ATO Interpretative Decision

ATO ID 2003/1040

Income Tax

Issue

Will trade finance borrowings under a short-term trade finance facility give rise to a debt interest in the taxpayer entity as defined in Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

Yes. The trade finance borrowings under a short-term trade finance facility will give rise to a debt interest in the taxpayer entity under Division 974 of the ITAA 1997.

Facts

The taxpayer's main business activity consists of importing and exporting commodities. The taxpayer buys and on-sells these commodities. Commonly, there is a timing mismatch between the time of purchase and sale. The contracts for the acquisition and sale of commodities are financed by a short-term trade finance facility.

The short-term trade finance facility allows the taxpayer to direct the financier to issue a letter of credit in favour of the supplier and to then pay the supplier once the financier is satisfied that the commodities are available and ready for delivery. In return for issuing the letter of credit, the taxpayer undertakes to pay the financier, an amount equal to the sum advanced by the financier to the supplier, including interest and reimbursement of expenses incurred by the financier.

The trade finance facility between the taxpayer and the financier limits the term of the borrowing to no more than 180 days.

Reasons for Decision

Division 974 of the ITAA 1997 sets out the tests that determine whether an interest is characterised as debt or equity.

Subsection 974-15(1) of the ITAA 1997 provides that a 'scheme' gives rise to a 'debt interest' if all the requirements of the debt test, as set out in subsection 974-20(1) of the ITAA 1997, are met. These requirements are:

(a)

the scheme is a financing arrangement for the entity, and

(b)

the entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme, and

(c)

the entity has an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when the financial benefit referred to in paragraph (b) is received, and

(d)

it is substantially more likely than not that the value provided (worked out under subsection 974-20(2) of the ITAA 1997) will be at least equal to the value received (worked out under subsection 974-20(3) of the ITAA 1997), and

(e)

the value provided (worked out under subsection 970-20(2) of the ITAA 1997) and the value received (worked out under subsection 970-20(3) of the ITAA 1997) are not both nil.

Under subsection 974-150(1) of the ITAA 1997, the term 'scheme' has the meaning given in subsection 995-1(1) of the ITAA 1997. Under subsection 995-1(1) of the ITAA 1997, the term scheme is defined to mean 'any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise'. In the present case, the trade finance borrowings the taxpayer acquires under the trade finance facility would be a scheme pursuant to that definition.

The trade finance borrowings are classified as a debt interest as those borrowings satisfy all the requirements of the debt test. That is:

(a)

The scheme is a financing arrangement for the taxpayer. A financing arrangement is a scheme entered into or undertaken to raise finance for the entity (paragraph 974-130(1)(a) of the ITAA 1997). The arrangement is entered into to raise finance for the taxpayer through the issue of the letters of credit by its banker for its benefit and the ability to draw down trade finance borrowings.

(b)

The taxpayer receives a financial benefit under the scheme. Financial benefit means anything of economic value, including property and services (in subsection 974-160(1) of the ITAA 1997). A financial benefit will exist even though under the transaction that confers the benefit on an entity, might also place that entity under an obligation. In applying the definition of a 'financial benefit', the benefits and obligations under a transaction are analysed separately (subsection 974-160(2) of the ITAA 1997). Each time the taxpayer acquires trade finance borrowings (obtains a letter of credit) under the trade finance facility, the taxpayer receives a financial benefit in the form of the amount of money its banker pays to the supplier in respect of the goods that the taxpayer has purchased from the supplier. The taxpayer is taken to have received a financial benefit because the money has been provided by its banker on its behalf (paragraphs 974-30(2)(a) or 974-30(2)(b) of the ITAA 1997).

(c)

The taxpayer has an effectively non-contingent obligation to provide a financial benefit (section 974-135 of the ITAA 1997). In particular, an obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity), other than the ability or willingness of the entity to meet that obligation (subsection 974-135(3) of the ITAA 1997). Each time the taxpayer draws down trade finance borrowings, having regard to the pricing, terms and conditions of the scheme, in substance or effect, the taxpayer has an obligation to repay any advances, interest and fees to the banker within 180 days of the funds being advanced. The taxpayer is required to make payment to the banker within this period. Therefore, this obligation is not contingent on any event condition, or situation, other than the ability or willingness of the taxpayer to meet that obligation.

(d)

It is substantially more likely than not that the financial benefit to be provided will at least equal the value of the financial benefit received by the taxpayer. Only those financial benefits that the issuer has an effectively non-contingent obligation to provide are required to be taken into account under the debt test (subsection 974-20(4) of the ITAA 1997). Under the terms and conditions of a trade finance facility, the trade finance borrowings cannot be re-financed for a term greater than 180 days. As a result, nominal values are required to be used in determining the value of the financial benefits provided and received in respect of the borrowings (subparagraph 974-35(1)(a)(i) of the ITAA 1997). The total nominal value of the financial benefits to be provided by the taxpayer (being the interest, fees and principal payment on the borrowing) will exceed the value of the financial benefits received in respect of the trade finance borrowings.

(e)

Both the value of the benefit provided and received are both not nil.

Year of income:  Year ended 31 December 2002

Legislative References:
Income Tax Assessment Act 1997
   section 974-15
   section 974-20
   section 974-30
   section 974-35
   section 974-130
   section 974-135
   section 974-150
   section 974-160
   subsection 995-1(1)

Related ATO Interpretative Decisions
ATO ID 2003/1041
ATO ID 2003/1042

Keywords
Debt equity borderline
Debt test
Financing arrangement
Short term schemes

Siebel/TDMS Reference Number:  3718376

Business Line:  Finance and Investment Centre of Expertise

Date of publication:  21 November 2003

ISSN: 1445-2782