When will an 'at call' loan be an equity interest?
From 1 July 2005, an 'at call' loan will generally be an equity interest if it does not satisfy the debt test in section 974-20 of the ITAA 1997, and is not carved-out.
A loan between a company and a connected entity which does not have a fixed term but is repayable on demand will usually be classified as an equity interest. Such a loan usually meets the requirements of item 3 of the equity table in subsection 974-75(1) of the ITAA 1997. This is because the right to, or amount of, the return of principal or interest under the arrangement is usually at the discretion of the company that has been advanced the funds, or at the discretion of a connected entity of the company, such as a controlling shareholder of the company. Accordingly, it will generally be the case that where a controlling shareholder lends money to a company, repayable on demand, with no fixed maximum term, and the loan is either interest free or has a low interest rate, the loan will be an equity interest for certain tax purposes.
However, if the loan satisfies both the debt and equity tests, it will qualify as a debt interest as a result of the tie-breaker test in the debt/equity rules (pursuant to paragraph 974-70(1) (b) of the ITAA 1997). It is unlikely that an 'at call' loan will meet the requirements of the debt test where the term of the loan is greater than 10 years, or the agreement is silent as to the term, and interest is nil, very low, or is as determined by the parties from time to time (as is common in 'at call' loan arrangements between associated parties).
Tax consequences of an equity interest
The tax consequences of an 'at call' loan being an equity interest are that any payment of interest on the loan will not be deductible but may be frankable. A non-share capital account is also kept in this instance (refer to Division 164 of the ITAA 1997).
An 'at call' loan that gives rise to an equity interest may, in specific circumstances, attract the application of the dividend substitution provisions contained in section 45B of the ITAA 1936.
Section 45B of the ITAA 1936 is designed to prevent the distribution of profits to shareholders as preferentially taxed capital rather than dividends. The enactment of the New Business Tax System (Debt and Equity) Act 2001 introduced amendments to section 45B of the ITAA 1936 to ensure that the anti-avoidance provisions relevant to ordinary shares (for example, the capital streaming and dividend substitution rules contained in sections 45A and 45B of the ITAA 1936) are also applicable in relation to non-share equity interests because the broad definition of equity and its related concepts are extended to them. Where necessary, minor modifications have been made to those provisions to ensure they can apply in relation to non-share equity interests.
These amendments to section 45B of the ITAA 1936 provide that a non-share distribution to an equity holder will be taken to be a distribution to the equity holder of share capital to the extent to which it is a non-share capital return.
The debt/equity rules in Division 974 of the ITAA 1997 provide that an 'at call' loan made to a company by a related party will usually give rise to an equity interest in the company if the loan fails the debt test or the turnover test. In those situations where the debt/equity rules continue to apply, the repayment of an 'at call loan' is treated as a non-share distribution to an equity holder.
The Tax Office considers that section 45B of the ITAA 1936 might apply if an 'at call' loan is repaid under a scheme which has, as one of its purposes, the enabling of a taxpayer to obtain a tax benefit. There are a number of relevant circumstances that need to be considered in ascertaining whether section 45B of the ITAA 1936 might apply.
These circumstances are set out in subsection 45B(8) of the ITAA 1936 and include such things as the pattern of distributions of dividends, bonus shares and returns of capital or share premium; whether the taxpayer has capital losses that might have otherwise been carried forward and whether the taxpayer is a non-resident. Accordingly, it is clear that the application or otherwise of section 45B of the ITAA 1936 to related party 'at call' loans will be determined by the facts and circumstances of the relevant taxpayer.
It is noted that the amendments to section 45B of the ITAA 1936 were limited to those interests that are characterised as non-share equity interests and taxpayers may choose to formalise their 'at call' loans so that they give rise to a debt interest.