Edited version of your private ruling

Authorisation Number: 1012563370401

Ruling

Subject: Division 974 - Related schemes and debt/equity characterisation

Question 1

Will the Ordinary Shares, Redeemable Preference Shares and the Loan together give rise to a related scheme for the purposes of section 974-155 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

If the Ordinary Shares, Redeemable Preference Shares and the Loan together give rise to a related scheme for the purposes of section 974-155 of the Income Tax Assessment Act 1997, will the combination of either the Ordinary Shares and Redeemable Preference Shares, or the Ordinary Shares, Redeemable Preference Shares and the Loan, together give rise to a debt interest in Taxpayer Co pursuant to subsection 974-15(2) of the Income Tax Assessment Act 1997?

Answer

Yes. The combination of the Ordinary Shares, Redeemable Preference Shares and the Loan together give rise to a debt interest pursuant to subsection 974-15(2) of the Income Tax Assessment Act 1997.

Question 3

If either the combination of the Ordinary Shares and Redeemable Preference Shares, or of the Ordinary Shares, Redeemable Preference Shares and the Loan, together give rise to a debt interest in Taxpayer Co, will the Commissioner make a determination under subsection 974-15(4) of the Income Tax Assessment Act 1997 that it would be unreasonable to treat the schemes as a related scheme giving rise to a debt interest under subsection 974-15(2) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 4

If the response to Question 3 is yes, will the Ordinary Shares be a scheme that gives rise to an equity interest in Taxpayer Co for the purposes of paragraph 974-70(1)(a) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 5

If the response to Question 3 is yes, will the Redeemable Preference Shares be a scheme that gives rise to a debt interest in Taxpayer Co pursuant to subsection 974-15(1) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 6

If the response to Question 3 is yes, will the Loan be a scheme that gives rise to a debt interest in Taxpayer Co pursuant to subsection 974-15(1) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 2014

Income year ending 30 June 2015

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018

Income year ending 30 June 2019

Income year ending 30 June 2020

Income year ending 30 June 2021

Income year ending 30 June 2022

Income year ending 30 June 2023

Income year ending 30 June 2024

The scheme commences on:

During the income year ended 30 June 2014.

Relevant facts and circumstances

Taxpayer Co is an Australian resident company.

Funding for Taxpayer comprises of:

· fully paid $X ordinary shares (the OS) issued to Lender Co

· fully paid redeemable preference shares (the RPS) issued to Lender Co

· interest free loan (the Loan) from Lender Co

The ordinary shares, RPS and/or the Loan are not stapled.

Taxpayer Co Ordinary Shares

The terms and conditions of the issue of OS are governed by the Taxpayer Co constitution (the Constitution).

Pursuant to the Constitution, the directors of Taxpayer Co may issue and cancel shares in Taxpayer Co.

Each OS confers the:

· right to receive dividends. Under the Constitution, the directors of Taxpayer Co have an absolute discretion to declare or determine that a dividend is payable, fix the amount and time for payment of the dividend

· right to vote at any meeting of shareholders on the basis of one vote per fully paid OS

· right to share of surplus capital on a winding up

· right to appoint directors of the company.

Taxpayer Co Redeemable Preference Shares

Pursuant to the Constitution, a RPS is a separate class of shares in Taxpayer Co, with a face value equal to the 'Issue Price' and carrying the rights, powers, privileges and obligations referred to in the Constitution.

Each RPS confers the right to a dividend payable in accordance with the Constitution.

The directors of Taxpayer Co may in their absolute discretion determine whether to pay dividends on the RPS for a financial year. If the directors determine that no dividend is payable, a RPS shareholder has no entitlement to receive any dividend in respect of the financial year.

Pursuant to the Constitution, Taxpayer Co must redeem the RPS for the redemption amount on the redemption date. The redemption date is the date that is one business day prior to the 10^th anniversary of the earliest issue date for any RPS issued by Taxpayer Co. The redemption amount is a fixed amount that is higher than the issue price of the RPS.

The RPS rank equally amongst themselves but in priority to OS on a return of capital.

If there is a return of capital on a winding-up of Taxpayer Co, a RPS confers the right to receive the Redemption Amount out of the assets of Taxpayer Co available for distribution before any return of capital is made to OS shareholders or any other class of shares ranking behind RPS.

A RPS does not confer any right to vote at a general meeting of Taxpayer Co, other than for the circumstances specified in the Constitution, which includes reducing Taxpayer Co's preference share capital, approving terms of a buy-back agreement to buy back or cancel RPS, a proposal that affects the terms of the RPS, to wind up the company, and disposal of the company's property, business and undertaking or during winding up of Taxpayer Co.

There are no restrictions on the transfer of a RPS.

The Loan

The term of the Loan is for a period less than 10 years.

Interest is not and will not be payable on the Loan.

Taxpayer Co must repay the principal outstanding on the earlier of demand by Lender Co and the repayment date, unless earlier converted to OS.

No fees or other borrowing costs in relation to the Loan are payable by Taxpayer Co under the Loan Agreement.

Pursuant to the Loan Agreement, the Loan, in full or in part, is convertible into OS solely at the request of the lender. Broadly, conversion is defined as the repayment of the principal outstanding (or part thereof) and the application of the proceeds to subscribe for OS in Taxpayer Co. At any time prior to the repayment date, Lender Co may, give Taxpayer Co a conversion notice stating that the conversion will occur and specifying the amount of Principal Outstanding that will convert to OS and the date on which the conversion will occur.

Lender Co does not anticipate it will assign the Loan to any other party or that the Loan will be replaced with a new loan from another party.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 section 974-5

Income Tax Assessment Act 1997 subsection 974-5(4)

Income Tax Assessment Act 1997 Subdivision 974-B

Income Tax Assessment Act 1997 section 974-10

Income Tax Assessment Act 1997 subsection 974-10(1)

Income Tax Assessment Act 1997 subsection 974-10(2)

Income Tax Assessment Act 1997 subsection 974-10(3)

Income Tax Assessment Act 1997 subsection 974-10(5)

Income Tax Assessment Act 1997 section 974-15

Income Tax Assessment Act 1997 subsection 974-15(1)

Income Tax Assessment Act 1997 subsection 974-15(2)

Income Tax Assessment Act 1997 paragraph 974-15(2)(a)

Income Tax Assessment Act 1997 paragraph 974-15(2)(b)

Income Tax Assessment Act 1997 paragraph 974-15(2)(c)

Income Tax Assessment Act 1997 subsection 974-15(4)

Income Tax Assessment Act 1997 subsection 974-15(5)

Income Tax Assessment Act 1997 section 974-20

Income Tax Assessment Act 1997 subsection 974-20(1)

Income Tax Assessment Act 1997 subsection 974-20(2)

Income Tax Assessment Act 1997 subsection 974-20(3)

Income Tax Assessment Act 1997 subsection 974-20(4)

Income Tax Assessment Act 1997 section 974-30

Income Tax Assessment Act 1997 subsection 974-30(1)

Income Tax Assessment Act 1997 paragraph 974-30(1)(a)

Income Tax Assessment Act 1997 section 974-35

Income Tax Assessment Act 1997 subsection 974-35(1)

Income Tax Assessment Act 1997 paragraph 974-35(1)(a)

Income Tax Assessment Act 1997 subparagraph 974-35(1)(a)(i)

Income Tax Assessment Act 1997 subsection 974-35(3)

Income Tax Assessment Act 1997 section 974-40

Income Tax Assessment Act 1997 Subdivision 974-C

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 subsection 974-70(1)

Income Tax Assessment Act 1997 paragraph 974-70(1)(a)

Income Tax Assessment Act 1997 paragraph 974-70(1)(b)

Income Tax Assessment Act 1997 section 974-75

Income Tax Assessment Act 1997 subsection 974-75(1)

Income Tax Assessment Act 1997 section 974-130

Income Tax Assessment Act 1997 subsection 974-130(1)

Income Tax Assessment Act 1997 paragraph 974-130(1)(a)

Income Tax Assessment Act 1997 section 974-135

Income Tax Assessment Act 1997 subsection 974-135(1)

Income Tax Assessment Act 1997 subsection 974-135(3)

Income Tax Assessment Act 1997 subsection 974-135(4)

Income Tax Assessment Act 1997 section 974-155

Income Tax Assessment Act 1997 subsection 974-155(1)

Income Tax Assessment Act 1997 subsection 974-155(2)

Income Tax Assessment Act 1997 subsection 974-155(3)

Income Tax Assessment Act 1997 section 974-160

Income Tax Assessment Act 1997 paragraph 974-160(1)(a)

Income Tax Assessment Act 1997 section 995-1

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

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997

Question 1

Summary

The OS, RPS and the Loan together give rise to a related scheme for the purposes of section 974-155 because they are schemes that are related to one another in a way contemplated in subsection 974-155(2).

Detailed reasoning

The term "scheme" is broadly defined in subsection 995-1(1) to include any arrangement or any scheme, plan, proposal, action, course of action or course of conduct whether unilateral of otherwise. The OS, RPS and the Loan are each a scheme as defined in subsection 995-1(1) for the purposes of Division 974.

Subsection 995-1(1) provides that "related scheme" has the meaning given by section 974-155, which sets out the circumstances in which 2 or more schemes are related to one another for the purposes of Division 974.

Subsection 974-155(1) provides that subject to subsection 974-155(3), two schemes are related to one another if they are related to one another in any way.

Two schemes are not related to one another merely because one refers to the other or they have a common party (subsection 974-155(3)).

To the extent relevant here, subsection 974-155(2) provides two schemes are related to each other if either one of the schemes would from a commercial point of view, be unlikely to be entered into unless the other scheme was entered into, or one scheme complements or supplements the other.

Having regard to the ordinary meaning of 'complement' and 'supplement', a scheme complements another scheme if it completes or forms a complement to the other scheme. A scheme forms a complement to another scheme if it completes or makes perfect the other scheme. A scheme supplements another scheme if it completes, extends or adds to the other scheme, or forms a supplement or addition to the other scheme. A scheme forms a supplement to another scheme if it is something added to complete the other scheme, or to reinforce or extend the other scheme.

Based on the particular facts of the funding arrangements for Taxpayer Co, from a commercial point of view, it is unlikely the particular amount of OS on issue and the issue of the RPS would be entered into unless Taxpayer Co also entered into the loan agreement with Lender Co. Taxpayer Co only offered the RPS to its sole shareholder, Lender Co. Accordingly, the OS, RPS and the Loan are related schemes pursuant to paragraph 974-155(2)(b). The OS and the RPS provide funding to Taxpayer Co. In terms of the overall funding intended for Taxpayer Co, the Loan scheme complements and supplements the OS and RPS schemes as it provides further funding, to the required total funding quantum, to Taxpayer Co. Accordingly, and notwithstanding that in legal form the OS, RPS and the Loan are complete in themselves, the OS, RPS and the Loan are related schemes pursuant to paragraph 974-155(2)(d). The relation between the schemes goes beyond one referring to another or the existence of a common party.

Question 2

Summary

The OS, RPS and the Loan, being related schemes pursuant to section 974-155, together give rise to a notional scheme that is a debt interest in Taxpayer Co because Taxpayer Co participates in the constituent schemes, the notional scheme would satisfy the condition in paragraph 974-15(2)(b) and it is reasonable to conclude that Taxpayer Co intended the combined economic effects of the OS, RPS and the Loan to be the same as, or similar to, the economic effects of a debt interest.

Detailed reasoning

Pursuant to subsection 974-15(2) two or more related schemes (the constituent schemes) together give rise to a debt interest in an entity if:

(a) the entity enters into, participates in or causes another entity to enter into or participate in the constituent schemes, and

(b) a scheme with the combined effect or operation of the constituent schemes (the notional scheme) would satisfy the debt test in subsection 974-20(1) in relation to the entity if the notional scheme came into existence when the last of the constituent schemes came into existence, and

(c) it is reasonable to conclude that the entity intended, or knew that a party to the scheme or one of the schemes intended, the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of a debt interest.

This is so whether or not the constituent schemes come into existence at the same time and even if none of the constituent schemes would individually give rise to that or any other debt interest.

The requirements of this subsection in relation to Taxpayer Co are considered below.

Paragraph 974-15(2)(a)

The OS, RPS and the Loan are the constituent schemes. Taxpayer Co participates in the OS scheme because it has those shares on issue. Taxpayer Co entered into the RPS scheme by issuing those shares to Lender Co. Taxpayer Co entered into the Loan scheme consequent to the Loan Agreement. Accordingly, the condition in paragraph 974-15(2)(a) is met.

Paragraph 974-15(2)(b)

The scheme to be considered for the purposes of paragraph 974-15(2)(b) (notional scheme) is a scheme with the combined effect or operation of the OS, RPS and the Loan. Paragraph 974-15(2)(b) thus requires a consideration of whether the notional scheme would satisfy the debt test in subsection 974-20(1).

The notional scheme satisfies the debt test in subsection 974-20(1) in relation to Taxpayer Co because:

(a) the notional scheme is a financing arrangement for Taxpayer Co (paragraph 974-20(1)(a)).

Paragraph 974-130(1)(a) provides that a scheme is a financing arrangement for an entity if it is entered into or undertaken to raise finance for the entity. The OS do not have to satisfy the financing arrangement requirement because they are covered by item 1 of the table in subsection 974-75(1). The RPS are issued, and the Loan is entered into, to raise finance for Taxpayer Co.

(b) Taxpayer Co receives, or will receive, a financial benefit, being a financial benefit that is one that another entity has an effectively non-contingent obligation to provide, under the scheme (paragraph 974-20(1)(b)).

A financial benefit includes anything of economic value (subsection 974-160(1)). The financial benefit, or benefits, Taxpayer Co receives, or will receive, under the notional scheme are represented by the funds raised by issue of the OS, RPS and the obtaining of the Loan.

It is only effectively non-contingent obligations to provide and receive financial benefits that are taken into account for valuation purposes (subsection 974-20(4)).

(c) Taxpayer Co has an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to another entity in the future (paragraph 974-20(1)(c)).

An effectively non-contingent obligation is defined in subsection 995-1(1) to have the meaning given by section 974-135. Subsection 974-135(1) states that there is an effectively non-contingent obligation to take 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 to take that action. An obligation is effectively non-contingent if it is not contingent on any event, condition or situation other than the ability or willingness of that entity, or a connected entity, to meet the obligation.

The key terms and conditions of the notional scheme indicate that in substance and effect Taxpayer Co has an effectively non-contingent obligation to provide a financial benefit, or financial benefits, to another entity, under the notional scheme.

Taxpayer Co does not have an effectively non-contingent obligation under to the scheme. An OS shareholder is entitled to a dividend if the Taxpayer Co directors in their absolute discretion declare such a dividend to be payable. Dividends on the OS are contingent on Taxpayer Co having profits and the directors exercising their discretion to pay a dividend. Thus, dividends under the OS scheme are a contingent obligation.

The payment of dividends under the RPS scheme is at the discretion of the directors of Taxpayer Co and contingent on the availability of profits. The RPS are redeemable at the option of Taxpayer Co for the term of the RPS and must be redeemed within 10 years after the earliest issue date of any RPS on issue. At the date of redemption Taxpayer Co must pay RPS holders the subscription amount plus a redemption premium. As this obligation is a requirement under the terms and conditions of the RPS issue, it is an effectively non-contingent obligation.

That Taxpayer Co may not be able to pay monies when required does not prevent there being an effectively non-contingent obligation (subsection 974-135(3)). A redemption of preference shares is not contingent merely because of a legislative requirement for the redemption amount to be met out of profits or a fresh issue of shares (subsection 974-135(5)).

The repayment of the Loan is a requirement of the Loan Agreement and is not contingent on the availability of profits or cash. That Taxpayer Co may not be able to pay monies to Lender Co when required does not prevent there being an effectively non-contingent obligation (subsection 974-135(3)). The Loan is convertible to OS at the option of Lender Co, and must occur on a A$1 for one OS basis. The financial benefit is the face value of the Loan. Taxpayer Co has that effectively non-contingent obligation at that time because, when regard is given to the pricing, terms and conditions of the related schemes, Taxpayer Co has an obligation, in both substance and effect, to repay the Loan Lender Co. The conversion to OS option of Lender Co does not of itself make Taxpayer Co's obligation to repay the Loan contingent (subsection 974-135(4)).

(d) It is substantially more likely than not that the value of the financial benefit provided, or to be provided, by Taxpayer Co, or the sum of all such benefits, under the notional scheme ('value provided'), will be at least equal to the value of the financial benefit received, or to be received, by Taxpayer Co, or the sum of all such benefits ('value received'), under the scheme (paragraph 974-20(1)(d)).

Section 974-35 provides general rules for calculating the value of a financial benefit to be provided or received under a scheme. The value of a financial benefit is calculated in nominal terms if the performance period ends no later than 10 years after the interest arising from the scheme is issued (paragraph 974-35(1)(a)).

Subsection 974-35(3) defines the performance period as:

the period within which, under the terms on which the interest is issued, the effectively non-contingent obligations of the issuer, and any connected entity of the issuer, to provide a financial benefit in relation to the interest have to be met.

Broadly, section 974-40 provides that a right or option of a party to terminate the scheme early is to be disregarded in ascertaining the performance period unless those rights and obligations are themselves an effectively non-contingent obligation.

The effectively non-contingent obligations under the notional scheme are Taxpayer Co's obligations in relation to the RPS and the Loan. The RPS must be redeemed prior to the 10^th anniversary of their issue and the Loan must be repaid within 10 years of being advanced to Taxpayer Co. The performance period from the date of implementation of the funding structure will be no greater than 10 years as that is the period within which the latest effectively non-contingent obligations must be provided by Taxpayer Co. Accordingly the value of the relevant financial benefits used to determine compliance with the debt test in respect of each of the Loan and the RPS is calculated in nominal terms (subparagraph 974-35(1)(a)(i)).

The financial benefits to be received by RPS holders will be at least equal to the paid up amount of the RPS plus the premium. In the case of the Loan the financial benefits to be received will be equal to the principal of the Loan. Accordingly the requirements of paragraph 974-20(1)(d) are satisfied in respect of the RPS and the Loan on a standalone basis.

Calculations provided by Taxpayer Co show that the nominal values of the financial benefits received by Taxpayer Co in relation to the notional scheme are less than the total effectively non-contingent financial benefits to be provided by Taxpayer Co in relation to the notional scheme.

On this basis, it is substantially more likely than not that the value of the effectively non-contingent financial benefits to be provided by Taxpayer Co will at least equal the value of the sum of the financial benefits received under the notional scheme. Accordingly the requirements of paragraph 974-20(1)(d) are satisfied in respect of the notional scheme.

(e) The value provided and the value received are not both nil (paragraph 974-20(1)(e)).

This requirement is satisfied on the basis of the values of the financial benefits given at (d) above.

Conclusion re paragraph 974-15(2)(b)

Paragraph 974-15(2)(b) is satisfied as all the requirements of the debt test are satisfied in relation to the combined effect or operation of the notional scheme.

Paragraph 974-15(2)(c)

Paragraph 974-15(2)(c) requires that:

it is reasonable to conclude that the entity intended, or knew that a party to the scheme or one of the schemes intended, the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of a debt interest.

The Commissioner's interpretation of paragraph 974-15(2)(c) is that the intention of the entity is to be concluded by a reasonable and independent observer based on the facts of the particular scheme. In that regard, consideration must be given to whether, overall, the combined economic effects (not merely the legal effects or rights) of the OS, RPS and the Loan are similar to those of a debt interest.

Particular consideration is given to the relative values of the interests in Taxpayer Co. The economic outlay for the Loan and RPS being, in aggregate, very considerably greater than the OS, it is reasonable to conclude that the notional scheme will have a combined economic effect that is the same as, or similar to a debt interest. The combined effect of the constituent schemes to produce a scheme with a combined economic effect similar to a debt interest was not produced by mere chance. Taxpayer Co's economic objectives and drivers of its aggregate funding structure were such that that structure can reasonably be regarded as having a combined economic effect similar to a debt interest, in particular the reasons for funding in the form of debt rather than through the issue of additional OS. A consideration of the totality of the arrangements including the rationale for structuring Taxpayer Co's funding in the manner undertaken supports that it is reasonable to conclude that the parties to the schemes intended the combined economic effects of the notional scheme to be the same as, or similar to, the economic effects of a debt interest. Accordingly paragraph 974-15(2)(c) is satisfied.

Conclusion re subsection 974-15(2)

As the constituent schemes satisfy paragraphs (a), (b) and (c) of subsection 974-15(2), together they give rise to a debt interest in Taxpayer Co.

Question 3

Summary

The Commissioner has made a determination under subsection 974-15(4) by the issuance of this ruling that it would be unreasonable to treat the schemes as a related scheme giving rise to a debt interest by application of subsection 974-15(2). This is a determination by the Commissioner that is covered by section 974-112.

Detailed reasoning

Two or more related schemes do not together give rise to a debt interest under subsection 974-15(2) if the Commissioner determines that it would be unreasonable to apply that subsection to those schemes (subsection 974-15(4)).

The Commissioner must have regard to the objects stated in subsections 974-10(1)-(3) in exercising the power to make a determination under subsection 974-15(4) (subsection 974-10(5). In particular, the Commissioner must, in exercising the power to make a determination under subsection 974-15(4), have regard to:

(a) the purpose of the schemes (considered both individually and in combination);

(b) the effects of the schemes (considered both individually and in combination);

(c) the rights and obligations of the parties to the schemes (considered both individually and in combination);

(d) whether the schemes (when considered either individually or in combination) provide the basis for, or underpin, an interest issued to investors with the expectation that the interest can be assigned to other investors;

(e) whether the schemes (when considered either individually or in combination) comprise a set of rights and obligations issued to investors with the expectation that it can be assigned to other investors;

(f) any other relevant circumstances.

Considered individually the purpose of the OS is to:

· raise equity finance for Taxpayer Co

· bear all residual risks

· enable the payment of after tax profits as franked dividends

· provide owners with rights to vote, appoint directors and receive dividends.

Considered individually the purpose of the RPS is to provide a commercial debt interest in Taxpayer Co that provides for:

· limited voting rights

· no eligibility to share in any surplus on winding up

· discretionary dividend payments giving Taxpayer Co flexibility to repatriate profits/surplus cash

· return of investment capital upon redemption.

Considered individually the purpose of the Loan is to provide a commercial debt interest in Taxpayer Co.

Having regard to the operation of the schemes in combination, the objectives of the individual schemes are achieved. Commercially, this may not occur if Taxpayer Co were financed solely by debt or by equity. Accordingly, it is reasonable to conclude that the purpose of implementing the schemes in combination was not different to the schemes when considered individually.

The individual effect of the issue of the OS was to create an equity interest in Taxpayer Co. The individual effect of the issue of the RPS was to create a debt interest in Taxpayer Co. The individual effect of the Loan was to create a debt interest in Taxpayer Co. When considered in combination, the economic effect of the notional scheme is to raise finance.

The OS carry rights and obligations normally associated with an OS investment. They provide OS shareholders with the risks and benefits associated with ordinary equity instruments (bearing residual risks of the company, voting rights and dividend entitlements contingent on economic performance and the exercise of the director's discretion).

That the result of treating the schemes as not related is advantageous to Taxpayer Co in the sense of facilitating the key objectives/drivers advised for undertaking the capital structure is neutral because it is no more than the result of debt and equity schemes being treated differently. Relevantly if the notional scheme characterisation was maintained Taxpayer Co would be rendered without any equity for tax purposes. Taxpayer Co has no other OS on issue. Any after tax profits of Taxpayer Co could not be distributed as frankable dividends. This could lead to an unwarranted accumulation of franking credits in the company.

As a matter of commercial reality, the interests are not stapled, can be dealt with separately according to the legal rights and obligations of the schemes and may allow for third parties to invest in Taxpayer Co. On the facts, there is no positive evidence that points to an intention to circumvent the debt and equity tests by entities entering into a number of separate schemes instead of a single scheme. The accounting and commercial reasons advised by Taxpayer Co surrounding the schemes support its stated intention in undertaking the funding structure and support the Commissioner making a determination under subsection 974-15(4).

In view of the totality of the above factors, none of which alone is conclusive, the Commissioner by the issue of this Ruling makes a determination under subsection 974-15(4) that it would be unreasonable to apply subsection 974-15(2) to the related schemes. Accordingly, the Commissioner does not treat the related schemes (the OS, RPS and the Loan) as together giving rise to a notional debt interest in Taxpayer Co pursuant to section 974-15 of the ITAA 1997.

Question 4

Summary

The OS are a scheme that gives rise to an equity interest in Taxpayer Co the purposes of paragraph 974-70(1)(a).

Detailed reasoning

Division 974 establishes a test for determining whether a scheme gives rise to a debt interest or an equity interest in an entity for particular income tax purposes.

Subsection 974-70(1) provides that 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 an 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 satisfies the equity test in relation to a company if it gives rise to one of the interests set out in the table in subsection 974-75(1).

The issue of OS by Taxpayer Co is a scheme as defined in subsection 995-1(1).

An OS in Taxpayer Co is an interest in the company as a member of the company (item 1 of the table in subsection 974-75(1)). Therefore the condition in paragraph 974-75(1)(a) is satisfied.

Subsections 974-75(2) and 974-75(3) do not apply to the OS scheme because the scheme satisfies item 1 of the table in subsection 974-75(1).

Pursuant to paragraph 974-70(1)(b), a scheme does not give rise to an equity interest in a company if the scheme is characterised as a debt interest in the company under Subdivision 974-B.

Subdivision 974-B provides the test for determining when a scheme gives rise to a debt interest in an entity. 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.

The debt test in subsection 974-20(1) is satisfied in relation to an entity if:

(a) the scheme is a financing arrangement for the entity

(b) the entity or a connected entity of the entity receives or will receive a financial benefit or benefits under the scheme

(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 the financial benefit (or first of the financial benefits if more than one) is received

(d) it is substantially more likely than not that the value provided will be at least equal to or exceed the value received, and

(e) the value provided and the value received are not both nil.

As Taxpayer Co is a company and the OS are an interest covered by item 1 of the table in subsection 974-75(1), the scheme does not need satisfy the requirement in paragraph 974-20(1)(a) (subsection 974-20(1)).

Taxpayer Co receives a financial benefit under the scheme, being the subscription money paid for the OS issued.

Taxpayer Co will not have an effectively non contingent obligation under the scheme to provide a financial benefit. The right to receive a dividend in relation to an OS is contingent on the economic performance of Taxpayer Co. Similarly, the right to a distribution of surplus capital on the winding up of Taxpayer Co is contingent on such event happening. As Taxpayer Co does not have an effectively non contingent obligation to provide financial benefits under the OS scheme, the scheme does not satisfy the debt test in subsection 974-20(1) in relation to Taxpayer Co, and the OS issued by Taxpayer Co do not give rise to a debt interest under Subdivision 974-B.

Accordingly, the conditions in subsection 974-70(1) are satisfied and the OS are a scheme that gives rise to an equity interest in Taxpayer Co under section 974-70.

Question 5

Summary

The Redeemable Preference Shares are a scheme that gives rise to a debt interest in Taxpayer Co pursuant to subsection 974-15(1).

Detailed reasoning

Division 974 establishes a test for determining whether a scheme gives rise to a debt interest or an equity interest in an entity for particular income tax purposes.

If an interest could be satisfy both the debt test and the equity test it is treated as a debt interest and not an equity interest (subsection 974-5(4)). Accordingly it is not necessary to apply the equity test if the debt test has been satisfied. That is, the issue of RPS does not give rise to an equity interest if the RPS are characterised as a debt interest in Taxpayer Co under Subdivision 974-B.

The issue of RPS is a scheme as defined in subsection 995-1(1). Subdivision 974-B provides the test for determining when a scheme gives rise to a debt interest in an entity. 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.

The debt test in subsection 974-20(1) is satisfied in relation to an entity if:

· the scheme is a financing arrangement for the entity: paragraph 974-20(1)(a)

· the entity or a connected entity of the entity receives or will receive a financial benefit or benefits under the scheme: paragraph 974-20(1)(b)

· 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 the financial benefit (or first of the financial benefits if more than one) is received: paragraph 974-20(1)(c)

· it is substantially more likely than not that the value of the financial benefits provided will be at least equal to the value of the financial benefits received: paragraph 974-20(1)(d), and

· the value provided and the value received are not both nil: paragraph 974-20(1)(e).

The requirement in paragraph 974-20(1)(a) does not need to be satisfied because Taxpayer Co is a company and the RPS are an interest covered by item 1 of the table in subsection 974-75(1) (subsection 974-20(1)).

Taxpayer Co receives a financial benefit under the scheme, being the amount of the issue price received for each RPS issued.

Taxpayer Co has an effectively non contingent obligation to provide a financial benefit under the scheme because the RPS must be redeemed for the redemption amount on the redemption date.

The RPS must be redeemed at a premium. Accordingly, the value of the financial benefit to be provided by Taxpayer Co will exceed the value of the financial benefit received by Taxpayer Co. Accordingly the requirements in paragraphs 974-20(1)(d) and 974-20(1)(e) are satisfied.

As the requirements of subsection 974-20(1) are met, the RPS satisfy the debt test in subsection 974-20(1) and the issue of RPS is a scheme that gives rise to a debt interest in Taxpayer Co under Subdivision 974-B. Therefore, the RPS are characterised as a debt interest under subsection 974-15(1) and not an equity interest.

Question 6

Summary

The Loan is a scheme that gives rise to a debt interest in Taxpayer Co pursuant to subsection 974-15(1.)

Detailed reasoning

Division 974 establishes a test for determining whether a scheme gives rise to a debt interest or gives rise to an equity interest in an entity for particular income tax purposes.

If an interest could be satisfy both the debt test and the equity test it is treated as a debt interest and not an equity interest (subsection 974-5(4)). Accordingly it is not necessary to apply the equity test if the debt test has been satisfied. That is, the Loan does not give rise to an equity interest in Taxpayer Co if it is characterised as a debt interest in Taxpayer Co under Subdivision 974-B.

The Loan is a scheme as defined in subsection 995-1(1). Subdivision 974-B provides the test for determining when an interest is a debt interest in an entity. 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.

The debt test in subsection 974-20(1) is satisfied in relation to an entity if:

· the scheme is a financing arrangement for the entity: paragraph 974-20(1)(a)

· the entity or a connected entity of the entity receives or will receive a financial benefit or benefits under the scheme: paragraph 974-20(1)(b)

· 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 the financial benefit (or first of the financial benefits if more than one) is received: paragraph 974-20(1)(c)

· it is substantially more likely than not that the value of the financial benefits provided will be at least equal to the value of the financial benefits received: paragraph 974-20(1)(d), and

· the value provided and the value received are not both nil: paragraph 974-20(1)(e).

The Loan is a financing arrangement as defined in section 974-130 because it raises finance for Taxpayer Co.

Taxpayer Co receives a financial benefit under the scheme, being the amount borrowed under the Loan.

The repayment of the loan principal is a requirement of the Loan Agreement and is not contingent on the availability of profits or cash. That Taxpayer Co may not be able to pay monies to the Lender when required does not prevent there being an effectively non-contingent obligation (subsection 974-135(3)). The Loan is convertible to OS at the option of Lender Co, and must occur on a A$X for one OS basis. The financial benefit is the face value of the Loan. Taxpayer Co has the effectively non-contingent obligation to provide that financial benefit because, when regard is given to the pricing, terms and conditions of the Loan, Taxpayer Co has an obligation, in both substance and effect, to repay the Loan. The conversion to OS option of Lender Co does not of itself make Taxpayer Co's obligation to repay the Loan contingent (subsection 974-135(4)).

Taxpayer Co must repay the full amount of the Loan on the repayment date unless repaid earlier or converted into OS at the Lender's election. Accordingly, the value of the financial benefit provided by Taxpayer Co will at least equal the value of the financial benefit received by Taxpayer Co and the value provided and the value received are not both nil.

Accordingly, the Loan satisfies the debt test in subsection 974-20(1) and the Loan gives rise to a debt interest in Taxpayer Co under Subdivision 974-B.

As the Loan satisfies the debt test under Subdivision 974-B, the Loan does not meet the requirement in paragraph 974-70(1)(b) and the scheme does not give rise to an equity interest in Taxpayer Co.

Subsection 974-5(4) provides that if an interest satisfies both the debt test and the equity test, it is treated as a debt interest and not an equity interest (referred to as the 'tie breaker' rule). Therefore, the Loan is characterised as a debt interest under subsection 974-15(1) and not an equity interest.

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