Edited version of private advice

Authorisation Number: 1012672764839

Ruling

Subject: Capital raising

Question 1

Will the Instrument be treated as an equity interest (as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997) in the Entity by virtue of the operation of Division 974 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

Will the Distributions made by the Entity on the Instrument be frankable non-share dividends within the meaning of sections 202-30 and 202-40 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 3

Will section 204-15 of the Income Tax Assessment Act 1997 apply to the Transaction?

Answer

No

Question 4

Will section 204-30 of the Income Tax Assessment Act 1997 apply to the Transaction?

Answer

No

Question 5

Will section 177EA of the Income Tax Assessment Act 1936 apply to the Transaction?

Answer

No

Question 6

Will the Commissioner make a determination under subsection 45C(3) of the Income Tax Assessment Act 1936 in relation to the Transaction?

Answer

No

Question 7

Is the Instrument subject to the commercial debt forgiveness provisions in Division 245 of the Income Tax Assessment Act 1997?

Answer

No

Question 8

Will an assessable profit or gain arise for the Entity in relation to the issue of the Instrument?

Answer

No

Question 9

Will the Entity be required to recognise gains and losses under Division 230 of the Income Tax Assessment Act 1997 in relation to the Instrument?

Answer

No

Question 10

Will the share capital account of the Entity become tainted, within the meaning of Division 197 of the Income Tax Assessment Act 1997, by an issue of the Instrument?

Answer

No

Relevant facts and circumstances

The Transaction concerns the issuance of an Instrument by an Entity.

Relevant legislative provisions

• Section 45B of the Income Tax Assessment Act 1936 (ITAA 1936)

• Paragraph 45B(2)(a) of the ITAA 1936

• Paragraph 45B(2)(b) of the ITAA 1936

• Paragraph 45B(2)(c) of the ITAA 1936

• Subsection 45B(3) of the ITAA 1936

• Section 45C of the ITAA 1936

• Subsection 45C(3) of the ITAA 1936

• Section 177EA of the ITAA 1936

• Subsection 177EA(5) of the ITAA 1936

• Paragraph 177EA(3)(a) of the ITAA 1936

• Paragraph 177EA(3)(d) of the ITAA 1936

• Paragraph 177EA(3)(e) of the ITAA 1936

• Paragraph 177EA(5)(a) of the ITAA 1936

• Division 197 of the ITAA 1997

• Section 202-30 of the ITAA 1997

• Section 202-40 of the ITAA 1997

• Section 202-45 of the ITAA 1997

• Section 202 -15 of the ITAA 1997

• Section 204-15 of the ITAA 1997

• Subsection 204-15(1) of the ITAA 1997

• Subsection 204-30(1) of the ITAA 1997

• Subsection 204-30(3) of the ITAA 1997

• Subsection 204-30(6) of the ITAA 1997

• Subdivision 204-D of the ITAA 1997

• Section 204-30 of the ITAA 1997

• Subdivision 245-C of the ITAA 1997

• Subdivision 245-G of the ITAA 1997

• Division 245 of the ITAA 1997

• Section 245-10 of the ITAA 1997

• Division 230 of the ITAA 1997

• Section 230-15 of the ITAA 1997

• Subsection 230-50(1) of the ITAA 1997

• Division 974 of the ITAA 1997

• Subsection 974-70(1) of the ITAA 1997

• Subsection 974-75(1) of the ITAA 1997

• Subsection 974-75(2) of the ITAA 1997

• Section 974-20 of the ITAA 1997

• Subsection 974-20(1) of the ITAA 1997

• Paragraph 974-20(1)(b) of the ITAA 1997

• Paragraph 974-20(1)(c) of the ITAA 1997

• Subsection 974-20(2) of the ITAA 1997

• Subsection 974-20(3) of the ITAA 1997

• Section 974-135 of the ITAA 1997

• Subsection 974-135(1) of the ITAA 1997

• Subsection 974-135(2) of the ITAA 1997

• Subsection 974-135(3) of the ITAA 1997

• Subdivision 974-C of the ITAA 1997

• Subsection 995-1(1) of the ITAA 1997

Reasons for decision

Question 1

Will the Instrument be treated as an equity interest (as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997) in the Entity by virtue of the operation of Division 974 of the Income Tax Assessment Act 1997?

Answer

Yes

Detailed reasoning

Subsection 995-1(1) of ITAA 1997 provides, among other things, that:

'equity interest' in a company has the meaning given by Subdivision 974-C of the ITAA 1997;

'non-share equity interest' in a company means an 'equity interest' in the company that is not solely a 'share'; and

'share' in a company means a share in the capital of the company, and includes stock.

Subsection 974-70(1) of the ITAA 1997 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.

The equity test in Subsection 974-75(1) of the ITAA 1997 is as follows:

A *scheme satisfies the equity test in this subsection in relation to a company if it gives rise to an interest set out in the following table:

Equity interests

This subsection has effect subject to subsection (2) (requirement for financing arrangement).

The first requirement in the equity test is that there must be a scheme. 'Scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The issue of the Instrument will constitute a scheme as described.

The next requirement of the equity test is that the scheme must give rise to an interest set out in the above table. The Instrument will satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as an interest covered by items 2 and 4 of the table in that subsection:

item 2: an interest that carries a right to a variable return from the Entity that is in substance or effect contingent on the economic performance of the Entity;

item 4(b): an interest issued by the Entity that is an interest that will or may convert into an equity interest in the Entity, i.e., an Ordinary share, which is an equity interest in the Entity.

Also, the requirement that the Instrument is a financing arrangement under subsection 974-75(2) of the ITAA 1997 is satisfied as the Instrument is entered into or undertaken to raise finance: refer paragraph 974-130(1)(a) of the ITAA 1997).

Accordingly, the Instrument will be characterised as an equity interest in the Entity, unless it is also characterised as a debt interest, in which case it will constitute a debt interest: refer paragraph 974-70(1)(b) of the ITAA 1997.

The Instrument will not be characterised as debt interest in the Entity or a connected entity of the Entity under Subdivision 974-B of the ITAA 1997

Subsection 974-15(1) of the ITAA 1997 provides that:

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.

Subsection 974-20(1) of the ITAA 1997 provides that:

  A *scheme satisfies the debt test in this subsection in relation to an entity if:

(a)  the scheme is a *financing arrangement for the entity; and

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

(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:

(i)  the financial benefit referred to in paragraph (b) is received if there is only one; or

(ii)  the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and

(d)  it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and

(e)  the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil.

For the purposes of paragraph 974-20(1)(b) of the ITAA 1997 and subsections 974-20(2) and (3) of the ITAA 1997, a financial benefit provided or received under the scheme is taken into account only if it is one that the relevant entity has an effectively non-contingent obligation to provide: subsection 974-20(4) of the ITAA 1997.

'Effectively non-contingent obligation' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 974-135 of the ITAA 1997. There is an effectively non-contingent obligation to take an 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: subsection 974-135(1) of the ITAA 1997.

This applies to providing a financial benefit under the scheme, or terminating the scheme: subsection 974-135(2) of the ITAA 1997. An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a connected entity of that entity) other than the ability or willingness of that entity or connected entity to meet the obligation: subsection 974-135(3) of the ITAA 1997.

In terms of the debt test requirements in subsection 974-20(1) of the ITAA 1997:

Paragraph 974-20(1)(a)

As stated above, the financing arrangement requirement is satisfied.

Paragraph 974-20(1)(b)

The Entity will receive a financial benefit equal to the initial principal amount as paragraph 974-160(1)(a) of the ITAA 1997 states that 'financial benefit' means 'anything of economic value'.

Paragraph 974-20(1)(c)

This requires the Entity to have, or the Entity and a connected entity of the Entity each to have an effectively non-contingent obligation under each Instrument to provide a financial benefit or benefits to one or more entities after the issue price of the initial principal amount for each Instrument is received.

The Terms indicate that the requirement of the debt test in paragraph 974-20(1)(c) of the ITAA 1997 is not satisfied and there is no need to further consider the other requirements in section 974-20 of the ITAA 1997.

Consequently, the issue of the Instrument will not give rise to a debt interest in the Entity. Further, the Commissioner will not determine that the issue of the Instrument otherwise gives rise to a debt interest pursuant to section 974-65 of the ITAA 1997. Thus, Each Instrument will constitute an equity interest in the Entity for the purposes of Subdivision 974-C of the ITAA 1997.

Question 2

Will the Distributions made by the Entity on the Instrument be frankable non-share dividends within the meaning of sections 202-30 and 202-40 of the Income Tax Assessment Act 1997?

Answer

Yes

Detailed reasoning

Each Instrument issued by the Entity is an equity interest. Section 202-30 of the ITAA 1997 provides that distributions and non-share dividends are frankable unless it is specified that they are unfrankable. Section 202-40 of the ITAA 1997 provides that distributions and non-share dividends are frankable distributions to the extent that they are not unfrankable under section 202-45 of the ITAA 1997.

Section 202-45 of the ITAA 1997 sets out the circumstances under which an amount or distribution is taken to be unfrankable. Based on the facts and assumptions supplied by the Applicant, it is considered that none of those circumstances will apply to the Distributions made by the Entity on the Instrument.

Accordingly, Distributions made by the Entity on the Instrument will be frankable non-share dividends within the meaning of sections 202-30 and 202-40 of the ITAA 1997.

Question 3

Will section 204-15 of the Income Tax Assessment Act 1997 apply to the Transaction?

Answer

No

Detailed reasoning

Subsection 204-15(1) of the ITAA 1997 provides that:

This section gives rise to a franking debit if:

(a) the exercise of a choice or selection by a member of an entity (the first entity); or

(b) the members' failure to exercise a choice or selection;

has the effect of determining (to any extent) that another entity makes to one of its members a distribution (the linked distribution) that is:

(c) in substitution (wholly or partly) for a distribution by the first entity to that member or any other member of the first entity: and

(d) unfranked, or franked at a franking percentage that differs from the first entity's benchmark franking percentage for the franking period in which the linked distribution is made.

This section would apply to the Transaction if the Holders of the Instrument have a choice or selection that enable them to receive a linked distribution from another entity that is franked to a greater or lesser extent than the distribution made by the Entity.

Based on the information furnished by the Applicant, there is no evidence that the requirements of subsection 204-15(1) will be satisfied in the circumstances of the Transaction.

Accordingly, section 204-15 of the ITAA 1997 will not apply.

Question 4

Will section 204-30 of the Income Tax Assessment Act 1997 apply to the Transaction?

Answer

No

Detailed reasoning

Section 204-30 of the ITAA 1997 is a general anti-streaming measure that applies if an entity streams distributions (or distributions and other benefits) in such a way that:

a) an imputation benefit is, or apart from that section would be, received by a member of the entity as a result of the distribution(s); and

b) the member would derive a greater benefit from franking credits than another member of the entity; and

c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits.

When these conditions are met, subsection 204-30(1) of the ITAA 1997 empowers the Commissioner to make one or more of the determinations listed in subsection 204-30(3) of the ITAA 1997:

a) that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member;

b) that a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member;

c) that no imputation benefit arises in respect of the relevant distribution that is made to a favoured member and specified in the determination.

Imputation benefit is defined to include an entitlement to a tax offset under Division 207 of the ITAA 1997 as a result of the distribution (see subsection 204-30(6) of the ITAA 1997). It is reasonable to expect that the Instrument Holders will receive an imputation benefit because the Distributions payable in respect of the Instrument are frankable distributions, which are expected to be fully franked.

The remaining issue is whether there will be a streaming of distributions in the way described in section 204-30 of the ITAA 1997. The expression 'streams' is not defined in the ITAA 1997, however, the Explanatory Memorandum (EM) to the New Business Tax System (Imputation) Bill 2002 (Cth), which introduced subdivision 204-D of the ITAA 1997 states at paragraphs 3.28 to 3.29 that:

3.28 Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

3.29 The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

Based on the information provided by the Applicant, it is considered that section 204-30 of the ITAA 1997 will have no application to the Transaction.

Question 5

Will section 177EA of the Income Tax Assessment Act 1936 apply to the Transaction?

Answer

No

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies where one of the purposes (other than an incidental purpose) of a scheme is to enable a relevant taxpayer to obtain an imputation benefit. Where this purpose exists, subsection 177EA(5) of the ITAA 1936 empowers the Commissioner to make a determination that either:

a) franking debits or exempting debits will arise in the franking account of a corporate tax entity that is the distributing entity and a party to the scheme; or

b) no imputation benefit is to arise in respect of a distribution, or a specified part of a distribution, that flows directly or indirectly to the relevant taxpayer.

Pursuant to subsection 177EA(3) of the ITAA 1936, the provision applies if the following conditions are satisfied:

a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

d) except for section 177EA of the ITAA 1936, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Based on the information and the qualifications provided by the Applicant, the Commissioner's consideration of all of the relevant circumstances of the scheme would not, on balance, lead to a conclusion that the purpose of enabling Holders to obtain imputation benefits is more than incidental to the Entity's purpose of raising capital.

Accordingly, section 177EA of the ITAA 1936 will not apply to the Transaction.

Question 6

Will the Commissioner make a determination under subsection 45C(3) of the Income Tax Assessment Act 1936 in relation to the Transaction?

Answer

No

Detailed reasoning

Pursuant to subsection 45B(3) of the ITAA 1936, the Commissioner may make a determination that section 45C applies in relation to the whole, or a part, of a capital benefit.

If the Commissioner makes a determination under subsection 45B(3) of the ITAA 1936, the Commissioner may make a further determination under subsection 45C(3) that the capital benefit, or part of the capital benefit, was paid under a scheme for which a non-incidental purpose was to avoid franking debits arising in relation to the distribution. A determination under subsection 45C(3) results in a franking debit arising for the company.

Section 45B of the ITAA 1936 applies where:

a) there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936);

b) under the scheme a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and

c) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).

Based on the information provided by the Applicant, paragraphs 45B(2)(a) and 45B(2)(b) are satisfied.

Paragraph 45B(2)(c) is not satisfied because the required element of purpose is not present. The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 in relation to the Transaction. As the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C will apply, a determination under subsection 45C(3) of the ITAA 1936 cannot be made.

Question 7

Is the Instrument subject to the commercial debt forgiveness provisions in Division 245 of the Income Tax Assessment Act 1997?

Answer

No

Detailed reasoning

Section 245-10 of the ITAA 1997 sets out the debts to which Division 245 applies:

Subdivisions 245-C to 245-G apply to a debt of yours if:

a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

b) interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2)(a), (b) and (c)) that has the effect of preventing a deduction.

Based on the information provided by the Applicant, paragraphs 245-10(a), 245-10(b) and 245-10(c) will not apply to the Instrument. As a result, the Instrument is not a 'commercial debt' under Division 245 of the ITAA 1936.

Question 8

Will an assessable profit or gain arise for the Entity in relation to the issue of the Instrument, and on conversion?

Answer

No

Detailed reasoning

Based on the information provided by the Applicant, no assessable profit or gain will arise for the Entity in relation to the issue of the Instrument, and on conversion to ordinary shares in the Entity.

Question 9

Will the Entity be required to recognise gains and losses under Division 230 of the Income Tax Assessment Act 1997 in relation to the Instrument?

Answer

No

Detailed reasoning

Gains and losses from a financial arrangement are recognised under section 230-15 of the ITAA 1997. Pursuant to subsection 230-50(1) an equity interest constitutes a financial arrangement for the purpose of Division 230. As the Instrument is an equity interest for the purposes of Division 974 of the ITAA 1997, the Instrument will be a financial arrangement for the purpose of Division 230.

Based on the information provided by the Applicant, the Entity will not be required to recognise gains and losses under Division 230 of the ITAA 1997 in relation to the Instrument.

Question 10

Will the share capital account of the Entity become tainted, within the meaning of Division 197 of the Income Tax Assessment Act 1997, by an issue of the Instrument or on conversion?

Answer

No

Detailed reasoning

Based on the information and the accounting journal entries provided by the Applicant, the conversion of the instrument to ordinary shares will not constitute a transfer of an amount to the share capital account for the purposes of section 197-5 of the ITAA 1997 and will not cause the share capital accounts to become tainted for the purposes of Division 197 of the ITAA 1997.

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