Edited version of private ruling

Authorisation Number: 1011385298198

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Proposed conversion of Convertible Debentures into ordinary shares and the formation of a tax consolidated group

Question 1

Will the conversion of the Convertible Debentures as set out in the scheme constitute an amount that is transferred to the share capital account of Company B for the purposes of section 197-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and therefore:

(a) cause a tainting of the share capital account of Company B pursuant to subsection 197-50(1) of the ITAA 1997; and

(b) cause a franking debit to arise in the franking account of Company B pursuant to subsection 197-45(1) of the ITAA 1997?

Answer

No.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company A is the parent entity of a group of entities that operate various businesses. A significant part of this business is operated principally through Company B and Company C. Company B and Company C are Australian resident wholly owned subsidiaries of Company A.

Company B currently has unsecured debentures on issue (the 'Convertible Debentures'), being the Convertible Debentures issued under the Conditions of Issue annexed to the Certificate issued to Company A by Company B.

Originally, Company X held all of the Convertible Debentures in Company B.

The Convertible Debentures were put in place at the time as a mechanism for Company X to fund the newly developed business in Australia. The terms and conditions of the Convertible Debentures were such that Company X considered that it enjoyed the same rights and benefits as an ordinary shareholder except for the ability to vote at general meetings of the Issuer.

For a period of 5 years, Company X funded the ongoing operations of Company B by periodically subscribing for further Convertible Debentures. No further Convertible Debentures have been issued since that time.

Subsequently, the Company A group underwent a corporate reorganisation for the purpose of listing the group on the ASX. In order to achieve this, an Australian resident holding company, Company A, was put in place.

As a result of the reorganisation, Company X sold all of its interests in Company B to Company A, including the Convertible Debentures, in exchange for shares in Company A. Accordingly, Company A became the owner of all the Convertible Debentures in Company B.

Relevantly, the terms and conditions of the Convertible Debentures confer on Company A the right to convert some or all of the Debentures in Company B into fully paid ordinary shares in Company B (see the Conditions of Issue).

The Conversion Mechanism set out in the Conditions of Issue first requires the redemption of the Convertible Debentures, followed by the issue of the shares. The Issuer (Company B) is required to apply the proceeds of the redemption on behalf of the holder to the paid up capital of the issued shares.

The Conditions of Issue sets out the formula in calculating the number of fully-paid shares to be issued to each Convertible Debenture holder upon the conversion of the Convertible Debentures. On the basis that the conversion factor is on a one-for-one basis, one share will be issued by Company B for each Convertible Debenture currently on issue.

On conversion of the Convertible Debentures into ordinary shares, the net asset position of Company B will not change under Australian International Financial Reporting Standards, on the basis that there will not be an increase in assets or a decrease in liabilities.

The accounting journal entry that will credit the increase of the share capital account of Company B upon conversion of the Convertible Debentures by the issue of ordinary shares will be associated with an increase in a receivable (asset) account. This accounting journal entry will result in the balance of both accounts increasing in size.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 197-5,

Income Tax Assessment Act 1997 Section 197-45 and

Income Tax Assessment Act 1997 Section 197-50.

Reasons for decision

Section 197-5 of the ITAA 1997 provides as follows:

(1) Subject to subsection (2), this Division applies to an amount (the transferred amount) that is transferred to a company's *share capital account from another of the company's accounts, if the company was an Australian resident immediately before the time of the transfer.

Note: If a company has 2 or more share capital accounts, those accounts are taken to be a single account (see subsection 975-300(2)).

If an amount, to which Division 197 of the ITAA 1997 applies, is transferred to a company's share capital account from another of the company's accounts, then under section 197-50 of the ITAA 1997 the company's share capital account becomes tainted. Further, under section 197-45 of the ITAA 1997, the transfer will also result in a franking debit arising in the company's franking account.

The expression 'transferred amount' in section 197-5 of the ITAA 1997 is not defined in Division 197 or section 995-1 of the ITAA 1997. Therefore, reference must be made to its ordinary meaning in the first instance.

The Macquarie Dictionary does not define the meaning of the compound expression 'transferred amount'. However, the Macquarie Dictionary does define 'transfer' as:

to convey or remove from one place, person etc to another

and 'amount' as:

quantity or extent.

While not determinative, these definitions suggest a 'transferred amount' in the context of section 197-5 of the ITAA 1997 may mean in its broadest sense the record of the movement of any quantity of money to a company's share capital from any other of the company's accounts.

However, the meaning of the expression 'transferred amount' is also discussed in the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.3) Bill 2006; New Business Tax System (Untainting Tax) Bill 2006 (2006 EM) which explains the underlying purpose or object of Division 197 of the ITAA 1997.

Relevantly, the 2006 EM states the following:

When is an amount transferred from one account to another account?

4.12 An amount is transferred from one account to another where that amount is moved from one account to another. This, in turn, requires the balance of the first account to be reduced, while the balance of the second account is increased by the same amount.

4.13 An amount is not transferred from one account to another where the particular accounting entries result in the balances of both accounts increasing in size. Accordingly, an accounting entry of the form 'debit asset, credit share capital account' does not represent a transfer in the relevant sense. Furthermore, a transfer to the share capital account will not arise if an expense account is debited at the same time that the share capital account is credited (emphasis added).

The accounting journal entry that will credit the increase of the share capital account upon conversion of the Convertible Debentures by the issue of ordinary shares will be associated with an increase in a receivable (asset) account. This accounting journal entry will result in the balance of both accounts increasing in size.

Having regard to the policy intent articulated in paragraphs 4.12 and 4.13 of the 2006 EM, this accounting journal entry by Company B will not be a transfer of an amount in the relevant sense as it will result in both accounts increasing in size.

Accordingly, the conversion of the Convertible Debentures to ordinary shares will not constitute a transfer of an amount to the share capital account of Company B for the purposes of section 197-5 of the ITAA 1997. Consequently, the conversion of the Convertible Debentures will not cause the share capital account of Company B to become tainted pursuant to subsection 197-50(1) of the ITAA 1997.

Further, because the conversion of the Convertible Debentures will not cause the share capital account of Company B to become tainted, a franking debit will not arise in the franking account of Company B under subsection 197-45(1) of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).