Edited version of private ruling

Authorisation Number: 1011513838371

NOTICE 

This edited version has been found to be incorrect. It does not represent the ATO’s view of the relevant law.

This notice must not be taken to imply anything about:

● the binding nature of the private advice issued to the applicant

● the correctness of other edited versions.

Edited versions cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.

Ruling

Subject: Interest Withholding Tax

Question 1

Will X Company as responsible entity of the X Trust constitute an eligible unit trust for the purposes of section 128FA of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Will the convertible notes constitute debentures such that interest paid in respect of the convertible notes meets the requirement under section 128FA of the ITAA 1936?

Answer

Yes

Question 3

Whether the issue of the debenture by the trustee of an eligible unit trust satisfies the public offer test in subsection 128F(3) of the ITAA 1936?

Answer

Yes

Question 4

Will any sell down of the convertible notes constitute a new agreement for the purposes of satisfying the public offer test in subsection 128F(3) of the ITAA 1936?

Answer

No

This ruling applies for the following period

1 July 2010 to 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

The draft Information Memorandum outlines the key terms of the convertible note.
The convertible note to be issued by X Trust is described and defined in the Convertible Note Deed Poll draft.

X Trust refers to X Company in its capacity as the responsible entity for X Trust.

X Trust is an unlisted real estate investment trust.

X Trust is proposing to undertake a capital raising through the issue of the convertible notes.

X Trust has engaged and appointed an advisory team as its financial advisor.

The advisory team will assist X Trust with the capital raising by circulating the Information Memorandum to potential investors by way of invitation to participate in the convertible note issue.

X Trust is widely held with well over 50 unit holders.

The top 20 unit holders own more than 50% of the total units on issue.

Any transfer of convertible notes will be in accordance with the Convertible Note Deed Poll.

Relevant legislative provisions

Subsection 128F(1) of the Income Tax Assessment Act 1936

Subsection 128F(3) of the Income Tax Assessment Act 1936

Paragraph 128F(3)(a) of the Income Tax Assessment Act 1936

Paragraph 128F(3)(b) of the Income Tax Assessment Act 1936

Subsection 128F(5) of the Income Tax Assessment Act 1936

Subsection 128F(6) of the Income Tax Assessment Act 1936

Subsection 128F(1) of the Income Tax Assessment Act 1936

Paragraph 128FA(1)(d) of the Income Tax Assessment Act 1936

Subsection 128FA(6) of the Income Tax Assessment Act 1936

Subsection 128FA(7) of the Income Tax Assessment Act 1936

Subsection 128FA(8) of the Income Tax Assessment Act 1936

Subsection 128G(1) of the Income Tax Assessment Act 1936

Subsection 128G(3) of the Income Tax Assessment Act 1936

Subsection 128G(4) of the Income Tax Assessment Act 1936

Subsection 128G(6) of the Income Tax Assessment Act 1936

Subsection 128G(9) of the Income Tax Assessment Act 1936

Reasons for decision

Question 1 - Will X Company as responsible entity of the X Trust constitute an eligible unit trust for the purposes of section 128FA of the ITAA 1936?

Summary

X Trust satisfies the requirements of a public unit trust in section 102G of the ITAA 1936 and is an eligible unit trust for the purposes of section 128FA of the ITAA 1936.

Detailed reasoning

To obtain a withholding tax exemption under section 128FA of the ITAA 1936, the interest paid in relation to a debenture or debt interest must be paid to a non resident by the trustee of an 'eligible unit trust'. Under subsection 128FA(8), an 'eligible unit trust' includes a 'public unit trust'. The requirements for a unit trust to be considered a public unit trust is set out in section 102G of the ITAA 1936.

Subsection 102G(1) of the ITAA 1936 states:

For the purposes of this Division, but subject to the succeeding provisions of this section, a unit trust is a public unit trust in relation to a year of income if, at any time during the year of income:

● any of the units in the unit trust were listed for quotation in the official list of a stock exchange in Australia or elsewhere;

● any of the units in the unit trust were offered to the public; or

● the units in the unit trust were held by not fewer than 50 persons.

The Unit holders register for X Trust lists the top 50 unit holders, therefore the X Trust would satisfy the relevant provisions of a public unit trust in subsection 102G(1) of the ITAA 1936 during the year of income. However, subsection 102G(1) is subject to the exclusions in subsections 102G(3) and (4).

Subsection 102G(3) of the ITAA 1936 states :

Notwithstanding subsection (1) but subject to subsection (4), a unit trust that, but for this subsection and subsection (6) , would be a public unit trust in relation to a year of income shall be deemed not to be a public unit trust in relation to the year of income if, at any time during the year of income, one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, a unit or units in the unit trust that entitled the holder or holders thereof to not less than 75% of- 

● the beneficial interests in the income of the unit trust; or 

● the beneficial interests in the property of the unit trust.

Subsection 102G(4) of the ITAA 1936 states:

Subject to subsection (6), where by virtue of subsection (3), a unit trust would, but for this subsection, be deemed not to be a public unit trust in relation to a year of income by reason that, at any time during the year of income, one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, the unit or units referred to in subsection (3) and the Commissioner is of the opinion that, having regard to: 

● the length of the period or the aggregate of the lengths of the periods in the year of income during which one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, the unit or units referred to in subsection (3); and

● any other matters that the Commissioner considers relevant,

● it is reasonable that the unit trust should be treated as a public unit trust in relation to the year of income, the unit trust shall be deemed to be a public unit trust in relation to the year of income. 

The discretion conferred upon the Commissioner in subsection 102G(4) of the ITAA 1936 is subject to subsection 102G(6). Any exercise of this discretion must necessarily have regard to and consideration of the matters referred to in subsection 102G(6).

The unit holders register for X Trust lists the top 20 unit holders. These unit holders own just of 50 per cent of the total units on issue.

As the unit holder register for X Trust contains at least 50 unit holders by name and percentage and the top 20 unit holders by name and percentage, none of the exclusions in subsections 102G(3), (4), (6) and (9) of the ITAA 1936 apply in this case.

Therefore, X Trust satisfies the requirements of a public unit trust in section 102G of the ITAA 1936 and accordingly X Trust is an eligible unit trust for the purposes of section 128FA of the ITAA 1936.

Question 2 – Will the convertible notes constitute debentures such that interest paid on the convertible notes meets the requirement under section 128FA of the ITAA 1936?

Summary

The convertible notes issued by X Trust constitute debentures for the purposes of section 128FA of the ITAA 1936.

Detailed reasoning

Subsection 128FA(1) of the ITAA 1936 applies to interest paid by the trustee of an eligible unit trust in respect of a debenture or debt interest issued by the trustee if certain requirements are met.

‘Interest paid by the trustee of an eligible trust in respect of a debenture’

For the purposes of section 128FA of the ITAA 1936, the term “debenture” is defined by subsection 128FA(8). This section states:

‘debenture’

● in relation to the trustee of an eligible unit trust includes debenture stock, bonds, promissory and other notes, bills of exchange and any other securities issued by the trustee, whether constituting a charge on the assets of the eligible unit trust or not; and

● in relation to a company, has the same meaning as in section 128F.
The general meaning of ‘debenture’ is discussed by Chitty J in Levy v. Abercorris Slate & Slab Co (1887) 37 Ch D 260 at 263 - 264:

Now what is a debenture?... A debenture means a document which either creates a debt or acknowledges it, and any document which fulfils either of these conditions is a “debenture”.

Based on analysis of the information provided by the Applicant, the convertible note satisfies the requirement of a ‘debenture’ for the purposes of section 128FA of the ITAA 1936.

Question 3 - Whether the issue of the debenture by the trustee of an eligible unit trust satisfies the public offer test in subsection 128F(3) of the ITAA 1936?

Summary

The issue of the debenture by the trustee of an eligible unit trust will satisfy the public offer test in subsection 128F(3) of the ITAA 1936.

Detailed reasoning

The Public Offer Test

Subsection 128FA(1) of the ITAA 1936 applies to interest paid by the trustee of an eligible unit trust in respect of a debenture or debt interest issued by the trustee if the issue of the debenture or debt interest satisfies the public offer test set out at subsection 128FA(6).

For the purposes of working out under subsection 128FA(6) of the ITAA 1936 whether the issue of a debenture by the trustee of an eligible trust satisfies the public offer test, subsection 128F(3) to (5) of the ITAA 1936 applies to the trustee of an eligible unit trust in a corresponding way to the way in which it applies to a company, subject to subsection 128FA(7).

Subsection 128FA(7) of the ITAA 1936 include that:

● the reference to a company knowing, suspecting or having reasonable grounds to suspect something, or it being reasonable for a company to have regarded something, is taken to be a reference to the trustee of the eligible unit trust knowing, suspecting or having reasonable grounds to suspect that thing or it being reasonable for the trustee of the eligible unit trust to have regarded that thing; and

● a reference in any of those subsections to an associate is taken to be a reference to an associate within the meaning of this section.

Subsection 128F(3) of the ITAA 1936 requires an issue of debentures or debt interests to have resulted from being “offered for issue”.

Taxation Determination TD 1999/24 considers the interpretation of the term ‘offered’, in the context of the tests in paragraphs 128F(3)(a) and 128F(3)(b) of the ITAA 1936. TD 1999/24 states, at paragraph 3 that ‘offered’, ‘...includes invitations or inducements to potential investors to make offers....’ and is not limited to meaning ‘offer’ in the context of a contractual offer.

Taxation Determination TD 1999/8 further examines the meaning of the term ‘offered for issue’ for the purposes of the public offer test provisions. It acknowledges that the requirements in subsection 128F(3) of the ITAA 1936 are ‘directed at ensuring an adequate dissemination of the details of the relevant issue to the markets.’ In particular, TD 1999/8 addresses the situation of reverse enquiries and agrees that actual market practice would not be properly accommodated if a strictly literal interpretation was applied. It concludes, at paragraph 4, that a ‘...debenture will be taken to have ‘resulted from’ being ‘offered for issue’ if the debenture otherwise satisfies one of the paragraphs set out in subsection 128F(3).’

Subsection 128F(3) of the ITAA 1936 contains five public offer tests, however X Trust needs to satisfy only one of the public offer tests to qualify for the interest withholding exemption.

Paragraph 128F(3)(a) of the ITAA 1936 contains the first public offer test. This section provides that the issue of a debenture by a company (or an eligible unit trust, in this case) satisfies the public offer test if the issue resulted from the debenture or debt interest being offered for issue:

to at least 10 persons, each of whom:

● was carrying on a business of providing finance, or investing or dealing in securities, in the course of operating in financial markets; and

● was not known, or suspected, by the company (or trustee of the unit trust) to be an associate of any other persons covered by this paragraph.

In general, the requirement of paragraph 128F(3)(a) of the ITAA 1936 is that the debenture be offered to at least 10 people each of whom are carrying on a business of providing finance, investing in securities or operating in financial markets with whom the issuer is not associated.

● However, a question arises as to when the issuer of a debenture will be taken to have satisfied these requirements, where they use an intermediary to promote the issue and they may not have any direct knowledge of the entities being approached. In this case the Applicant states that the advisory team actively marketed the convertible notes to prospective investors. This process involved the Information Memorandum being circulated to potential investors with a view to ascertaining their interest in participating in an issue of the convertible notes and, if so, to submit the terms upon which any such participation would be made.

The Applicant confirmed that:

● the advisory team has made invitations on behalf of X Trust for participation in the convertible note issue to at least 10 different persons;

● each person to whom the Notes have been offered carries on a business of providing finance: or

● investing or dealing in securities, in the course of operating in financial markets; and
in making these invitations on behalf of the X Trust for participation in the Notes, the advisory team did not have knowledge, and did not suspect, that any 10 of the offerees were associates of the X Trust and it is in fact that case that none of the offerees were associates of the X Trust.

Taxation Determination TD 1999/13 contains the Commissioner’s view on what is required of a company to establish that the persons to whom the debentures are offered are carrying on business in the manner required by the legislation.

Paragraph 3 states ‘‘Persons’ may include a dealer, manager or underwriter, provided they are carrying on a business of the kind required by the section, and are not associates of one another’.

Further paragraph 6 states ‘It would be unreasonable to expect a company to be aware whether or not persons to whom it offers debentures are carrying on the business of providing finance, or investing or dealing in securities. A company is able to rely on a representation by a person to whom the debenture is offered that it is carrying on business as required by the legislation. Where a dealer, manager or underwriter offers the debentures on behalf of the company under paragraph 128F(3)(e), a company may also rely on a representation or undertaking by the dealer, manager or underwriter, that it offered, or it will offer, the debenture for sale in compliance with paragraph128F(3)(a)...’

In this regard, paragraph 7 states ‘Therefore, a detailed examination of offerees is not required by the company offering debentures for issue’.

Subparagraph 128F(3)(a)(ii) of the ITAA 1936 further requires the persons to whom the debentures are offered are not known or suspected by the company offering the debentures, to be associates of one another.

In this respect, paragraph 8 of TD 1999/13 states “Knowledge” in this sense refers to the actual knowledge of the company, assessed at the time the debentures are offered for issue. Suspicion needs to be looked at objectively in the light of what is reasonable in the individual circumstances of a particular case. A company will not be regarded as knowing or suspecting persons are associates unless it is established that officers of the company knew or had reasonable grounds to suspect otherwise’.
Finally paragraph 10 states ‘As pointed out in the explanatory memorandum that accompanied the legislation, a company offering debentures for issue is not required to undertake a detailed examination into the relationship between persons it offers debentures to. However, it cannot ignore companies that are generally known to be associates.’

Application of the public offer test to the X Trust

X Trust can rely on the representations provided by the advisory team as outlined in the application in determining whether the requirements of the “public offer test” have been satisfied. In making these invitations on behalf of X Trust for participation in the convertible notes, the advisory team did not have knowledge, and did not suspect that any 10 of the offerees were associates of X Trust and it is a fact that none of the offerees were associates of X Trust.

Based on the Commissioner’s views in TD 1999/13 and the information provided, X Trust can rely on the representations provided by the advisory team in determining whether the requirements of paragraph 128F(3)(a) of the ITAA 1936 have been satisfied. Therefore, as the first test in the public offer test is satisfied, the public offer test in subsection 128F(3) is satisfied.

In conclusion, as the interest paid in respect of a debenture will be issued by a trustee of an eligible unit trust and the issue of the debenture will satisfy the public offer test, the basic requirements of subsection 128FA(1) of the ITAA 1936 will be met, and therefore the withholding tax exemption under section 128FA of the ITAA 1936 will apply to that interest.

Question 4 – Will any sell down of the convertible notes constitute a new agreement for the purposes of satisfying the public offer test in subsection 128F(3) of the ITAA 1936?

Summary

Any sell down of the convertible notes will not constitute a new agreement for the purposes of satisfying the public offer test.

Detailed reasoning

The Convertible Note Deed Poll has a specific clause that deals with the transfer of the convertible notes. This clause states that the convertible notes may only be transferred only:

● with X Company as responsible entity of the X Trust prior written consent; and

● to a person in circumstances that would not require X Company to issue any form of prospectus or other disclosure document under the Corporations Act in Australia or in other jurisdiction.

The relevant clause of the Convertible Note Deed Poll accommodates the transfer of the convertible note as part of a secondary transaction between the holder of the convertible note and their assignee. In the event that a convertible note is assigned under the relevant clause, this does not represent a subsequent or further “issue” by X Trust of that convertible note.

As the transfer of the convertible notes is based on the original offer documentation, the transfer of a debenture will be taken to have ‘resulted from’ the original debenture ‘offered for issue’.

As such, any transfer under the convertible notes pursuant to the relevant clause of the Convertible Note Deed Poll will not constitute a new agreement for the purposes of satisfying the public offer test.

Conclusion

The sell down of the convertible notes will not constitute a new agreement for the purposes of satisfying the public offer test.

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