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Ruling

Subject: Capital raising

Question 1

Will the securities be classified as equity interests in accordance with Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The securities will be classified as equity interests in accordance with Division 974 of the ITAA 1997.

Question 2

Will the dividends payable on the securities be frankable distributions within the meaning of sections 202-30 and 202-40 of the ITAA 1997?

Answer

Yes. Dividends payable on the securities will be frankable distributions within the meaning of sections 202-30 and 202-40 of the ITAA 1997.

Question 3

Will section 204-15 of the ITAA 1997 have any application to the scheme?

Answer

No. Section 204-15 will not apply in respect of dividends paid on the securities.

Question 4

Will section 204-30 of the ITAA 1997 have any application to the scheme?

Answer

No. Section 204-30 will not apply in respect of dividends paid on the securities.

Question 5

Will section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936) have any application to the scheme?

Answer

No. Section 177EA of the ITAA 1936 will not apply to the scheme.

This ruling applies for the following periods:

The 2012 income year to the 2020 income year

The scheme commenced:

In the 2012 income year

Relevant facts and circumstances

The rulee is proposing to offer securities in order to raise capital.

The rulee has requested that the Commissioner provide the Ruling on the basis of the following matters:

· During the term of the transaction, the rulee will be a resident of Australia under the income tax laws of Australia and of no other jurisdiction.

· No dividends paid in respect of the securities will be sourced, directly or indirectly, from the rulee's share capital account or its non-share capital account.

· The rulee reasonably expects to have sufficient available profits from which to pay dividends on the securities, and have net assets in excess or ordinary share capital, immediately before the payment of any dividends payable on the securities.

· No debit will be made to any of the rulee's reserves in respect of dividends payable on the securities.

Assumptions

The documents provided by rulee in respect of the transaction represent a complete and accurate description of the transaction, are intended by the parties to have their legal effect and will be implemented according to their terms.

All parties to the transaction are dealing with each other on arm's length terms and fair value consideration will be provided by the Holders to acquire the securities;

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 974,

Income Tax Assessment Act 1997 section 202-30,

Income Tax Assessment Act 1997 section 202-40,

Income Tax Assessment Act 1997 section 202-45,

Income Tax Assessment Act 1997 section 204-15,

Income Tax Assessment Act 1997 section 204-30, and

Income Tax Assessment Act 1936 section 177EA.

Reasons for decision

Question 1

Will the securities be classified as equity interests in accordance with Division 974?

Summary

As the rulee does not have an effectively non-contingent obligation to provide a financial benefit under the scheme, the securities fail the debt test in subsection 974-20(1). As the securities are interests in the rulee they satisfy the equity test in subsection 974-75(1) and are therefore equity interests in accordance with Division 974.

Detailed reasoning

Division 974 provides the test for distinguishing between debt interests and equity interests, which focuses on economic substance rather than mere legal form.

Section 974-10 provides that the object of Division 974 is to establish a test for determining, for particular tax purposes, whether a scheme, or the combined operation of a number of schemes, gives rise to a debt interest or an equity interest.

Pursuant to subsection 974-70(1), a scheme gives rise to an equity interest in a company if, when the scheme comes into existence:

(a) the scheme satisfies the equity test in subsection 974-75(1) in relation to the company because of the existence of the interest; and

(b) the interest is not characterised as, and does not form part of a larger interest that is characterised as, a debt interest in the company, or a connected entity of the company, under Subdivision 974-B.

A scheme (defined for the purposes of Division 974 in subsection 974-150(1) and having the meaning given in section 995-1) is any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. A scheme will be a financing arrangement if it is undertaken to raise finance for the company (paragraph 974-130(1)(a)). The securities satisfy both of these requirements.

Item 1 of the table in subsection 974-75(1) provides that an interest in the company as a member of the company satisfies the equity test. Therefore, the securities will be equity interests provided they are not debt interests under Subdivision 974-B.

Pursuant to subsection 974-20(1) a scheme satisfies the debt test in relation to an entity if:

(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, or the entity and a connected entity of the entity each 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:

i. the financial benefit referred to in paragraph (b) is received if there is only one; or

ii. the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and

(d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and

(e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil.

The scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company).

Pursuant to subsection 974-20(1), it is not necessary to determine whether the scheme satisfies paragraph 974-20(1)(a) above.

Further, paragraph 974-20(1)(b) is satisfied as the rulee received a 'financial benefit under the scheme'.

Paragraph 974-20(1)(c) requires that the rulee has an effectively non-contingent obligation under the scheme to provide a financial benefit. An 'effectively non-contingent obligation' is defined in section 974-135 as:

There is an effectively non-contingent obligation to take an action under a *scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation (see subsections (3), (4) and (6)) to take that action.

Without limiting subsection (1), that subsection applies to:

· providing a *financial benefit under the *scheme; or

· terminating the scheme.

An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a *connected entity of that entity), other than the ability or willingness of that entity or connected entity to meet the obligation.

The existence of the right of the holder of an *interest that will or may convert into an *equity interest in a company to convert the interest does not of itself make the issuer's obligation to repay the investment not non-contingent.

An obligation to redeem a preference share is not contingent merely because there is a legislative requirement for the redemption amount to be met out of profits or a fresh issue of *equity interests.

A 'financial benefit' is defined as anything of economic value (subsection 974-160(1)). However, the issue of an equity interest in the issuer is not considered to be the provision of a 'financial benefit' by an entity (subsection 974-30(1)). It is necessary to consider whether the obligation on the rulee to pay the dividends on the securities will be an 'effectively non-contingent obligation' to provide any financial benefits with respect to the securities.

Based on the information provided by the rulee, the rulee does not have an 'effectively non-contingent obligation' to provide any financial benefits with respect to the securities.

Therefore, the securities fail the debt test under subsection 974-15(1) and are therefore equity interests under Division 974.

Question 2

Will dividends paid on the securities be frankable distributions within the meaning of sections 202-30 and 202-40?

Summary

As dividends paid in relation to the securities will not be unfrankable distributions pursuant to section 202-45, they will be frankable distributions pursuant to section 202-40.

Detailed reasoning

In respect of a corporate tax entity that is a company, section 960-120 defines a 'distribution' is as being "a dividend, or something that is taken to be a dividend, under this Act". Therefore any dividends paid on the securities will be distributions.

Subsection 202-40(1) provides that a distribution is a frankable distribution unless it is specified that it is unfrankable under section 202-45.

Section 202-45 sets out what distributions would be unfrankable:

(a) (Repealed by No 101 of 2003)

(b) a distribution to which paragraph 24J(2)(a) of the Income Tax Assessment Act 1936 applies that is taken under section 24J of the Income Tax Assessment Act 1936 to be *derived from sources in a prescribed Territory, as defined in subsection 24B(1) of the Income Tax Assessment Act 1936 (distributions by certain *corporate tax entities from sources in Norfolk Island);

(c) where the purchase price on the buy-back of a *share by a *company from one of its *members is taken to be a dividend under section 159GZZZP of that Act - so much of that purchase price as exceeds what would be the market value (as normally understood) of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place;

(d) a distribution in respect of a *non-equity share;

(e) a distribution that is sourced, directly or indirectly, from a company's *share capital account;

(f) an amount that is taken to be an unfrankable distribution under section 215-10 or 215-15;

(g) an amount that is taken to be a dividend for any purpose under any of the following provisions:

(i) unless subsection 109RB(6) or 109RC(2) applies in relation to the amount - Division 7A of Part III of that Act (distributions to entities connected with a *private company);

(ii) (Repealed by No 79 of 2007)

(iii) section 109 of that Act (excessive payments to shareholders, directors and associates);

(iv) section 47A of that Act (distribution benefits - CFCs);

(h) an amount that is take to be an unfranked dividend for any purpose

(i) under section 45 of that Act (streaming bonus shares and unfranked dividends);

(ii) because of a determination of the Commissioner under section 45C of that Act (streaming dividends and capital benefits);

(i) a *demerger dividend;

(j) a distribution that section 152-125 or 220-105 says is unfrankable.

Paragraphs 202-45(b) to (d), (f) to (g), (i) and (j) do not apply with respect to the payment of the dividends on the securities. The Commissioner has also determined that paragraph (h) will not apply to payments of dividends on the securities. As no dividends paid on the securities will be sourced, directly or indirectly, from the rulee's share capital account, the rulee reasonably expects to have sufficient available profits from which to pay the dividends and no debit will be made to any rulee reserve in respect of securities dividends, paragraph (e) will also not apply.

Accordingly, the dividends paid on the securities will be frankable distributions under section 202-40.

Question 3

Will section 204-15 have any application to the scheme?

Summary

In the absence of the availability of a choice or selection to holders of the securities which would determine whether they receive a distribution from the rulee or another entity in substitution for the distribution they might have otherwise received from the rulee on the securities, section 204-15 will not apply to give rise to a franking debit in respect of the payment of dividends on the securities.

Detailed reasoning

Subsection 204-15(1) gives rise to a franking debit if:

(a) the exercise of a choice or selection by a *member of an entity (the first entity); or

(b) the member's failure to exercise a choice or selection;

has the effect of determining (to any extent) that another entity makes to one of its members a *distribution (the linked distribution) that is:

(c) in substitution (in whole or in part) for a distribution by the first entity to that member or any other member of the first entity; and

(d) unfranked, or *franked at a *franking percentage that differs from the first entity's *benchmark franking percentage for the *franking period in which the linked distribution is made.

With respect to the payment of the dividends on the securities, holders are not provided with a choice or selection which would determine whether they receive a distribution from the rulee or another entity in substitution for the distribution they might have otherwise received from the rulee on the securities.

In the absence of such a choice being available, subsection 204-15(1) will have no application to the payment of dividends on the securities.

Question 4

Will section 204-30 have any application to the scheme?

Summary

Section 204-30 does not apply to the scheme as the rulee does not seek to direct the flow of distributions so as to deliver imputation benefits to members that would derive a greater benefit from franking credits at the expense of other members that receive lesser or no imputation benefits.

Detailed reasoning

Section 204-30 was introduced as a specific anti-avoidance provision to apply where a company streams dividends so as to provide imputation benefits to shareholders who derive a greater benefit from franking credits at the expense of those members that do not.

Subsection 204-30(1) empowers the Commissioner to make determinations if an entity streams one or more distributions (or distributions and other benefits such as the issue of bonus shares, the return of paid-up share capital or forgiving a debt), whether in a single franking period or in a number of franking periods, in the following circumstances:

· an imputation benefit is received by a member of the entity as a result of the distribution; and

· that member would derive a greater benefit from the franking credits than another member; and

· the other member receives lesser or no imputation benefits, whether or not the other member receives other benefits.

Pursuant to paragraph 204-30(3)(c), the Commissioner has the power to determine (in writing) that no imputation benefit is to arise in respect of a distribution that is made to a member of a corporate tax entity under these circumstances.

While 'streaming' is not defined for the purposes of Subdivision 204-D, the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002 states:

3.28 Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

3.29 The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

Based on information provided by the rulee with respect to the transaction, the requisite element of directing the flow of franked distributions to its shareholders based upon their ability to effectively utilise franking credits does not exist with respect to dividends paid on the securities. As such, section 204-30 will not apply to the payment of dividends on the securities.

Question 5

Will section 177EA of the ITAA 1936 have any application to the scheme?

Summary

The Commissioner will not make a determination under section 177EA of the ITAA 1936 to deny any imputation benefits received by security holders in respect of dividends paid on the securities.

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies where one of the purposes (other than an incidental purpose) of the scheme is to obtain an imputation benefit. In these circumstances, subsection 177EA(5) of the ITAA 1936 enables the Commissioner to make a determination with the effect of either:

· imposing a franking debit or an exempting debit on the distributing entity's franking account; or

· denying the imputation benefit on the distribution that flowed directly or indirectly to the relevant taxpayer.

Pursuant to subsection 177EA(3) of the ITAA 1936, the provision applies if the following conditions are satisfied:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

In the present case, the Commissioner considers that the conditions in paragraph 177EA(3)(a) to (d) of the ITAA 1936 are satisfied in respect of the securities.

Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that a person, or one of the persons who entered into or carried out the scheme, did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936.

The relevant circumstances listed encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose. Due to the diverse nature of these circumstances, some may or may not be present at any one time in relation to a particular scheme.

Based on the information provided by the rulee and the qualifications set out in this ruling, the Commissioner's consideration of all of the relevant circumstances of the scheme would not, on balance, lead to a conclusion that the purpose of enabling security holders to obtain imputation benefits is more than incidental to the rulee's purpose of raising capital.

Accordingly, the Commissioner will not make a determination under paragraph 177EA(5)(b) of the ITAA 1936 that would deny the imputation benefits.

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