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Ruling

Subject: Redeemable Preference Shares

Question 1

Are the RPS issued to Foreign Co debt interests of Austco for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will Austco be entitled to a deduction when dividends are paid on the RPS pursuant to section 8-1 of the ITAA 1997 (as modified by section 25-85 of the ITAA 1997)?

Answer

Yes

Question 3

Will the Commissioner make a determination under s177F of the Income Tax Assessment Act 1936 (ITAA 1936) to cancel any tax benefit in relation to dividends paid on the RPS?

Answer

No

This ruling applies for the following periods:

Year ending 31 December 2012

Year ending 31 December 2013

Year ending 31 December 2014

The scheme commences on:

1 July 2003

Relevant facts and circumstances

Austco is the head entity of an Australian MEC group. Austco is wholly owned by an overseas tax resident company, Foreign Co. The overseas ultimate parent company of Austco and Foreign Co acquired a number of new businesses overseas over a number of years, many of which had subsidiary companies operating in Australia.

Austco initially acquired 100% of the shares in company A for the purpose of creating an Australian holding company for one of the ultimate parent company's business activities in Australia.

Later, following the acquisition of further overseas businesses by the ultimate parent company, the Australian subsidiaries of these businesses were transferred into Austco's MEC group.

The acquisition of company A and the other Australian subsidiaries were initially financed through an issue of shares and inter-company loans.

The inter-company loans were interest bearing.

The decision to replace the inter-company loans with RPS was made by the ultimate parent company.

The RPS funding provided additional funds to meet Austco's ongoing business needs and pay income taxes.

Terms of the Redeemable Preference Shares

The terms of RPS are described below.

The key terms of the RPS.

· Issue Price / Subscription Amount

· Each RPS has a face value of A$X (Issue Price).

· Foreign Co subscribed for the RPS at a price equal to the Issue Price (Subscription Amount).

Redemption Date

The RPS have a mandatory redemption date, which requires them to be redeemed no later than one day prior to the tenth anniversary of the Date of Issue.

On the Redemption Date, the taxpayer must redeem all outstanding RPS.

Redemption Amount

The Redemption Amount of each RPS is calculated in accordance with the following formula:

Redemption Amount (A$) = Issue Price of each RPS + any accrued but unpaid dividends in respect of that RPS at the Redemption Date - any amount of capital returned on that RPS prior to the Redemption Date

Priority Repayment of Capital

Repayment of the Issue Price of the RPS is in priority to the repayment of capital on any other class of shares in the taxpayer.

Dividend Entitlement

Subject to the Dividend Conditions, a RPS gives the Holder the right to receive a preferential dividend in each Calculation Period in priority to all other classes of shares in the taxpayer.

Dividends may be paid in each period ending the earlier of 31 December in the relevant calendar year or the date the RPS is redeemed, bought back or cancelled.

The Dividend Entitlement of the RPS is at a fixed rate. If the dividend is not paid it accumulates until paid or the RPS are redeemed. Consequently, the Dividend Entitlement automatically accrues in respect of each Calculation Period where such Dividend Entitlement is not paid to the Holder regardless of the Company having available profits or any determination of the directors of the Company.

The Dividend Conditions ensure that the right of the Holder be paid a dividend is subject to the following:

· the absolute discretion of the directors of the taxpayer, having regard to, amongst other things, their obligation to ensure that payment of the dividend would not adversely affect the solvency of the taxpayer;

· the availability of distributable profits of the taxpayer; and

· the existence of accrued but unpaid dividends will not bear, or entitle the Holder of RPS to receive interest.

Right and Restrictions

Unless waived by the Holder of the RPS, while any payment of dividend entitlements on RPS is outstanding, the directors cannot pay dividends on, cause a capital reduction on, cancel for any consideration or buy back any shares in the capital of the company other than RPS.

Subject to certain restrictions relating to Redemption, there are no restrictions on the right of the Holder to transfer RPS.

Voting

The holders of the RPS are generally not entitled to vote at a general meeting except in the following circumstances:

On a proposal:

· to reduce the share capital of the taxpayer;

· that affects rights attached to a RPS;

· to wind up a company; or

· for the disposal of the whole of the property business and undertaking of the company;

During a period which a Dividend Entitlement or part of a Dividend Entitlement on RPS is in arrears; or

During the winding up of the taxpayer.

Participation in Surplus Assets:

A RPS does not entitle the holder to participate in the surplus assets of Austco in the event of winding up other than the right to payment of the Redemption Amount.

Meetings:

The Holder of a PRS has the same right as the holder of an ordinary share to receive notice of and attend a general meeting and to receive a copy of documents to be laid before that meeting.

Other matters

The application of Division 13 of the ITAA 1936 to the scheme has not been considered.

Assumptions

The face value of the RPS will not exceed Auscto's safe harbour debt amount determined in accordance with section 820-95 of the ITAA 1997.

Austco will deduct and remit interest withholding tax to the ATO on a timely basis such that the limitations in section 26-25 of the ITAA 1997 will not apply.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6,

Income Tax Assessment Act 1936 Subsection 6(1),

Income Tax Assessment Act 1936 Division 13,

Income Tax Assessment Act 1936 Part IVA.

Income Tax Assessment Act 1936 Section 177F,

Income Tax Assessment Act 1936 Subsection 177F(1),

Income Tax Assessment Act 1997 Section 8-1,

Income Tax Assessment Act 1997 Section 25-85,

Income Tax Assessment Act 1997 Subsection 25-85(2),

Income Tax Assessment Act 1997 Subsection 25-85(3),

Income Tax Assessment Act 1997 Paragraph 25-85(3)(a),

Income Tax Assessment Act 1997 Paragraph 25-85(3)(b),

Income Tax Assessment Act 1997 Subsection 25-85(5),

Income Tax Assessment Act 1997 Section 26-25,

Income Tax Assessment Act 1997 Section 820-95,

Income Tax Assessment Act 1997 Division 974,

Income Tax Assessment Act 1997 Section 974-15,

Income Tax Assessment Act 1997 Subsection 974-15(1),

Income Tax Assessment Act 1997 Section 974-20, and

Income Tax Assessment Act 1997 Subsection 974-20(1).

Reasons for decision

Question 1

The debt/equity rules in Division 974 of the ITAA 1997 characterise an interest in a company as equity or debt for the purpose of determining the taxation treatment of the return on the interest. 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.

The issue of the RPS constitutes a scheme for income tax purposes.

Based on the description of the scheme, the RPS satisfies the debt test in subsection 974-20(1) and is a debt interest for the purposes of Division 974.

Question 2

Section 25-85 of the ITAA 1997 deals with certain returns that an entity pays on a debt interest. Subsection 25-85(2) of the ITAA 1997 provides that a deduction will not be prevented from being a general deduction under section 8-1 of the ITAA 1997 merely because the return is contingent on economic performance, or secures a permanent or enduring benefit for the entity or a connected entity.

Where the return on the RPS is a dividend, subsection 25-85(3) of the ITAA 1997 applies so that the return will be deductible to the extent that it would be deductible under section 8-1 of the ITAA 1997 if:

· the payment of the return were the incurring by the entity of a liability to pay the same amount as interest, and

· that interest were incurred in respect of the finance raised by the entity and in respect of which the return was paid or provided; and

· the debt interest retained its character as a debt interest for the purposes of subsection (2).

The term 'dividend' is defined in subsection 6(1) of the ITAA 1936 and includes 'any distribution made by a company to any of its shareholders, whether in money or other property'. In the present case, the return on the RPS will be a dividend as defined.

Generally, in order to deduct an outgoing under section 8-1, it must have been incurred.

Paragraph 25-85(3)(a) of the ITAA 1997 specifically fixes the point in time at which a dividend is incurred for the purposes of section 8-1.

Thus, the 'payment' of the dividend is to be treated as the point in time in which, had the return been interest, the liability would have been incurred by the entity. The linkage of incurring to the actual payment of the return has the result that the liability is not incurred until the dividend on the MRPS is paid.

Paragraph 25-85(3)(b) of the ITAA 1997 then provides for a linkage between the payment of the dividend and the finance raised by the entity from issuing the RPS to enable a determination to be made as to whether the 'interest' satisfies the positive limbs of section 8-1.

In this case the funds raised by issuing the RPS were used to replace existing inter-company loans used to acquire the subsidiaries and to fund ongoing business needs.

An amount of interest incurred on a loan to refinance the intercompany loans would be deductible under the section 8-1 as the funds raised are used to produce assessable income. Hence, the dividend on the RPS would be deductible by virtue of section 8-1 and section 25-85 when it is paid.

Subsection 25-85(5) of the ITAA 1997 limits how much of the dividend paid on the RPS is deductible by effectively capping the deduction to the benchmark rate of return for the RPS (equivalent to a straight debt interest) increased by 150 basis points.

Question 3

Part IVA of the ITAA 1936 contains a number of anti-avoidance provisions. Part IVA gives the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. This discretion is found in subsection 177F(1) of the ITAA 1936.

Based on the description of the scheme Part IVA will not apply to cancel any tax benefit in relation to dividends paid on the RPS.

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