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Ruling

Subject: Refinancing Arrangement

Question 1

Is the Loan 'debt interests' pursuant to section 974-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does section 974-80 of the ITAA 1997 apply to re-characterise the Loan as equity interests for the purposes of Division 974 of the ITAA 1997?

Answer

No

Question 3

Is the Loan a 'financial arrangement' pursuant to section 230-45 of the ITAA 1997?

Answer

Yes

Question 4

Are the interest payments made by Aus Ltd in respect of the Loan taken into account to calculate the amount of a loss (if any) that is deductible to Aus Ltd under section 230-15 of the ITAA 1997?

Answer

Yes

Question 5

Does the 'accruals method' apply to the Loan pursuant to section 230-100 of the ITAA 1997?

Answer

Yes

Question 6

Are the interest payments made by Aus Ltd to Foreign Ltd in respect of the Loan 'interest' for the purposes of subsection 128A(1AB) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 7

If an amount is required to be withheld under Division 12-F of Schedule 1 to the Tax Administration Act 1953 (TAA 1953) in respect of interest accrued at the end of a tax year, and that amount is withheld and paid to the Commissioner of Taxation, does section 26-25 of the ITAA 1997 apply to deny Aus Ltd deductions under Division 230 of the ITAA 1997 for that tax year in respect of interest accrued on the Loan?

Answer

No

Question 8

Will the Commissioner make a determination under section 177F of the ITAA 1936 in respect of the Loan?

Answer

No

This ruling applies for the following periods:

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Foreign Ltd is a company that is a non resident for Australian tax purposes.

Aus Ltd is company that is an Australian tax resident.

Fin Co is a non-resident for Australian tax purposes.

Foreign Ltd, Aus Ltd and Fin Co are part of the same global group of companies.

Fin Co is the finance company for the global group.

Refinancing Arrangement (the Scheme)

The Scheme concerns the refinancing of AUD X debt owed by Aus Ltd to Fin Co. The AUD X debt originated from a previous loan arrangement between Aus Ltd and Fin Co. Interest on the previous loan arrangement was deductible in Australia.

The Refinancing Arrangement involves a loan of AUD X from Foreign Ltd to Aus Ltd (the Loan).

The term of the Loan is X years and interest is payable with reference to the AUD LIBOR plus a margin.

Relevant legislative provisions

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

Section 177F of the Income Tax Assessment Act 1936

Section 26-25 of the Income Tax Assessment Act 1997

Section 230-15 of the Income Tax Assessment Act 1997

Section 230-45 of the Income Tax Assessment Act 1997

Section 974-15 of the Income Tax Assessment Act 1997

Section 974-80 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Is the Loan 'debt interests' pursuant to section 974-15 of the ITAA 1997?

Answer

Yes

Detail Reasoning

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) in relation to the entity."

Subsection 974-20(1) of the ITAA 1997 provides that a scheme satisfies the debt test in relation to an entity if the following requirements are met:

1. Paragraph 974-20(1)(a) of the ITAA 1997 - The scheme is a financing arrangement for the entity

The term 'scheme' is defined in subsection 995-1(1) of the ITAA 1997 to mean:

'any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.'

The Loan will be a 'scheme' under this definition because it constitutes an arrangement where a loan is provided to Aus Ltd.

Pursuant to paragraph 974-130(1)(a) of the ITAA 1997, a scheme is a 'financing arrangement' for an entity if it is entered into or undertaken to raise finance for the entity (or a connected entity of the entity).

As this scheme was entered into to raise finance for the entity, the scheme would be a financing arrangement.

2. Paragraph 974-20(1)(b) of the ITAA 1997 - The entity (Aus Ltd) or a connected entity receives a financial benefit under the scheme

'Financial benefit' is defined in subsection 974-160(1) of the ITAA 1997 to mean anything of economic value, including property and services.

Aus Ltd receives a financial benefit under the scheme.

3. Paragraph 974-20(1)(c) of the ITAA 1997 - The entity (Aus Ltd) or the entity and a connected entity of the entity each have an effectively non-contingent obligation (ENCO) to provide a financial benefit after the time when the financial benefit referred to in paragraph 974-20(1)(b) of the ITAA 1997 is received

Subsection 974-135(3) of the ITAA 1997 defines an obligation as '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.

Having regard to the terms of the Loan agreement, the obligation to repay the nominal amount of the Loan and the interest is not contingent on any event, condition, or situation, other than the ability or willingness of Aus Ltd to meet that obligation.

4. Paragraphs 974-20(1)(d) and (e) of the ITAA 1997 - The value provided is substantially more likely than not that the value provided will be at least equal to the value received and not both nil

Section 974-35 of the ITAA 1997 provides rules for the valuation of financial benefits. Subparagraph 974-35(1)(a)(i) of the ITAA 1997 provides that the value of a financial benefit to be provided or received under a scheme is to be calculated in 'nominal terms' if the performance period ends no later than ten years after the interest arising from the scheme is issued. The value of financial benefits for the Loan will be calculated in 'nominal terms' because the performance period of the Loan ends no later than 10 years after the Loan is issued.

The value of the financial benefits provided and financial benefits received are both not nil.

The Loan gives rise to a debt interest for the purpose of subsection 974-15(1) of the ITAA 1997 because all the conditions in subsection 974-20(1) of the ITAA 1997 are satisfied.

Question 2

Does section 974-80 of the ITAA 1997 apply to re-characterise the Loan as equity interests for the purposes of Division 974 of the ITAA 1997?

Answer

No

Detailed reasoning

Section 974-80 of the ITAA 1997 can apply in certain circumstances to re-characterise debt interests 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.

Subsection 974-80(1) of the ITAA 1997 applies to the situations in which:

(a) an interest carries a right to a variable or fixed return from a company; and

(b) the interest is held by a *connected entity of the company; and

(c) apart from this section, the interest would not be an *equity interest in the company; and

(ca) the *scheme that gives rise to the interest is a *financing arrangement for the company; and

(d) there is a scheme, or a series of schemes, designed to operate so that the return to the connected entity is to be used to fund (directly or indirectly) a return to another person (the ultimate recipient).

Subsection 974-80(2) of the ITAA 1997 operates to treat the interest as an equity interest in the company if subsection 974-80(1) of the ITAA 1997 applies and certain conditions in subsection 974-80(2) of the ITAA 1997 are satisfied.

Considering the facts of the Scheme and the terms Loan, the Commissioner determines that there is no scheme, or a series of schemes, designed to operate so that the return to the connected entity is to be used to fund (directly or indirectly) a return to another person (the ultimate recipient).

Since paragraph 974-80(1)(d) of the ITAA 1997 is not satisfied, section 974-80 of the ITAA 1997 will not apply to re-characterise Loan.

Question 3

Is the Loan a 'financial arrangement' pursuant to section 230-45 of the ITAA 1997?

Answer

Yes

Detailed reasoning

Financial Arrangement

Subsection 230-45(1) of the ITAA 1997 provides that:

You have a financial arrangement if you have, under an *arrangement:

(a) a *cash settlable legal or equitable right to receive a *financial benefit; or

(b) a cash settlable legal or equitable obligation to provide a financial benefit; or

(c) a combination of one or more such rights and/or one or more such obligations;

unless:

(d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and

(e) for one or more of the rights and/or obligations covered by paragraph (d):

(i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or

(ii) the right or obligation is not cash settlable; and

(f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).

The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.

Arrangement

Subsection 995-1(1) of the ITAA 1997 defines 'Arrangement' as:

Any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

The Loan is an arrangement pursuant to the definition in subsection 995-1(1) of the ITAA 1997 because it is an arrangement where funds are provided from Foreign Ltd to Aus Ltd.

The financial benefits are cash settleable within the definition of paragraph 230-45(2)(a) of the ITAA 1997 because the Loan amounts (the financial benefit for the purposes of Division 230 of the ITAA 1997) comprise of the monetary amounts of AUD X.

Paragraphs 230-45(1)(d) to 230-45(1)(f) of the ITAA 1997 provides for an exclusion to the definition of 'financial benefit'. None of the exclusions to financial benefits contained in paragraphs 230-45(1)(d) to 230-45(1)(f) of the ITAA 1997 apply to exclude the arrangement from being a financial arrangement because paragraph 230-45(1)(e) of the ITAA 1997 is not satisfied as the rights and obligations under the Loan is in respect of financial benefits, and are cash settleable.

The Loan is a financial arrangement as defined in section 230-45 of the ITAA 1997.

Question 4

Are the interest payments made by Aus Ltd in respect of the Loans taken into account to calculate the amount of a loss (if any) that is deductible to Aus Ltd under section 230-15 of the ITAA 1997?

Answer

Yes

Detailed reasoning

Subsection 230-15(2) of the ITAA 1997 states that:

You can deduct a loss you make from a *financial arrangement, but only to the extent that:

(a) you make it in gaining or producing your assessable income; or

(b) you necessarily make it in carrying on a *business for the purpose of gaining or producing your assessable income.

The interest payments made under the Loan will be taken into account to calculate the amount of a loss (if any) that is deductible to Aus Ltd under section 230-15 of the ITAA 1997 because the loan is used in its business to produce assessable income.

Question 5

Does the 'accruals method' apply to the Loan pursuant to section 230-100 of the ITAA 1997?

Answer

Yes

Detailed Reasoning

Division 230 of the ITAA 1997 provides for a number of elective tax-timing methods that can be applied to work out when, for tax purposes, an entity makes a gain or a loss from certain financial arrangements.

Where none of the elective method are chosen, the accruals and realisation methods contained in subdivision 230-B of the ITAA 1997 will apply by default to the financial arrangement. (subsection 230-40(4) of the ITAA 1997)

Aus Ltd has not made any of the tax timing method elections contained in subdivisions 230-C to 230-F of the ITAA 1997. In particular, Aus Ltd has not made an election under sections 230-210, 230-255, 230-315 or 230-395 of the ITAA 1997.

The accruals method applies to a financial arrangement when there is:

· an overall gain or loss from the arrangement that is sufficiently certain at the time when an entity starts to have the arrangement (subsection 230-100(2) of the ITAA 1997) or;

· a particular gain or loss from the arrangement that is sufficiently certain, either at the time when an entity starts to have the arrangement or that becomes sufficiently certain during the life of the arrangement. (subsection 230-100(3) of the ITAA 1997).

An entity will have a sufficiently certain overall gain or loss from a financial arrangement at the time it started to have the arrangement if it is sufficiently certain that it will make a gain or loss of a particular amount or at least a particular amount.(subsection 230-105(1) of the ITAA 1997)

An entity will have a sufficiently certain gain or loss at a particular time if it is sufficiently certain at that time that it will make a gain or loss of an amount of a particular amount or at least a particular amount. (subsection 230-110(1) of the ITAA 1997)

The Loan creates obligations in Aus Ltd to provide certain financial benefits in the future. These financial benefits are:

· the obligation to pay interest to Foreign Ltd respect of the Loan; and

· the obligation to repay the principal amount on maturity.

Sufficiently certain gain or loss

In deciding whether Aus Ltd has a sufficiently certain gain or loss from a financial arrangement, regard can only be had to financial benefits that Aus Ltd is sufficiently certain to receive and provide. (subsection 230-115(1) of the ITAA 1997)

The interest component satisfies subsection 230-115(2) of the ITAA 1997, and is a sufficiently certain financial benefit.

Sufficiently certain overall gain or loss

In determining the overall gain or loss for the purpose of section 230-105 of the ITAA 1997, the included financial benefit for the purposes of calculating the overall gain or loss for the Loan include:

· the receipt of the principal under the Loan;

· the obligation to repay the principal; and

· the interest payments in respect of the principal.

All of the above amounts are sufficiently certain financial benefits Aus Ltd will receive or provide because it is reasonably expected that Aus Ltd will receive or provide those financial benefits, and at least some of the value or value of the benefit is, at that time, fixed or determinable with reasonable accuracy. (subsection 230-115(2) of the ITAA 1997)

Question 6

Are the interest payments made by Aus Ltd to Foreign Ltd in respect of the Loan 'interest' for the purposes of subsection 128A(1AB) of the ITAA 1936?

Answer

Yes

Detailed reasoning

Taxation Ruling 2002/4: Income tax: taxation implications of the Century Yuasa Batteries decision, provides guidance on the interpretation of the term 'interest'.

Paragraph 2 of TR 2002/4:

Interest, said the Full Federal Court in FCT v. Century Yuasa Batteries 98 ATC 4380; (1998) 38 ATR 442 (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'

The payments made by Aus Ltd to Foreign Ltd satisfy the definition of 'interest' for the purposes of subsection 128A(1AB) of ITAA 1936 because they agree with the principles stated paragraph 2 of TR2002/4 as they are a form of return, consideration, or compensation for the use or retention by one person (Aus Ltd) of a sum of money belonging to, or owed to, another, and that interest is referable to a principal amount.

Question 7

If an amount is required to be withheld under Division 12-F of Schedule 1 to the TAA 1953 in respect of interest accrued at the end of a tax year, and that amount is withheld and paid to the Commissioner of Taxation, does section 26-25 of the ITAA 1997 apply to deny Aus Ltd deductions under Division 230 of the ITAA 1997 for that tax year in respect of interest accrued on the Loan?

Answer

No

Detailed reasoning

Section 26-25 of the ITAA 1997 prohibits a taxpayer from deducting a payment of interest or a royalty unless the taxpayer has complied with the requirements of the PAYG withholding system.

Aus Ltd complies with the requirements of the PAYG withholding system. Section 26-25 of the ITAA 1997 does not operate to deny Aus Ltd deductions under Division 230 of the ITAA 1997 for that tax year in respect of interest accrued on the Loan.

Question 8

Will the Commissioner make a determination under section 177F of the ITAA 1936 in respect of the Loan?

Answer

No

Detailed reasoning

The Commissioner can make a determination under section 177F of the ITAA 1936 to cancel the tax benefit if the following prerequisites are satisfied.

1. there is a 'scheme' as defined in section 177A(1) of the ITAA 1936;

2. a taxpayer has obtained a 'tax benefit' in connection with the 'scheme'; and

3. having regard to the eight matters listed in section 177D(b) of the ITAA 1936, it would be concluded that a person who entered into or carried out the scheme did so for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme.

No Australian tax benefit can be identified from the implementation of the Scheme. As a result of the absence of a 'tax benefit' within the meaning of section 177C of the ITAA 1936, the Commissioner will not make a determination under section 177F of the ITAA 1936 in respect of the Loan.

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