Edited version of your written advice

Authorisation Number: 1012640149124

Ruling

Subject: Redeemable preference shares

Question 1

Are the redeemable preference shares treated as equity interests under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does payment of a dividend to the holders of the redeemable preference shares constitute dividend streaming under Subdivision 204-D of the ITAA 1997?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences on

1 July 2011

Relevant facts and circumstances

The arrangement that is the subject of the private ruling involves redeemable preference shares (RPSs).

The arrangement is set out in the following documents:

• the application for private ruling

• further documentation, including emails, received in relation to the application; and

• records of conversation with respect to the application.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1936 Section 974-135

Income Tax Assessment Act 1936 Section 725-90

Income Tax Assessment Act 1936 Section 204-30

Reasons for decision

Debt/Equity

Division 974 of the ITAA 1997 contains provisions which determine whether a scheme gives rise to a debt interest or an equity interest for taxation purposes.

A scheme will give rise to an equity interest in a company if the scheme satisfies the equity test in subsection 974-75(1) of the ITAA 1997 and the interest is not characterised as a debt interest.

Equity test

An interest in a company as a member or stockholder meets the equity test (item 1 of the table in subsection 974-75(1) of the ITAA 1997).

The redeemable preference shares issued by the Company are shareholder interests and therefore meet the equity test.

Debt test

A scheme will give rise to a debt interest in an entity if the debt test in subsection 974-20(1) of the ITAA 1997 is satisfied. A scheme satisfies the debt test if all of the following conditions are met:

• the scheme is a financing arrangement for the entity (this condition does not need to be met it the entity is a company and the interest is as a member or stockholder)

• the entity or a connected entity receives or will receive a financial benefit under the scheme

• the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation (ENCO) under the scheme to provide a financial benefit

• it is substantially more likely than not that the value provided will be at least equal to the value received

• the value provided and the value received are not both nil.

Section 974-135 of the ITAA 1997 specifies that there is an ENCO 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 action. The section also states that an obligation is non-contingent if it is non-contingent on any event, condition or situation, other than the ability or willingness of that entity or connected entity to meet the obligation.

It is considered that the RPSs issued by the Company fail the debt test as there is no ENCO to provide a financial benefit as required by section 974-20 of the ITAA 1997. Although it is intended that the Company pay a dividend on the RPSs, there is no obligation for it to do so. The payment of a dividend on the RPSs is still contingent on a decision by the company directors.

Conclusion

The RPSs issued by the Company are equity interests as they are shareholder interests (and therefore meet the equity test) and are not characterised as debt interests.

Dividend streaming

Subdivision 204-D of the ITAA 1997 contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another.

Section 204-30 of the ITAA 1997 applies where an entity streams one or more distributions in such a way that the franking credits attaching to the distribution are received by those members of the entity who derive a greater benefit from them; and other members receive lesser imputation or no imputation benefits.

For this section to apply, members to whom distributions are streamed must be in a position to derive a greater benefit from the franking credits than other members.

Subsection 204-30(8) of the ITAA 1997 details examples of when a member of an entity will be taken to have derived a greater benefit from franking credits than another member. These are where the other member:

(a) is not an Australian resident;

(b) is not entitled to use the tax offset under Division 207;

(c) incurs a tax liability as a result of the distribution that is less than the benefit associated with the tax offset attributable to the distributions;

(d) is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e) is a corporate tax entity at the time the distribution is made, but cannot use the franking credits to frank a distribution to its own members because it is not a franking entity or is unable to make a frankable distribution; and

(f) is an exempting entity.

Streaming is not a defined term but the Explanatory Memorandum, to the New Business Tax (Imputation) 2002 at Chapter 3, Paragraph 28 described streaming as 'selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.'

In this case the 'other members' are the Original Shareholders who are resident individuals. It is not considered that the Original Shareholders would receive less of a benefit from franking credits than the holders of the RPSs.

Therefore, it is not considered that the arrangement in question is dividend streaming to which Division 204-D of the ITAA 1997 applies.

Note:

This decision is limited to the issues for the company with respect to the debt/equity provisions under Division 974 and the dividend streaming provisions under Subdivision 204-D of the ITAA 1997. The application of Part IVA of the Income Tax Assessment Act 1936 to shareholders is not the subject of this private ruling.

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