Edited version of private ruling

Authorisation Number: 1011590104618

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Ruling

Subject

Debt funding arrangement

This ruling applies to

Company X

Question 1

Will each amount drawn down under the credit agreement between Company X and Company Y constitute a separate debt interest pursuant to section 974-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

Yes.

Question 2

On the basis that the answer to Question 1 above is 'yes', will section 974-80 of the ITAA 1997 apply to classify the draw downs arising pursuant to the credit agreement as equity interests for the purposes of Division 974 of the ITAA 1997?

Advice/Answers

No.

Question 3

Will a deduction be allowable under section 8-1 of the ITAA 1997 (where Division 230 of the ITAA 1997 does not apply) for interest incurred by Company X on the draw downs under the credit agreement?

Advice/Answers

Yes.

Question 4

Will the Commissioner make a determination under section 177F of the Income Tax Assessment Act 1936 (ITAA 1936) denying any part of the deductions arising to Company X relating to interest or other amounts incurred in respect of the draw downs under the credit agreement?

Advice/Answers

No.

Question 5

Will Company X be required to withhold interest withholding tax pursuant to section 12-245 of Schedule 1 to the Taxation Administration Act 1953 (TAA) in relation to indemnity amounts to be paid by Company X to Company Y under the credit agreement?

Advice/Answers

No.

Question 6

Will, where Division 230 of the ITAA 1997 does not apply to the draw downs, the indemnity amounts to be paid by Company X to Company Y under the credit agreement be deductible to Company X under section 8-1 of the ITAA 1997?

Advice/Answers

Yes.

Question 7

Will Company X be required to withhold interest withholding tax pursuant to section 12-245 of Schedule 1 to the TAA in relation to the commitment fee to be paid by Company X to Company Y under the credit agreement?

Advice/Answers

No.

Question 9

Will subsection 230-55(4) of the ITAA 1997 apply to treat the credit agreement or alternatively each draw down made under the credit agreement as separate arrangements for the purposes of Division 230 of the ITAA 1997?

Advice/Answers

Yes. The credit agreement and each draw down will be separate arrangements for the purposes of Division 230 of the ITAA 1997.

Question 10

Will both the credit agreement and each draw down made under the credit agreement be treated as a financial arrangement for the purposes of Division 230 of the ITAA 1997?

Advice/Answers

Yes, the credit agreement and each draw down are separate financial arrangements for the purposes of Division 230 of the ITAA 1997.

Question 11

Will Company X make a loss that is deductible pursuant to subsection 230-15(2) of the ITAA 1997 from a financial arrangement constituted by a draw down under the credit agreement?

Advice/Answers

Yes. Company X will make a loss that is deductible pursuant to subsection 230-15(2) of the ITAA 1997 from a financial arrangement constituted by a draw down under the credit agreement.

This ruling applies for the following period

1 July 2009 to 30 June 2019

The scheme commenced on

1 July 2009

Relevant facts

Company X has entered into a credit agreement with Company Y (a related company) to borrow money for its business (the credit agreement).

Company Y has entered into a credit agreement with Company Z (a related company) to borrow money.

Under the credit agreement, Company X is required to pay the principal, interest and other fees and expenses to Company Y by the final maturity date and in accordance with the agreement.

Reasons for decision

Question 1

Subsection 974-15(1) of the ITAA 1997 provides that a scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) of the ITAA 1997 in relation to the entity.

It is each draw down under the credit agreement that is considered to be the scheme that is subject to classification under Division 974 of the ITAA 1997. Each draw down is the 'interest that carries the right to receive a financial benefit that the entity or a connected entity has an effectively non-contingent obligation to provide under the scheme': refer to subsection 974-55(1) of the ITAA 1997.

Subsection 974-20(1) of the ITAA 1997 requires certain conditions to be satisfied before a scheme can be said to give rise to a debt interest in an entity.

All of the requirements of the debt test in subsection 974-20(1) of the ITAA 1997 will be satisfied in relation to each draw down that is made under the credit agreement. Each draw down made under the credit agreement will form a separate debt interest for the purposes of section 974-20 of ITAA 1997.

Question 2

Section 974-80 of the ITAA 1997 applies to reclassify certain debt interests in a company which are held by a connected entity of the company as equity interests, where there is a scheme, or a series of schemes, that is designed to use the return on the debt interests held by the connected entity to fund a return to an ultimate recipient on certain equity like interests.

Section 974-80 of the ITAA 1997 will not apply to classify the draw downs under the credit agreement as equity interests because while paragraphs 974-80(1)(a) to (ca) of the ITAA 1997 are satisfied, it cannot be concluded that the scheme was one designed to operate so that the return to the connected entity is to be used to fund a return to an ultimate recipient on an equity like interest.

Question 3

The interest incurred by Company X on the draw downs under the credit agreement will be deductible under section 8-1 of the ITAA 1997 if either of the positive limbs in subsection 8-1(1) of the ITAA 1997 are first satisfied and it does not fall within any of the negative limbs in subsection 8-1(2) of the ITAA 1997.

A loss or outgoing will satisfy the positive limbs of subsection 8-1(1) of the ITAA 1997 to the extent that the loss or outgoing is either incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

The interest will be deductible under the first positive limb of subsection 8-1(1) of the ITAA 1997 if it is 'incidental and relevant' to the gaining or production of assessable income (Ronpibon Tin N.L. and Tongkah Compound N.L. v. FC of T (1949) 78 CLR 47 (Ronpibon)).

The interest will be deductible under the second positive limb of subsection 8-1(1) of the ITAA 1997 if the interest is 'reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business' (FC of T v. Snowden Willson Pty Ltd 99 CLR 431; Magna Alloys & Research Pty Ltd v. FC of T 80 ATC 4542).

Whether the interest satisfies one of these limbs is generally determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put (Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613; FC of T v. Energy Resources of Australia Limited 96 ATC 4536; (1996) 33 ATR 52, and Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139 (Steele)).

An examination of the purpose of the borrowing by Company X under the credit agreement and the use to which the borrowed funds are put leads to the conclusion that the interest is 'incidental and relevant' to Company X's income producing activities and is 'reasonably capable as being seen as desirable or appropriate from the point of view of the pursuit of the business ends of Company X'.

Accordingly, the interest on the draw downs under the credit agreement will satisfy the positive limbs in subsection 8-1(1) of the ITAA 1997.

Having satisfied the positive limbs in subsection 8-1(1) of the ITAA 1997, the interest must also not fall within any of the negative limbs in subsection 8-1(2) of the ITAA 1997.

In the current case, the relevant negative limb in subsection 8-1(2) of the ITAA 1997 is whether the interest is capital, or of a capital nature.

The courts have established a number of principles or tests to be applied in determining whether a loss or outgoing is capital, or of a capital nature (as opposed to being of a revenue nature). In Sun Newspapers Ltd & Associated Newspapers Ltd v. FC of T (1938) 61 CLR 337 (Sun Newspapers), Dixon J formulated the following test (at 363):

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and underthe former head recurrence may play its part, and (c) the means adopted toobtain it; that is, by providing a periodical reward…or by making a final provision or payment so as to secure future use or enjoyment.

In relation to the nature or character of interest, the courts have held that it is a recurrent payment to secure the use for a limited term of loan funds and therefore it is ordinarily of a revenue character (Australian National Hotels Limited v. FC of T 88 ATC 4627; (1988) 19 ATR 1575; Steele).

The interest incurred by Company X on the draw downs under the credit agreement are recurrent and periodic payments that secure Company X the advantage, not of an enduring nature, but the use by the company of the borrowed money for a limited period, being the period of the loan to its final maturity date. It is therefore proper to regard the interest as a revenue item.

Therefore, the interest incurred will not be capital, or of a capital nature and accordingly, will not fall within any of the negative limbs in subsection 8-1(2) of the ITAA 1997.

Therefore, the interest incurred in relation to the draw downs under the credit agreement will be deductible under section 8-1 of the ITAA 1997 (where Division 230 of the ITAA 1997 does not apply).

Question 4

Part IVA of the ITAA 1936 applies to a scheme, or any part of a scheme, entered into or carried out by a person for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the scheme. If Part IVA applies to a scheme, the Commissioner can make a determination under section 177F of the ITAA 1936 to cancel the tax benefit obtained under the scheme.

The relevant scheme is the credit agreement between Company X and Company Y and the use of the money borrowed by Company X under that agreement for its business.

Having regard to the eight factors in paragraph 177D(b) of the ITAA 1936, the Commissioner has concluded that the relevant scheme was not entered into or carried out by a person for the dominant purpose of enabling Company X to obtain a tax benefit in connection with the scheme.

Question 5

An entity must withhold an amount from interest (as that term is defined in Division 11A of Part III of the ITAA 1936) it pays to an overseas entity or entities pursuant to section 12-245 of Schedule 1 to the TAA.

In Division 11A of Part III of the ITAA 1936, 'interest' is defined in subsection 128A(1AB) of the ITAA 1936 and includes an amount:

a) that is in the nature of interest; or

b) to the extent that it could reasonably be regarded as having being converted into a form that is in substitution for interest; or

c) to the extent that it could reasonably be regarded as having being received in exchange for interest in connection with a washing arrangement; or …

In FCT v. Century Yuasa Batteries 98 ATC 4380; (1998) 38 ATR 442 (Century Yuasa Batteries), the Full Federal Court ruled that the amounts paid to a lender by a borrower under an indemnification of tax clause were 'neither interest nor in the nature of interest but were an indemnity against the lender's liability for income tax'.

'Interest', said the Court (at ATC 4383, ATR 444) 'is the return, consideration or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, and that interest must be referable to a principal'.

In holding that the amounts paid by the borrower to the lender under the tax indemnification clause were neither 'interest' or an amount 'in the nature of interest', the Full Federal Court approved the reasoning of the primary judge in the case that such amounts are not referable to the principal sum advanced.

Taxation Ruling TR 2002/4, which provides the Commissioner's view of the taxation implications of the decision in Century Yuasa Batteries, states that payments made under clauses similar to that found in Century Yuasa Batteries are indemnification of tax payments and not interest. The tax indemnification clause in the credit agreement between Company X and Company Y is similar to the indemnification clause in Century Yuasa Batteries.

Thus, the indemnity amounts to be paid by Company X to Company Y under the credit agreement will not constitute 'interest' as defined in subsection 128A(1AB) of the ITAA 1936.

Accordingly, Company X will not be required to withhold interest withholding tax pursuant to section 12-245 of Schedule 1 to the TAA in relation to those amounts.

Question 6

An amount payable by a taxpayer will be deductible under section 8-1 of the ITAA 1997 where either of the positive limbs in subsection 8-1(1) of the ITAA 1997 are first satisfied and the amount does not fall within any of the negative limbs in subsection 8-1(2) of the ITAA 1997.

TR 2002/4 provides the Commissioner's view of the taxation implications of indemnity payments. At paragraph 40 of TR 2002/4, the Commissioner states that in the ordinary case where the underlying borrowed funds are used for business purposes by the Australian borrower, the interest will be deductible under the first or second limb of section 8-1 of the ITAA 1997 and the indemnity amount will likewise be deductible unless it is properly regarded as a payment of capital.

As stated above at Question 3, the interest on the draw downs under the credit agreement will satisfy the positive limbs in subsection 8-1(1) of the ITAA 1997.

Likewise, the indemnity payments by Company X to Company Y under the credit agreement will satisfy both of the positive limbs in subsection 8-1(1) of the ITAA 1997 as these indemnity payments are 'incidental and relevant' to the production of Company X's assessable income and are 'reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of Company X'.

Accordingly, it needs to be considered whether the indemnity payments will be regarded as capital, or capital in nature.

The Commissioner's view of whether amounts paid to a lender by a borrower under a tax indemnification clause of the type the subject of the decision in Century Yuasa Batteries are capital, or of a capital nature, is found in paragraphs 39-47 of TR 2002/4.

In paragraph 41 of TR 2002/4, the Commissioner states, having regard to various authorities including Dixon J's judgment in Sun Newspapers, that it is the character of the advantage sought which provides the best guidance as to the nature of the expenditure because it reveals most about the essential character of the expenditure itself.

In paragraph 42 of TR 2002/4, the Commissioner states that, according the test laid down in Sun Newspapers by Dixon J, the advantage sought by the indemnity payment has no lasting qualities, and the use of the money is secured by a periodical outlay to cover its use and enjoyment for periods commensurate with the payment. The character of the advantage sought is simply the use of the money for the interest period.

Further, at paragraph 44 of TR 2002/4, the Commissioner expresses the view that indemnity payments are similar to interest outgoings by a borrower in that they are periodic payments made by a borrower to secure the use of the borrowed money during the term of the loan. The payment of an indemnification amount is therefore a payment of a revenue nature.

For these reasons, the Commissioner concludes in paragraph 47 of TR 2002/4 that indemnity amounts payable under an indemnity of the type considered in Century Yuasa Batteries are, where one of the positive limbs in section 8-1 of the ITAA 1997 has been satisfied, deductible under that provision. They are not outgoings of capital or of a capital nature.

Accordingly, where Division 230 of the ITAA 1997 does not apply to the draw downs under the credit agreement, the indemnity amounts to be paid by Company X to Company Y under the credit agreement will be deductible to Company X under section 8-1 of the ITAA 1997.

Question 7

As stated at Question 5, an entity must withhold an amount from interest (as that term is defined in Division 11A of Part III of the ITAA 1936) it pays to an overseas entity or entities pursuant to section 12-245 of Schedule 1 to the TAA.

In Division 11A of Part III of the ITAA 1936, 'interest' is defined in subsection 128A(1AB) of the ITAA 1936. Subsection 128A(1AB) relevantly provides that interest includes an amount that is in the nature of interest (paragraph 128A(1AB)(a) of the ITAA 1936), or an amount to the extent that it could reasonably be regarded as having being converted into a form that is in substitution for interest (paragraph 128A(1AB)(b) of the ITAA 1936).

In FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199 (Myer Emporium), the High Court stated (at CLR 218):

…interest is regarded as flowing from the principal sum (Federal Wharf Co.Ltd v. DFCT (1930) 44 CLR 24 at 28) and to be compensation to the lender for being kept out of the use and enjoyment of the principal sum: Riches v. Westminster Bank Limited (1947) AC 390 at 400…

In the context of interest withholding tax, the Full Federal Court in Century Yuasa Batteries referred to Myer Emporium and stated (at ATC 4383, ATR 444) that the ordinary meaning of 'interest':

is the 'return, consideration or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, and that interest must be referable to a principal'.

Further, in the first instance decision in Century Yuasa Batteries Pty Ltd v. Federal Commissioner of Taxation 97 ATC 4299, Cooper J said in relation to the precursor to paragraph 128A(1AB)(a) of the ITAA 1936 (at 4315):

In my view, for a payment to fall within the extended definition under s 128A(1) in the context of the withholding tax provisions of the ITAA it must have the character of a return or profit to the lender for the use of money advanced to the borrower howsoever calculated or ascertained. For example, the difference between the "extended credit price" and the cash price under consideration in Re Rouse; South Australian Gas Co v Official Receiver, in my opinion would fall within the extended definition in s 128A(1) of the ITAA.

The Full Federal Court expressly agreed with this view on appeal.

A common feature of these definitions of the nature of 'interest' provided by the courts is that in order for a payment to be interest, it must be paid in respect of keeping a person out of the use and enjoyment of a principal sum. It must have the character of compensation or consideration payable in respect of an amount of money which the person can require to be repaid either upon demand or at a fixed date.

Although the commitment fee payable by Company X is calculated by reference to a principal sum (namely the undrawn balance of the funds available under the credit agreement), it does not possess one of the essential qualities which gives interest its character. That is, it is not payable as consideration or compensation for (or calculated by reference to) amounts actually advanced and in relation to which a liability to repay exists. Furthermore, the lender (Company Y) is not put out of the use and enjoyment of a sum of money.

Furthermore the payment cannot be reasonably regarded as having being 'converted into a form that is in substitution for interest' for the purposes of paragraph 128A(1AB)(b) of the ITAA 1936. There is no suggestion that the commitment fee is payable in substitution for an amount payable to compensate Company Y for being kept out of the use and enjoyment of money. This is covered by a separate charge in the credit agreement being 'interest'.

The commitment fee will therefore not be 'interest' as defined in subsection 128A(1AB) of the ITAA 1936.

Accordingly, Company X will not be required to withhold interest withholding tax pursuant to section 12-245 of Schedule 1 to the TAA in relation to the commitment fee to be paid by Company X to Company Y under the credit agreement.

Question 9

The definition of 'financial arrangement' determines the unit of taxation in respect of which gains and losses are recognised under Division 230 of the ITAA 1997. In order to determine whether gains and losses arise under a financial arrangement, it is first necessary to establish whether the rights and obligations under the agreement give rise to an 'arrangement' that in turn meets the definition of a financial arrangement.

An 'arrangement' is defined in subsection 995-1(1) of the ITAA 1997 and includes any arrangement, agreement, understanding, promise or undertaking, whether express or implied. Section 230-55 of the ITAA 1997 modifies this broad notion of arrangement and provides guidance in subsection 230-55(4) of the ITAA 1997 as to which specific rights and obligations will make up the arrangement to be tested for the purposes of the Division.

Whether a number of rights and/or obligations are themselves an arrangement or are two or more separate arrangements is a question of fact and degree. A contract will often define the boundaries of a relevant arrangement, especially where the form of the contract is consistent with its substance. Relevantly, paragraph 2.47 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (the EM) states:

…[T]he 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. 

However, section 230-55 of the ITAA 1997 is not limited by the form of a single contract in the identification of an arrangement. Whether a number of rights and/or obligations are themselves an arrangement, or are two or more separate arrangements, is a question of fact and degree that must be determined having regard to each of the factors listed in subsection 230-55(4) of the ITAA 1997. The way various rights and obligations are combined under subsection 230-55(4) is an objective enquiry, the purpose of which is to identify the correct 'unit of taxation' upon which the provisions of Division 230 of the ITAA 1997 apply.

The issue that arises in respect of the credit agreement is how the various rights and obligations are combined under subsection 230-55(4) of the ITAA 1997 to identify an arrangement(s) and whether or not each of the draw downs made under the credit agreement form individual arrangements in their own right or are a part of one arrangement including the credit agreement.

It is considered having regard to subsection 230-55(4) of the ITAA 1997 and the facts provided, that the credit agreement and each draw down under the credit agreement are separate arrangements for the purposes of Division 230 of the ITAA 1997.

Question 10

The arrangements must meet the definition of a 'financial arrangement' before they will be subject to Division 230 of the ITAA 1997. Broadly, an arrangement will be a financial arrangement if it satisfies the 'primary definition' of a financial arrangement under section 230-45 of the ITAA 1997 (cash settlable rights and obligations to financial benefits) or the 'secondary definition' under section 230-50 of the ITAA 1997 (equity interests and rights and obligations to equity interests).

It is noted that the secondary definition of a financial arrangement in subsection 230-50 of the ITAA 1997 does not apply.

It is first necessary to test whether the credit agreement is a financial arrangement as defined in section 230-45 of the ITAA 1997.

The rights and obligations that arise under the credit agreement are in respect of financial benefits (as defined in paragraph 974-160(1)(a) of the ITAA 1997) for the purposes of section 230-45 of the ITAA 1997. Further, the rights and obligations in respect of those financial benefits will be cash settlable within the meaning of paragraph 230-45(2)(a) of the ITAA 1997 as the benefits are monetary amounts.

As the rights and obligations under the credit agreement are cash settlable rights to receive and obligations to provide financial benefits, the exclusions to the definition of a financial arrangement in paragraphs 230-45(1)(d) to (f) of the ITAA 1997 have no application. Likewise, the exclusion rules in sections 230-450 and 230-455 of the ITAA 1997 have no application on the facts presented.

Thus, the credit agreement is an arrangement that constitutes a financial arrangement as defined in section 230-45 of the ITAA 1997.

It is also necessary to test whether each draw down under the credit agreement is a financial arrangement as defined in section 230-45 of the ITAA 1997.

The rights and obligations that arise under each draw down under the credit agreement are rights or obligations to receive or provide financial benefits (as defined in paragraph 974-160(1)(a) of the ITAA 1997) for the purposes of section 230-45 of the ITAA 1997. Further, the rights and obligations will be cash settlable within the meaning of paragraph 230-45(2)(a) of the ITAA 1997 as they are rights and obligations to receive or provide monetary amounts.

As the rights and obligations under each draw down are cash settlable rights to receive and obligations to provide financial benefits, the exclusions to the definition of a financial arrangement in paragraphs 230-45(1)(d) to (f) of the ITAA 1997 have no application. Likewise, the exclusion rules in sections 230-450 and 230-455 of the ITAA 1997 have no application on the facts presented.

Therefore each draw down under the credit agreement will be a financial arrangement for the purposes of section 230-45 of the ITAA 1997.

Question 11

In order for Company X to deduct a loss under subsection 230-15(2) of the ITAA 1997, it must make a loss from a financial arrangement to which Division 230 applies.

As explained at Question 10, each draw down under the credit agreement is a financial arrangement. Thus, each draw down will have its gains and losses worked out under Division 230 of the ITAA 1997.

Division 230 of the ITAA 1997 does not define 'gain' or 'loss'. The EM provides that, as a general rule, the gain or loss from a financial arrangement can be calculated by subtracting the cost of the financial arrangement from the money received from the financial arrangement. Where the result is a positive amount, a gain will arise. Conversely, a loss will arise where the result is a negative amount.

For the purposes of this ruling, it has been assumed that Company X will not make any of the tax timing method elections contained in Subdivisions 230-C to 230-F of the ITAA 1997. Therefore, Subdivision 230-B of the ITAA 1997 will apply for Company X to work out the gains and losses it makes from this arrangement.

If a gain or a loss is allocated to an income year in accordance with the accruals method, Company X is taken to have made that gain or loss in that income year: section 230-170 of the ITAA 1997. Alternatively, if the realisation method applies to take account of the gain or loss, Company X is taken to have made that gain or loss in the income year in which it occurs: subsection 230-180(1) of the ITAA 1997.

Subdivision 230-B of the ITAA 1997 - the accruals and realisation methods

A taxpayer will apply the accruals method where there is:

§ a sufficiently certain overall gain or loss at the time the taxpayer starts to have the arrangement; or

§ a sufficiently certain particular gain or loss.

Therefore, in determining whether or not Company X applies the accruals method to a draw down, it needs to be worked out whether or not, and the extent to which, particular financial benefits that are provided or that are received under the arrangement, or so deemed to be provided or received under the arrangement, cause Company X to make gain(s) or loss(es).

It is considered that the receipt of the first draw down under the credit agreement creates an obligation in Company X to provide certain financial benefits into the future. These are:

§ the obligation to provide interest on the outstanding amount of the draw down to Company Y as specified;

§ the obligation to provide an indemnity payment where Company X is required to make any deduction or withholding for or on account of any tax from the payment of principal, interest or other amounts payable under the draw down; and

§ the obligation to repay the principal amount of each draw down by the Final Maturity Date.

This then raises the question as to whether or not these obligations listed above give rise to losses. It is considered that the obligation to provide interest is a loss equal to the amount of interest provided: subparagraph 230-75(4)(c)(i) of the ITAA 1997.

In addition, the amount of the indemnity payment is also a loss because there are no financial benefits received or to be received that are reasonably attributable to it: subsection 230-75(2) of the ITAA 1997.

Overall gain or loss - first draw down under the credit agreement

Company X will make a sufficiently certain overall gain or loss from each draw down only if it is sufficiently certain at the start of the arrangement that it will make an overall gain or loss of a particular amount or at least a particular amount (subsection 230-105(1) of the ITAA 1997).

In deciding whether an overall gain or loss is sufficiently certain, Company X may only have regard to the financial benefits it is sufficiently certain to receive or provide (subsection 230-115(1) of the ITAA 1997).

Subsection 230-115(2) of the ITAA 1997 provides that a financial benefit to be received or provided will be sufficiently certain only if it is reasonably expected that Company X will receive or provide the financial benefit and at least some of the amount or value of the financial benefit is, at that time, fixed or determinable with reasonable accuracy. In assessing whether this requirement is satisfied, it is assumed that Company X will continue to have the financial arrangement for the remainder of its life.

In determining whether a financial benefit is fixed or determinable with reasonable accuracy, certain variables which may affect the value of the financial benefit are deemed to remain constant over the life of the arrangement: subsection 230-115(4) of the ITAA 1997. A draw down will be subject to a variable interest rate. For the purposes of determining if these financial benefits are fixed and determinable with reasonable accuracy, Company X must assume that the interest rate will continue to have the same value it had at the reference point: see subsection 230-115(4) of the ITAA 1997.

Further, the obligation to make an indemnity payment where an amount is deducted or withheld from the interest payment must also be assessed to determine if it is a financial benefit that it is sufficiently certain to be provided. This financial benefit is also an amount that depends on a variable that is based on an interest rate, as the indemnity payment is based on the rate of interest used to calculate the interest payment: see paragraph 230-115(4)(a) of the ITAA 1997. Again, for the purposes of determining if these financial benefits are fixed and determinable with reasonable accuracy, Company X must assume that the interest rate will continue to have the same value it had at the reference point in order to determine if the indemnity payment is a financial benefit that it is sufficiently certain to provide: see subsection 230-115(4) of the ITAA 1997.

Accordingly the only financial benefits Company X is to have regard to in determining whether it makes a sufficiently certain overall gain or loss from a draw down is the first draw down under the credit agreement, the obligation to repay that draw down, and the interest payment and indemnity amount in respect of that draw down. Those benefits may give rise to a loss as discussed in the paragraphs above having regard to the attribution rules. This is a loss of at least a particular amount for the purposes of subsection 230-105(1) of the ITAA 1997 which on the face of it means there is a sufficiently certain overall loss.

Sufficiently certain particular gain or loss - further draw downs under the credit agreement

Company X will have a sufficiently certain particular gain or loss from a financial arrangement where it is sufficiently certain, at a particular time, that a gain or loss of a particular amount, or at least a particular amount. This is when:

§ the taxpayer receives a particular financial benefit or one of the taxpayer's rights ceases under the arrangement; or

§ the taxpayer provides a particular financial benefit or one of the taxpayer's obligations ceases under the arrangement.

Where a second draw down is made and in the case of each subsequent draw down, further obligations to provide financial benefits under the arrangement constituted by the draw down will become sufficiently certain.

The receipt by Company X of a draw down under the credit agreement subsequent to the first draw down may give rise to a particular loss provided that the amount that is paid (consisting of the repayment of the draw down, interest and indemnity payment(s)) exceeds the receipt(s) in respect of which these payments are made. This is the case in the present circumstances.

The amount of that loss is one that Company X is sufficiently certain to make if the requirements in subsection 230-110(1) of the ITAA 1997 are satisfied in relation to that loss. As discussed above, in respect of the first draw down, and for the same reasons, each of the obligations to provide the financial benefits in respect of a draw down subsequent to the first draw down, being:

§ the obligation to pay interest;

§ the obligation to make an indemnity payment as required; and

§ the obligation to repay the draw down on the Final Maturity Date,

are financial benefits that Company X is sufficiently certain to provide following the receipt of the draw down to which those obligations relate (see paragraph 230-115(1)(b) of the ITAA 1997).

Are the losses described above deductible?

A loss Company X makes from a financial arrangement is deductible under subsection 230-15(2) of the ITAA 1997 if it is:

§ made in gaining or producing assessable income, or

§ necessarily made in carrying on business for the purposes of gaining or producing assessable income.

The Commissioner considers that a loss that Company X makes that arises from a financial benefit it provides in the form of interest on a draw down, or an indemnity payment in relation to the interest on that draw down, is deductible under subsection 230-15(2) of the ITAA 1997.

In addition, any other losses that Company X makes for the purposes of subsection 230-15(2) of the ITAA 1997 that arise under any other circumstances not discussed above will only be deductible if they are losses that are deductible under subsection 230-15(2) of the ITAA 1997.

Assumptions

Company X will not make an election under sub-item 104(2) of Schedule 1 to the TOFA Act within the period allowed by sub-item 104(5) of the same Schedule.

Company X will not make an election under sections 230-210, 230-255, 230-315 or 230-395 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 11A of Part III

Income Tax Assessment Act 1936 Subsection 128(1AB)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177F

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 Section 230-15

Income Tax Assessment Act 1997 Section 230-20

Income Tax Assessment Act 1997 Section 230-40

Income Tax Assessment Act 1997 Section 230-45

Income Tax Assessment Act 1997 Section 230-50

Income Tax Assessment Act 1997 Section 230-55

Income Tax Assessment Act 1997 Section 230-75

Income Tax Assessment Act 1997 Section 230-85

Income Tax Assessment Act 1997 Section 230-100

Income Tax Assessment Act 1997 Section 230-105

Income Tax Assessment Act 1997 Section 230-110

Income Tax Assessment Act 1997 Section 230-115

Income Tax Assessment Act 1997 Section 230-130

Income Tax Assessment Act 1997 Section 230-135

Income Tax Assessment Act 1997 Section 230-170

Income Tax Assessment Act 1997 Section 230-175

Income Tax Assessment Act 1997 Section 230-210

Income Tax Assessment Act 1997 Section 230-255

Income Tax Assessment Act 1997 Section 230-315

Income Tax Assessment Act 1997 Section 230-395

Income Tax Assessment Act 1997 Section 230-445

Income Tax Assessment Act 1997 Section 230-450

Income Tax Assessment Act 1997 Section 230-455

Income Tax Assessment Act 1997 Section 820

Income Tax Assessment Act 1997 Section 974-160

Income Tax Assessment Act 1997 Section 974-15

Income Tax Assessment Act 1997 Section 974-20

Income Tax Assessment Act 1997 Section 974-35

Income Tax Assessment Act 1997 Section 974-55

Income Tax Assessment Act 1997 Section 974-80

Income Tax Assessment Act 1997 Section 974-130

Income Tax Assessment Act 1997 Section 974-135

Income Tax Assessment Act 1997 Section 974-160

Income Tax Assessment Act 1997 Section 995-1

Taxation Administration Act 1953 Section 12-245

Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 sub-item 103(2) of Schedule 1

Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 sub-item 104(2) of Schedule 1

Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 sub-item 104(5) of the same Schedule

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