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  • Section B: Financial arrangements

    Question 19 Debt interests and equity interests

    This question seeks to help us assess the risk that an interest has been mischaracterised as either:

    • a debt interest and inappropriate tax deductions have been claimed
    • an equity interest and inappropriate franked distributions have been made.

    The information reported at this question may also help us in doing both of the following:

    • identifying arrangements with international related parties where the use of hybrid instruments may indicate a tax risk
    • assessing any risk regarding your thin capitalisation position.

    The dollar amounts or values asked for in this question are all based on your accounting records.

    The terms debt interest and equity interest are defined in Division 974 of the ITAA 1997.

    To complete this question:

    • identify all debt and equity interests you had on issue or which you held during 2020–21 that were on issue to or issued by international related parties and where the characterisation between debt and equity is different under Division 974 of the ITAA 1997 from your treatment for accounting purposes
    • identify which of those financing arrangements would be classified as debt interests and which would be classified as equity interests under Division 974 of the ITAA 1997
    • identify which of those financing arrangements under which you received finance from a related party and those under which you provided finance to a related party
    • calculate the average quarterly balance of each relevant financing arrangement (by adding the relevant financing arrangement amount at the end of each quarter and dividing by four)
    • add up the total of the average quarterly balances of each financial arrangement under which you    
      • received finance from a related party that is characterised as a debt interest under Division 974 of the ITAA 1997
      • provided finance to a related party that is characterised as a debt interest under Division 974 of the ITAA 1997
      • received finance from a related party that is characterised as an equity interest under Division 974 of the ITAA 1997
      • provided finance to a related party that is characterised as an equity interest under Division 974 of the ITAA 1997.
       

    If you had financing arrangements to which this question applies, answer Yes at A item 19 and complete the required fields.

    At B item 19, write the average quarterly balance of debt interests issued (finance received).

    At C item 19, write the average quarterly balance of debt interests held (finance provided.

    At D item 19, write the average quarterly balance of equity interests issued (finance received).

    At E item 19, write the average quarterly balance of equity interests held (finance provided.

    For help working out the tax characterisation of an interest as debt or equity (debt and equity tests), see:

    Example 18

    Bob & Co analyses the financial arrangements they had during the income year that were entered into with international related parties where the debt and equity treatment under Division 974 of the ITAA 1997 is different from the debt and equity treatment for accounting purposes.

    Bob & Co identifies the following information:
    Bob & Co identifies the following information:

    Financial arrangements

    Tax treatment

    Received or provided

    Quarter 1
    $

    Quarter 2
    $

    Quarter 3
    $

    Quarter 4
    $

    Redeemable preference shares

    Equity

    Received

    35,000,000

    27,000,000

    42,000,000

    23,000,000

    Convertible notes

    Debt

    Received

    16,800,000

    16,800,000

    16,800,000

    16,800,000

    Perpetual notes

    Debt

    Provided

    31,000,000

    28,500,000

    25,000,000

    22,500,000

    Stapled security

    Equity

    Received

    27,500,000

    32,500,000

    32,500,000

    0

    Bob & Co then collates the following information for those financial arrangements where the debt equity characterisation under Division 974 of the ITAA 1997 is different from their treatment for accounting purposes.

    Financial arrangements where the debt equity characterisation under Div 974 is different from their treatment for accounting purposes

    Financial arrangements

    Average quarterly balances Div 974 treats as debt – Received
    $

    Average quarterly balances Div 974 treats as debt – Provided
    $

    Average quarterly balances Div 974 treats as equity – Received
    $

    Average quarterly balances Div 974 treats as equity – Provided
     

    Redeemable preference shares

    na

    na

    31,750,000

    na

    Convertible notes

    16,800,000

    na

    na

    na

    Perpetual notes

    na

    26,750,000

    na

    na

    Stapled security

    na

    na

    23,125,000

    na

    Total

    16,800,000

    26,750,000

    54,875,000

    0

    With this information Bob & Co complete question 19 as follows:

    This image shows an example of how to complete question 19. Question 19 Average quarterly balance of debt interests Label B Amounts received: $16,800,000 Label C Amounts received: $26,750,000 Average quarterly balance of equity interests Label D Amounts received: $54,875,000 Label E Amounts received: nil

    End of example

    Question 19a Financial arrangements under taxation of financial arrangements rules

    This question helps us identify the quantum of financial arrangements that fall under taxation of financial arrangements (TOFA) rules contained in Division 230 of ITAA 1997 and give rise to TOFA gains or TOFA losses under Division 230, that is not also a debt interest under Division 974.

    If you had a financial arrangement for the purpose of Division 230 that gave rise to TOFA gains or TOFA losses under Division 230, and that financial arrangement is not a debt interest under Division 974:

    • answer Yes at A item 19a and complete the required fields
    • specify at B item 19a the total value of all Division 230 financial arrangements that gave rise to TOFA gains or TOFA losses under Division 230 but are not debt interests under Division 974, excluding ordinary shares.

    The total TOFA value of the financial arrangements asked for in this question is based on your accounting records.

    The TOFA value of the financial arrangements must not be netted off against each other. Hence financial arrangements that are ‘assets’ of $16 million and financial arrangements that are ‘liabilities’ of $12 million add up to a total TOFA value of $28 million not $4 million.

    At C item 19a, include the total value of any TOFA gains recognised in relation to the amount of financial arrangements specified at B item 19a, excluding ordinary shares.

    At D item 19a, include the total value of any TOFA losses recognised in relation to the amount of financial arrangements specified at B item 19a, excluding ordinary shares.

    Ordinary shares are shares issued by a company carrying proportionate rights to voting and to profit and capital distributions, and carrying no special rights.

    Question 20 Taxation of financial arrangements rules and tax timing method elections

    This question aims to identify if you are subject to taxation of financial arrangements (TOFA) rules contained in Division 230 of ITAA 1997. Understanding whether you are subject to the TOFA rules and the tax timing method elections you have made will provide us with the context to understand the information you report regarding your financial arrangements.

    The TOFA rules will apply to you if your aggregated turnover, financial assets or assets exceed relevant thresholds or you have otherwise made an election for the TOFA rules to apply.

    If you are subject to the TOFA rules contained in Division 230 of the ITAA 1997 answer Yes at A item 20 and complete the required fields.

    If you answer Yes, you must specify which (if any) of the tax timing method elections you have made to assess your gains and losses from financial arrangements, at B to F item 20. If no election was made, you should complete G. These tax timing method elections are contained in subdivisions 230-C to 230-F of the ITAA 1997.

    For help working out if Division 230 of the ITAA 1997 applies to you and the relevant threshold tests, see:

    Example 19

    ABC Co is an authorised deposit taking institution and the TOFA rules apply to all of its financial arrangements entered into on or after 1 July 2010.

    ABC Co has made elections in accordance with Division 230 of the ITAA 1997 to apply the fair value method and the foreign exchange retranslation method – general election.

    With this information, ABC Co would complete question 20 as follows:

    This image shows an example of how to complete Question 20. Label B Fair value method B: X Label C Foreign exchange retranslation method - general election: X Label D Foreign exchange retranslation method - qualifying foreign exchange accounts election: nil Label E Hedging financial arrangements method: nil Label F Reliance on financial reports method: nil Label G No elections made: nil

    End of example
    Last modified: 08 Feb 2022QC 64900