non-income producing purposes (such as purchasing a home) would give rise to assessable income. However, the answer would likely be different for a loan used to purchase an investment property.

Lenders making payments of negative interest amounts

From the lender’s viewpoint, Mr Humphrey argued that negative interest would unlikely be regarded as interest, or an amount in the nature of interest, for non-resident withholding purposes. Similarly, such negative interest amounts should not be subject to non-quotation of TFN (or Tax File Number) withholding requirements.

On the other hand, there would be consequences under the thin capitalisation rules in Div 820 of ITAA 1997 for a financial entity having a borrowing that would not satisfy the debt test. The arrangement would likely be a non-debt liability because it would neither be debt capital nor equity interest issued by the entity. In the same vein, it would not be included in adjusted average debt. Further, any amount of interest actually payable would not be a debt deduction. Accordingly, the gearing ratios permitted under the rules would likely change.

Finally, s 25-90 of ITAA 1997 currently allows a deduction for interest paid on money borrowed that is used to derive foreign income that is non-assessable non-exempt income under s 768-5 of ITAA 1997. Specifically, a deduction is allowed under s 25-90 for an “amount that is a cost in relation to a debt interest issued by the entity that is covered by paragraph (1)(a) of the definition of debt deduction”. Mr Humphrey argued that the reference to both “debt interest” and “deduction” are problematic where the arrangement would not satisfy the debt test.


As discussed above, there are some aspects of the tax law which may not operate as intended if negative interests apply to borrowing and lending arrangements. Mr Humphrey suggested that some technical issues might be solved by an appropriately worded regulation to treat ordinary debt interests that are subject to negative interest rates as debts for tax purposes. However, this “solution” had not previously proved to be “a timely mechanism” for correction of technical problems with the debt test.


1.Humphrey, J, “The current interest rate environment”, The Tax Institute 2021 Financial Services Taxation Conference, 22–23 April 2021. © CCH

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