Related scheme rules
The debt and equity test provisions have rules which can, under certain circumstances, aggregate a number of schemes and treat that aggregated scheme as a debt interest or an equity interest. These rules are the ‘related scheme’ rules.
There is also a rule which, in certain circumstances, allows a single scheme to be treated as 2 or more separate schemes.
Non-share equity interest
A non-share equity interest is an equity interest in a company that is not, in legal form, solely a share in the capital of the company or stock in the company. The definition of 'equity interest' and the related concepts of 'equity holder' and 'non-share dividend' are used in the imputation provisions of the income tax law. Both shareholders and holders of non-share equity interests may be paid frankable dividends by the entity.
To be a non-share equity interest it is necessary for the whole interest, or a part of it, to be in a form other than a share. Therefore, if an equity interest in a company is made up of related interests and at least one of those interests is not a share, the interest is a non-share equity interest.
Capital raised by a company from the issue of non-share equity interests is credited to a non-share capital account. A company has a non-share capital account if the company issues a non-share equity interest in the company on or after 1 July 2001, or the company has issued a non-share equity interest in the company before 1 July 2001 that was still in existence on 1 July 2001.
Keeping a non-share capital account
If a company issues a non-share equity interest in the company, the company has a notional account called a non-share capital account. The account records:
- contributions to the company in respect of those non-share equity interests
- returns by the company of those contributions.
A distribution on a non-share equity interest can be characterised as either a non-share dividend or a non-share capital return. Specifically, non-share distributions that are debited against the notional account are non-share capital returns.
Sections 164–15 and 164–20 of the Income Tax Assessment Act 1997 specify the credits and debits that may be made to the non-share capital account.
Connected entities
The debt/equity provisions also include the concept of connected entities. A connected entity of an entity is either:
- an associate of the entity
- another member of the same wholly owned group, if the entity is a company and is a member of that group.
Small business turnover carveout for at calls between connected entities
If a company has a turnover of less than $20 million, there is a carve-out which means that related party ‘at call’ loans will be treated as being debt interests rather than equity interests.
A company's annual turnover (worked out at the end of an income year) is to be determined in accordance with subsection 188-10(2) of the Goods and Services Tax (GST) Act 1999. This test is already used by small companies for GST purposes.
Private companies with related party 'at call' loans that don't qualify for debt treatment may change their loans so they are debt interests under the debt/equity rules. Taxpayers may elect to treat this change as if it occurred at the beginning of the previous income year. This election must be made before the earlier of the due date for the company's tax return or the date of actual lodgment for that year.
Because the turnover test applies on an annual basis, a company may qualify for deemed debt treatment under the debt/equity rules for one year but not the next. This means that related party 'at call' loans to the company could change from being debt interests to being equity interests if their turnover exceeds $20 million.