Debt interest not previously giving rise to debt deductions and subsequently does
A discussion document was provided to members at the meeting. The Chair advised that the purpose of the document was to foster discussion and to elicit responses from members. The document is intended to formalise the Tax Office's articulation of the issue discussed at the April 2009 meeting. The discussion document is not intended to be a Tax Office view document.
This issue was submitted by the ICAA representative at the April 2009 meeting at which the Tax Office provided a verbal response. The issue concerns step 1 of the adjusted average debt method statement in subsections 820-85(3) and 820-185(3) of the ITAA 1997. Whether at the end of an income year, a taxpayer who has not incurred a debt deduction in respect of a particular debt interest in that year or in an earlier year includes in step 1 of the method statement, that debt interest. The ICAA member went on to explain that it concerns a cost free instrument issued in that year or an earlier year, but upon which interest subsequently becomes payable. The ICAA member queried in such a scenario would the earlier years require amendment to take account of the change in the instruments contingency?
The ICAA representative explored the phrase 'gives rise to' as used in step one of the relevant method statement. The ICAA representative submitted that the phrase 'gives rise to' should be interpreted so as an amount would not be included in Step 1 until the year when the interest is paid on the loan/instrument (that is, when the issuer is profitable). Essentially the words 'gives rise to debt deductions' do not require the taxpayer to take into account something that is merely a possibility.
Another member made reference to the discussion paper which referred to the supplementary explanatory memorandum introducing the sub-section. The member went on to explain that the supplementary explanatory memorandum uses an example of an instrument which incurs all its costs in the first year and conversely another instrument incurring all its costs in the last year. The example indicates that in such a case the debt capital comes within step 1. The member inquired that, in terms of other contingencies, such as interest free loans and other 'shades of grey', which are not alluded to in the explanatory memorandum, what is the Tax Office's position on their inclusion in step 1.
Response
The Tax Office observed that the issue seemed to be a straightforward interpretation of the provision. The phrase 'gives rise to debt deductions of the entity for that year or any other income year', clearly takes into account the current year and future years. The Tax Office referred to another scenario where for example, interest is only payable in a later year but may equate to the accumulated time value of money. The words 'or any other income year' in the context of the applicable method statement and the subject of Division 820 directs attention to the period of time for which a debt interest was on issue.
Of course where the terms of a loan or instrument may have contingencies that make it so remote that there are no costs associated with the instrument, then there is the possibility of it not being included within step one. Conversely where a contingency may well arise in the future then the debt capital is required to be included in step one of the subsection. Critically, in relation to the technical issue under discussion the answer applicable to a particular debt instrument requires consideration of all years to which the debt instrument relates. It was suggested that in relation to specific debt interests the answer would ultimately turn on the particular facts applicable to the term of that debt instrument with effect that a PBR could be sought in doubtful cases.
The Chair provided the opportunity to members to consider the Tax Office's discussion document out of session. The members agreed to consider the document and would attempt to develop a joint response to be forwarded to the Secretariat.
Action item
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FSISG 0709/03
External members to consider the Tax Office discussion paper for the next NTLG FSI Sub-group: debt interests that give rise to debt deductions in later income years.
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Description
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Members to review content of document and provide a joint response
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Responsibility
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Members
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Due date
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By next meetings
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Sections within Agenda items
Last Modified: Monday, 3 May 2010