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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your private ruling

Authorisation Number: 1012604590681

Ruling

Subject: Convertible preference shares and mandatory convertible notes

Question 1

Are the Convertible Preference Shares (CPS) an equity interest under subsection 974-75(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are the Mandatory Convertible Notes (MCN) an equity interest under subsection 974-75(1) of the ITAA 1997?

Answer

Yes

Question 3

Will the provisions of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the actions provided for under the arrangement?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2014

The scheme commences on:

1 July 200X

Relevant facts and circumstances

The taxpayer is a non-resident company ('the company') which has issued Convertible Preference Shares (CPSs) and Mandatory Convertible Notes (MCNs) to investors in Australia and overseas.

The key terms of the CPSs are stated as follows:

The key terms of the MCNs are as follows:

The company has not made any cash payment of interest on the MCNs or payment of dividends on the CPSs.

Under the proposed arrangement the company will take steps to:

The CPS will be cancelled for an amount equal to the average capital contribution per share and accordingly the MCNs will also be cancelled for the same value and on the same basis to maintain shareholder parity (i.e., to ensure there is no economic shift in value between the company's shareholders).

There is no "de facto" controller of the company in terms of subsection 727-355(3) ITAA1997.

Relevant legislative provisions

Section 974-15 Income Tax Assessment Act 1997

Section 974-20 Income Tax Assessment Act 1997

Section 974-50 Income Tax Assessment Act 1997

Section 974-70 Income Tax Assessment Act 1997

Section 974-75 Income Tax Assessment Act 1997

Section 974-145 Income Tax Assessment Act 1997

Reasons for decision

Question 1

Equity test

Section 974-75 of the ITAA 1997 sets out the requirements for a scheme to satisfy the equity test in relation to a company.

The term 'scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The issue of the convertible preference shares (CPSs) would fall within the definition of a scheme.

A scheme gives rise to an equity interest in the company under section 974-70 of the ITAA 1997 if the scheme satisfies the equity test in section 974-75 and the interest is not a debt interest under section 974-20 of the ITAA 1997.

A scheme satisfies the equity test in relation to a company if it gives rise to an interest of the kind listed in subsection 974-75(1) of the ITAA 1997 which are:

1

An interest in the company as a member or stockholder.

2

An interest that carries a right to a variable or fixed return from the company where the right or the amount of the return is in substance or effect contingent on the economic performance (whether past, current or future) of the company or a "connected entity".

3

An interest that carries a right to a variable or fixed return from the company where the right or the amount of the return is at the discretion of the company or a connected entity.

4

An interest issued by the company that:

 

(a)

gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or a connected entity of the company; or

 

(b)

is an interest that will or may convert into an equity interest in the company or a connected entity of the company.

Each CPS will satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as the interest arising from its issue is an interest covered by either or both of items 1 and 4 of the table listed in subsection 974-75(1) of the ITAA 1997.

Therefore, each CPS will be an equity interest unless they are characterised as debt interests under section 974-20 of the ITAA 1997.

Debt test

Subsection 974-20(1) of the ITAA 1997 provides that a scheme satisfies the debt test if:

Scheme is a 'financing arrangement'

The scheme which the company has entered into constitutes a 'financing arrangement' and will therefore satisfy paragraph 974-20(1)(a) of the ITAA 1997.

Issuing entity receives 'financial benefit'

Subsection 974-160(1) of the ITAA 1997 provides that financial benefit:

The company has received the 'issue price' from the issue of each CPS. The total amount received from the shareholders who subscribed for the CPS will, therefore, constitute a 'financial benefit' for the purposes of paragraph 974-20(1)(b) of the ITAA 1997).

Issuing entity has an effectively non-contingent obligation to provide 'financial benefit'

The financial benefits that the company may provide to the holders of the convertible preference shares are as follows:

As the company will not have an effectively non-contingent obligation to provide any financial benefits in respect of the CPSs, the CPSs have failed the debt test as they do not satisfy paragraph 974-20(1)(c) of the ITAA 1997.

Conclusion

The CPSs issued by the company are considered to be equity interests as they satisfy the equity test in subsection 974-75(1) of the ITAA 1997 and are not characterised as, and do not form part of a larger interest that is characterised as, a debt test in subsection 974-20 (1) of the ITAA 1997.

Question 2

Equity test

The issue of the MCNs would fall within the definition of a 'scheme' for the purpose of section 974-75 of the ITAA 1997.

A scheme gives rise to an equity interest under section 974-70 of the ITAA 1997 if the scheme satisfies the equity test in section 974-75 and the interest is not a debt interest under section 974-20 of the ITAA 1997.

A scheme satisfies the equity test in relation to a company if it gives rise to an interest of the kind listed in the table in subsection 974-75(1) of the ITAA 1997 as stated above in Question 1.

Each MCN will satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as the interest arising from its issue is an interest covered by item 4 of the table listed in subsection 974-75(1).

Therefore, each MCN will be an equity interest unless they are characterised as debt interests under section 974-20 of the ITAA 1997.

Debt test

Scheme is a 'financing arrangement'

The scheme which the company has entered into constitutes a 'financing arrangement' and will therefore satisfy paragraph 974-20(1)(a) of the ITAA 1997.

Issuing entity receives 'financial benefit'

The company has received the 'issue price' from the issue of each MCN. The total amount received from the shareholders who subscribed for the MCNs will, therefore, constitute a 'financial benefit' for the purposes of paragraph 974-20(1)(b) of the ITAA 1997).

Issuing entity has an effectively non-contingent obligation to provide 'financial benefit'

The financial benefits that the company may provide to the holders of the MCNs are as follows:

The issue of additional ordinary shares do not constitute the provision of a financial benefit under section 974-30 of the ITAA 1997.

Therefore, there is no effectively non-contingent obligation to provide a financial benefit to the holder of the MCNs in respect of the interest calculation, the face value or the conversion of the mandatory convertible notes.

Accordingly, it will not be possible for each of the MCNs to satisfy paragraph 974-20(1)(c) of the ITAA 1997.

Conclusion

The MCNs are considered to be equity interests as they satisfy the equity test in subsection 974-75(1) of the ITAA 1997and are not characterised as, and do not form part of a larger interest that is characterised as, a debt test in subsection 974-20 (1) of the ITAA 1997.

Question 3

As determined above, both of the CPSs and MCNs are equity interests which would ordinarily convert into a number of ordinary shares. The removal of the right to a larger number of shares is not a tax benefit as defined in subsection 177C(1) of the ITAA 1936. As the actions provided for under the arrangement will not give rise to a tax benefit, Part IVA of the ITAA 1936 will not apply.


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