Edited version of your private ruling

Authorisation Number: 1012578249353

Ruling

Subject: Income Tax: Debt/Equity rules: equity interest arising from arrangement funding return through connected entities

Question 1

Will section 974-80 of the Income Tax Assessment Act 1997 apply to classify the interest free loan as an equity interest?

Answer

No

Question 2

Will section 974-80 of the Income Tax Assessment Act 1997 apply to classify the redeemable preference shares as an equity interest?

Answer

No

This ruling applies for the following periods:

1 July 2013 to 30 June 2023

The scheme commences in:

Income year ending 30 June 2014

Relevant facts and circumstances

The Taxpayer is an Australian resident proprietary company and holding company for a number of wholly owned Australian subsidiary companies.

Following a restructure, the Taxpayer's capital comprises of:

· Ordinary Shares issued to the Lender, an Australian resident and connected entity of the Taxpayer.

· Redeemable Preference Shares (RPS) issued to the Lender.

· Interest Free Loan from the Lender (Loan).

The ordinary shares, RPS and Loan are not stapled.

The terms of the RPS are contained in the Taxpayer's Constitution. The main terms include:

· Each RPS is issued for the Issue Price

· Each RPS confers the right to a dividend payable at the discretion of the directors.

· The RPS must be redeemed for the Redemption Amount on the Redemption Date, which is less than 10 years after the earliest issue date for any RPS issued.

· The Redemption Amount exceeds the Issue Price.

· The RPS does not confer any right to vote at a general meeting.

The terms of the Loan are contained in the Interest Free Loan Agreement and include:

· The loan is denominated in Australian dollars.

· The term of the loan is less than 10 years from earlier of the date of the Loan Agreement and the date of the first advance.

· The loan is interest free for the entire loan term.

· The loan is repayable in full at the end of the loan term with earlier repayment possible.

· The loan is convertible into ordinary shares at the election of the Lender.

· The loan is repayable at any time at the election of the Lender.

The Lender obtains an interest bearing loan from a related entity, Entity A, for the sole purpose of acquiring the RPS from the Taxpayer. The main terms of the loan include:

· Interest is payable on the loan.

· The loan must be repaid in full, together with an additional specified amount, on the Repayment Date, which is less than 10 years from the earlier of the date of the agreement and the date of the first advance.

· Any amount Entity A receives from the Taxpayer for the redemption of any RPS must be paid to the Lender.

· Any dividends on the RPS that Entity A receives from the Taxpayer must be paid to the Lender.

The Lender also obtains an interest free loan from Entity A for the sole purpose of on-lending each advance to the Taxpayer. The main terms of the interest free loan include:

· No interest is or will be payable on the loan.

· The loan term is less than 10 years from the earlier of the date of the loan agreement and date of the first advance.

· The loan must be repaid in full at the end of the loan term, unless repaid earlier at the Lender's demand.

· Any amounts Entity A receives from the Taxpayer in repayment of the Loan must be paid to the Lender.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 Subdivision 974-B

Income Tax Assessment Act 1997 section 974-80

Income Tax Assessment Act 1997 subsection 974-80(1)

Income Tax Assessment Act 1997 paragraph 974-80(1)(a)

Income Tax Assessment Act 1997 paragraph 974-80(1)(b)

Income Tax Assessment Act 1997 paragraph 974-80(1)(c)

Income Tax Assessment Act 1997 paragraph 974-80(1)(ca)

Income Tax Assessment Act 1997 paragraph 974-80(1)(d)

Income Tax Assessment Act 1997 subsection 974-80(2)

Income Tax Assessment Act 1997 paragraph 974-80(2)(a)

Income Tax Assessment Act 1997 paragraph 974-80(2)(b)

Income Tax Assessment Act 1997 paragraph 974-80(2)(c)

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 subsection 995-1(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997).

Section 974-80 was introduced to deal with arrangements that granted an investor (the ultimate recipient) an interest which was effectively an equity interest in a company. The provision is intended to apply when the returns that are paid to the ultimate recipient are funded from tax deductible payments made by the company and the connected entities of the company.

Section 974-80 provides:

Equity interest arising from arrangement funding return through connected entities

(1) This section deals with the situation in which:

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

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

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

(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).

(2) the interest is an equity interest in the company if:

(a) the amount of the return to the ultimate recipient is in substance or effect contingent on the economic performance (whether past, current or future) of:

(i) the company,

(ii) a part of the company's activities, or

(iii) a connected entity of the company or a part of the activities of the company; or

(b) either the right itself or the amount of the return to the ultimate recipient is at the discretion of:

(i) the company,

(ii) a part of the company's activities, or

(iii) a connected entity of the company or a part of the activities of the company; or

(c) the interest in respect of which the return to the ultimate recipient is made or another interest that arises from the scheme, or any of the schemes, referred to in paragraph (1)(d):

(i) gives the ultimate recipient (or a connected entity of the ultimate recipient) a right to be issued with an equity interest in the company or a connected entity of the company, or

(ii) is an interest that will, or may, convert into an equity interest in the company or a connected entity of the company;

and if the interest does not form part of a larger interest that is characterised as a debt interest in the entity in which it is held, or a connected entity under Subdivision 974-B of the ITAA 1997. The return may be a return of an amount invested in the interest.

Section 974-80 of the ITAA 1997 cannot apply unless each of the five requirements in subsection 974-80(1) of the ITAA 1997 is satisfied, and it is only when these conditions are present that subsection 974-80(2) of the ITAA 1997 needs to be considered.

Question 1

Subsection 974-80(1) does not apply unless all of the five conditions are present.

Paragraph 974-80(1)(a) requires that an interest carries a right to a variable or fixed return from a company.

Section 995-1 defines various terms, except so far as the contrary intention appears. Defined terms are identified with an asterisk. 'Return' is not identified with an asterisk in section 974-80 of the ITAA 1997. Accordingly, it is a question of interpretation whether the definition in section 995-1 of the ITAA 1997 applies to the term 'return'. There is no contrary intention discernible from the terms, context or policy of section 974-80 that suggests the definition in section 995-1 should not apply, nor is the definition inconsistent with the context and underlying purpose or object of section 974-80.

Subsection 995-1(1) provides that a return on a debt interest or an equity interest does not include a return of an amount invested in the interest.

On the facts, the return on the Loan is the principal amount, which represents a return of the amount invested in the Loan. Accordingly, the condition in paragraph 974-80(1)(a) is not present.

As the first condition in subsection 974-80(1) is not present, it is unnecessary to consider the remaining conditions in subsection 974-80(1).

Therefore, section 974-80 does not apply to classify the Loan as an equity interest.

Question 2

Subsection 974-80(1) does not apply unless all of the five conditions are present.

The relevant interest is the RPS.

On the facts, the RPS carries a variable return (being the redemption amount and dividends) from the Taxpayer and accordingly, the condition in paragraph 974-80(1)(a) is present.

The RPS is held by the Lender, a connected entity of the Taxpayer; therefore the condition in paragraph 974-80(1)(b) is present.

On the facts, the RPS satisfies both the debt test in subsection 974-20(1) and the equity test in subsection 974-75(1). Subsection 974-5(4) provides that where an interest satisfies both the debt test and the equity test, the interest is treated as a debt interest and not an equity interest. Accordingly, the RPS is not an equity interest in the Taxpayer; therefore, the condition in paragraph 974-80(1)(c) is present.

Pursuant to paragraph 974-130(1)(a), a scheme is financing arrangement if it is entered into for the purpose of raising finance. The Taxpayer issued the RPS for the purpose of raising finance; therefore, the condition in paragraph 974-80(1)(ca) is present.

Paragraph 974-80(1)(d) requires that there is a scheme, or 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).

A scheme is defined in subsection 995-1(1) to mean any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The type of arrangement to which section 974-80 applies involves a chain or interests through which the company funds (through at least one connected entity) returns on an interest held by an ultimate recipient. The definition of scheme is very broad. Each step in the arrangement would be a scheme (together comprising a series of schemes) and the whole arrangement would constitute a single scheme.

On the facts, there is a scheme or series of schemes designed to operate so that the return on the RPS to the Lender is to be used to fund a return to Entity A (the ultimate recipient). Accordingly, the condition in paragraph 974-80(1)(d) is present.

Therefore, subsection 974-80(1) applies and it is necessary to consider the requirements in subsection 974-80(2).

The test in subsection 974-80(2) mirrors the basic equity test in section 974-75. Section 974-80 tests whether the interest of the ultimate recipient, from the perspective of the ultimate recipient, has a sufficient equity-like character. If it does, then the interest held by the connected entity is taken to be an equity interest.

Subsection 974-80(2) provides that the interest is an equity interest in the company if:

· the amount of the return to the ultimate recipient is in substance or effect contingent on the economic performance (whether past, current or future) of the company, the company's activities or a connected entity of the company or part of the connected entity's activities: subparagraph 974-80(2)(a)

· either the right itself or the amount of the return to the ultimate recipient is at the discretion of the company or a connected entity of the company: subparagraph 974-80(2)(b), or

· the interest in respect of which the return to the ultimate recipient is made or another interest that arises from the scheme or any of the schemes, referred to in paragraph 974-80(1)(d) gives the ultimate recipient (or a connected entity of the ultimate recipient) a right to be issued with an equity interest in the company or a connected entity of the company, or is an interest that will or may convert into an equity interest in the company or a connected entity of the company: subparagraph 974-80(2)(c).

Subsection 974-80(2) looks at both a return on and of the investment. The subsection also refers specifically to the amount of the return to the ultimate recipient and the effect of any relevant contingency must relate to that return.

On the facts, the return to Entity A (as the ultimate recipient) is the repayment of the interest bearing loan. Repayment of the loan is not contingent on the economic performance of the Taxpayer or a connected entity of the Taxpayer, nor is the amount of the return to Entity A at the discretion of the Taxpayer or a connected entity of the Taxpayer. The RPS does not give Entity A a right to be issued with an equity interest in the Taxpayer or a connected entity of the Taxpayer, nor is the RPS an interest that will or may convert into an equity interest in the Taxpayer or a connected entity of the Taxpayer. Accordingly, subsection 974-80(2) is not satisfied.

Therefore, section 974-80 of the ITAA 1997 does not apply to classify the RPS as an equity interest.

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