ATO Interpretative Decision

ATO ID 2004/611

Income Tax

Issue

Will any material changes or alterations made to a loan agreement with the terms described in the facts below form a new scheme for the purposes of classifying the loan as a debt or equity interest in accordance with Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

Yes. The effect of a material change to the loan agreement will mean that a new scheme has been entered into for the purposes of the application of Division 974 of the ITAA 1997.

Facts

A Company maintains accounts with a number of related entities that deposit funds into separate sub accounts. The Company refers to these lenders as its 'Depositors'.

The Company has entered into written Cash Management Account agreements with each of the Depositors.

These agreements have common terms, but in particular:

(a)

Each loan agreement is dated 1 July 2003

(b)

The initial term of the loan agreement is for 12 months. This term may be extended by agreement in writing between the Company and the Depositor

(c)

Interest will be calculated on the daily balance of the account at the prevailing interest rate and credited at 30 June of the following year. The interest rate may be varied by the Company in accordance with market interest rate changes but will initially be set at a certain rate

(d)

Any amount overdrawn on the account will be a debt owing to the Company and will be repayable on demand and will bear interest at a rate double the deposit rate, and

(e)

The Company may close the account after giving 30 days notice.

The loan is classified as a debt interest under Division 974 of the ITAA 1997.

Reasons for Decision

Section 974-110 of the ITAA 1997 contains rules which ensure that the general requirement under Division 974 of the ITAA 1997 that the debt and equity tests are applied to schemes at the time the scheme comes into existence does not prevent Division 974 applying where the scheme has changed in a material way.

In particular subsection 974-110(1) of ITAA 1997 provides that if:

(a)

a scheme or schemes give rise to a debt interest (or an equity interest) in a company; and

(b)

the scheme, or one or more of the schemes, are subsequently changed; and

(c)

the scheme or schemes as they exist immediately after the change would give rise to an equity interest (or a debt interest) in the company if they came into existence when the change occurred;

this Division applies after the change as if the scheme or schemes as they exist immediately after the change came into existence when the change occurred.

The effect of section 974-110 of the ITAA 1997 is to put an imperative on the issuer to retest the instrument under Division 974 of the ITAA 1997 every time there is a change to an existing scheme to ensure it is not a material change that changes its classification under Division 974 from debt to equity or vice versa. The section can apply to an interest a number of times so that, for example, an interest that is debt when issued may change to equity because of one subsequent change and then back to debt because of a later change.

This has the result that if at the end of the initial term the parties agree to extend the term of the loan, it will be necessary for the issuer to test the new arrangement to determine whether it is a debt or equity interest in accordance with Division 974 of the ITAA 1997.

Year of income:  Year ended 30 June 2004

Legislative References:
Income Tax Assessment Act 1997
   section 974-110

Keywords
Debt equity borderline
Debt interest

Siebel/TDMS Reference Number:  3905507

Business Line:  Finance and Investment Centre of Expertise

Date of publication:  30 July 2004

ISSN: 1445-2782