House of Representatives

Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 2 Definition of 'financial arrangement'

Outline of chapter

2.1 Division 230 uses the term 'financial arrangement' as the item to which taxation applies. Gains and losses in relation to a financial arrangement are taken into account in determining taxable income.

2.2 This chapter sets out:

the meaning and scope of the term 'financial arrangement';
which financial arrangements are specifically excluded from the operation of Division 230; and
the additional operation of Division 230 to certain things.

Overview of the definition of 'financial arrangement'

2.3 A Division 230 financial arrangement is an arrangement where the rights and obligations under that arrangement are cash settlable.

2.4 Besides financial arrangements, Division 230 will also apply to certain arrangements that are not financial arrangements but have very similar characteristics. For example, foreign currency and non-equity shares.

2.5 However, the gains and losses from certain financial arrangements, such as some short term arrangements arising out of the provision of goods or services, and arrangements held by individuals and small business, where there is no significant deferral of gains, will generally not be subject to tax under Division 230.

2.6 Often, the time to determine whether an arrangement is a financial arrangement will be at the time the arrangement comes into existence or commences to be held. However, Division 230 also provides for testing throughout the life of arrangements.

Cash settlable rights and obligations

2.7 In the context of Division 230, obligations and rights are cash settlable where they may be settled by money or money equivalent.

2.8 Basically, money is cash or a unit of Australian currency. A money equivalent typically sounds in money and has a liquidity that is similar to that of cash. Examples of money equivalent include bonds and loans.

2.9 However, an arrangement will not be a financial arrangement if the cash settlable rights and obligations are insignificant compared to other rights and obligations under the arrangement or if the cash settlable rights and obligations no longer exist.

Additional operation of Division 230

2.10 Division 230 extends to certain assets and contracts that would not ordinarily come within the definition of a Division 230 financial arrangement. While these assets and contracts may not be cash settlable financial arrangements, they share some of the key characteristics of such arrangements, for example because of their money-like nature or the way they are dealt with by relevant parties to the arrangement.

2.11 The additional operation of Division 230 applies to:

equity interests;
foreign currency;
non-equity shares in companies; and
certain commodities and offsetting commodity contracts.

2.12 Equity interests that are financial arrangements are only subject to either the elective fair value method or the election to rely on financial reports and in limited circumstances the elective tax hedge method.

Specifically excepted gains and losses of certain financial arrangements

2.13 Division 230 does not apply to certain gains or losses made from a financial arrangement for compliance cost or other policy reasons. Such arrangements include:

short term arrangements where amounts that are not money for example, short term trade credit; and either:

-
a financial arrangement that is given in exchange for property or services;
-
an arrangement where there is 12 months or less delay in payment after receipt of property or services;
-
arrangement is not a cash settlable financial arrangement;
-
arrangement is not a derivative financial arrangement; or
-
a fair value election does not apply to the arrangement; or

arrangements held by individuals and entities that satisfy the threshold tests where there is no significant deferral of tax.

2.14 There are also exceptions for various rights and/or obligations including those in respect of:

leasing arrangements;
an asset to which Division 250 of the Income Tax Assessment Act 1997 (ITAA 1997) applies;
interests in partnerships and trust;
life insurance policies;
general insurance policies;
certain worker's compensation arrangements;
certain guarantees and indemnities;
personal arrangements and personal injury:

-
personal services;
-
deceased estates;
-
gifts under deed;
-
personal injury; or
-
injury to reputation;

superannuation and pension income;
interests in a foreign investment fund, foreign life policy or a controlled foreign company;
proceeds from certain business sales including 'earn-outs';
infrastructure borrowings;
farm management deposits;
deemed interest payments to owners of offshore banking units;
forestry managed investment schemes;
ceasing to hold financial arrangements in certain circumstances;
forgiveness of commercial debts; or
franked distributions.

2.15 Gains and losses from certain financial arrangements are excluded from Division 230 for the avoidance of doubt. They include retirement village residence contracts, retirement village services contracts and provision of residential or flexible care.

Context of amendments

What is a financial arrangement?

2.16 Financial innovation has created an endless variety of arrangements under which finance is provided or risk is shifted. The characteristics of such arrangements can mean that arrangements similar in form can vary significantly in terms of the risks and benefits involved, or that there is very little difference in substance notwithstanding that the form and the name given to the two are quite different.

2.17 Traditionally the income tax law has tended to place emphasis on the legal form of the arrangement to determine its tax treatment. This is not sustainable in the face of modern financial innovation. More recently, specific areas of income tax law have been designed so that tax treatments better reflect the economic and commercial characteristics of arrangements: see, for example, the debt/equity rules in Division 974 of the ITAA 1997.

2.18 Reflecting this trend - and the need to minimise the distortionary tax treatment that can arise under the current tax law in respect of economically similar financial arrangements - development of a set of principles to establish the definitional scope of financing and risk shifting arrangements for the purposes of Division 230 has taken into account the common economic substance underpinning all such arrangements. As well, account has been taken of the need to align tax (to the greatest extent possible) with the commercial recognition of gains and losses from financial arrangements. Centred on these foundations the general and broadly applicable definition of a 'financial arrangement' adopted in Division 230 is intended to enhance tax neutrality, consistency and the functional effectiveness of the tax system.

2.19 A possible approach to the definition of 'financial arrangement' would be to rely on the relevant definitions in financial accounting standards. For example, the scope of Australian Accounting Standard AASB 132 Financial Instruments: Disclosure and Presentation (AASB 132) is governed by the definition of the term 'financial instrument' which, in turn, is based on definitions of the terms 'financial asset' and 'financial liability'. For measurement purposes, Australian Accounting Standard AASB 139 Financial Instruments: Recognition and Measurement (AASB 139) adopts the same meaning of 'financial instrument' as used in AASB 132.

2.20 The Division 230 definition of 'financial arrangement' draws on and closely corresponds with the definitions in these accounting standards. A complete alignment was not considered appropriate after consideration was given to a range of factors including those set out in the paragraphs below.

2.21 The AASB 132 definition of 'financial instrument' was developed in a different context to that relevant to the tax law. First, that standard is but one of a number of interrelated standards that form a broader financial accounting framework. These accounting standards have different purposes to the income tax system.

2.22 Second, the approach of AASB 132 and AASB 139 to the question of scope appears to be based on rights and obligations under individual contracts. However, the provision of finance and risk-shifting can occur through arrangements that comprise one or more contracts (eg, stapled securities) and by way of rights and obligations that are not necessarily founded on contract.

2.23 Third, not all entities subject to Division 230 would be required to prepare financial accounts which classify arrangements based on the definitions in AASB 139. If the scope of the Division was based on the scope of particular financial accounting standards, these entities would need to understand, or obtain advice on, the scope of relevant financial accounting standards, including changes to these standards and their interpretation, merely for income tax purposes. Such entities may view such compliance as burdensome and unfair.

2.24 Against this background, the definition of 'financial arrangement' for the purposes of Division 230 is cast in terms of what fundamental and common elements, in principle, characterise both the provision of finance and the shifting or allocation of risk. In this regard, key common elements of all financial arrangements are the right to receive, or obligation to provide, a financial benefit (irrespective of whether the value or existence of the right or obligation is contingent on some event or other thing) which is:

monetary in nature;
non-monetary in nature and may be settled by money or a money equivalent; or
in substance and effect monetary in nature.

2.25 Collectively, these rights and obligations are described in Division 230 as 'cash settlable'.

2.26 Limiting the definition of financial arrangement solely to formal (legal) rights to receive, or obligations to provide, financial benefits of a monetary nature would not facilitate tax neutrality and consistency, or enable the taxation of certain transactions to be aligned with commercial outcomes. In particular, this could occur where the right to receive, or the obligation to provide, a financial benefit is of a non-monetary nature but having regard to factors such as the pricing, terms and conditions of the arrangement, business practices, the intention of the parties, or the nature of the activities relating to the arrangement, those rights and obligations will be likely settled in monetary terms. This is why the cash settlable rights and obligations relevant for Division 230 purposes include those which are in substance or effect monetary in nature.

2.27 Because the definition of 'financial arrangement' in Division 230 is based on characteristics common to all financial arrangements it will cope better with future financial innovation than would a definition based on legal form or on lists of arrangements. In that sense the definition is considered to be appropriately comprehensive and durable.

Additions and exceptions

2.28 Equity interests, including rights to receive, and obligations to provide, equity interests, are specifically brought into the scope of Division 230 as a separate category of financial arrangement. However, gains and losses made from these 'equity' financial arrangements will be subject to Division 230 only in limited circumstances.

2.29 In addition to the general definition for financial arrangements and 'equity' financial arrangements, specific inclusion provisions exist to ensure that arrangements which can operate in a similar way to these defined financial arrangements are bought within the scope of Division 230 - specifically, foreign currency, non-equity shares and commodities and offsetting commodity contracts in certain circumstances.

2.30 Division 230 also provides for various exceptions which exclude gains and losses made from particular financial arrangements from being subject to Division 230. For example, there are circumstances in which an arrangement that conceptually comes within the scope of the definition of financial arrangement is covered by another specific area of the income tax law, and there are policy reasons for it to continue to be so covered. In such cases, gains and losses from the arrangement are specifically excluded from being dealt with under Division 230.

2.31 In addition, there are compliance and administrative reasons for excluding other types of arrangements from treatment under Division 230. Those arrangements are also the subject of either a general or specific exclusion.

2.32 The scope of Division 230 should therefore be considered by looking at what, by definition, is a financial arrangement together with the exclusions and the additional operation of the Division.

2.33 The Board of Tax's 'review of foreign source income anti-tax deferral rules' is currently considering the operation of the tax law in relation to interests held in controlled foreign companies as well as foreign investment funds and non-resident trusts more widely. Consequently, how Division 230 should apply in relation to interests in these entities will receive further consideration in the light of outcomes of that review.

Unit of taxation

2.34 The definition of 'financial arrangement' is important because it determines the unit of taxation in respect of which gains and losses are recognised under Division 230. That is, the applicable tax-timing methods apply in relation to a defined financial arrangement (and to those arising from the additional operation of this Division) to determine the gains and losses that will be subject to Division 230 (excluding financial arrangements from which the gains and losses are covered by an exception).

2.35 A financial arrangement is an arrangement which at the relevant time satisfies the definition of financial arrangement under Division 230.

2.36 Typically, an arrangement will be constituted by a contract. Generally, this would be the case for ordinary financial instruments, common hybrid instruments and derivatives. However, the concept of arrangement as used in Division 230 recognises that a contractual basis may be insufficient to reflect the substance of an arrangement in all circumstances. It is recognised that modern arrangements can be put together in very complex ways and that their substance may be different from their form.

2.37 To deal with the various forms in which relevant arrangements may take, what rights and obligations constitute the relevant arrangement for Division 230 purposes (ie, the arrangement to be tested to determine whether it is or is not a financial arrangement), is based on various factors. These factors go to the substance of these rights and obligations and the facts and circumstances surrounding them.

Summary of new law

2.38 A financial arrangement is defined as a cash settlable right to receive, or obligation to provide, a financial benefit, or a combination of such rights and obligations (irrespective of whether the value or existence of the right or obligation is contingent on some event or other thing) which exist under an arrangement. An exception will apply where, under the same arrangement, there are other rights and obligations that are not insignificant (ie, the cash settlable rights and/or obligations otherwise comprising the financial arrangement must be the only rights and/or obligations of any significance subsisting under the arrangement before a financial arrangement will arise).

2.39 A right to receive a financial benefit or an obligation to provide a financial benefit will be cash settlable where the financial benefit is broadly:

money or a money equivalent; or
non-monetary, but the right or obligation to that financial benefit is in substance and effect expected to be dealt with in a manner that results in receiving or paying money or a money equivalent, when regard is given to factors such as:

-
the taxpayer's intended way of settling the right or obligation;
-
the practice by which the taxpayer settles similar rights and/or obligations;
-
the taxpayer's dealings with respect to the rights or obligations or similar rights and/or obligations; or
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the liquidity of the financial benefit, or the ability to cash settle the right or obligation, where the financial benefit is to be provided or received other than as part of the taxpayer's expected purchase, sale or usage requirements.

2.40 Division 230 does not generally apply to gains and losses from arrangements that do not satisfy this definition of a financial arrangement. However, equity interests (and certain rights and obligations to equity interests that are not otherwise financial arrangements) are a separate category of a financial arrangement that will have gains and losses dealt with under Division 230 in limited circumstances. In addition, specific inclusion provisions exist to ensure that arrangements which can operate in a similar way to these types of financial arrangements are bought within the scope of Division 230.

2.41 Division 230 also provides for various exceptions which take gains and losses from certain financial arrangements outside the scope of the Division.

Comparison of key features of new law and current law

New law Current law
The definition of 'financial arrangement' is based on rights to receive, or obligations to pay, financial benefits that are cash settlable.
Specific additions include certain arrangements that have a similar effect or operation to these financial arrangements.
There is no comprehensive definition of financial arrangement, which creates gaps, distortions and anomalies in tax treatments.
Some financial arrangements have their gains and losses excluded from the operation of Division 230 for compliance, administrative or other policy reasons. Certain types and classes of financial arrangements are not specifically addressed.
Arrangements comprising a number of different rights and obligations are generally determined on a stand-alone contractual basis where the form of the contract is consistent with its substance. Arrangements are generally treated based on legal form.
The ability to cope with financial innovation is increased. It is inadequate to deal with financial innovation.

Detailed explanation of new law

2.42 Whether or not a particular arrangement is a financial arrangement will depend on whether or not it satisfies:

the principal financial arrangement definition dealing with cash settlable rights and obligations to financial benefits (a cash settlable financial arrangement); or
the secondary financial arrangement definition dealing with equity interests and rights and obligations to equity interests (an equity financial arrangement).

An entity can have rights to receive financial benefits and/or obligations to provide financial benefits. Accordingly, an entity can be either a holder of a financial arrangement that is an asset or an issuer of a financial arrangement that is a liability. [ Schedule 1, item 1, sections 230-45 and 230-50 ]

The arrangement that is being tested

2.43 Before it can be decided whether either of the tests for a financial arrangement are satisfied, the particular arrangement being tested must be determined.

2.44 An arrangement , as defined in the ITAA 1997, is a broad concept. It includes any arrangement, agreement, understanding, promise or undertaking, whether express or implied. Moreover, it does not need to be enforceable, or intended to be enforceable, by legal proceedings.

2.45 Division 230 modifies this broad notion of an arrangement, providing guidance as to which specific rights and obligations will make up the relevant arrangement to be tested for the purposes of the Division. [ Schedule 1, item 1, subsection 230-55(4 )]

2.46 Arrangements can be constructed in very flexible ways. However, for straightforward situations, an arrangement will often be contract based. So too for Division 230 purposes, a contract will often define the boundaries of a relevant arrangement. This is where the form of the contract is consistent with its substance.

2.47 The various rights and obligations subsisting under a contract will typically constitute the relevant arrangement for the purposes of Division 230. That is, the contract is typically viewed on a 'stand-alone' basis. In this context, the contract is neither aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230.

2.48 On this basis, all cash flows under an instrument will typically form part of the one arrangement and will not be disaggregated to represent separate arrangements. For example, in the usual case, a right to receive dividends will form part of a share instrument, and an obligation to pay interest will form part of a loan agreement.

2.49 However, in certain cases, the form of the contract may be inconsistent with the economic or commercial substance of an arrangement. This could arise where, for instance, one or more rights and obligations under separate formal contracts (whether or not they come into existence at the same time) are intended to give rise to a single arrangement (such as the case with a stapled security). Division 230 is directed at reflecting the commercial and economic substance of arrangements; 'commercial' in this sense refers to non-tax factors driving the way in which the particular arrangement is structured.

2.50 Which rights and/or obligations comprise the relevant arrangement for Division 230 purposes is a question of fact and degree. To determine whether a number of rights and/or obligations arise under one or more arrangements, regard is to be given to the:

nature of those rights and/or obligations, when considered separately and in combination (including having regard to the substance and character of the rights and/or obligations);
terms and conditions of the rights and/or obligations, including those relating to any payment or other consideration for them, both when considered separately and when considered in combination (including having regard to the legal terms of the rights and/or obligations in their economic context, including those relating to the amount and timing of the consideration to be paid or received, and the pricing of those rights and/or obligations relative to what would otherwise be expected of such rights and/or obligations, when considered separately and together);
circumstances surrounding the creation of those rights and/or obligations and their proposed exercise or performance, (including what can reasonably be seen as the purposes of one or more of the parties involved), when the rights and/or obligations are considered separately and when considered in combination (also taking into account the context in which the rights and/or obligations were created and are anticipated to cease, when consideration is given to one or more of the relevant parties' intentions);
whether the rights and/or obligations can be dealt with separately or whether they must be dealt with together (eg, the separate interests that comprise a stapled security cannot be separately dealt with);
normal commercial understandings and practices in relation to the rights and/or obligations when considered separately and when considered in combination, including whether commercially they are regarded as separate things or as a group or a series that forms a whole (a comparison with similar or typical commercial arrangements may help determine the commercial understanding of the relevant rights and/or obligations under consideration); and
objects of Division 230 (and so having regard to minimising the extent to which the tax treatment of relevant arrangements distorts commercial decision making, more closely aligning the tax and commercial treatment of relevant arrangements, and minimising compliance costs).

[ Schedule 1, item 1, subsection 230-55(4 )]

Example 2.1 : Loan and hedge

Oz Co borrows in pounds sterling from Bank Co. To hedge its exposure to pounds sterling, Oz Co also enters a cross currency swap. Without this exposure being hedged, Bank Co would not lend to Oz Co in pounds sterling.
The fact that the swap and the borrowing may not have been entered into without the other, is not sufficient for them to comprise one arrangement. A consideration of the following factors:

the nature of the loan and the swap, and the rights and obligations which comprise them, differ;
the loan and the swap are not contractually bound together (ie, amongst other things the termination of one will not automatically lead to the termination of the other, such that their creation and performance times may differ);
the payment terms and conditions, including the counterparties and relevant dates may differ;
the commercial effect of the loan or the swap can be, and is typically, understood without reference to the other;
commercially the loan and the swap are regarded as separate arrangements, and each can be defeased or assigned to a third party separately; and
treating the loan and swap as separate arrangements would not defeat the objects of the Division,

reveals that for the purpose of Division 230 the loan and the swap should be treated as separate arrangements, each of which may be assessed to determine whether or not it is a financial arrangement subject to the Division (subsection 230-55(4)).
Later in this chapter, in Example 2.17, consideration is given to whether Oz Co's hedge and loan are, when considered separately, financial arrangements.
Example 2.2 : Convertible note
Hamish Co holds a convertible note that pays coupon payments at a floating rate over the life of the note. At maturity of the note, Hamish Co has the option to convert the note and receive ordinary shares of the issuing company. If Hamish Co chooses not to take this option, it will receive a return of its original investment in the note on maturity instead of the note converting into ordinary shares.
Hamish Co does not have the sole or dominant purpose of entering into the convertible note to receive the shares.
Economically, Hamish Co's convertible note represents one arrangement that comprises both a fixed income security (similar to a bond) and an equity derivative embedded in the security (the option to convert).
However, in light of the fact that:

normal commercial practice is for the holder of a convertible note to deal with the note as one arrangement;
packaged as a note the various components of the convertible note have the nature of them being only one arrangement;
the terms and conditions indicate the arrangement, whilst having the same effect as its separate components, must be dealt with together and contain no provision for separate assignment of the various embedded rights and obligations;
the rights and obligations under the notes were created under the one arrangement and at the same time, and are proposed to extinguish together on maturity;
it would be reasonable to assume that Hamish Co intends to deal with its rights and obligations under the note together and not separately. Arguably, commercial understandings would suggest that where taxpayers intend on dealing with a fixed income security and an equity derivative separately, they would be more inclined to enter into an arrangement that comprises an equity linked debt security with equity warrants, which is economically similar to a convertible note with the exception that normal commercial understanding is that the equity warrants are detachable and may be dealt with separately; and
the objectives of more closely aligning tax and commercial treatment of relevant arrangements,

Hamish Co's rights and obligations under the convertible note will be taken to comprise one arrangement (subsection 230-55(4)).
Whether or not Hamish Co's convertible note arrangement is a financial arrangement is considered later in this chapter, in Example 2.17.
Example 2.3 : CPI index-linked bond
At the end of the 2012 income year High Hope Co, a company with an aggregated turnover of $3 billion, purchases a five-year index-linked bond with a face value of A$100 from the issuer, XYZ Co, for its face value (A$100). The index-linked bond pays coupons calculated by reference to movements in the United States of America (US) consumer price index (CPI). Specifically, the index-linked bond pays annual coupons of 7 per cent of the face value of the bond, adjusted upwards or downwards according to the percentage movement on the US CPI. If the percentage movement in the CPI in the relevant period falls below the initial set percentage, no coupon will be paid in that period. The bond contains no separate or detachable option. The bond will pay A$100 on redemption (at the end of the 2017 income year).
Based on history the US CPI is expected to increase by 2 per cent per annum over the relevant five-year period.
Having regard to the features of High Hope Co's CPI indexed-linked bond and the circumstances surrounding this arrangement, it will be treated as a single arrangement for the purposes of Division 230, having regard to the fact that (see subsection 230-55(4)):

the rights and obligations under the CPI index-linked bond are dealt with together as one arrangement;
the terms and conditions reflect those of a common commercial arrangement that is commercially treated as a single arrangement;
normal commercial practice is to view CPI index-linked bonds as one arrangement, and High Hope Co's bond is consistent with other such bonds commonly available; and
treating High Hope Co's bond as such would be consistent with the objects of the Division.

Whether or not High Hope Co's CPI index-linked bond, as a single arrangement, is a financial arrangement, is set out later in this chapter, in Example 2.17.
For similar reasons to those listed in relation to High Hope Co's CPI indexed-linked bond, typical equity linked bonds, where the coupon return is based on the movement in an equity interest or basket of equity interests, would also constitute the one arrangement.
However, other arrangements where a return based on a share or index movement is artificially or unusually attached to what would otherwise be a stand-alone arrangement may not, having regard to the factors set out in subsection 230-55(4), be treated as being the one arrangement for the purposes of Division 230.
Example 2.4 : Two arrangements under the one contract
LA Co enters into a contract to purchase an office building from Vendor Co. LA Co also arranges to acquire a significant amount of office furniture from Vendor Co. Both the building and the office furniture are delivered at the same time, but Vendor Co agrees to defer payment of the building for two years. The office furniture is paid for at the time of delivery. While this transaction may have been structured under the one contract, the purchase of the office building and the purchase of the furniture, taking into account the following factors, are treated as separate arrangements (see subsection 230-55(4)):

The payment terms and timeline for performance of each, are significantly different.
They can be commercially understood separately, and could be negotiated separately.
Having regard to the objects of the Division, and the fact that accounting would treat the deferred arrangement differently to that which was paid for on delivery, each purchase should be treated as a separate arrangement.

Therefore, the contract entered into by LA Co represents two separate arrangements. Each of these arrangements will have to be separately tested to determine whether it is a financial arrangement as defined within the Division. For a discussion on whether or not LA Co's arrangements are financial arrangements, see Example 2.17.
Example 2.5 : Sale and repurchase agreement
A typical cash-based sale and repurchase agreement involves the sale of a cash-based security (such as a bond or bank bill) and a simultaneous agreement to buy it, or substantially the same security, back at an agreed future date for an agreed price (which may be the sale price plus a lender's return). The combined sale and repurchase arrangement is often referred to as a 'repo'.
In terms of subsection 230-55(4):

The nature of the rights and/or obligations under the repo are such that the sale of the security would not be entered into without entering into the repurchase agreement.
The terms and conditions of the repo suggest that, in substance, it is one arrangement.
The parties to a repo would ordinarily view the sale and repurchase rights and/or obligations together, and intend that they be considered together.
It would be unlikely for the sale rights and/or obligations to be dealt with separately to the repurchase rights and/or obligations.
Normal commercial understandings and practices are that the sale and repurchase rights and/or obligations would be viewed as being integrally related to each other. For example, AASB 139 would consider them in combination and not de-recognise the security because the seller retains substantially all the risks and rewards of ownership (see paragraph AG51(b) of AASB 139).
Treatment of the repo as an arrangement under subsection 230-55(4) is consistent with the substance of the situation and, accordingly, with the objects of Division 230.

In the circumstances, typical repos would constitute one arrangement for the purposes of Division 230.

Right or obligation to more than one financial benefit

2.51 A right to receive two or more financial benefits, or an obligation to provide two or more financial benefits, is taken for the purpose of Division 230 to be two or more separate rights, or two or more separate obligations, respectively. [ Schedule 1, item 1, subsections 230-55(1) and (2 )]

Example 2.6 : Interest bearing bank account

Retailer Pty Ltd opens a current account with Bank Ltd on 1 July 2013. Under the terms of the account, Retailer Pty Ltd may make deposits and withdrawals at any time, provided it does not overdraw the account. Interest is calculated daily (on the minimum daily balance) and payable on 30 June each year. If the account is closed, interest calculated up until the date it is closed becomes payable at that time. The interest rate is set in advance and can change at any time at Bank Ltd's discretion.
A bank account is a single debt existing between the customer and the banker in their respective capacities as creditor and debtor ( Foley v Hill [1843-1860] All ER 16). The right to receive the balance of the bank account is therefore taken to be the one right. However, that right is in relation to each dollar that comprises the balance of the account. Each dollar is a relevant financial benefit. Hence, for the purposes of the Division, Retailer Pty Ltd is taken to have a separate right to receive each dollar that comprises the balance of the account (subsection 230-55(1)).
Having regard to the features of Retailer Pty Ltd's bank account and the circumstances surrounding this arrangement, it will be treated as a single arrangement for the purposes of Division 230, having regard to the fact that (see subsection 230-55(4)):

the rights and obligations under the bank account are dealt with together as one arrangement;
the terms and conditions reflect those of a common commercial arrangement that is commercially treated as a single arrangement;
normal commercial practice is to view the bank account as one arrangement, and Retailer Pty Ltd's bank account is consistent with other such accounts that are commonly available; and
treating Retailer Pty Ltd's bank account as such would be consistent with the objects of Division 230.

As explained in Example 2.17, Retailer Pty Ltd's bank account with Bank Ltd is a cash settlable financial arrangement.

Is the relevant arrangement subject to Division 230?

2.52 The relevant arrangement for Division 230 purposes, determined using the principles set out above, must meet the definition of a 'financial arrangement' before it will be subject to Division 230. As mentioned above, whether or not the relevant arrangement is a financial arrangement will depend on whether or not it satisfies:

the principal 'financial arrangement' definition dealing with cash settlable rights and obligations to financial benefits (a cash settlable financial arrangement); or
the secondary 'financial arrangement' definition dealing with equity interests and rights and obligations to equity interests (an equity financial arrangement).

[ Schedule 1, item 1, sections 230-45 and 230-50 ]

Cash settlable financial arrangement

Background

2.53 In a commercial context, arrangements commonly identified as 'financial instruments', 'financial transactions', 'financial assets' and 'financial liabilities' include:

debt instruments such as bonds, loans, bills of exchange and promissory notes, whether Australian dollar or foreign currency denominated; and
derivatives such as options, forwards and swaps.

2.54 A factor that is common to all of the above - and to equivalent arrangements - is that a party to the arrangement has either a right to receive, or an obligation to provide, cash or something equivalent to cash or some combination thereof.

2.55 The rights and obligations embodied in such arrangements represent a promise by one party to the arrangement to provide something of economic value that is money or a money equivalent and a corresponding right of another party to receive something of economic value that is money or a money equivalent. Financially and economically, the value embodied in these commercial arrangements is based on the time value of money and risk.

2.56 In other situations, even though the rights and obligations associated with an arrangement are in respect of a non-monetary item, it is possible that the way in which the arrangement is settled or dealt with will have the same effect as the provision or receipt of a financial benefit that is in respect of money or a money equivalent.

2.57 For example, taxpayers holding rights or obligations to financial benefits that are non-monetary, may, through business practices, settle these rights or obligations with money, a money equivalent or by transfer or entry into another financial arrangement (monetary financial benefits). In other cases, taxpayers may by intention settle non-monetary rights and obligations in a way that result in the receipt or payment of monetary financial benefits. Even without this practice or intention, a non-monetary right or obligation that is able to be settled in monetary financial benefits may have the same effect as a monetary right or obligation if the taxpayer did not have the sole or dominant purpose of receiving or providing that non-monetary thing as part of its expected purchase, sale or usage requirements in the ordinary course of business.

2.58 In other circumstances taxpayers may enter into arrangements giving rise to highly liquid non-monetary rights and obligations which are readily convertible to money or a money equivalent, and which are not entered into for the purpose of their ordinary business dealings or usage.

2.59 There will also be circumstances where a taxpayer might carry on, for profit, a business as dealer or trader in the rights and obligations in respect of financial benefits of a non-monetary nature. An example of such a dealer would be one who deals in rights to commodities with the objective of profiting from differences in the buy and sell margins from holding offsetting positions, or through short-term strategies seeking to exploit fluctuations in the price of the rights to the commodity.

2.60 The arrangements described above, in substance and effect have identical consequences to those of monetary arrangements - that is, they, through the conduct of the parties, give rise to rights and obligations to provide financial benefits that are monetary in nature. The concept of a cash settlable financial arrangement , as set out in section 230-45, seeks to bring within the scope of the Division those arrangements that in commercial and economic terms reflect these attributes.

What is a cash settlable financial arrangement?

2.61 An entity has a cash settlable financial arrangement where, under an arrangement:

the entity has one or more cash settlable legal or equitable rights to receive, and/or obligations to provide, a financial benefit; and
in comparison to these rights and/or obligations, the entity does not also have one or more non-insignificant rights and/or obligations that:

-
are not cash settlable; and/or
-
are not rights to receive, or obligations to provide, a financial benefit.

[ Schedule 1, item 1, subsection 230-45(1 )]

2.62 If the entity meets these conditions at any time, looking only at the entity's subsisting rights and obligations under an arrangement, then at that time, by definition, the entity will have a financial arrangement that consists (only) of any of its cash settlable legal or equitable rights to receive, and obligations to provide, a financial benefit under that arrangement (however, see paragraph 2.63). In including only cash settlable rights and obligations, the financial arrangement as defined may be narrower than the arrangement being tested, which is determined under the principles in section 230-55.

Additional rights and obligations or financial benefits may be taken into account

2.63 The financial arrangement as defined will only comprise the cash settlable rights to receive, and obligations to provide, financial benefits under the arrangement. Often, whether the cash settlable rights or obligations to financial benefits are received or provided under the particular financial arrangement can be determined by reference to the contractual terms of the arrangement. Although, the concept of what is the arrangement can be modified by the application of subsection 230-55(4). This is determined on a case by case basis. However, for the purpose of working out any gain or loss from that financial arrangement, financial benefits the taxpayer receives or provides (or has a right or obligation to do so) which play an integral role in determining whether a gain or loss is made from the financial arrangement, are also taken to be relevant rights and obligations under that financial arrangement. These rules ensure that an appropriate cost or amount of proceeds is allocated to the cash settlable financial arrangement. These rules operate only for the purpose of assisting in working out any gain or loss from the financial arrangement and are not intended to broaden what constitutes the financial arrangement as determined under section 230-45 or 230-50. The rules are described in more detail in Chapter 3. [ Schedule 1, item 1, section 230-60 ]

Relevant rights and obligations

2.64 It is critical to the definition of a 'cash settlable' financial arrangement that there be one or more cash settlable rights to receive, or obligations to provide, a financial benefit. The term financial benefit as defined in the ITAA 1997 means anything of economic value. Economic value encapsulates money, money equivalent and non-monetary items.

2.65 A right to receive, or an obligation to provide, a financial benefit for the purposes of Division 230 will exist irrespective of whether the value or existence of the right or obligation to the financial benefit is contingent on some event or other thing. For example, a party that issues an option assumes an obligation to provide a financial benefit, notwithstanding that the value or existence of the obligation is contingent on the exercise of the option. [ Schedule 1, item 1, section 230-85 ]

2.66 In addition to being in respect of a financial benefit, it is fundamental to the definition of a 'cash settlable' financial arrangement that the relevant rights and obligations be cash settlable. The general limitation of the scope of cash settlable financial arrangements to cash settlable rights to receive, or obligations to provide, financial benefits supports the relatively close correspondence between tax and commercial outcomes to financial arrangements.

2.67 Because a right or obligation may be settled or dealt with in a way that makes it cash settlable, whether or not a particular right or obligation is a cash settlable right or obligation must be determined from the relevant taxpayer's perspective. That is, the question of whether or not an arrangement is a cash settlable financial arrangement is a relative question, needing to be determined separately from the viewpoint of each relevant taxpayer. This means that a particular taxpayer may have a cash settlable financial arrangement, but the relevant counterparty's corresponding rights and obligations under that arrangement may or may not amount to a cash settlable financial arrangement from their perspective.

Definition of cash settlable

2.68 Cash settlable rights and obligations naturally include those rights and obligations to the receipt or payment of money or a money equivalent. However, limiting cash settlable rights and obligations to only monetary rights and obligations would not appropriately reflect the circumstances where 'cash-like' rights and obligations are dealt with in the same way as monetary rights and obligations, as discussed in the background above. Accordingly, cash settlable rights and obligations include all of the following.

Money or a money equivalent

2.69 For the purpose of the definition of 'cash settlable', a right to receive money, or an obligation to provide money, is taken to be a 'cash settlable' right or obligation. In addition, the definition of 'cash settlable' rights and obligations includes a right to receive, or an obligation to provide, a money equivalent. [ Schedule 1, item 1, paragraph 230-45(2)(a )]

2.70 A money equivalent for the purposes of Division 230 is defined as:

a right to receive money, or something that is a money equivalent; and
a cash settlable financial arrangement.

[ Schedule 1, item 21, subsection 995-1(1 )]

2.71 Because of this definition of 'money equivalent', a cash settlable right or obligation includes a right to receive, or obligation to provide, a financial arrangement which itself meets the test for a cash settlable financial arrangement, in addition to a right to receive, or obligation to provide, a right to such a financial arrangement, or a right to receive money.

2.72 Money in its simplest form is a unit of Australian currency. An item that is a money equivalent will typically have a degree of proximity to cash. Some examples would include bonds, loans and other forms of financial accommodation.

Example 2.7 : Option to settle by money equivalent: satisfaction of a debt by the issue of a bond

Oil Co has an outstanding loan owing to Grease Co of $100,000 which is due on 20 June 2012. Under the terms of the loan Oil Co is entitled to issue a five-year zero-coupon bond with a face value of $150,000 in satisfaction of that loan obligation.
Oil Co's option to settle its obligation under the loan by the provision of the bond is a contingent obligation to provide a bond (contingent in the sense that it is subject to Oil Co choosing to settle the loan through the provision of the bond instead of satisfying its loan obligation by the provision of money).
The five-year bond is both a right to receive money (being the right to receive its $150,000 face, or redemption, value) and is itself a cash settlable financial arrangement (in that it consists only of cash settlable rights to receive, and/or obligations to provide, financial benefits). As such, Oil Co's contingent obligation to provide the bond satisfies both limbs of the definition of 'money equivalent'.
Oil Co therefore has an arrangement consisting of its contingent, cash settlable, obligation to provide Grease Co with $100,000 (being its loan obligation) and its contingent, cash settlable, obligation to provide Grease Co with a money equivalent (being its contingent option to provide the bond in satisfaction of this loan obligation). (Note that the settlement of either one of these obligations, being alternative obligations, would effectively be a settlement of that obligation and an extinguishment of the alternative obligation.)
Example 2.17 explains that these obligations satisfy the definition of a 'cash settlable financial arrangement'.
Example 2.8 : Value of a monetary item determined by a non-monetary amount
Kramer Co enters into an agreement with Diamond Co under which Kramer Co receives $10,000, in consideration for assuming an obligation to pay Diamond Co a cash amount in five years time, determined by a formula that is based on a commodity value.
The fact that Kramer Co's obligation to pay a monetary amount is calculated by reference to a change in a non-monetary variable does not prevent it from being a cash settlable obligation to provide a financial benefit (specifically, it is an obligation to pay money).
Whether or not Kramer Co's arrangement is a cash settlable financial arrangement is discussed in Example 2.17.

Non-monetary financial benefits

2.73 In certain situations, even though the rights and obligations associated with an arrangement are in respect of a non-monetary item, it is possible that the way in which the arrangement is settled or dealt with will have the same effect as the provision or receipt of a financial benefit that is money or a money equivalent. For example, in some cases, taxpayers holding rights or obligations to financial benefits that are non-monetary, may intend to settle, or have a practice of settling, these rights or obligations with money, a money equivalent or by cessation of, or entry into, another cash settlable financial arrangement. These types of rights and obligations, amongst others having a similar effect, are captured within the definition of 'cash settlable' as follows.

Intention to settle with money or money equivalent, or by starting or ceasing to have another financial arrangement (monetary items)

2.74 Where a taxpayer has an obligation to provide a non-monetary financial benefit that they intend to settle by the provision of money, a money equivalent, or by the starting or ceasing to have another cash settlable financial arrangement (the provision of 'monetary items'), that obligation will be taken to be cash settlable. The test of the taxpayer's intention is an objective one, and confirms the economic substance of such an arrangement. [ Schedule 1, item 1, paragraph 230-45(2)(c )]

2.75 Likewise, a right to receive a non-monetary financial benefit that the taxpayer intends to satisfy by the receipt of money, a money equivalent, or by starting or ceasing to have another cash settlable financial arrangement (the receipt of 'monetary items') will be treated as being a cash settlable right to receive a financial benefit. [ Schedule 1, item 1, paragraph 230-45(2)(b )]

2.76 In a general sense, the provision of a monetary item as explained above also encapsulates set-off of monetary rights and obligations or the waiving of a present right to receive money or a money equivalent. Similarly, the receipt of a monetary item will include the extinguishment of a present obligation to provide a monetary item and a relevant set-off. [ Schedule 1, item 1, paragraphs 230-45(2)(b) and (c )]

2.77 What is meant by satisfy or settle also takes its commercial meaning, so there must in substance be a satisfaction or settlement of the relevant right or obligation as such. For example, a penalty for non-performance may in substance settle an obligation to deliver or a right to receive a non-monetary thing, if the amount of the penalty is based on changes in the price of that non-monetary thing. However, a fixed penalty for such non-performance will often not amount to settlement of the relevant right or obligation (see Example 2.10).

Practice of settling with monetary items

2.78 Where a taxpayer has an obligation to provide a non-monetary financial benefit, but they have a practice of settling similar obligations by the provision of a monetary item, the obligation will be taken to be a cash settlable financial benefit. Likewise, a right to receive a non-monetary financial benefit will be taken to be cash settlable where the taxpayer has a practice of settling similar rights by the receipt of a monetary item. [ Schedule 1, item 1, paragraph 230-45(2)(d )]

Example 2.9 : Practice to settle futures contract by cash payment (set-off)

Ore Co usually enters into nickel futures contracts with the Metals Exchange, whereby Ore Co will agree to sell a set quantity of nickel for an agreed price. The contracts require delivery of the underlying commodity. However, the practice as between Ore Co and the Metals Exchange is to settle these contracts by cash payment equal to the difference between the agreed price for that quantity of nickel and the prevailing market price for that nickel at the exchange date.
Ore Co currently has a futures contract with the Metals Exchange under which it has an obligation to provide two tonnes of nickel at $40,000 per tonne for delivery in six months time. Were the market value of the nickel to be $45,000 per tonne at the settlement date, Ore Co's prior practice with similar contracts would suggest that it will pay the Metals Exchange $10,000 rather than providing the nickel (in full satisfaction of both its obligation to provide nickel worth $90,000 and its right to receive $80,000 from the Metals Exchange). Likewise, were the market price of nickel to fall to $35,000 per tonne, Ore Co's previous practice with its nickel futures contracts would suggest that it will receive $10,000 from the Metals Exchange (in full satisfaction of both its obligation to provide the nickel worth $70,000 and its right to receive $80,000 from the Metals Exchange).
Ore Co in fact intends to satisfy this particular contract through the delivery of the nickel. Nonetheless, because Ore Co has a practice of settling similar obligations by the provision of money or a money equivalent (including where relevant by the extinguishment of its right to otherwise receive a greater sum from the Metals Exchange, where the prevailing market price is less than the agreed price), its obligation to provide the nickel is taken to be cash settlable.
Example 2.17 explains that Ore Co's arrangement is a cash settlable financial arrangement.
Example 2.10 : Take-or-pay penalty clause
Kanga Co, a deep sea mining company, enters into a take-or-pay arrangement to supply natural gas on a monthly basis to Roo Co, a fuel processing company, over a period of four years. Under the arrangement, Roo Co is required to pay a penalty for any delivery it refuses to accept below a set threshold. As Roo Co's demand for natural gas varies widely from month to month in line with demand for its fuel products, it is not uncommon for the penalty to be invoked.
The penalty is based on a fixed fee determined at the commencement of the arrangement (indexed by the CPI annually), multiplied by the difference between the volume of natural gas delivered and the specified threshold.
Under this arrangement, Roo Co has a right to receive natural gas on a monthly basis and an obligation to provide payment on delivery of the natural gas, as well as a contingent obligation to provide an amount of money as a penalty for non-receipt, if non-receipt occurs because it refuses to accept at least the threshold amount.
The payment of the penalty, in the event that Roo Co requires delivery of a volume of natural gas below the specified monthly threshold, is a fixed fee arrangement that is not dependent on the actual market price of the underlying item at the time it is to be supplied. In these circumstances, the payment of the penalty does not amount to a dealing of a non-monetary nature in Roo Co's right to receive the non-monetary thing, being a volume of natural gas that it had agreed to take.
Notwithstanding Roo Co's history of having such a penalty clause exercised against it, payments under such penalty clauses are not in satisfaction or settlement of a right to receive a non-monetary thing. Accordingly, no part of its right to receive the non-monetary thing (the natural gas) under this arrangement is a cash settlable right.
Whether or not Roo Co's take-or-pay arrangement is a cash settlable financial arrangement is discussed in Example 2.17.

Dealing for profit from a dealer's margin and/or short-term price fluctuations

2.79 There will be circumstances where a taxpayer might carry on a business as a dealer or trader in rights to receive, or obligations to provide, non-monetary financial benefits for profit. An example of such a dealer would be one who deals in rights to receive commodities with the objective of profiting from differences in the buy and sell margins from holding offsetting positions, or through short-term strategies seeking to exploit fluctuations in price of the commodity (and thus in the value of the rights and/or obligations).

2.80 Where a taxpayer 'deals' with a right to receive, or an obligation to provide, a non-monetary financial benefit, or with similar rights or obligations, for the purpose of:

generating a profit from short-term changes in price; and/or
the purpose of generating a profit from a dealer's margin,

the right or obligation will be taken to be cash settlable. [ Schedule 1, item 1, paragraph 230-45(2)(e )]

2.81 Note that the relevant dealing, for the purpose of this aspect of the definition of 'cash settlable', must be with the relevant rights and obligations themselves, and not in respect of the particular non-monetary financial benefits that the taxpayer has the right to receive, or obligation to provide. This means, for example, that a dealing by a taxpayer with a physical item of trading stock it has a right to receive, or a taxpayer's dealings in items of trading stock similar to that which it has a right to receive, would not be relevant dealings for the purpose of this aspect of the definition of cash settlable.

2.82 A taxpayer may 'deal' with rights or obligations in a relevant sense where, for example:

the taxpayer deals with the non-monetary right or obligation, or similar rights and obligations, on a short-term basis with the purpose of taking advantage of price fluctuations;
the taxpayer frequently deals with similar non-monetary rights or obligations for short-term price fluctuation gains or dealer's margins; or
the taxpayer acquires the rights or obligations, or similar rights or obligations, and offsets the resulting risk by entering into offsetting arrangements that provide the taxpayer with a profit margin.

[ Schedule 1, item 1, note to subsection 230-45(2 )]

Highly liquid rights and/or obligations readily convertible into money or money equivalent

2.83 Where the relevant financial benefit the taxpayer has a right to receive, or an obligation to provide, under the arrangement is:

readily convertible into an amount of money or a money equivalent; and
there is a market for the financial benefit that has a high degree of liquidity, (a 'liquid financial benefit'); and
either:

-
the taxpayer had a purpose of liquidating or converting the financial benefit into money or a money equivalent ( purpose of converting ); or
-
the amount of money or money equivalent the financial benefit is convertible into is a set amount or is not subject to a substantial risk of changes in value ( set value ),

the right to receive, or obligation to provide, the liquid financial benefit will be economically equivalent to a right to receive or obligation to provide cash (or a money equivalent). Such a right or obligation will therefore be taken to be a cash settlable right or obligation. [ Schedule 1, item 1, paragraph 230-45(2)(f) and subsection 230-45(3 )]

2.84 A financial benefit will be readily convertible into money or a money equivalent and be subject to a highly liquid market if, for example, the financial benefit is a security or commodity traded in an active market or if it is an amount of foreign currency that is readily convertible into the functional currency of the taxpayer. A right to receive, or an obligation to provide, a financial benefit that is a publicly traded security for which the market is not very active will still be readily convertible to cash and subject to a highly liquid market if the number of shares or other units of the security the right or obligation is for, is small relative to the daily transaction volume for that security. A right to receive, or an obligation to provide, that same security would not be so readily convertible if the number of shares or units the right or obligation is for is large relative to the daily transaction volume for that security. [ Schedule 1, item 1, paragraphs 230-45(3)(a) and (b )]

Purpose of converting

2.85 Where the taxpayer does not intend to deal with such a liquid financial benefit as part of its ordinary business requirements, but rather intends to liquidate or convert the financial benefit into money or a money equivalent, it is appropriate that it be treated in a similar manner as a right to receive money or a money equivalent. However, where the taxpayer intends to provide or receive such a financial benefit as part of its ordinary business requirements (in the sense that the taxpayer plans to deal with the financial benefit as a non-monetary item and not as a substitute for money), it will not be treated as being like money despite it being readily convertible to cash. [ Schedule 1, item 1, subparagraph 230-45(3)(c)(ii )]

Set value

2.86 The exception to this ordinary course of business exclusion will occur where the value of the highly liquid thing is predetermined. That is, the value the taxpayer has a right to receive or an obligation to provide, as represented by the thing that is readily convertible into money or a money equivalent, is either known or not subject to a substantial risk of change in value. In this situation, the highly liquid non-monetary thing is a proxy for that value of money or a money equivalent. [ Schedule 1, item 1, subparagraph 230-45(3)(c)(i )]

Example 2.11 : Right to receive shares

Henry Group Ltd enters into a forward contract under which it will acquire 10,000 Kaye Co shares in 18 months for $200,000. Henry Group Ltd has an obligation to make a large cash payment in 18 months time under a separate arrangement, and has entered into this forward contract with the view that the value of Kaye Co shares will increase at a higher rate than other prevailing investment options. Henry Group Ltd is not acquiring these shares as part of its ordinary course of business, and irrespective of their value in 18 months time intends to dispose of the Kaye Co shares as soon as they are delivered, due to its cash requirements at that time.
Henry Group Ltd does not have an intention, practice or ability to settle this contract anyway other than through delivery of the shares. Henry Group Ltd does not deal with its rights under this forward contract. Nor does Henry Group Ltd deal with any of its similar rights to receive shares (under other arrangements) in order to generate a profit from short-term price movements or from a dealer's margin.
Kaye Co shares are listed on a national stock exchange and subject to high trading volumes. That is, they are subject to a highly liquid market, and are readily convertible into money or a money equivalent.
Henry Group Ltd's right to receive 10,000 Kaye Co shares, from the time Henry Group Ltd starts to have this right under its arrangement, is a cash settlable right. This is because it is a right to receive a financial benefit that is readily convertible into money, and that is subject to a highly liquid market, that Henry Group Ltd intends to convert into money by disposing of it. In determining whether this is a cash settlable financial arrangement, because Henry Group Ltd intends to convert the Kaye Co shares and this is not part of the ordinary course of its business, it is not relevant that the precise value of the financial benefit owed by Kaye Co to Henry Group Ltd, in the form of 10,000 shares, is unknown (paragraph 230-45(2)(f) and subparagraph 230-45(3)(c)(ii)).
Example 2.17 explains that Henry Group Ltd's arrangement under the forward contract is a cash settlable financial arrangement.
Note that on these facts if Henry Group Ltd did not intend to dispose of the Kaye Co shares but instead intended to hold them for a reasonable time, its right to receive these shares under the arrangement would not be a cash settlable right. This is because their value between the time Henry Group Ltd acquired the right and when it will be satisfied is not set, and will be subject to a substantial risk of changes in value. However, had Henry Group Ltd instead contracted to acquire $200,000 worth of Kaye Co shares, determined at the time of delivery, the right would still be cash settlable (paragraph 230-45(2)(f) and subparagraph 230-45(3)(c)(i)).

The ability to settle a non-monetary right and/or obligation with a monetary item, where the non-monetary item is not part of the expected purchase sale or usage requirements

2.87 Where a taxpayer has a right to receive, or an obligation to provide, a non-monetary financial benefit that it is able to settle by the receipt or provision of a monetary item, the right or obligation will be taken to be cash settlable if the taxpayer does not have the sole or dominant purpose of entering into the arrangement to receive or provide the relevant non-monetary financial benefit as part of its expected purchase, sale or usage requirements. [ Schedule 1, item 1, paragraph 230-45(2)(g )]

2.88 For example, where a non-monetary financial benefit may be provided in satisfaction of a right under an arrangement, but the taxpayer is able to instead receive a monetary payment in satisfaction of that right, and the taxpayer is indifferent as to what it receives, the right will be a cash settlable right. The test of the taxpayer's intention is an objective one. [ Schedule 1, item 1, paragraph 230-45(2)(g )]

Example 2.12 : An obligation is not cash settlable merely due to an ability to cash settle

On 1 June 2011, Cereal Co enters into a forward contract with Corn Co-operative to deliver on 20 June 2012, 200 bushels of corn for $10,000. Under the terms of the forward contract, Cereal Co has the choice of delivering 200 bushels of corn or settling the forward contract by the payment of an amount of cash (referable to the value of corn).
Under this forward contract, Cereal Co therefore has a contingent obligation to provide a non-monetary financial benefit (200 bushels of corn) and an alternative contingent obligation to pay an amount of money.
Cereal Co does not intend to settle its forward contract in cash, nor does it have the practice of settling similar arrangements other than by delivering the corn. Cereal Co is not a dealer in rights or obligations such as those under this forward contract.
The contract was entered into as part of Cereal Co's expected sale requirements, and thus despite being able to be settled by a monetary payment, Cereal Co's obligation to provide 200 bushels of corn is not cash settlable. This obligation is not insignificant in comparison with Corn Co's other rights and obligations under the forward contract.
For the reasons given in Example 2.17, Cereal Co's arrangement is therefore not a cash settlable financial arrangement.
Example 2.13 : Damages or compensation payments
Commercial Textiles Co enters into a contract to purchase a new warehouse. This is not in the ordinary course of its business of manufacturing. Under the arrangement Commercial Textiles Co has a right to receive the warehouse, and a corresponding obligation to pay the contract price for it.
The terms of the agreement also provide that should the vendor default on the agreement, it will pay Commercial Textiles Co a cash payment in full satisfaction of its rights and obligations under the agreement. Because of the specific terms, this has the effect that Commercial Textiles Co's right to receive the warehouse under the agreement is able to, in the appropriate circumstances, be settled by a payment of money.
Because Commercial Textile Co entered into the agreement with the purpose of acquiring the warehouse as part of its expected purchase and usage requirements (albeit not part of its ordinary requirements), its right to receive the warehouse will not be deemed to be cash settlable. This is despite the ability for this right, in certain circumstances, to be satisfied by the vendor paying a money amount. Accordingly, the only cash settlable rights and/or obligations under this arrangement is Commercial Textile Co's obligation to pay the contract price, and its contingent right to receive a cash payment from the vendor in the event of default. Its right to receive the warehouse under the arrangement is not cash settlable within the meaning of subsection 230-45(2).
As explained in Example 2.17, this has the effect that Commercial Textile Co's arrangement is not a cash settlable financial arrangement.

2.89 A right or obligation having a value limited by a set amount of money, or referable to a set amount of money, will not necessarily be a cash settlable right or obligation.

Example 2.14 : Consumer loyalty points and gift certificates

Yvonne is an individual who, due to the particular financial arrangements relevant to her business, has elected to have her gains and losses from financial arrangements be subject to Division 230 under subsection 230-455(7)).
In addition to her main business transactions, Yvonne is awarded points as part of a consumer loyalty program ('the program') of which she is a member. Under the terms of the program, and subject to certain eligibility requirements and thresholds, she is entitled to redeem these points for various products and services, or gift certificates with a prescribed cash face value, exchangeable by her for goods and services. As her points have an economic value, Yvonne therefore has a right to receive financial benefits under the program.
This right is not money or a money equivalent. Yvonne does not have the practice, intention or ability to settle her right to receive financial benefits under the program by receiving money, a money equivalent, or by starting or ceasing to have another financial arrangement. Yvonne cannot deal in her right to receive financial benefits under the program (or under any gift certificate she acquires). The financial benefits she has a right to receive, including to the gift certificates with a set cash face value, are not readily convertible into money or a money equivalent, nor are subject to a liquid market.
Yvonne's rights under the program, and under any gift certificates acquired, are not cash settlable and, as explained in Example 2.17, therefore do not constitute a cash settlable financial arrangement.

Exception to the test for a cash settlable financial arrangement

2.90 An arrangement (as determined under section 230-55) may consist of both cash settlable and non-cash settlable rights and obligations. The arrangement will only be a cash settlable financial arrangement at a time when:

compared to the cash settlable rights to receive financial benefits under the arrangement and the cash settlable obligations to provide financial benefits under the arrangement:

-
any non-cash settlable rights and obligations under the arrangement are insignificant; and
-
any rights to receive or obligations to provide something that is not a financial benefit are insignificant; or

any non-cash settlable rights and obligations under the arrangement, or rights and obligations to things other than financial benefits, that are not insignificant when compared to the cash settlable rights and obligations to financial benefits, have ceased. In this case, the only subsisting rights and obligations under the arrangement that are not insignificant must be cash settlable rights to receive and/or obligations to provide, financial benefits.

[ Schedule 1, item 1, paragraphs 230-45(1)(d) to (f )]

2.91 This further demonstrates that whether or not an arrangement is a financial arrangement may change over time. At the point in time when the only rights and obligations remaining under an arrangement are cash settlable rights and/or obligations to receive or provide financial benefits, the arrangement will be a cash settlable financial arrangement, which is comprised of those cash settlable rights and obligations. Note further that for the purpose of working out any gain or loss from the cash settlable financial arrangement, other financial benefits which play an integral role in determining whether a gain or loss is made from the financial arrangement, are also taken to be relevant rights and obligations under that financial arrangement. [ Schedule 1, item 1, subsection 230-45(1) and section 230-60 ]

2.92 An arrangement such as this will not be precluded from being a cash settlable financial arrangement merely because the arrangement also consists of other rights and obligations that are insignificant when compared to those cash settlable rights and obligations comprising the financial arrangement. However, during any period any other, non-cash settlable, rights or obligations under the arrangement subsist and are not insignificant when compared to the cash settlable rights and/or obligations to financial benefits under the arrangement, the arrangement will not be a cash settlable financial arrangement. [ Schedule 1, item 1, paragraphs 230-45(1)(d) to (f )]

2.93 The intent of this exception is to ensure that arrangements that predominantly relate to transactions that involve one side of the arrangement being of a monetary nature and the other side being non-monetary are excluded from the definition of a 'financial arrangement'.

Example 2.15 : No financial arrangement where there is an outstanding non-monetary benefit

Bill Co enters into an agreement on 1 July 2011 to sell land to Jim Co for $100,000. At the time of the agreement, Bill Co has a right to receive a financial benefit of a monetary nature (ie, $100,000) and an obligation to provide a non-monetary benefit (title to the land). As Bill Co's obligation to provide the land is not insignificant when compared to its right to receive payment from Jim Co, the entire arrangement will not constitute a financial arrangement.
The arrangement may later become a financial arrangement if, after delivery of the land, payment to Bill Co remains outstanding. If payment remains outstanding after the land is delivered, the only subsisting rights and/or obligations under the arrangement will be Bill Co's (cash settlable) right to receive payment from Jim Co. Note further, though, that if payment is due within 12 months of delivery of the land, Division 230 will not apply to Bill Co's gains and losses from this financial arrangement.

2.94 What is or is not an insignificant right or obligation to provide a financial benefit of a non-monetary nature is to be determined by the facts and circumstances of each case, the purpose of the arrangement, the intention of the parties to the arrangement and the objects of Division 230.

2.95 The effect of this exception to the definition of a 'cash settlable financial arrangement' is that many arrangements for the supply of property or goods or services will not, be cash settlable financial arrangements. Most prepayments for property or goods or services (other than the situations where the property or goods or services are themselves cash settlable) are excluded. However, as illustrated in Example 2.15, this exclusion will not extend to periods after the obligation to provide, or right to receive, property or services has been satisfied, and the cash settlable amount to be paid or received as consideration remains outstanding. As such, the definition of a cash settlable financial arrangement will extend to deferred settlement arrangements where property or services that the taxpayer had a non-cash settlable right or obligation to receive or provide has been delivered, and only the payment remains outstanding. However, gains and losses from these deferred settlement arrangements where the relevant property or services are not money or a money equivalent will not be subject to Division 230 unless payment is deferred in excess of 12 months after receipt or delivery of that property or services.

Testing time for the existence of a financial arrangement

2.96 Generally, it will be necessary to classify a set of rights or obligations as a financial arrangement or a non-financial arrangement at the time that arrangement comes into existence or commences to be held.

2.97 Some rights and/or obligations under an arrangement can start or cease to be held at times different to other rights and/or obligations under the arrangement. This can occur even where there is no new agreement between a party to the arrangement and another party (either the counterparty or a third party). Over the term of an arrangement, as illustrated above, there may be a point in time where a financial benefit of a monetary nature and financial benefit of a non-monetary nature co-exist, but at a later point in time only the monetary or non-monetary financial benefits exist.

2.98 As discussed above, such outcomes can result in an arrangement not being a cash settlable financial arrangement at a particular time but becoming a cash settlable financial arrangement at another time. As a result, when an arrangement moves from having some non-cash settlable rights and/or obligations that are not insignificant (whether or not there are also cash settlable rights and/or obligations) to effectively having only cash settlable rights and/or obligations, or vice versa, there is a need to re-assess whether the arrangement (even where there is no new agreement between parties to the arrangement) is a financial arrangement.

Example 2.16 : Financial arrangement - deferred payment

Steam Co enters into an arrangement with Big Co to acquire a train for $1 million. Steam Co's obligation to pay for the train is a cash settlable obligation to provide a financial benefit, and its right to receive the train from Big Co is not cash settlable.
Scenario 1: The train is delivered and payment is made at the same time.
Under this scenario, there is no financial arrangement as under the arrangement there is, until the time of settlement, a non-insignificant non-cash settlable right, and after settlement there are no subsisting rights or obligations under the arrangement.
Scenario 2: The terms of the agreement are such that the train will be delivered to Steam Co immediately, but payment will be deferred for 18 months.
Under this Scenario, there is a financial arrangement immediately after delivery of the train (which is at the date of contract) as, at this time, the only subsisting rights and obligations under the arrangement are cash settlable.
Scenario 3: The terms of the agreement are such that the train will be delivered to Steam Co after 12 months, and payment will be deferred for 18 months (ie, six months after delivery of the train).
Under this Scenario, there is also a financial arrangement immediately after delivery of the train, which in this case is 12 months after the date of the contract. Until this time, the arrangement includes a non-insignificant non-cash settlable right (being the right to receive delivery of the train). After the time at which the train is delivered, the only subsisting rights and/or obligations under the arrangement are cash settlable (the obligation to pay for the train), and thus from this time the arrangement is a financial arrangement. However, because the time between delivery of the train and the date that payment is due is less than 12 months, any gains and losses from this financial arrangement will not be subject to Division 230 (refer to discussion on exemptions from Division 230 for certain financial arrangements).
Scenario 4: Under the terms of the arrangement, the train must be delivered in 12 months time and payment is to be made at that time. However Steam Co and Big Co agree to defer payment for three years after delivery.
Similarly to above, until delivery of the train there is no financial arrangement, as the arrangement includes a subsisting right that is not cash settlable, and is not insignificant in relation to the other rights and obligations under the arrangement (the right to receive the train). After delivery, by agreement, the only rights and/or obligations that remain are those of a monetary nature. At this time, a financial arrangement will come into existence. Because the time between delivery of the train and the date that payment is due is more than 12 months, any gains and losses from this financial arrangement will be subject to Division 230.
Example 2.17 : Cash settlable financial arrangements under earlier examples
Continuation of Example 2.1 - Loan and hedge (cash settlable financial arrangement )
Oz Co's loan and cross-currency swap would both be cash settlable financial arrangements, as from inception both arrangements consist only of cash settlable rights and obligations to receive or provide financial benefits.
Continuation of Example 2.2 - Convertible note (cash settlable financial arrangement )
Hamish Co's convertible note is a cash settlable financial arrangement. This is because under this arrangement Hamish has the right to receive cash coupon payments, and the ability to redeem the note upon maturity by receiving a payment of money, and Hamish Co did not have the sole or dominant purpose when entering into the arrangement of receiving the shares on conversion instead (subsection 230-45(1) and paragraph 230-45(2)(g)).
If Hamish Co's convertible note is also an equity interest , it will satisfy the definition of an 'equity financial arrangement' (see subsection 230-50(1)), and therefore will only be subject to a limited operation of Division 230 (refer to discussion on the limited operation of Division 230 to 'equity financial arrangements').
Continuation of Example 2.3 - CPI index-linked bond (cash settlable financial arrangement )
The rights and obligations under High Hope Co's index-linked bond (being the right to receive the coupon payments, as adjusted for the index movement) and the right to receive the face value of the bond on maturity) are all cash settlable and so the arrangement is a cash settlable financial arrangement (section 230-45).
Continuation of Example 2.4 - Two arrangements under the one contract (only one cash settlable financial arrangement )
In this example, LA Co has an arrangement to purchase an office building which is paid for two years after delivery, and an arrangement to purchase office furniture paid for at the time of delivery.
The office furniture arrangement is not a financial arrangement at any time as, at all times under the arrangement, LA Co's subsisting rights and obligations include a significant non-cash settlable right to receive furniture (section 230-45).
The office building arrangement will become a financial arrangement after delivery of the office building, as from this time the only rights and/or obligations subsisting under the arrangement is LA Co's cash settlable obligation to pay Vendor Co for the building (section 230-45).
Continuation of Example 2.6 - Interest bearing bank account (cash settlable financial arrangement )
Retailer Pty Ltd's rights and obligations under its current account held with Bank Ltd consist entirely of its rights to receive financial benefits totalling the amount standing to the credit of its account, as explained in Example 2.6.
Each right to receive a dollar of the balance of the account (the financial benefit) is a 'cash settlable' right to a financial benefit because the benefit is money (paragraph 230-45(2)(a)).
Retailer Pty Ltd's rights under its bank account therefore comprise a cash settlable financial arrangement (section 230-45).
Continuation of Example 2.7 - Option to settle by money equivalent : satisfaction of a debt by the issue of a bond (cash settlable financial arrangement )
Oil Co's loan to Grease Co is a cash settlable financial arrangement consisting of its contingent obligation to provide Grease Co with $100,000 and its contingent cash settlable obligation to provide Grease Co with the bond (section 230-45).
Continuation of Example 2.8 - Value of a monetary item determined by a non-monetary amount (cash settlable financial arrangement )
Kramer Co's agreement with Diamond Co is a cash settlable financial arrangement, as from its inception all of Kramer Co's rights and obligations under this agreement are cash settlable and in respect of financial benefits (section 230-45).
Continuation of Example 2.9 - Practice to settle futures contract by cash payment (cash settlable financial arrangement )
Ore Co's futures contract with the Metals Exchange is a cash settlable financial arrangement consisting of its right to receive a set payment from the Metals Exchange, and its cash settlable obligation to provide nickel to the Metal's Exchange. Ore Co has no rights or obligations under this arrangement that are not cash settlable (section 230-45).
Continuation of Example 2.10 - Take or pay arrangement (not a cash settlable financial arrangement )
Roo Co's agreement with Kanga Co is to receive natural gas in exchange for making a payment for the gas. As explained in Example 2.10, no part of Roo Co's right to receive natural gas is cash settlable. Because this right is not insignificant when compared to Roo Co's other rights and obligations under the arrangement, its take-or-pay arrangement with Kanga Co is not a cash settlable financial arrangement (paragraphs 230-45(1)(d) to (f)).
Continuation of Example 2.11 - Right to receive shares (cash settlable financial arrangement )
Henry Group Ltd's rights and obligations under its forward contract comprise a right to receive 10,000 shares in Kaye Co, and an obligation to pay $200,000. For the reasons given in Example 2.11, Henry Group Ltd's right to receive 10,000 Kaye Co shares is a cash settlable right.
Henry Group Ltd's arrangement under the forward contract will therefore be a cash settlable financial arrangement, within the meaning of section 230-45, comprised by its cash settlable right to receive 10,000 Kaye Co shares and its cash settlable obligation to pay $200,000. Henry Group Ltd has no rights or obligations under this arrangement that are not cash settlable (section 230-45).
If Henry Group Co's right to receive Kaye Co shares was not cash settlable, its forward contract would not be a cash settlable financial arrangement as its right to receive Kaye Co shares is not insignificant when compared to Henry Group Ltd's other rights and obligations under the arrangement (paragraphs 230-45(1)(d) to (f)).
Continuation of Example 2.12 - Obligation is not cash settlable merely due to an ability to cash settle (not a cash settlable financial arrangement )
Cereal Co's forward contract with Corn Co-operative is not a cash settlable financial arrangement despite having a cash settlable right to receive $10,000 and an option to settle its obligation to provide corn with a cash payment (a cash settlable obligation). Cereal Co's forward contract is not a cash settlable financial arrangement because Cereal Co may also settle its obligation under the contract by providing corn. This alternative obligation, despite being able to be settled in cash, is not a cash settlable obligation due to Cereal Co's purpose at the time of entering into the arrangement as explained in Example 2.12. Therefore, for the duration of the arrangement, Cereal Co has a non-insignificant non-cash settlable obligation to provide 200 bushels of Corn, in addition to its other rights and obligations under the arrangement which are cash settlable.
Accordingly, as Cereal Co has a non-insignificant non-cash settlable obligation for the duration of its arrangement, its arrangement with Corn Co-operative is not a cash settlable financial arrangement (section 230-45).
Continuation of Example 2.13 - Damages or compensation payments (not a cash settlable financial arrangement )
Commercial Textile Co's right to receive the warehouse is not, for the reasons given in Example 2.13, a cash settlable right. Because this non-cash settlable right to receive the warehouse is not insignificant in comparison to Commercial Textile Co's other rights and obligations under the arrangement, its warehouse purchase arrangement is not a cash settlable financial arrangement within the meaning of section 230-45.
Continuation of Example 2.14 - Consumer loyalty points and gift certificates (not a cash settlable financial arrangement )
Because Yvonne has no cash settable rights or obligations under her arrangement as described, that arrangement is not a cash settlable financial arrangement.

Equity interest is a financial arrangement

Equity interest financial arrangements

2.99 An 'equity interest', as defined in the ITAA 1997, is also a financial arrangement. [ Schedule 1, item 1, subsection 230-50(1 )]

2.100 An equity interest has the meaning given by Subdivision 974-C of the ITAA 1997 in the case of a company (contained within Division 974 of the ITAA 1997 dealing with debt and equity interests), and by section 820-930 of the ITAA 1997 in the case of a partnership or trust (contained within Subdivision 820-J of the ITAA 1997, dealing with equity interests in a trust or partnership under the thin capitalisation rules). [ Schedule 1, item 7, subsection 820-930(1 )]

2.101 Once determined under these other provisions of the ITAA 1997, an equity interest in its entirety will constitute a relevant financial arrangement under subsection 230-50(1). [ Schedule 1, item 1, subsection 230-50(1 )]

2.102 An equity interest will comprise a financial arrangement under subsection 230-50(1), even if it comprises an arrangement that fails to satisfy the definition of a financial arrangement under section 230-45. Such an arrangement, being an equity interest or part of an equity interest, will be subject to the limited scope of Division 230 that applies to equity financial arrangements.

Financial arrangements consisting of a right or obligation to an equity interest

2.103 A right or obligation to receive or provide an equity interest, or a combination of such rights and/or obligations will also be an equity financial arrangement, if such a right, obligation or combination does not already meet the definition of a cash settlable financial arrangement in section 230-45. [ Schedule 1, item 1, subsection 230-50(2 )]

2.104 Likewise, a right or obligation to receive or provide such a financial arrangement (or a combination of these rights and/or obligations, whether or not together with other rights and/or obligations to other equity interests) will also be a financial arrangement if it is not already a cash settlable financial arrangement (or part of a cash settlable financial arrangement) under subsection 230-45(1). [ Schedule 1, item 1, paragraph 230-50(2)(b )]

2.105 For these types of equity financial arrangements, the financial arrangement is constituted by the relevant right, obligation or combination explained above. However, for the purpose of working out any gain or loss from equity financial arrangements, other financial benefits which play an integral role in determining whether a gain or loss is made from the financial arrangement, are also taken to be relevant rights and obligations under that financial arrangement. [ Schedule 1, item 1, subsection 230-50(2) and section 230-60 ]

Limited scope of Division 230 to equity financial arrangements

2.106 Equity financial arrangements as explained above will be 'financial arrangements' as defined in Division 230. However, they will not be subject to all of the provisions of Division 230 that apply to cash settlable financial arrangements. As a general rule, other areas of the income tax law - such as the capital gains, imputation and general income provisions - largely provide an adequate basis for recognising the gains and losses, including dividends, from equity interests.

2.107 Specifically, an equity financial arrangement will not be subject to:

Subdivision 230-B, which contains the accruals and realisation methods for calculating gains and losses from financial arrangements [ Schedule 1, item 1, paragraphs 230-5(2)(b) and 230-40(4)(e )];
a foreign exchange retranslation election in Subdivision 230-D [ Schedule 1, item 1, subsection 230-270(1), paragraph 230-5(2)(b ))]; or
a hedging financial arrangement election in Subdivision 230-E, except to the extent it is a foreign currency hedge issued by the taxpayer (as explained in Chapter 8) [ Schedule 1, item 1, subsections 230-300(7) and (8) and 230-330(1), paragraph 230-5(2)(b )].

2.108 In addition, an equity financial arrangement will only be subject to a fair value election under Subdivision 230-C (where the taxpayer has made such an election) and/or the election to rely on financial reports in Subdivision 230-F (where the taxpayer has made such an election) and/or, in very limited circumstances, the hedging financial arrangement election under Subdivision 230-E (where the taxpayer has made such an election) if:

the taxpayer is required by the accounting standards (or comparable foreign standards) to classify or designate the equity financial arrangement as at fair value through profit or loss; and
where the financial arrangement is an equity interest, the taxpayer is not the issuer of that interest (except where the equity financial arrangement is a foreign currency hedge under subsections 230-300(7) and (8).

[ Schedule 1, item 1, paragraphs 230-220(1)(c) and 230-410(1)(d), subsections 230-225(1), 230-300(7) and (8) and 230-415(1 )]

2.109 Finally, an equity financial arrangement will only be subject to the balancing adjustment in Subdivision 230-G if it is otherwise subject to either the fair value election or the election to rely on financial reports, as explained above. [ Schedule 1, item 1, subsection 230-440(1 )]

2.110 The fair value election and the election to rely on financial reports are explained in more detail in Chapters 6 and 9.

Additional operation of Division 230

2.111 The application of Subdivision 230-J extends the operation of Division 230 to arrangements that would not otherwise satisfy the definition of a financial arrangement. The extended operation of Division 230 applies to:

foreign currency [ Schedule 1, item 1, subsection 230-530(1 )];
non-equity shares in companies [ Schedule 1, item 1, subsection 230-530(2 )];
certain commodities held by traders for the purposes of dealing, and fair valued through profit or loss for accounting purposes [ Schedule 1, item 1, subsection 230-530(3 )]; and
offsetting commodity contracts that are entered into for the purpose of dealing in a commodity through the performance of offsetting contracts, and fair valued through profit or loss for accounting purposes [ Schedule 1, item 1, subsection 230-530(4 )],

as though these assets were a right that constituted a financial arrangement or, with respect to offsetting commodity contracts, the contracts were a financial arrangement.

2.112 The extended operation of the Division to these assets and offsetting contracts is directed at ensuring that these arrangements are not inappropriately excluded from the scope of Division 230. While they may not be cash settlable financial arrangements, they share some of the characteristics of such arrangements, for example because of the money-like nature of the way in which they are dealt with by the relevant party to the arrangement.

2.113 These specific inclusion provisions operate to treat:

foreign currency as a right that constituted a financial arrangement [ Schedule 1, item 1, subsection 230-530(1 )];
a non-equity share in a company as if the share were a right that constituted a financial arrangement. A non-equity share is defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as a legal form share that is not an equity interest in the company. A share will not be an equity interest if it is characterised as, or forms part of a larger interest that is characterised as, a debt interest under Subdivision 974-B of the ITAA 1997 [ Schedule 1, item 1, subsection 230-530(2 )]; and
a commodity as if the commodity were a right that comprised a financial arrangement where all of the following are satisfied [ Schedule 1, item 1, subsection 230-530(3 )]:

-
it is held by a taxpayer who trades or deals in that commodity, and who holds the relevant commodity for the purposes of dealing in the commodity;
-
that taxpayer also trades or deals in financial arrangements whose value changes in response to the price or value of that commodity;
-
the taxpayer has made a fair value election (see Chapter 6) or an election to rely on financial reports (see Chapter 9); and
-
the commodity is an asset that the taxpayer is required to designate or classify as at fair value through profit or loss in its financial reports, in accordance with the Australian Accounting Standards (or comparable foreign accounting standards if the Australian standards do not apply).

2.114 Division 230 also applies to a contract to which a taxpayer is a party as if the contract were a financial arrangement if:

the taxpayer has a right to receive or an obligation to provide a commodity under the contract;
the taxpayer has a practice of dealing in the commodity using offsetting contracts of that nature;
the taxpayer does not have, as their sole or dominant reason for entering into the contract, the purpose of receiving or delivery the commodity as part of the taxpayer's expected purchase, sale or usage requirements;
the fair value method or the financial reports method applies to financial arrangements that a taxpayer starts to have when they enter into the contract; and
the contract is an asset or liability that the taxpayer is required by accounting standards or comparable foreign accounting standards to classify or designate in their financial reports as at fair value through profit or loss.

[ Schedule 1, item 1, subsection 230-530(4 )]

Specific disaggregation provisions

2.115 Once a financial arrangement has been determined, there are specific disaggregation provisions in Division 230 that apply in particular circumstances, which may operate to split the financial arrangement into two financial arrangements. An example of this is where an entity elects fair value tax treatment and has hybrid financial arrangements in respect of which the host and derivative components have dissimilar economic characteristics and risks (see Chapter 6 for further details). [ Schedule 1, item 1, section 230-235 ]

Exceptions for certain financial arrangements

2.116 Division 230 will not apply to the gains and losses of a number of other financial arrangements. While these financial arrangements meet the essential characteristics of the definition of a financial arrangement, there are administrative, compliance or other policy reasons for effectively excluding them from Division 230.

Short-term arrangements where non-monetary amounts are involved

2.117 Division 230 will not apply to gains and losses arising from certain short-term financial arrangements. A key feature of financing is where one party to an arrangement performs its part in advance of another party. However, where the delay in performance is relatively short it could be said that the financing component is usually subservient to the purpose of providing goods or services. For compliance and administrative reasons, Division 230 will not apply to the gains and losses that arise from financial arrangements which satisfy all of the items listed below. Financial arrangement consideration for property or services

2.118 The financial benefits the taxpayer is to provide (or receive) under the financial arrangement are consideration for property (including goods) or services:

that the taxpayer has acquired from (or provided to) another person; and
that is not money or a money equivalent.

[ Schedule 1, item 1, paragraph 230-450(b )]

No more than 12 months delay in payment

2.119 The period from the time the taxpayer acquired (or provided) the property or services (or a substantial proportion of them), until the time the taxpayer is to provide (or receive) the consideration (or a substantial proportion of it), is not more than 12 months. [ Schedule 1, item 1, paragraph 230-450(c )]

The arrangement is not a derivative financial arrangement

2.120 The financial arrangement is not a derivative financial arrangement for any income year [ Schedule 1, item 1, paragraph 230-450(d )]. Derivative financial arrangements are arrangements that:

change in value in response to a change in a specified variable or variables; and
require little or no net investment, in that the net investment is smaller than that required for other types of financial arrangements, besides other derivative financial arrangements, that would be expected to have similar results to changes in market factors.

[ Schedule 1, item 1, subsection 230-350(1 )]

The fair value election does not apply

2.121 The fair value election does not apply to the financial arrangement [ Schedule 1, item 1, paragraph 230-450(e )]. For a discussion of the fair value election, see Chapter 6.

Example 2.18 : Short-term trade credits

Manufacturer Co sells widgets (which are not money or a money equivalent) to Retailer Co on 90-day terms. That is, Retailer Co has 90 days after delivery of the widgets to pay for them. Manufacturer Co does not recognise gains and losses from these contracts on the basis of fair value through profit or loss under AASB 139.
For the 90-day period, it could be said that Manufacturer Co is financing Retailer Co's purchase of the widgets. During this period Manufacturer Co's only subsisting rights and obligations under these contracts is its right to receive payment for the widgets. From the time of delivery, Manufacturer Co therefore has a cash settlable financial arrangement (under section 230-45).
However, the period between delivery of the widgets and the time for payment is not more than 12 months. As the contracts are not subject to a fair value election, the gains or losses arising from these financial arrangements will be disregarded for Division 230 purposes (pursuant to section 230-450).
Example 2.19 : Continuation of Example 2.11 - forward contract over shares
In Example 2.11, Henry Group Ltd entered into a forward contract under which it will acquire 10,000 Kaye Co shares in 18 months for consideration of $200,000. As explained in Example 2.17, Henry Group Ltd's arrangement under the forward contract is a cash settlable financial arrangement.
On settlement of this contract, Henry Group Ltd receives property (Kaye Co shares) and is obliged to make payment immediately (ie, there is no delay, so that the period between acquisition of the property, and the time Kaye Co is to provide the $200,000 consideration, is not more than 12 months).
Notwithstanding that Henry Group Ltd's right to receive the shares is a cash settlable right (as explained in Example 2.11), the shares are not money or a money equivalent as defined.
Accordingly, assuming Henry Group Ltd has not made a fair value election that could apply to this arrangement, it will be subject to the exception for short-term arrangements where non-monetary amounts are involved, unless it is a derivative financial arrangement (section 230-450).
Henry Group Ltd's financial arrangement is its rights and obligations under the forward contract, which is a forward purchase of shares. The value of this arrangement changes over time in response to changes in the value of Kaye Co shares. Henry Group Ltd would have either paid a premium of an amount less than the value of 10,000 Kaye Co shares at that time, or received a premium of less than this amount, or paid or received nothing at the time of entering into the forward contract. This will be considerably less than the amount Henry Group Ltd would have otherwise had to pay at the time of entry into the forward contract were it to have purchased those shares at that time. Further, the shares would be expected to have similar responses to changes in market factors as the forward contract.
Henry Group Ltd's financial arrangement constituted by its cash settlable rights and obligations under the forward contract is therefore a derivative financial arrangement, and not subject to this exception for short-term arrangements where non-monetary amounts are involved (paragraph 230-450(d) and subsection 230-350(1)).

2.122 Where an arrangement otherwise satisfies the requirements for the exception for short-term arrangements where non-monetary amounts are involved, but the deferral of payment from the time the property or services is received or provided is more than 12 months, Division 230 will apply to the financial arrangement constituted by the 'deferred settlement' or trade credit arrangement. (See Chapters 3 and 11 for an explanation of how Division 230 interacts with the other provisions of the ITAA 1997 or the ITAA 1936 that may apply to the relevant property or services in these cases.)

Entities that satisfy relevant threshold test where there is no significant deferral

2.123 For compliance cost reasons, gains and losses from financial arrangements of individuals and those entities that satisfy the relevant threshold test will not be subject to Division 230, except to the extent that:

the financial arrangement is a qualifying security with a remaining term of more than 12 months at the time the taxpayer started to have it; or
the taxpayer has made an election to have Division 230 apply to all their financial arrangements, and the taxpayer started to have the financial arrangement in or after the year of making that election.

2.124 To have gains and losses from financial arrangements subject to this exception, the taxpayer must be :

an individual;
a superannuation entity (within the meaning of section 10 of the Superannuation Industry (Supervision) Act 1993 ), a managed investment scheme (within the meaning of the Corporations Act 2001 ) or an entity with a similar status to such a scheme under a *foreign law relating to corporate regulation with assets of less than $100 million;
an authorised deposit-taking institution, securitisation vehicle or entity which is required to register under the Financial Sector (Collection of Data) Act 2001 , (or would be required to so register if the entity were a corporation) with an aggregated turnover of less than $20 million (hereafter referred to as financial entities); or
any other entity whose:

-
aggregated turnover is less than $100 million; and
-
financial assets are worth less than $100 million; and
-
assets (including both financial and non-financial assets) are worth less than $300 million.

[ Schedule 1, Part 1, section 230-455 ]

2.125 The following paragraphs elaborate on the meaning of the threshold tests as they apply to particular entities.

Superannuation entities and managed investment schemes

2.126 Superannuation funds or managed investment schemes or similar entities are required to apply a threshold test based on the value of assets reported in their financial statements in accordance with Australian Accounting Standard 25 Financial Reporting by Superannuation Plans (AAS 25).

2.127 To have gains and losses from financial arrangements subject to this exception, the entity must:

be a superannuation entity (within the meaning of section 10 of the Superannuation Industry (Supervision) Act 1993 ); or
be a managed investment scheme (or similar entity under a foreign law related to corporate regulation); and
hold assets with a total value of less than $100 million, determined in accordance with AAS 25, other relevant accounting standards or commercially accepted valuation principles.

2.128 For the purpose of this exception, the timing of the assets test is specified, and may vary for different entities. An entity determines whether or not it meets this assets test for a particular income year (the relevant income year) for the purpose of this exception based on:

its assets as reported at years end in the immediately preceding income year, (worked out at the end of that income year); or
where the entity only came into existence during the particular income year, the value of its assets is worked out at the end of that relevant income year.

[ Schedule 1, Part 1, subparagraph 230-455(1)(a)(ii), paragraph 230-455(1)(b), subsection 230-455(2 )]

Financial entities

2.129 Financial entities are required to apply a threshold test based on that entity's aggregated turnover as defined in Division 328 of the ITAA 1997.

2.130 To have gains and losses from financial arrangements subject to this exception, the entity must:

be a financial entity (see above for entities included in this category); and
have aggregated turnover of less than $20 million worked out under Division 328 of the ITAA 1997.

[ Schedule 1, Part 1, subparagraph 230-455(1)(a)(iii), paragraph 230-455(1)(c), subsection 230-455(3 )]

What is an entity's aggregated turnover?

2.131 'Aggregated turnover' is defined in section 328-115 of the ITAA 1997, and for the purpose of this Division 230 test it carries the same meaning. In summary, an entity's aggregated turnover is based on the ordinary income the entity derives for an income year in the ordinary course of carrying on a business plus the sum of the relevant annual turnovers (adjusted in particular circumstances) of the entity, its connected entities and affiliates.

2.132 This definition also ensures that where an entity does not carry on a business for an entire income year, its aggregated turnover is worked out using a reasonable estimate of what it would be if that entity carried on business for the whole of the relevant income year.

Timing for the application of the aggregated turnover test

2.133 For the purpose of this exception, the timing of the relevant turnover test is specified, and may vary for different entities. An entity determines whether or not it meets this turnover test for a particular income year (the relevant income year) for the purpose of this exception based on:

its turnover in the immediately preceding income year, (worked out at the end of that income year); or
where the entity only came into existence during the particular income year, its turnover as worked out at the end of that relevant income year.

[ Schedule 1, Part 1, section 230-455 ]

Other entities

2.134 All other entities of a type that have not been discussed above (and are not individuals) are required to apply a threshold test based on their aggregated turnover, financial assets they hold, and all assets they hold (including both financial and non-financial assets).

2.135 To have gains and losses from financial arrangements subject to this exception, the entity must:

not be an entity of the kind discussed above (and not be an individual);
have aggregated turnover of less than $100 million worked out under Division 328 of the ITAA 1997 (see above for a discussion on the meaning of aggregated turnover);
hold financial assets with a total value of less than $100 million, determined in accordance with AAS 25, other relevant accounting standards or commercially accepted valuation principles; and
hold assets (including both financial and non-financial assets) with a total value of less than $100 million, determined in accordance with AAS 25, other relevant accounting standards or commercially accepted valuation principles.

[ Schedule 1, Part 1, section 230-455 ]

Timing for the application of the threshold tests

2.136 For the purpose of this exception, the timing of the relevant turnover test is specified, and may vary for different entities. An entity determines whether or not it meets this threshold test for a particular (the relevant income year) for the purpose of this exception based on:

it meeting the threshold in the immediately preceding income year, (worked out at the end of that income year); or
where the entity only came into existence during the particular income year, it meeting the threshold test as worked out at the end of that relevant income year.

[ Schedule 1, Part 1, section 230-455 ]

Qualifying securities of more than 12 months

2.137 Gains and losses from a financial arrangement of an individual or entity falling below the relevant threshold test may still be subject to Division 230 where that arrangement is a 'qualifying security' within the meaning of Division 16E of the ITAA 1936. [ Schedule 1, item 1, paragraph 230-455(1)(e )]

2.138 Broadly, a 'qualifying security' is a security which, at the time of issue, is reasonably likely to result in the sum of the payments (excluding periodic interest as defined in subsection 159GP(6) of the ITAA 1936) exceeding the statutorily established formula in subsection 159GP(1) of the ITAA 1936.

2.139 Where an individual or entity falling below the relevant threshold test starts to have a qualifying security, and it is otherwise a financial arrangement that would be subject to Division 230, its gains and losses will not be excluded from the Division under section 230-455, where that security has more than 12 months remaining of its term at the time when the taxpayer starts to have the qualifying security. That is, these qualifying securities will have gains and losses on them subject to Division 230. [ Schedule 1, item 1, paragraph 230-455(1)(e )]

Irrevocable election to have Division 230 apply to all financial assets and liabilities

2.140 Taxpayers may make an election to have Division 230 apply to all their gains and losses from their financial arrangements. The election once made is irrevocable and applies to all financial arrangements a taxpayer acquires, or otherwise starts to have (such as a financial arrangement the taxpayer creates), in the income year in which the election is made and for subsequent income years. [ Schedule 1, item 1, subsections 230-455(6) to (8 )]

2.141 Entities (other than individuals) who become subject to Division 230 in respect of all of their gains and losses from financial arrangements will continue to have Division 230 apply notwithstanding that the entities turnover or assets may fall below the thresholds set out in subsections 230-455(2), (3) or (4) [ Schedule 1, Part 1, subsection 230-455(9 )]. Where this happens, Division 230 will continue to apply to all of that entities existing and new financial arrangements. The object of this provision is to ensure that, once the entity becomes subject to Division 230, it does not have to continually test whether Division 230 continues to apply to its financial arrangements. In addition, it will ensure that entities whose turnover or assets fluctuate above or below the relevant thresholds over time are not exposed to balancing adjustment and other consequences that otherwise arise as a consequence of having financial arrangements subject to Division 230 one year and not the next.

Exceptions for various rights and/or obligations

2.142 Division 230 does not apply to a taxpayer's gains and losses from a financial arrangement for an income year to the extent that the rights and/or obligations under that arrangement are subject to any of the following exceptions.

Leasing or property arrangement

2.143 Most leasing arrangements will not be cash settlable financial arrangements, as under the arrangement the taxpayer will have not insignificant non-cash settlable rights or obligations (the lessee's right to use the relevant thing being leased, and the lessor's obligation to allow, and be deprived of, such use). However, to the extent that particular leasing arrangements do satisfy the definition of a financial arrangement, the leasing or property exception will apply to a right or obligation arising under:

a luxury car lease under Division 42A of Schedule 2E to the ITAA 1936 [ Schedule 1, item 1, paragraph 230-460(2)(a )];
sale and loan arrangements to which Division 240 of the ITAA 1997 applies [ Schedule 1, item 1, paragraph 230-460(2)(b )];
an arrangement dealing with assets put to tax preferred use to which Division 250 of the ITAA 1997 applies [ Schedule 1, item 1, paragraph 230-460(2)(c )]; or
an arrangement that:

-
is a licence to use; or
-
in substance or effect, depends on the use of a specific asset, and gives a right to control the use of that specific asset, where that asset is,

goods or a personal chattel (other than money or a money equivalent, real property, or intellectual property [ Schedule 1, item 1, paragraphs 230-460(2)(d) and (e )].

2.144 A luxury car lease within the meaning of Division 42A of Schedule 2E to the ITAA 1936 excludes hire purchase agreements and short-term hiring arrangements. The leases that are subject to this Division are treated as a notional sale (generally for the cost of the vehicle) and a loan transaction. The Division contains specific rules to determine the finance charge under this notional loan, and how the notional loan is to be treated for tax purposes. Division 230 will not disturb the tax treatment of arrangements subject to Division 42A of Schedule 2E.

2.145 Division 240 of the ITAA 1997 operates to recharacterise some arrangements (such as hire purchase agreements) as a sale of property, combined with a loan, by the notional seller to the notional buyer, to finance the purchase price. Amongst other things, this Division determines the notional interest on this notional loan, and how it is treated for tax purposes. Division 230 will not disturb the tax treatment of arrangements subject to Division 240.

2.146 Division 250 of the ITAA 1997 operates to deny or reduce certain capital allowance deductions that would otherwise be available in relation to an arrangement that relates to an asset where the asset is put to a tax-preferred use. For Division 250 to apply to an asset, the taxpayer does not have a predominant economic interest in the asset at the test time and:

the asset must be put to a tax-preferred use;
the arrangement period for the preferred use is greater than 12 months;
the financial benefits in relation to the preferred use will be provided to the taxpayer by a tax-preferred end-user, or a tax-preferred entity, or a non-resident;
there will be an entitlement to a capital allowance deduction for the decline in value of the asset or for expenditure in relation to the asset; and
the taxpayer lacks a predominant economic interest in the asset at the time.

Where Division 250 applies to an arrangement in relation to an asset, the arrangement is treated as a loan and Division 230 will not disturb the tax treatment of that arrangement.

2.147 The fourth category under this exclusion broadly covers licences and leases over goods (other than money or a money equivalent), real property, and intellectual property.

2.148 Goods, personal chattels, real and intellectual property take their ordinary meaning, and so in a broad sense cover personal property (other than money or a money equivalent), land, and interests in land and rights in respect of creative and intellectual effort including copyright, registered designs, patents and trademarks.

Interest in a partnership or trust

2.149 A right carried by an interest in a partnership or trust (or a corresponding obligation) will be subject to an exception if there is only one class of interest in the partnership or trust, or the interest is an equity interest in the partnership or trust, or the right or obligation relating to a trust is managed by a funds manager, custodian or 'responsible entity' of a registered scheme [ Schedule 1, item 1, subsection 230-460(3 )]. The reference to an equity interest in the context of a partnership or trust takes its meaning from section 820-930 of the ITAA 1997.

2.150 What is meant by the reference to a funds manager and a custodian takes on its ordinary commercial meaning. A responsible entity of a registered scheme draws its meaning from the Corporations Law. It is the company named in the Australian Securities and Investments Commission's record of the scheme's registration as the responsible entity or temporary responsible entity of a managed investment scheme registered under section 601EB of the Corporations Act 2001 . In a general sense, a managed investment scheme as defined under the Corporations Act 2001 covers (subject to certain exceptions) a scheme where the contribution made by members to acquire interests in the scheme are pooled and used to produce benefits for members, where the members do not have day-to-day control of the operation of the scheme (see section 9 of the Corporations Act 2001 ).

2.151 The exception for multi-class trusts that are managed by a funds manager or custodian promotes competitive neutrality, avoiding the unnecessary creation of multiple single class trusts that are managed by the same funds manager, custodian or responsible entity. [ Schedule 1, item 1, paragraph 230-460(3)(c )]

2.152 Where a right carried by such an interest in a partnership or trust as explained above (or a corresponding obligation) is a right (or obligation) under a financial arrangement that is subject to either a fair value election or an election to rely on financial reports, this exception for certain interests in a partnership or trust will not apply to that right (or obligation). [ Schedule 1, item 1, subsection 230-460(4 )]

Certain insurance policies

2.153 A right or obligation under a life insurance policy or a general insurance policy is subject to an exception from Division 230. [ Schedule 1, item 1, subsections 230-460(5) and (6 )]

2.154 The exception for certain insurance policies applies to both the issuer and the holder of an insurance policy. Accordingly, the exception can apply to a life insurance company, a general insurance company, certain life insurance policyholders and certain general insurance policyholders.

2.155 Subject to certain exclusions applying to holders of policies, the exceptions ensure that Division 230 does not apply to rights and obligations under life insurance policies and general insurance policies. These rights and obligations may also be taken into account under the insurance taxation rules in Division 320 of the ITAA 1997, Division 321 of Schedule 2J to the ITAA 1936 and Division 15 of Part III of the ITAA 1936. To this extent, the exceptions have the effect of preventing the application of both Division 230 and the specific insurance provisions to an excepted policy right or obligation.

2.156 The exception, preventing Division 230 from applying, does not extend to investments (other than investments by way of a policy covered by the exceptions) that support the policy liabilities of the insurance company.

Exception for life insurance policies

2.157 A right or obligation under a life insurance policy is subject to an exception. This exception ensures that Division 230 does not apply to rights and obligations under those life insurance policies that are subject to taxation under Division 320 of the ITAA 1997. [ Schedule 1, item 1, subsection 230-460(5 )].

2.158 The exception does not apply to a life insurance policy if the policy is an annuity that is a qualifying security and the entity is not a life insurance company (as defined by the ITAA 1997) that is the insurer. Therefore, the holder of such a security would not be eligible for the exception.

2.159 However, from the holder's perspective, the exception will apply in respect of an annuity if it is an 'ineligible annuity' within the meaning of Division 16E of the ITAA 1936 (as these annuities are not qualifying securities).

2.160 A life insurance policy is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given to the expression 'life policy' in the Life Insurance Act 1995 , but includes:

a contract made in the course of carrying on business that is life insurance business because of a declaration in force under section 12A or 12B of the Life Insurance Act 1995 ; and
a sinking fund policy within the meaning of the Life Insurance Act 1995 .

Example 2.20 : A life insurance policy that is subject to exception

Bianca is an individual who has elected under subsection 230-455(7) to have all of her gains and losses from financial arrangements that are not otherwise excepted, subject to Division 230. She holds an endowment life insurance policy issued to her by a life insurance company in her own right. As a result of the application of subsection 230-460(5), Division 230 will not apply to any gain or loss that Bianca makes under the policy.

Exception for general insurance policies

2.161 A right or obligation under a general insurance policy is subject to an exception, except where the policy is a derivative financial arrangement and the taxpayer is not a general insurance company as defined by the ITAA 1997. [ Schedule 1, item 1, subsection 230-460(6 )]

2.162 This exception ensures that Division 230 does not apply to rights and obligations under those general insurance policies that are subject to taxation under Division 321 of Schedule 2J to the ITAA 1936.

2.163 A general insurance policy is defined in subsection 995-1(1) of the ITAA 1997 to mean a policy of insurance that is not a life insurance policy or an annuity instrument. The term 'policy of insurance' is not defined and therefore takes its ordinary meaning. It may include a policy of reinsurance. Examples of general insurance policies include fire, theft, injury, accidental damage, negligence, storm and professional indemnity insurance.

2.164 The activities of a general insurance company can be split into underwriting and investment activities. As previously stated, investment activities involving financial arrangements will generally be subject to Division 230. The underwriting activities of a general insurance company (to the extent that they would otherwise be subject to Division 230) will usually be the subject of this exception and would therefore be excluded from the operation of Division 230.

Certain workers' compensation arrangements

2.165 A right or obligation in relation to an outstanding claims liability for certain workers' compensation liabilities is subject to an exception. This exception ensures that Division 230 does not apply to rights or obligations arising under these workers' compensation liabilities that are subject to the taxation treatment set out under Division 323 of Schedule 2J to the ITAA 1936. [ Schedule 1, item 1, subsection 230-460(7 )]

2.166 Division 323 of Schedule 2J to the ITAA 1936 specifies the taxation treatment of outstanding claims liabilities for workers' compensation liabilities of companies that are not required by law to insure, and do not insure, against liability for such claims ('self insurers').

Certain guarantees and indemnities

2.167 A right or obligation under a guarantee or indemnity will be subject to an exception unless:

the financial arrangement is the subject of a fair value election, or an election to rely on financial reports (see Chapters 6 and 9) [ Schedule 1, item 1, paragraph 230-460(8)(a )];
the financial arrangement is a derivative financial arrangement for any income year [ Schedule 1, item 1, paragraph 230-460(8)(b )]; or
the actual guarantee or indemnity is itself given in relation to another financial arrangement [ Schedule 1, item 1, paragraph 230-460(8)(c )].

2.168 What is meant by a 'guarantee' or an 'indemnity' takes on its ordinary meaning to include a promise to answer for the debt or default of another, or to make good a loss suffered through a third party.

Example 2.21 : Cash settlable guarantee

On 1 September 2012 Gez Co enters into an arrangement to acquire a fleet of cars for use in its business. Both delivery of the vehicles and payment occurs on 1 October 2012. Under the arrangement, from the date of delivery, Gez Co continues to have a subsisting right to be indemnified against the cost of repairing a specified range of potential faults that may arise in the vehicles, for a period of three years.
Gez Co is an entity with a relevant aggregated turnover in excess of $100 million, that has not made any elections under Division 230.
As the contingent right to receive a payment under this indemnity clause in the arrangement is a cash-settlable right under paragraph 230-45(2)(a), and it is the only subsisting right or obligation Gez Co has under its fleet purchase arrangement, from the time of delivery of the fleet cars, Gez Co has a cash settlable financial arrangement.
However, the only right under Gez Co's arrangement is a right under an indemnity, that is not a derivative financial arrangement and that is not subject to a relevant election under Division 230. Further, it is not an indemnity in relation to a financial arrangement (as the obligation of Gez Co to pay the cost of repairing the potential faults it is being indemnified for, does not itself arise under a financial arrangement).
As such, any gains or losses Gez Co makes from its financial arrangement constituted by its rights under the indemnity will not be subject to Division 230.

2.169 An example of where this exception would not apply is where a guarantee is provided in respect of a loan agreement. As the loan agreement is itself a financial arrangement, the guarantee would be subject to Division 230. [ Schedule 1, item 1, paragraph 230-460(8)(c )]

Personal arrangements and personal injury

2.170 Certain personal arrangements and arrangements in respect of personal injuries will not have their gains and losses subject to Division 230. Specifically, rights and obligations under a financial arrangement are the subject of an exception in the following circumstances.

Personal services

2.171 A right to receive consideration, or an obligation to provide consideration, for the provision of personal services is the subject of an exception [ Schedule 1, item 1, paragraph 230-460(9)(a )]. Personal services are broadly the provision of personal effort, labour or skill of an individual.

Deceased estates

2.172 A right, or an obligation, that arises from the administration of a deceased estate is the subject of an exception [ Schedule 1, item 1, paragraph 230-460(9)(b )]. Rights and obligations arising from the administration of a deceased estate include those arising under a will as well as those arising through common law or legislatively, such as in the case of an intestate estate.

Gifts under deed

2.173 A right to receive, or an obligation to provide, a gift under a deed, is the subject of an exception. [ Schedule 1, item 1, paragraph 230-460(9)(c )]

Maintenance amounts

2.174 A right to receive, or an obligation to provide, a financial benefit by way of maintenance:

to an individual who is a spouse or former spouse of the person liable to provide the financial benefit;
to, or for the benefit of, an individual who is a child (or who was a child), of the person liable to provide the financial benefit; or
to, or for the benefit of, an individual who is a child (or who was a child) of a spouse or former spouse of the person liable to provide the financial benefit,

is the subject of an exception. [ Schedule 1, item 1, paragraph 230-460(9)(d )]

2.175 In this context, maintenance refers to a financial benefit paid to, or for the relevant individual, to assist in that individual's support. A right to receive or an obligation to provide a financial benefit by way of maintenance may include periodic payments, lump sum payments, and/or a transfer of property.

Personal injury

2.176 A right to receive, or an obligation to provide, a financial benefit in relation to personal injury to an individual is the subject of an exception [ Schedule 1, item 1, paragraph 230-460(9)(e )]. Personal injury includes any injury or disease sustained to an individual's person.

2.177 Where a taxpayer has a right to receive, or an obligation to provide, a financial benefit in relation to personal injury of an individual, the exception will apply even if:

the personal injury is in the form of a wrong to the individual or an illness of the individual; and/or
the person to whom the financial benefit is provided is not the individual who was injured.

[ Schedule 1, item 1, subsection 230-460(10 )]

Injury to reputation

2.178 A right to receive, or an obligation to provide, a financial benefit in relation to an injury to an individual's reputation is the subject of an exception [ Schedule 1, item 1, paragraph 230-460(9)(f )]. Such rights or obligations may arise, for example, from defamation actions.

Superannuation and pension income

2.179 A right to receive, or an obligation to provide, financial benefits will be subject to an exception if that right or obligation arises from a person's membership of a superannuation or pension scheme. This may include the right of a dependant of a member to receive financial benefits (or the corresponding obligation to provide financial benefits to that dependant). It may also include the right or obligation arising from an interest in a complying or non-complying superannuation fund, a pooled superannuation trust, an approved deposit fund or a retirement savings account. [ Schedule 1, item 1, subsection 230-460(11 )]

2.180 This exception ensures that Division 230 does not apply to rights and obligations that arise under certain superannuation or pension schemes and that where relevant the primacy of other provisions (such as those contained in Division 295 of the ITAA 1997) in respect of those rights and obligations are preserved.

An interest in a foreign investment fund, foreign life policy or a controlled foreign company

2.181 Division 230 does not apply to gains and losses from a financial arrangement for any income year to the extent that the rights and/or obligations under the arrangement arise under an interest in a foreign investment fund or an interest in a foreign life assurance policy (both as defined in Part XI of the ITAA 1936). [ Schedule 1, item 1, subsection 230-460(12 )]

2.182 An interest in a foreign investment fund includes an interest in a foreign company or foreign trust. An interest in a foreign company includes an interest in a company that is a controlled foreign company. Therefore, the exception covers not only an interest in a foreign company to which Part XI of the ITAA 1936 applies, but also includes an interest in a foreign company to which the controlled foreign company rules in Part X of the ITAA 1936 applies.

2.183 These relevant interests in foreign investment funds and controlled foreign companies are in a broad sense akin to equity interests. Division 230 only has a limited operation in respect of financial arrangements that are equity interests. This exception for relevant interests in foreign investment funds and controlled foreign companies ensures that they are not given an inappropriate treatment under Division 230.

Proceeds from certain business sales

2.184 A right to receive, or an obligation to provide, financial benefits arising from the direct or indirect sale of business, including those rights or obligations arising from the sale of shares in a company (or interests in a trust) that operates the business, may be the subject of an exception. These rights and obligations will only be the subject of this exception where the amounts or the values of the financial benefits to be received or provided are contingent on the economic performance of the business after the sale. [ Schedule 1, item 1, subsection 230-460(13 )]

2.185 This exception applies to exclude arrangements commonly known as 'earn-outs'.

2.186 For the purposes of Division 230, a right to receive one or more financial benefits is treated as being two separate rights (see Chapter 3) [ Schedule 1, item 1, subsection 230-55(1 )]. This means that if an earn-out arrangement includes a right to receive a fixed amount, plus a right to receive an amount that is contingent on the economic performance of a business that has been sold, the latter right will itself be subject to this exception. Division 230 can continue to apply to the arrangement to the extent that any rights or obligations (including the right to receive a fixed amount) are not subject to this (or any other) exception.

Infrastructure borrowings

2.187 Division 16L of the ITAA 1936 broadly provides tax concessions for infrastructure borrowings in respect of which a certificate has been issued by the Development Allowance Authority. Whilst no new certificates have been issued in the last 10 years, existing arrangements in respect of previously issued certificates can be traded or novated, so can start to become new arrangements in the hands of different taxpayers.

2.188 Generally speaking, one of the outcomes of Division 16L of the ITAA 1936 is that interest derived from infrastructure borrowings is tax exempt, whilst any interest incurred by an investor on funds borrowed for the purpose of investing in infrastructure borrowings may be deductible as if the interest derived from infrastructure borrowings were not exempt.

2.189 Often arrangements under which an investor may borrow to invest in infrastructure borrowings are packaged together with the infrastructure bond itself, such that under Division 230 it may be considered to be the one arrangement. Such an arrangement may (due to certainty of cash flows) have an overall gain for the purposes of Subdivision 230-B (the accrual rules). However, this gain (which should essentially be exempt) may have been calculated by taking into account outgoings that would otherwise be deductible.

2.190 As Division 16L of the ITAA 1936 has ceased to have effect for any new infrastructure arrangements, its treatment of infrastructure borrowings only continues to have residual application. It nevertheless continues to have application to relevant arrangements which are excluded from Division 230.

2.191 Note also that Division 16E of the ITAA 1936 is only excluded from applying during the first 15 years of an infrastructure borrowing. After this time it may start to have application. Division 16E will continue to apply to those arrangements that are subject to Division 16L of the ITAA 1936, as appropriate. [ Schedule 1, item 1, subsection 230-460(14 )]

Farm management deposits

2.192 A right to receive, or obligation to provide, financial benefits arising under a farm management deposit (within the meaning of Schedule 2G to the ITAA 1936) is the subject of an exception, provided the right or obligation is held by the owner of the farm management deposit. This exception therefore does not apply to a financial institution with whom the farm management deposit is held. [ Schedule 1, item 1, subsection 230-460(15 )]

2.193 Broadly speaking, a farm management deposit is an account held with a financial institution which enables the relevant primary producer owner to deduct amounts deposited into such an account in the year of deposit, while requiring that amounts when repaid be included in assessable income. In this way, farm management deposits are tax-linked, financial risk management tools, designed to allow primary producers to set aside income from profitable years for subsequent 'draw-down' in low-income years.

2.194 It is not intended that Division 230 disturb the tax treatment of farm management deposits, which is the reason for this exception.

Rights and obligations to which section 121EK of the ITAA 1936 applies

2.195 In certain circumstances, the owner of an offshore banking unit will be deemed to have received a payment in the nature of interest. The deemed interest is assessable income in the hands of the owner of the offshore banking unit. An exception has been included in Division 230 so that a right or obligation that gives rise to a deemed interest payment is not a financial arrangement to which Division 230 applies. [ Schedule 1, item 1, subsection 230-460(16 )]

Forestry managed investment schemes

2.196 Division 394 of the ITAA 1997 broadly provides that initial investors in forestry managed investment schemes (forestry schemes) will receive a tax deduction equal to 100 per cent of their contributions and subsequent investors will receive a tax deduction for their ongoing contributions to forestry schemes, provided that at least 70 per cent of the scheme manager's expenditure under the scheme is expenditure attributable to establishing, tending and felling trees for harvesting (direct forestry expenditure).

2.197 Subsection 394-15(3) of the ITAA 1997 defines a forestry interest in a forestry managed investment scheme to be a right to benefits produced by the scheme (whether the right is actual, prospective or contingent and whether it is enforceable or not). A right to receive, or obligation to provide, financial benefits arising under a forestry interest in a forestry managed investment scheme would ordinarily be a financial arrangement as it constitutes a cash settlable right to receive, or obligation to provide, such benefits. An exception from Division 230 has been inserted for situations where the investor can claim deductions under section 394-10 of the ITAA 1997. [ Schedule 1, item 1, subsection 230-460(17 )]

Regulation-making power for exceptions

2.198 Subsection 230-460(18) contains a regulation-making power to enable regulations to be made that specify a right or obligation as being the subject of an exception. [ Schedule 1, item 1, subsection 230-460(18 )]

Ceasing to hold financial arrangements in certain circumstances

2.199 Section 230-465 broadly operates to prevent losses from being allowed as revenue losses under Division 230 as a result of the disposal (including partial disposal) or redemption (including partial redemption) of a financial arrangement, where it can be objectively concluded that a reason for the disposal or redemption was an apprehension or belief that the issuer, or other parties to the arrangement, would likely be unable or unwilling to discharge their obligations to make payments under the financial arrangement.

2.200 Section 230-465 applies if:

a taxpayer ceases to have a financial arrangement (or part of a financial arrangement);
the taxpayer makes a loss, in the context of Division 230 (see Chapter 3) from ceasing to have the financial arrangement (or relevant part);
if the financial arrangement is a marketable security within the meaning of section 70B of the ITAA 1936:

-
the taxpayer did not acquire the marketable security in the ordinary course of trading on a securities market and at the time of acquisition the taxpayer did not have the ability to acquire an identical financial arrangement in the ordinary course of trading on a securities market;
-
the taxpayer did not dispose of the marketable security arrangement in the course of trading on a securities market; and

it would be concluded that the taxpayer ceased to have the financial arrangement (whether a marketable security or not) wholly or partly because there was an apprehension or belief that the other party or other parties to the financial arrangement were, or would be likely to be, unable or unwilling to discharge all their liabilities to pay amounts under the financial arrangement.

[ Schedule 1, item 1, subsection 230-465(1 )]

2.201 Subsection 70B(7) of the ITAA 1936 defines a marketable security as a traditional security (within the meaning of subsection 26BB(2) of the ITAA 1936) that is either a stock, bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security.

2.202 In determining whether the taxpayer has ceased to have a financial arrangement because there was an apprehension or belief that the other party would be unable or unwilling to disclose its liabilities, regard is to be had to:

the financial position of the other party or parties to the arrangement;
the perceptions of the financial position of the other party or parties; and
other relevant matters.

[ Schedule 1, item 1, subsection 230-465(3 )]

2.203 Where section 230-465 applies to a financial arrangement, a deduction is not allowable under Division 230 in respect of the amount of the loss that is a loss of capital or of a capital nature. However, this loss may still be treated as a capital loss under the capital gains tax provisions of the ITAA 1997. [ Schedule 1, item 1, subsection 230-465(2 )]

Forgiveness of commercial debts

2.204 To ensure that relevant gains made from the release, waiver or extinguishment of a debt under a financial arrangement continue to be subject to the commercial debt forgiveness provisions as set out in Subdivision 245-B of Schedule 2C to the ITAA 1936, Division 230 provides that where a taxpayer makes a gain from a financial arrangement from the forgiveness of a debt in accordance with the commercial debt forgiveness provisions, that gain is decreased by:

the debt's net forgiven amount. This is in accordance with paragraph 245-85(2)(a) of Schedule 2C to the ITAA 1936 where section 245-90 of the ITAA 1936 - dealing with agreements to forgo capital losses or revenue deductions - does not apply; or
the debt's provisional net forgiven amount. This is in accordance with paragraph 245-85(2)(b) - where section 245-90 applies.

[ Schedule 1, item 1, section 230-470 ]

Exceptions by way of clarification only

2.205 For the avoidance of doubt, Division 230 does not apply to a taxpayer's gains and losses from a financial arrangement for any income year to the extent that the taxpayer's rights and/or obligations are a right or obligation arising under a retirement village residence contract, a retirement village services contract or an arrangement under which residential care or flexible care is provided. [ Schedule 1, item 1, subsection 230-475(3 )]

2.206 The reason why this exception is only for the avoidance of doubt is that it is expected that these arrangements will include non-insignificant non-cash settlable rights and obligations for their duration, and therefore be prevented from being cash settlable financial arrangements under subsection 230-45(1).

Retirement village residence contracts

2.207 A right or obligation arising under a 'retirement village residence contract' is the subject of an exception. [ Schedule 1, item 1, paragraph 230-475(3)(a )]

2.208 A retirement village residence contract is a contract that gives rise to a right to occupy 'residential premises' in a 'retirement village' [ Schedule 1, item 1, paragraph 230-475(4)(a )]. These terms take their meaning from section 195-1 of the A New Tax System (Goods and Services) Act 1999 . That definition provides that a residential premises in a retirement village exists if:

the premises are occupied by one or more persons as a main residence;
accommodation in the premises is intended to be for persons who are at least 55 years old, or who are a certain age that is more than 55 years; and
the premises include communal facilities for use by the residents of the premises;

but excludes:

premises used, or intended to be used, for the provision of residential care (within the meaning of the Aged Care Act 1997 ) by an approved provider (within the meaning of that Act); and
'commercial residential premises' as defined in section 195-1 of the A New Tax System (Goods and Services) Act 1999 .

Retirement village services contracts

but excludes:2.209 A right or obligation arising under a 'retirement village services contract' is the subject of an exception [ Schedule 1, item 1, subsection 230-475(1), paragraph 230-475(3)(b )]. A retirement village services contract is a contract under which a retirement village resident is provided with general or personal services in the retirement village [ Schedule 1, item 1, paragraph 230-475(4)(b )].

Provision of residential or flexible care

2.210 A right or obligation arising under an arrangement under which residential care or flexible care is provided is the subject of an exception. [ Schedule 1, item 1, subsection 230-475(1), paragraph 230-475(3)(c )]. This exception is intended to exclude gains and losses from rights or obligations arising under an accommodation bond style arrangement arising from residential or flexible care.

2.211 'Residential care' is defined to have the same meaning as in section 41-3 of the Aged Care Act 1997 , while 'flexible care' is defined under section 49-3 of the Aged Care Act 1997 . Residential care covers personal and/or nursing care provided to individuals in residential care facilities, but does not cover such care when it is provided via a hospital, personal residence, psychiatric facility or a non-aged care facility. Flexible care refers to alternative care provided in the same setting as residential care.

Exception for gains in the form of franked distributions

2.212 Division 230 does not apply to gains to the extent they are gains in the form of a franked distribution or a right to receive a franked distribution. [ Schedule 1, item 1, section 230-480 ]


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