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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:
• Some of the CPSs are effectively 'stapled' to the company's ordinary shares (Ordinary Shares) and cannot be transferred without the Ordinary Shares.
• The CPSs entitle the holder to receive any dividends authorised from time to time.
• The CPSs do not confer voting rights at a general meeting of shareholders.
• The CPSs are entitled to share pari passu with Ordinary Shares in the distribution of surplus assets on liquidation of the company.
• The CPSs do not otherwise confer a right to participate in any profits or assets of the company, except as provided under the relevant legislations and the Shareholders Agreement.
• The CPSs can only be converted to Ordinary Shares on the Alteration Date, being the first to occur of the following dates:
(i) the date of commencement of liquidation of the company, the date of the removal of the company from the Register of Companies or of the appointment of a statutory manager,
(ii) the date of completion of a Change Event (being a sale of 100% of the issued share capital of the company, an IPO or a sale of either all of the operating subsidiaries of the company or the whole or a substantial part of the business of the company and its subsidiaries to an arms' length third party),
(iii) the date notified in writing by the company as the Alteration Date, and
(iv) following the notification of a Conversion Date for MCNs - the date notified in writing by any holder of CPSs.
The key terms of the MCNs are as follows:
• The company can elect to pay interest in respect of the MCNs on the day immediately before the anniversary of the issue date of the MCNs. If such an election is not made the company is taken to have elected not to pay the cash interest for that period and no obligation to pay cash interest for that period is taken to have accrued. However, on the Conversion Date the MCNs will be converted into additional ordinary shares.
• No MCN may be repaid, redeemed or repurchased.
• The MCNs can only be converted to Ordinary Shares on the Conversion Date, which is the same as for the CPSs
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:
• remove the non-taxable bonus issue on the CPSs, un-staple the CPSs from the Ordinary Shares (where applicable), and amend the terms of the CPSs so that they do not convert on a one for one basis, but instead each convert into the number of Ordinary Shares the current market value of which is equal to the CPS cancellation amount,
• buy back (on a pro rata basis) and cancel each CPS in consideration for a payment equal to the CPS cancellation,
• remove coupon on the MCNs, un-staple the MCNs from the Ordinary Shares (where applicable), and amend the terms of the MCNs so that they do not convert on a one for one basis, but instead each convert into the number of Ordinary Shares the total market value of which is equal to the number of MCNs multiplied by the CPS cancellation amount, and
• cancel each MCN in consideration for a payment equal to the CPS cancellation amount.
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:
a it is a financing arrangement for the entity, and
b the entity or a connected entity receives or will receive some financial benefit under the scheme, and
c the entity has, or both the entity and a connected entity have, an effectively non-contingent obligation under the scheme to provide financial benefit(s) to one or more entities after the time when the first of the financial benefits in (b) above is received, and
d it is substantially more likely than not that the value provided under (c) above will be at least equal to the value received under (b) above, and
e the value provided and the value received are not both nil.
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:
(a) means anything of economic value; and
(b) includes property and services; and
(c) includes anything that regulations made for the purposes of subsection (3) provide is a financial benefit;'
even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.'
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:
(1) Dividends:
There is no automatic right for convertible preference shares to participate in the profits or assets of the company. The dividends (if any) are payable at the discretion of the directors of the company.
Accordingly, the company will not have an effectively non-contingent obligation to make the dividend payments in respect of each CPS.
(2) Issue price:
The convertible preference shares have no 'maturity' date and there is no obligation on the company to redeem the convertible preference shares for cash.
Therefore, there is no effectively non-contingent obligation to provide a financial benefit to the holder in respect of the issue price of the convertible preference shares.
(3) Conversion:
The conversion of the CPS into Ordinary Shares does not constitute the provision of a financial benefit.
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:
(1) Interest
There is no obligation to make a cash payment for the 'interest' on the mandatory convertible notes.
(2) Issue Price
The MCNs have no maturity date. That is, the MCN is a perpetual note. There is no obligation on the company to redeem the MCNs for cash.
(3) Conversion
The MCNs must mandatorily be converted into ordinary shares.
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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