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Ruling

Subject: Assessability of interest received and deductibility of losses on financial arrangements.

Issue 1

Question 1

Will Company A's assessable income include the amounts of interest received by Company A and its current subsidiaries from the Commissioner of Taxation pursuant to the T(IOEP)A under subsection 6-10(1) of the ITAA 1997 and section 15-35 of the ITAA 1997?

Answer

Yes

Issue 2

Question 1

Will Company A be entitled to claim deductions for losses made on the financial arrangements, arising as a result of amounts paid by Company B on behalf of Company A and its current subsidiaries to pay liabilities under assessments issued by the Commissioner, under subsection 230-15(2) of the ITAA 1997?

Answer

No. Company A will not be entitled to claim deductions for losses made on the relevant financial arrangements.

Issue 2

Question 2

Will the amounts of the losses made by Company A on the financial arrangements with Company B for the purpose of subsection 230-15(2) of the ITAA 1997, be determined by taking into account:

· the financial benefits provided by Company A, including the obligations to provide financial benefits, being the amounts referable to the amounts received by Company A and its current subsidiaries from the Commissioner that are payable to Company B pursuant to the Deed

· the financial benefits received by Company A, including the amounts paid by Company B to the Commissioner on behalf of Company A and its current subsidiaries?

Answer

Decline to Rule refer to Issue 2 question 1.

Issue 2

Question 3

Did Company A have a sufficiently certain loss from each of the financial arrangements at a particular time for the purposes of subsection 230-110(1) of ITAA 1997 when Company A received notification of resolution of a tax dispute?

Answer

Decline to Rule refer to Issue 2 question 1.

Issue 2

Question 4

Will Company A be required to apply the accruals method to the loss made under each of the financial arrangements pursuant to subsection 230-100(3) of the ITAA 1997?

Answer

Decline to Rule refer to Issue 2 question 1.

Issue 2

Question 5

Pursuant to sections 230-130 and 230-135 of the ITAA 1997, will Company A be required to spread the loss made under each of the financial arrangements over, and allocate the parts of the loss to one or more intervals within, the period commencing on 1 July 2010 and ending at the time that the payment is made by the relevant company to Company B pursuant to the Deed?

Answer

Decline to Rule refer to Issue 2 question 1.

This ruling applies for the following periods:

The year ended 30 June 2011

The year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Background

Company A

Company A is the head company of a tax consolidated group for the purposes of Part 3-90 of the ITAA 1997. Company A and its current subsidiaries were all wholly owned subsidiaries of Company B. In 2011, Company A and its subsidiaries left Company B's tax consolidated group. Immediately thereafter, Company A formed a tax consolidated group with its current subsidiaries.

Company A as head company of the Company A consolidated group (formed with effect from May 2011), for the purpose of Division 230-455 had an aggregated turnover (as defined in section 328-115 of the ITAA 1997) greater than $100 million for the income year ending 30 June 2011.

Prior to Company B and its subsidiaries leaving Company A's consolidated group, Company A and Company B (amongst others) entered into certain obligations (The Deed).

One of the clauses of the Deed stipulates that if Company A or its current subsidiaries receives any money from the Commissioner in relation to the tax dispute (Refer below) it must be repaid to Company B.

Tax dispute

In 2007, Company B and a number of its subsidiaries and former subsidiaries received assessment notices from the Commissioner. The amounts include the total amounts of primary tax, penalties and interest.

In 2007 Company B made a payment to the Commissioner, on behalf of Company A and its current subsidiaries. The payments were credited to the running balance accounts of each of the relevant companies.

In June 2011, as a result of the resolution of the tax dispute, the Commissioner refunded to Company A and its current subsidiaries amounts that had been paid to the Commissioner by Company B on behalf of Company A and its current subsidiaries. The amounts were repaid to Company B in accordance with the Deed.

The resolution of the tax dispute also resulted in amounts of interest payable by the Commissioner to Company A and its current subsidiaries in respect of the amounts paid by Company B to the Commissioner on their behalf (refer to section 9(1) of the T(IOEP)A). The amounts of interest in relation to the Company A assessments (Company A lnterest Amounts), were paid by the Commissioner by way of cheques made payable to the relevant companies.

Pursuant to the Deed, Company A and its current subsidiaries are required to pay any amount received from the Commissioner in relation to the tax dispute to Company B. The debts owing by Company A and its current subsidiaries as a result of Company B having made the payments in respect of the assessments was repaid to Company B in 2011.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-90

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 6-10(1)

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 15-35

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Subsection 230-15(2)

Income Tax Assessment Act 1997 Section 230-45

Income Tax Assessment Act 1997 Subsection 230-45(1)

Income Tax Assessment Act 1997 Subsection 230-45(2)

Income Tax Assessment Act 1997 Section 230-50

Income Tax Assessment Act 1997 Section 230-55

Income Tax Assessment Act 1997 Subsection 230-100(3)

Income Tax Assessment Act 1997 Subsection 230-110(1)

Income Tax Assessment Act 1997 Section 230-130

Income Tax Assessment Act 1997 Section 230-135

Income Tax Assessment Act 1997 Section 701-1

Income Tax Assessment Act 1997 Section 701-40

Income Tax Assessment Act 1997 Subsection 974-160(1)

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Subsection 995-1(1)

Taxation (Interest on Overpayments and Early Payments) Act 1983 (T(IOEP)A).

Subsection (3)(1)

Taxation (Interest on Overpayments and Early Payments) Act 1983 (T(IOEP)A) Section 9

Taxation (Interest on Overpayments and Early Payments) Act 1983 (T(IOEP)A) Subsection 9(1)

Taxation (Interest on Overpayments and Early Payments) Act 1983 (T(IOEP)A) Subsection 9(4)

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

Reasons for decision

Issue 1 Question 1

Section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides:

(1) Your assessable income also includes some amounts that are not ^*ordinary income.

(2) Amounts that are not ^*ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

Section 10-5 of the ITAA 1997 follows to provide a table of provisions that include assessable income amounts that are not ordinary income. Relevantly, the table includes a reference to section 15-35 of the ITAA 1997 relating to interest on overpaid tax.

Section 15-35 provides:

Your assessable income includes interest payable to you under the Taxation (Interest on Overpayments and Early Payments) Act 1983 (T(IOEP)A). The interest becomes assessable when it is paid to you or applied to discharge a liability you have to the Commonwealth.

Interest on overpayments

An entitlement to interest on certain overpayments of tax debts are provided for under the T(IOEP)A.

Section 9 of the T(IOEP)A provides that where, as a result of a decision to which that Act applies, the whole or part of the amount paid is overpaid by the person and is refunded to the person, interest is payable by the Commissioner to that person in respect of the amount overpaid.

According to subsection (3)(1) of the T(IOEP)A, the definition of a "decision to which this Act applies" includes:

· a decision of a court in relation to an objection, or a decision of a Tribunal in relation to an objection (paragraph (3)(1)(c); and

· a decision of the Commissioner to amend an assessment made in relation to a taxpayer reducing the liability of the taxpayer to tax (paragraph (3)(1)(ca)).

Relevantly, subsection 9(4) of the T(IOEP)A provides that, where the Commissioner applies an amount that has been paid by a person, against the liability of another person to pay an amount of relevant tax, the other person shall, for the purposes of the T(IOEP)A, be deemed to have paid to the Commissioner the amount of relevant tax.

Accordingly, as Company B paid the relevant amounts of the Company A assessments to the Commissioner and the Commissioner applied the Company B payments against the liabilities of Company A and its current subsidiaries under the Company A assessments, Company A and its current subsidiaries are deemed for the purposes of the T(IOEP)A to have paid to the Commissioner the amounts applied. lt follows that the Company A lnterest Amounts were payable by the Commissioner to Company A and its current subsidiaries pursuant to subsection 9(1) of the T(IOEP)A.

Thus, taking the effect of the above provisions together, Company A and its current subsidiaries were entitled to receive interest on the overpayment of tax pursuant to the T(IOEP)A because:

· there is a decision to which the T(IOEP)A applies - being the decision of the Full Federal Court

· the result of the decision was that there was an amount of tax that was overpaid; and

· the entities that are taken to have made the overpayment of tax are Company A and its current subsidiaries.

To be assessable under subsection 6-10(1) of the ITAA 1997, the interest payable under the T(IOEP)A needs to be paid to Company A and its current subsidiaries.

The relevant companies were paid by the Commissioner in 2011.

Single-entity rule

Under section 701-1 of the ITAA 1997, subsidiary members of a consolidated group are taken, for head company and entity core purposes (core purposes), to be part of the head company of the group, rather than separate entities for any period the subsidiaries are members of the group. Core purposes are to work out the amount of the head company and subsidiary member's liability for income tax and the amount of a loss for a relevant period. Section 15-35 of the ITAA 1997 is a provision that is relevant for core purposes.

Accordingly, Company A as Head Company of the tax consolidated group will include the Company A Interest Amounts received by Company A and its current subsidiaries in its assessable income.

Conclusion

The Company A Interest Amounts paid by the Commissioner to Company A and its current subsidiaries, to the extent that it constitutes interest payable under the T(IOEP)A, are considered assessable income for the purposes of subsection 6-10(1) and section 15-35 of the ITAA 1997. Pursuant to the single-entity rule, Company A, as Head Company of the tax consolidated group will include the Company A Interest Amounts received as assessable income.

Issue 2 Question 1

As Company A's aggregated turnover is not less than $100 million for the purposes of subparagraph 230-455(4)(a)(i) of the ITAA 1997, Division 230 applies on a mandatory basis.

As provided for in subsection 230-15(2) of the ITAA 1997, Division 230 only applies to losses made from a financial arrangement.

Therefore, in order to establish whether the amounts referred to in question 2 are deductible pursuant to subsection 230-15(2), it must first be established that the amounts constitute losses that can be said to have been made from a financial arrangement.

Is there a financial arrangement?

'Financial arrangement' is defined in subsection 995-1(1) as having the meaning given by sections 230-45 to 230-55.

In the present circumstances, it is considered that the obligations of Company A in question do not give rise to a financial arrangement under section 230-50.

However, it is considered that, in the present circumstances, the obligations of Company A that are the subject of question 2 are under a financial arrangement as defined in section 230-45 of the ITAA 1997.

Section 230-45

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;

Arrangement is defined very broadly in subsection 995-1(1) of the ITAA 1997. The arrangement between Company A and Company B would fall within that broad definition of an arrangement.

In order for the arrangement to be a financial arrangement, it must give rise to a cash settlable legal or equitable right to receive a financial benefit or a cash settlable legal or equitable obligation to provide a financial benefit under subsection 230-45(2).

In the present circumstances, it is considered that the obligation that Company A and its current subsidiaries have to provide the refund of primary tax, penalties, interest amounts plus GIC (referred in totality as the 'refund amount') under the Deed constitutes a cash-settlable obligation to provide a financial benefit.

As a result, this obligation is one that arises under the financial arrangement, and any loss arising from it would need to be tested for deductibility under subsection 230-15(2).

These financial arrangements are recognised for Division 230 purposes at the time that Company A and its current subsidiaries cease to be subsidiary members of the Company B consolidated group. Note that no financial arrangements between Company A or its current subsidiaries and Company B can be recognised for the purposes of Division 230 prior to the leaving time as a result of the operation of the single entity rule under section 701-1.

The question arises whether any losses resulting from the relevant financial arrangements (whether between Company A and Company B or between the subsidiary members of Company A and Company B) will be deductible.

Subsection 230-15(2) of the ITAA 1997 provides 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.

Paragraph 3.71 of the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 provides:

This rule (that is, subsection 230-15(2)) reflects the current general deduction rule in section 8 1 of the ITAA 1997 with the exception that it generally does not deny deductions for a loss of a capital nature. This is consistent with an object of Division 230, which is to generally ignore distinctions between capital and revenue.

It goes onto say, at paragraph 3.72 of that Explanatory Memorandum:

(Subsection 230-15(2)) reflects the current general deduction rule in section 8 1 of the ITAA 1997 - in particular the 'nexus' aspects of section 8 1. Hence, the case law in respect of the nexus aspects would also apply in determining whether losses made from a financial arrangement will satisfy the test for deductibility in subsection 230 15(2). (emphasis added)

Subsections 230-15(2) and 8-1(1) are identical, except for these two differences:

· subsection 8-1(1) refers to losses or outgoings, whereas subsection 230-15(2) refers to losses only; and

· subsection 230-15(2) requires that the losses be made, whereas subsection 8-1(1) requires that the losses be incurred.

In the context of section 8-1, the case law states that an outgoing must be productive of assessable income or what is expected to produce assessable income (Ronpibon Tin NL v FCT (1949) 78 CLR 47, in relation to the first limb) or reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business (Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276, in relation to the second limb.

In Income Taxation in Australia, LBC, 1985 Professor Ross Parsons stated (at paragraph 6.302):

'A payment to discharge an obligation which arises because of acts done or omitted in the process of deriving income may be sufficiently connected. But a payment to discharge an obligation which arises because a derivation of income has occurred is not sufficiently connected.'

This principle is consistent with the approach adopted by the high Court in cases such as FC of T v The Midland Railway Co of Western Australia Ltd (1952) 9 ATD 372; (1952) 85 CLR 306 and DCT (WA) v. Boulder Perseverance (1937) 58 CLR 223,. In fact those cases demonstrate the importance of the principle.

An application of the principle can also be found in Hill J decision in Macquarie Finance Ltd v Commissioner of Taxation (2004) 210 ALR 508; [2004] FCA 1170; 57 ATR 115; 2004 ATC 4866 at paragraph 55:

'It is accepted without question in the Australian income tax system and indeed in most other systems that a deduction is not available for dividends paid by a taxpayer company on its share capital. It may not be possible to give a clear logical answer as to the reasons (cf Upfold ``When might Dividends be Deductible'' (2001) 30 Australian Tax Review 5). One answer might be that dividends are a distribution or division of profit after that profit has been ascertained, which means that they could not be seen to be part of the cost of earning or deriving that profit….':

Another, and more important, application of the principle is to be found in the reasons for decision of the majority of the House of Lords in Smith's Potato Estates Ltd v. Bolland [1948] AC 508; [1948] 2 All ER 367. That case considered the deductibility in the UK income tax system expenses incurred in preparing the annual accounts. Lord Simonds stated (at page 527):

'The reason is not far to seek. It is that neither the cost of ascertaining taxable profit nor the cost of disputing it with the revenue authorities is money spent to enable the trader to earn profit in his trade. What profit he has earned, he has earned before ever the voice of the tax gatherer is heard. He would have earned no more and no less if there was no such thing as income tax. His profit is no more affected by the eligibility of tax than is a man's temperature altered by the purchase of a thermometer, even though he starts by haggling about the price of it. It is in this sense that the learned Master of the Rolls used a phrase which was challenged by counsel for the appellants. He said in the Rushden Heel case ([1947] 1 All ER 699, 702): "… but his obligation to pay it [the tax] is his obligation as a subject and a taxpayer, and, in ascertaining the amount of his liability, he is putting himself in a position to discharge his duty to the Crown." As a trader it is his job to make profits: as a taxpayer it is his duty, like that of any other subjects, to pay taxes. It is as little a part of his trade to find out how much tax he must pay as it is a part to pay it when he has found out. In this respect he is in the same position as any other taxpayer under any other Case of any other schedule. This aspect of the case may be examined more closely. Let me suppose that a trader, having been assessed to income tax in the sum of £x in a certain year, disputes the assessment, claiming that his taxable profits is not £x but a lesser sum, say £y. Suppose further that he succeeds in his claim. I fail to see how he has by the expenditure that he incurred earned profit in his trade. His taxable profit has been reduced, which was the object of his expenditure. But what has this to do with his trading profit? If his trading profit is to be regarded as the same thing as his taxable profit (which it is not or is not necessarily), then his money has been laid out for the purpose of reducing his trading profit, a purpose difficult to ascribe to a trader and impossible to bring within the scope of the rule. To use an expression of Rowlatt J unless the expenditure is at least intended to "bring grist to the mill" of the trader, it cannot, within the meaning of the rule, be money laid out for the purposes of his trade.'

Lord Porter made a similar point (at page 253):

'Therefore what your Lordships have to determine is whether the expense is incurred in order to earn gain or is the application or distribution of that gain when earned.'

He later added that tax is the sum '… to be paid to the crown out of profits or gains, which have already been earned and computed.'

In his reasons for decision Lord Normand also stated (at page 530):

'There is a more substantial reason, that income tax is an imposed upon profits after they have been earned … a payment out of profits after they have been earned is not within the purpose of the trade carried on by the taxpayer.'

The reasoning in Smith's Potato Estates Ltd v. Bolland [1948] AC 508; [1948] 2 All ER 367 appears to be equally applicable in Australian income tax context. See for example: Cliffs International Inc v. Federal Commissioner of Taxation (1985) 80 FLR 12; (1985) 16 ATR 601; (1985) 85 ATC 4374; Federal Commissioner of Taxation v. Ryder (1989) 20 FCR 568; (1989) 98 ALR 320; (1989) 20 ATR 443; (1989) 89 ATC 4250; United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169; (1997) 37 ATR 1; (1997) 157 ALR 589; (1997) 97 ATC 4796; Bartlett v. Federal Commissioner of Taxation [2003] FCA 1125; (2001) 54 ATR 261; (2003) 2003 ATC 4962.

While the payment by Company A or its current subsidiaries to Company B are clearly not payments of income tax to the Commissioner, the requirement to make such payment arose as a direct result of the disputed tax liabilities of Company A or its current subsidiaries. That much is objectively ascertainable from the Deed. As such, it is considered that any loss that might arise from the payments made by Company A or its current subsidiaries to Company B does not have a sufficient connection with either the:

(a) gaining or producing your assessable income; or

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

Conclusion

On the facts as set out in the ruling request a sufficient connection does not exist between any loss that may arise as result of Company A discharging the relevant obligation to Company B and either Company A's income earning activity; or the business carried on by Company A. In the present circumstances the obligation arose as a direct consequence of Company A satisfying its obligations under the Deed to pay the equivalent of the tax benefit received by Company A and its current subsidiaries. It is not part of the process whereby assessable income is gained or produced; nor is it part of the carrying on of a business to produce such income. Any potential losses would have no nexus with the production of assessable income. Rather, they are associated with purported income tax liabilities which do not arise in the process of income derivation.

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