Edited version of your written advice

Authorisation Number: 1012724801956

Date of advice: 24 November 2014

Ruling

Subject: Capital Raising

Question 1

Will the Instrument be characterised as an ‘non-share equity interest’ for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will distributions payable in respect of the Instrument constitute frankable distributions under section 202-40 of the ITAA 1997?

Answer

Yes

Question 3

Will section 204-30 of the ITAA 1997 apply to the scheme?

Answer

No

Question 4

Will section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme?

Answer

No

Relevant facts and circumstances

The scheme involves the issuance of an Instrument by a Company in order to raise capital and is based on the following matters:

(a) the Instrument is convertible to ordinary shares in the Company and conversion is subject to certain conditions being satisfied;

(b) the Instrument may be redeemed or resold at face value in certain circumstances;

(c) distributions on the Instrument are payable subject to the Company’s discretion and certain conditions being satisfied;

(d) distributions on the Instrument will be franked;

(e) all holders of the Instrument will receive franked distributions irrespective of their tax attributes or their individual tax position;

(f) distributions payable in respect of the Instrument will not be debited to the Company’s share capital account or non-share capital account; and

(g) the Instrument is being issued by the Company to satisfy its financing requirements.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 subsection 177EA(3)

Income Tax Assessment Act 1936 paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 paragraph 177EA(3)(e)

Income Tax Assessment Act 1936 subsection 177EA(5)

Income Tax Assessment Act 1936 paragraph 177EA(14)(a)

Income Tax Assessment Act 1936 subsection 177EA(17)

Income Tax Assessment Act 1997 section 202-40

Income Tax Assessment Act 1997 section 202-45

Income Tax Assessment Act 1997 Subdivision 204-D

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 subsection 204-30(1)

Income Tax Assessment Act 1997 subsection 204-30(3)

Income Tax Assessment Act 1997 subsection 204-30(6)

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 960-120

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 Subdivision 974-B

Income Tax Assessment Act 1997 section 974-15(1)

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

Income Tax Assessment Act 1997 paragraph 974-20(1)(c)

Income Tax Assessment Act 1997 subsection 974-20(4)

Income Tax Assessment Act 1997 subsection 974-70(1)

Income Tax Assessment Act 1997 paragraph 974-70(1)(a)

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

Income Tax Assessment Act 1997 subsection 974-75(2)

Income Tax Assessment Act 1997 paragraph 974-130(1)(a)

Income Tax Assessment Act 1997 section 974-135

Income Tax Assessment Act 1997 subsection 974-135(3)

Income Tax Assessment Act 1997 subsection 974-160(1)(a)

Income Tax Assessment Act 1997 section 974-165

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Summary

1. The Instrument will be characterised as an ‘non-share equity interest’ for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

2. For instruments issued on or after 1 July 2001, Division 974 of the ITAA 1997 provides rules that govern the classification of debt and equity interests for income tax purposes.

3. Subsection 974-70(1) of the ITAA 1997 states that a scheme gives rise to an equity interest in a company if, when it comes into existence, it satisfies the equity test in subsection 974-75(1) of the ITAA 1997 and is not characterised as, and does not form part of a larger interest that is characterised as a debt interest under Subdivision 974-B.

Equity test

4. 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

Item Interest

1 An interest in the company as a member or stockholder of the company.

2 An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is in substance or effect *contingent on the economic performance (whether past, current or future) of:

(a) the company; or

(b) a part of the company’s activities; or

(c) a *connected entity of the company or a part of the activities of a connected entity of the company.

The return may be a return of an amount invested in the interest.

3 An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is at the discretion of:

(a) the company; or

(b) a *connected entity of the company.

The return may be a return of an amount invested in the interest.

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.

5. Furthermore, subsection 974-75(2) of the ITAA 1997 provides:

A *scheme that would otherwise give rise to an *equity interest in a company because of an item in the table in subsection (1) (other than item 1) does not give rise to an equity interest in the company unless the scheme is a *financing arrangement for the company.

Scheme

6. The first requirement in the equity test is that there must be a scheme. A ‘scheme’ is defined in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, or any scheme, plan, proposal, action, course of action or conduct, whether unilateral or otherwise. The issue of the Instrument by the Company constitutes a scheme.

The scheme gives rise to an interest set out in subsection 974-75(1) of the ITAA 1997

7. An equity interest in a company arises if an interest issued by the company will, or may, convert into an equity interest in the company or a connected entity of the company: see item 4(b) of the table in subsection 974-75(1) of the ITAA 1997. The expression ‘interest that will or may convert into another interest’ has the meaning given in section 974-165 of the ITAA 1997:

An interest (the first interest) is an interest that will or may convert into another interest (the second interest) if:

(a) the first interest, or a part of the first interest, must be or may be converted into the second interest; or

(b) the first interest, or a part of the first interest, must be or may be redeemed, repaid or satisfied by:

(i) the issue or transfer of the second interest (whether to the holder of the first interest or to some other person); or

(ii) the acquisition of the second interest (whether by the holder of the first interest or by some other person); or

(iii) the application in or towards paying-up (in whole or in part) the balance unpaid on the second interest (whether the second interest is to be issued to the holder of the first interest or to some other person); or

(c) ….

8. In certain circumstances the Instrument will convert into ordinary shares in the capital of the Company. The conversion is within the meaning of section 974-165 of the ITAA 1997. Furthermore, the Company ordinary shares issued on conversion of the Instrument are equity interests in the Company in accordance with item 1 of the table in subsection 974-75(1) of the ITAA 1997. Accordingly, the Instrument constitute interests that may convert into equity interests in the Company and the scheme gives rise to an interest covered in item 4(b) of the table in subsection 974-75(1) of the ITAA 1997.

The scheme must be a financing arrangement

9. As the Company enters into the scheme to raise finance for itself, the scheme is a financing arrangement within the meaning of paragraph 974-130(1)(a) of the ITAA 1997.

10. As the scheme satisfies paragraph 974-70(1)(a) of the ITAA 1997 it is necessary to consider whether the scheme satisfies the debt test.

Debt test

11. 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.

12. 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.

The scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company).

The scheme is a financing arrangement for the entity

13. As stated above the scheme is a financing arrangement.

The entity, or connected entity of the entity, receives or will receive a financial benefit or benefits under the scheme

14. Paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes ‘anything of economic value’. Subsection 974-20(4) of the ITAA 1997 provides that a financial benefit received under the scheme is taken into account only if it is one that the other entity has an effectively non-contingent obligation to provide.

15. An ‘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. Subsection 974-135(1) of the ITAA 1997 states that there is an effectively non-contingent obligation 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 that action. Subsection 974-135(3) of the ITAA 1997 further provides inter alia that an effectively non-contingent obligation is an obligation that is not contingent on any event, condition or situation other than the ability or willingness of that entity or a connected entity of the entity to meet the obligation.

16. The Company will therefore receive a financial benefit under the scheme, namely the issue price that the holders have an effectively non-contingent obligation to provide. Accordingly, this requirement of the debt test is satisfied.

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.

17. Whilst a financial benefit includes anything of economic value, subsection 974-30(1) of the ITAA 1997 provides that the issue of an equity interest in the entity or a connected entity of the entity or an amount that is to be applied in respect of the issue of an equity interest in the entity or a connected entity of the entity does not constitute the provision of a financial benefit. Thus, the financial benefits to be provided by the Company pursuant to conversion will not constitute the provision of a financial benefit by the Company.

18. Consequently, in deciding whether the Company has an effectively non-contingent obligation under the scheme to provide a financial benefit, the relevant items of economic value (and therefore financial benefits) pursuant to section 974-135 of the ITAA 1997 are the obligations on the Company to pay distributions and return any amount of the face value.

19. The Company does not have an effectively non-contingent obligation to provide a financial benefit under the scheme as the provision of financial benefits (by way of distribution, and on redemption or resale) is contingent on certain conditions being satisfied.

20. As paragraph 974-20(1)(c) of the ITAA 1997 is not satisfied, the issue of the Instrument will not give rise to a debt interest in the Company.

Conclusion

21. As the issue of the Instrument satisfies the equity test in subsection 974-75(1) of the ITAA 1997 and does not meet the requirements to be characterised as a debt interest under Subdivision 974-B, it is treated as an equity interest in the Company under Division 974 of the ITAA 1997.

Question 2

Summary

22. The distributions payable in respect of the Instrument constitute frankable distributions under section 202-40 of the ITAA 1997.

Detailed reasoning

23. Subdivision 202-C of the ITAA 1997 details the circumstances in which a distribution can be franked. Section 202-40 of the ITAA 1997 provides that distributions and non-share dividends are frankable unless it is specified that they are unfrankable under section 202-45 of the ITAA 1997.

24. As stated above, each Instrument issued by the Company is an equity interest.

25. Section 202-45 of the ITAA 1997 sets out the circumstances under which an amount or distribution is taken to be unfrankable. In the present case, it is considered that none of those circumstances will apply to the distributions made by the Company on the Instrument.

Conclusion

26. Accordingly, distributions payable in respect of the Instrument constitute frankable distributions under section 202-40 of the ITAA 1997.

Question 3

Summary

27. Section 204-30 of the ITAA 1997 will not apply to the scheme.

Detailed reasoning

28. 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 section 204-30 of the ITAA 1997 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.

29. Where these conditions are met, subsection 204-30(1) of the ITAA 1997 empowers the Commissioner to make one or more of the following 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 is to arise in respect of the relevant distribution that is made to a favoured member and specified in the determination.

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

31. 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.

32. It is expected that all holders of the Instrument will receive franked distributions irrespective of their tax attributes or their individual tax position.

33. The conversion of the Instrument to the Company’s ordinary shares will not attract the operation of section 204-30 of the ITAA 1997 because the conversion to the Company’s ordinary shares does not constitute a distribution, as defined in section 960-120 of the ITAA 1997. The conversion is a change in the type of equity interest that a holder holds in the Company, rather than a distribution.

Conclusion

34. The purpose of issuing the Instrument is to raise capital. In the circumstances described above, it is considered that section 204-30 of the ITAA 1997 will not apply to the scheme.

Question 4

Summary

35. Section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936) will not apply to the scheme.

Detailed reasoning

36. 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.

37. 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.

38. It is considered that the conditions in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 are satisfied in respect of the issue of the Instrument because:

(a) the issue of the Instrument constitutes a scheme for a disposition of membership interests: see paragraph 177EA(3)(a) of the ITAA 1936. Pursuant to paragraph 177EA(14)(a) of the ITAA 1936, ‘a scheme for a disposition of membership interests or an interest in membership interests’ includes a scheme that involves issuing membership interests;

(b) frankable distributions are expected to be payable to the holders of the Instrument in respect of the membership interest: see paragraph 177EA(3)(b) of the ITAA 1936. The Commissioner accepts that distributions payable on the Instrument will be frankable distributions under section 202-40 of the ITAA 1997;

(c) franked distributions are expected to be paid to holders of the Instrument: see paragraph 177EA(3)(c) of the ITAA 1936. It is expected that the Company will frank distributions made by it; and

(d) it is reasonable to expect that an imputation benefit will be received by the holders of the Instrument (that is, the relevant taxpayers) given that the Company expects to frank the distributions on the Instrument: see paragraph 177EA(3)(d) of ITAA 1936.

39. Accordingly, the issue is whether, 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 (i.e. the holder of the Instrument) to obtain an imputation benefit (paragraph 177EA(3)(e) of the ITAA 1936).

40. This is a test of objective purpose. Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose. Due to the diverse nature of these circumstances, some may or may not be present at any one time in any one scheme.

41. Having regard to the factors listed in subsection 177EA(17) and the relevant circumstances of the scheme, the Commissioner is of the opinion that the Instrument was not issued for a more than incidental purpose of enabling the relevant taxpayer to obtain an imputation benefit.

Conclusion

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

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