Edited version of your written advice

Authorisation Number: 1012828239881

Date of advice: 26 June 2015

Ruling

Subject: Loan notes - equity interests

Question 1

Are the Notes equity interests in Company B for the purposes of Division 974 of the ITAA 1997?

Answer

Yes

Question 2

Will any Redemption Premiums paid by Company B on the Notes be frankable distributions within the meaning of section 202-40 of the ITAA 1997?

Answer

Yes

Question 3

Will section 177EA of the ITAA 1936 apply to the Scheme?

Answer

No

Question 4

Will section 204-15 of the ITAA 1997 apply to the Scheme?

Answer

No

Question 5

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

Answer

No

Question 6

Will section 45A of the ITAA 1936 apply in relation to a redemption of Notes?

Answer

No

Question 7

Will the Commissioner make a determination under section 45C of the ITAA 1936 that section 45B of the ITAA 1936 applies in relation to a redemption of Notes?

Answer

No

Question 8

Will the commercial debt forgiveness rules in Subdivisions 245-C to 245-G of the ITAA 1997 apply to Company B in respect of any Notes that are redeemed for a Redemption Price that is less than the Issue Price of the Notes?

Answer

No

Question 9

Will a gain or profit be assessable under section 6-5 of the ITAA 1997 for Company B in relation to the issue or redemption of Notes?

Answer

No

Question 10

Does the issue or redemption of Notes give rise to CGT event D1 for Company B pursuant to section 104-35 of the ITAA 1997?

Answer

No

Question 11

Will Company B be required to recognise gains and losses under Division 230 of the ITAA 1997 in relation to the Notes?

Answer

No

Question 12

Are the Notes 'traditional securities' as defined in section 26BB of the ITAA 1936?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 2015

Income year ended 30 June 2016

Income year ended 30 June 2017

Income year ended 30 June 2018

Income year ended 30 June 2019

The scheme commenced on:

1 July 2014

Relevant facts and circumstances

1. This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Background

2. Company B is the parent company of a privately-owned Australian corporate group.

3. Company B is the head company of a tax-consolidated group.

4. The shareholders of Company B are Australian resident individuals.

5. Company B undertakes a number of investment related business activities.

Issue of Notes by Company B

6. A number of shareholders of Company B deposited additional funds with Company B and were issued with Notes. The additional deposits were made on the understanding that Company B would pay a return to the Investors which would be linked to the performance of Company B's investment portfolio. The scheme also permitted the issuance of additional Notes, and other entities may also acquire Notes (although those other entities would not be covered by the requested private ruling).

7. The Investors required the flexibility to withdraw some or all of their invested funds from time to time.

8. There are a number of commercial benefits for Company B from participating in the scheme.

9. The issue of ordinary or preference/special class shares by Company B to the Investors was not considered appropriate because such an issue to some (but not all) of the current shareholders, and the issue to entities that are not currently shareholders in Company B, would have created an unintended and inconvenient imbalance between the shareholders of the company.

Key terms of the Notes

10. The Notes are fully paid on issue and a Noteholder's Notes are redeemable at any time at the option of either the Noteholder or Company B.

11. The Notes are not interest-bearing, and no other periodic payments or repayments of principal will be made on the Notes.

12. Company B must pay to a Noteholder the Redemption Price for each Note that is redeemed.

13. The Redemption Price for a Note will vary depending on the value of the Company B's Investment Portfolio.

14. In addition to the Initial Notes that have been issued to the shareholders, Company B may issue new Notes in accordance with the Terms. The issue price for any new Notes issued will depend on the value of the Company B Investment Portfolio at the relevant time.

The accounting treatment of the Notes for Company B

15. The Notes will be recorded as giving rise to liabilities in its statement of financial position, and the funds raised from the issuance of the Notes will not be recorded in Company B's share capital account.

16. The liabilities representing the Notes will be 'market-to-market' through profit or loss for accounting purposes. Company B's accounting liabilities in relation to the Notes will be equal to the issue price of the Notes adjusted for movements in the market value of the underlying 'Company B Note Investment Portfolio' since the Initial Valuation Date.

Other matters

17. All parties to the Transaction will be dealing with each other on arm's length terms and fair value consideration will be provided by the Investors to acquire the Notes.

18. Assuming that any Redemption Premium paid by Company B is a frankable distribution, Company B will frank that distribution at the same franking percentage as Company B's benchmark percentage for the franking period in which the payment is made.

19. The quantum, timing and level of attached franking credits in relation to dividends on the ordinary shares in Company B are not expected to materially change as a result of the issue of the Notes.

20. Any Redemption Premiums paid on the redemption of Notes will not be sourced, directly or indirectly, from Company B's share capital account or non-share capital account. Apart from any Redemption Premiums, the Redemption Price paid on the redemption of Notes (i.e. the Issue Price or a lower amount if the Redemption Price is less than the Issue Price) will be entirely debited against Company B's non-share capital account. Overall, the redemption of the Notes would not have any impact on the value of the ordinary shares on issue.

21. Immediately before the payment of any Redemption Premium on the Notes, Company B will have sufficient available frankable profits (worked out under section 215-20 of the ITAA 1997) to pay the Redemption Premium.

22. Company B is subject to the taxation of financial arrangement (TOFA) provisions in Division 230 of the ITAA 1997. Company B has not elected into any of the Division 230 elective taxing methods.

23. The Notes will not be 'trading stock' (as defined in section 70-10 of the ITAA 1997) in the hands of Investors.

Relevant legislative provisions

Section 26BB of the Income Tax Assessment Act 1936

Section 45A of the Income Tax Assessment Act 1936

Subsection 45A(2) of the Income Tax Assessment Act 1936

Subsection 45A(3) of the Income Tax Assessment Act 1936

Section 45B of the Income Tax Assessment Act 1936

Section 45C of the Income Tax Assessment Act 1936

Section 177EA of the Income Tax Assessment Act 1936

Subsection 159GP(1) of the Income Tax Assessment Act 1936

Subsection 159GP(3) of the Income Tax Assessment Act 1936

Subsection 177EA(3) of the Income Tax Assessment Act 1936

Subsection 177EA(5) of the Income Tax Assessment Act 1936

Subsection 177EA(12) of the Income Tax Assessment Act 1936

Section 6-5 of the Income Tax Assessment Act 1997

Section 8-1 of the Income Tax Assessment Act 1997

Section 26-26 of the Income Tax Assessment Act 1997

Section 104-35 of the Income Tax Assessment Act 1997

Section 202-5 of the Income Tax Assessment Act 1997

Section 202-40 of the Income Tax Assessment Act 1997

Section 202-45 of the Income Tax Assessment Act 1997

Subdivision 204-D of the Income Tax Assessment Act 1997

Section 204-15 of the Income Tax Assessment Act 1997

Section 204-30 of the Income Tax Assessment Act 1997

Section 207-145 of the Income Tax Assessment Act 1997

Section 215-1 of the Income Tax Assessment Act 1997

Section 215-15 of the Income Tax Assessment Act 1997

Division 230 of the Income Tax Assessment Act 1997

Subsection 230-50(1) of the Income Tax Assessment Act 1997

Subsection 230-440(1) of the Income Tax Assessment Act 1997

Section 245-10 of the Income Tax Assessment Act 1997

Subdivision 245-C of the Income Tax Assessment Act 1997

Subdivision 245-D of the Income Tax Assessment Act 1997

Subdivision 245-E of the Income Tax Assessment Act 1997

Subdivision 245-F of the Income Tax Assessment Act 1997

Subdivision 245-G of the Income Tax Assessment Act 1997

Division 974 of the Income Tax Assessment Act 1997

Section 974-20 of the Income Tax Assessment Act 1997

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

Section 974-70 of the Income Tax Assessment Act 1997

Section 974-75 of the Income Tax Assessment Act 1997

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

Section 974-120 of the Income Tax Assessment Act 1997

Subsection 995-1(1) of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary

24. The Notes are equity interests in Company B for the purposes of Division 974 of the ITAA 1997.

Detailed reasoning

Equity test

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

26. 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 Notes would fall within the definition of a scheme.

27. 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 of the ITAA 1997 and the interest is not a debt interest under section 974-20 of the ITAA 1997.

28. 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:

29. In this case each Note 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 2 of the table listed in subsection 974-75(1) of the ITAA 1997: i.e. it is an interest that carries a right to a variable return from the company and the amount of the return is in substance and effect contingent on the economic performance of a part of the company's activities.

30. As Item 2 is satisfied it is unnecessary, in the present context, to further consider whether any other Items in the table are also satisfied for the purposes of passing the equity test.

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

Debt test

32. Subsection 974-15(1) of the ITAA 1997 defines the meaning of a 'debt interest' as follows:

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).

33. Subsection 974-20(1) of the ITAA 1997 states that a scheme satisfies the debt test 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:

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

• 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.

34. In order to satisfy the debt test, the scheme must satisfy all 5 limbs in subsection 974-20(1) of the ITAA 1997.

35. In this case the Notes are not debt interests pursuant to subsection 974-20(1) of the ITAA 1997, on the basis that not all of the cumulative requirements under that provision are satisfied:

(a) Paragraph 974-20(1)(a) of the ITAA 1997 is satisfied on the basis that the issue of the Notes constitutes a financing arrangement for Company B.

(b) Paragraph 974-20(1)(b) of the ITAA 1997 is satisfied on the basis that Company B receives financial benefits in the form of the Issue Price of the Notes.

(c) With respect to paragraphs 974-20(1)(c) and 974-20(1)(d) of the ITAA 1997, there are no periodic amounts payable by Company B on the Notes and the Redemption Price is contingent on the value of the Company B Investment Portfolio at the relevant time (and may be less than the Issue Price for the Notes), even if Company B has an 'effectively non-contingent obligation' (ENCO) to pay the Redemption Price. Therefore, paragraphs 974-20(1)(c) and 974-20(1)(d) of the ITAA 1997 are not satisfied because it is not substantially more likely than not that the value of the financial benefits which Company B has an ENCO to provide will be at least equal to the value of the Issue Price that it receives.

(d) The condition in paragraph 974-20(1)(e) of the ITAA 1997 is satisfied; however, this is immaterial given that the condition in paragraph 974-20(1)(d) of the ITAA 1997 is not satisfied.

36. Based on the above, the Notes fail the debt test under section 974-20(1) of the ITAA 1997. Therefore, the Notes are equity interests under Division 974 of the ITAA 1997.

Question 2

Summary

37. Any Redemption Premiums paid by Company B on the Notes will be frankable distributions within the meaning of section 202-40 of the ITAA 1997.

Detailed reasoning

38. The term 'frankable distribution' is defined pursuant to section 202-40 of the ITAA 1997. It provides that a non-share dividend is a frankable distribution to the extent that is not unfrankable under section 202-45 of the ITAA 1997.

39. Any Note Redemption Distribution paid to Note Holders will be a non-share dividend pursuant to section 974-120 of the ITAA 1997, on the basis that neither amount will be sourced from or debited to Company B's non-share capital account or share capital account.

40. A distribution will be unfrankable if it falls within any of the circumstances listed in section 202-45 of the ITAA 1997. There is no specific circumstance listed within section 202-45 of the ITAA 1997 which would cause a Note Redemption Distribution to be an unfrankable non-share dividend.

41. However, paragraph 202-45(f) of the ITAA 1997 provides that a distribution will be unfrankable if section 215-15 of the ITAA 1997 applies. Section 215-15 of the ITAA 1997 states that a non-share dividend will be unfrankable where a corporate tax entity pays a non-share dividend and immediately before the payment, the amount of the available frankable profits of the entity is nil or less than nil.

42. On the basis of the information provided, Company B will have available frankable profits to pay any non-share dividend at least equal to the amount of the franked distribution, immediately before the payment of the non-share dividend.

43. In these circumstances section 215-15 of the ITAA 1997 will not apply and consequently paragraph 202-45(f) of the ITAA 1997 should also not apply.

44. Therefore, any Note Redemption Distribution will constitute a frankable distribution as defined under subsection 202-40(2) of the ITAA 1997 satisfying the requirements of paragraph 202-5(b) of the ITAA 1997.

45. Provided Company B allocates franking credits to a Note Redemption Distribution (pursuant to paragraph 202-5(c) of the ITAA 1997), such distributions will be capable of being franked in accordance with section 202-5 of the ITAA 1997.

Question 3

Summary

46. Section 177EA of the ITAA 1936 will not apply to the Scheme.

Detailed reasoning

47. 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 the scheme is to obtain an imputation benefit. In these circumstances, subsection 177EA(5) of the ITAA 1936 enables the Commissioner to make a determination with the effect of either:

(a) imposing franking debits or exempting debits on the distributing entity's franking account, or

(b) denying the imputation benefit on the distribution that flowed directly or indirectly to the relevant taxpayer.

48. According 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:

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

• 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 this section, 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.

49. Subsection 177EA(12) of the ITAA 1936 extends the operation of section 177EA of the ITAA 1936 to non-share equity interests. Subsection 177EA(12) of the ITAA 1936 provides that section 177EA of the ITAA 1936:

(a) applies to a non-share equity interest in the same way as it applies to a membership interest, and

(b) applies to an equity holder in the same way as it applies to a member, and

(c) applies to a non-share dividend in the same way as it applies to a distribution.

50. Based on the information provided, it is considered that:

(a) the condition in paragraph 177EA(3)(a) of the ITAA 1936 is satisfied as the issue of Notes constitutes a 'scheme for a disposition' of equity interests (paragraph 177EA(3)(a) of the ITAA 1936).

(b) the conditions in paragraphs 177EA(3)(b) and (c) of the ITAA 1936 are satisfied because, based on the information provided, the applicant is expected to pay a franked distribution in respect of their ownership of Notes for the purposes of section 177EA of the ITAA 1936.

(c) as the conditions in paragraphs 177EA(3)(b) and (c) of the ITAA 1936 are satisfied, the condition in paragraph 177EA(3)(d) of the ITAA 1936 will also be satisfied on the basis that, but for the operation of section 177EA, Investors (assuming they are qualified persons within the meaning of section 207-145 of the ITAA 1997) could reasonably be expected to receive imputation benefits (defined in subsection 204-30(6) of the ITAA 1997 to include an entitlement to a tax offset, receipt of franking credits etc.) in respect of their ownership of Notes.

51. In relation to paragraph 177EA(3)(e) of the ITAA 1936, it is necessary to consider whether having regard to the relevant circumstances of the scheme, it would be concluded that a person, or one of the persons, who entered into or carried out 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.

52. Based on the information provided, it is considered that the requisite purpose for an application of section 177EA of the ITAA 1936 is not present as any purpose of enabling Investors to obtain imputation benefits was/will be no more than incidental to the Investors' acquisition and holding of Notes, in order to acquire an exposure to the Company B Investment Portfolio. Section 177EA of the ITAA 1936 will therefore not apply.

53. Accordingly, the Commissioner will not make a determination under paragraph 177EA(5)(b) of the ITAA 1936 that would deny the imputation benefits to the Note Holders.

Question 4

Summary

54. Section 204-15 of the ITAA 1997 will not apply to the Scheme.

Detailed reasoning

55. Section 204-15 of the ITAA 1997 gives rise to a franking debit in the franking account of an entity where:

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

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

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

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

• 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.

56. According to section 215-1 of the ITAA 1997, the imputation system applies to a non-share equity interest in the same way as it applies to a membership interest, and to an equity holder of the entity in the same way as it applies to a member of the entity. Therefore, section 204-15 of the ITAA 1997 should apply on the basis that Investors in Notes are 'members' of Company B.

57. It is considered that section 204-15 of the ITAA 1997 will not apply to give rise to a franking debit in the franking account of Company B. This is because:

• there is no ability on the part of Investors to exercise a choice or to make a selection to substitute a distribution made by Company B for a distribution made by any other entity;

• Investors do not have any entitlement to choose whether or not they will receive unfranked or franked distributions on the Notes from Company B or any other entity;

• Investors do not have any entitlement to choose whether or not they will receive Redemption Premiums on the Notes; and

• in addition, Investors will not have any entitlement to choose whether or not they will receive unfranked or franked Redemption Premiums in respect of the Notes.

58. Therefore, section 204-15 of the ITAA 1997 will have no application to the Scheme. Investors do not have any entitlement to exercise a choice or selection (or not exercise a choice or selection) which will have the effect of them receiving a distribution from another entity that is franked to a greater or lesser extent than distributions made to equity interest holders in Company B.

Question 5

Summary

59. Section 204-30 of the ITAA 1997 will not apply to the Transaction.

Detailed reasoning

60. Subdivision 204-D of the ITAA 1997 enables the Commissioner to make a determination where distributions with attached imputation benefits are streamed to a member of a corporate tax entity in preference to another member.

61. Section 204-30 of the ITAA 1997 prescribes the circumstances that are required to exist before the Commissioner may make such a determination. Section 204-30 of the ITAA 1997 applies where an entity 'streams' the payment of distributions in such a way that:

• 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 or distributions (paragraph 204-30(1)(a) of the ITAA 1997)

• the member (favoured member) would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b) of the ITAA 1997), and

• the other member (disadvantaged 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 (paragraph 204-30(1)(c) of the ITAA 1997).

62. Streaming is not defined for the purposes of Subdivision 204-D of the ITAA 1997. However, the Commissioner understands it to refer to a company 'selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits' (paragraph 3.28 of the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002).

63. In this case, the Transaction is not intended to give rise to Company B paying franked distributions to some equity holders in preference to other equity holders in Company B such as holders of ordinary shares. There is also no certainty as to whether any Redemption Premiums will actually be payable by Company B on the Notes.

64. Company B intends to frank any Redemption Premiums that it does pay on the Notes (to the extent of the franking credits available in its franking account) and to continue to frank any dividends that it pays on its ordinary shares. The Transaction does not involve the 'streaming' of imputation benefits from one set of equity holders to another.

65. All of the Investors in the Notes would receive any franked Redemption Premium distribution irrespective of their individual tax position or tax profile. Further, the Notes rank equally amongst themselves in all respects and the Terms do not allow Company B to discriminate between Investors in respect of paying any Redemption Premium.

66. The dividend payout ratios and associated franking credits attached to dividends paid on the ordinary shares in Company B are not expected to materially change as a result of the issue of the Notes. There is no purpose of streaming imputation benefits away from ordinary shareholders to Note Holders.

67. Based on the information provided, the Commissioner has concluded that the requisite element of streaming does not exist in relation to any franked distributions to be paid by Company B to the Note Holders. Accordingly, the Commissioner will not make a determination under paragraph 204-30(3)(c) of the ITAA 1997 to deny imputation benefits to the Note Holders.

Question 6

Summary

68. Section 45A of the ITAA 1936 will not apply in relation to a redemption of Notes.

Detailed reasoning

69. Section 45A of the ITAA 1936 applies in circumstances where a company streams the provision of capital benefits to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholders) and it is reasonable to assume that the other shareholders have received or will receive dividends (the disadvantaged shareholders).

70. The Commissioner may make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies. The effect of such a determination is that the capital benefit is taken to be an unfranked dividend.

71. A redemption of Notes will involve the provision of capital benefits to Note Holders within the meaning of subsection 45A(3) of the ITAA 1936 as it will constitute (in whole or in part - i.e. with the exception of any Redemption Premium) a non-share capital return.

72. However, on redemption of Notes the Investor is merely receiving a return of the capital that they have invested in the Notes. There is no element of 'streaming' capital benefits to Note holders in place of dividends to be paid to ordinary shareholders.

73. Accordingly, it cannot be said that Note Holders would derive a greater benefit from capital benefits than other Company B shareholders. Therefore, a redemption of Notes will not trigger the application of section 45A of the ITAA 1936.

74. Accordingly the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936.

Question 7

Summary

75. The Commissioner will not make a determination under section 45C of the ITAA 1936 that section 45B of the ITAA 1936 applies in relation to a redemption of Notes.

Detailed reasoning

76. Section 45B of the ITAA 1936 applies where certain capital benefits are provided to shareholders in substitution for dividends and the conditions in subsection 45B(2) of the ITAA 1936 are met.

77. The Commissioner may make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies. The effect of such a determination is that the capital benefit is taken to be an unfranked dividend.

78. The Redemption of Notes will constitute a scheme under which the holders are provided with a capital benefit by Company B (paragraph 45B(5)(b) and subsection 45B(7) of the ITAA 1936).

79. For the provision to apply, among other things, paragraph 45B(2)(c) of the ITAA 1936 requires that, 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. A non-exhaustive list of relevant circumstances of the scheme are provided in subsection 45B(8) of the ITAA 1936.

80. Based on the information supplied, it is considered that a redemption of Notes pursuant to the Terms would not be objectively viewed as evidencing a purpose on the part of Company B or the Investors to enable the Investors to obtain a tax benefit.

81. If a redemption occurs, the payment of an amount equal to the Capital Component of the Redemption Price on the Redemption Date simply represents the return of (all or part of) the amount invested - it does not impact the payment of any positive return receivable by Investors (i.e. any Redemption Premiums payable on the Notes). Also, there is no mechanism under the Terms for entitlements to Redemption Premiums to be effectively paid as part of the Capital Component of the Redemption Price.

82. Further, an Investor's Notes will cease to exist upon redemption and payment of the Redemption Price, which indicates that the requisite purpose for section 45B of the ITAA 1936 to apply will not be present (paragraph 45B(8)(h) of the ITAA 1936).

83. Accordingly, it is submitted that the conditions for section 45B of the ITAA 1936 to apply in respect of the Transaction will not be satisfied, such that the Commissioner will not make a determination under subsection 45C(1) of the ITAA 1936 that the Capital Component of the Redemption Price payable on redemption is to be treated as an unfranked dividend. Also, the Commissioner will not make a determination under subsection 45C(3) of the ITAA 1936 that a franking debit arises for Company B.

Question 8

Summary

84. The commercial debt forgiveness (CDF) rules in Subdivisions 245-C to 245-G of the ITAA 1997 will not apply to Company B in respect of any Notes that are redeemed for a Redemption Price that is less than the Issue Price of the Notes.

Detailed reasoning

85. The CDF rules in Subdivisions 245-C to 245-G of the ITAA 1997 will not apply to Company B in respect of any Notes that are redeemed for a Redemption Price that is less than the Issue Price of the Notes. This is on the basis that:

(a) the Notes are not debts to which the CDF rules apply, and

(b) in any case, redemption of the Notes would not constitute the 'forgiveness' of a debt for CDF purposes.

Debts to which Division 245 of the ITAA 1997 applies

86. Section 245-10 of the ITAA 1997 sets out the debts to which Subdivisions 245-C to 245-G apply:

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.

87. No periodic interest amounts are payable on the Notes, although it is possible that a Redemption Premium payable could be regarded as being 'in the nature of interest'. As the Notes are Division 974 equity interests, any Redemption Premium as well as any interest payments if interest was payable on the Notes would be non-share dividends and non-deductible under section 26-26 of the ITAA 1997.

88. Further, even disregarding section 26-26 of the ITAA 1997, any Note Redemption Premium or interest payment would be a non-share dividend and would not be deductible in accordance with Taxation Ruling TR 2002/15.

89. As any Redemption Premiums as well as any interest payments (if interest was payable on the Notes) should, disregarding section 26-26 of the ITAA 1997, not be an allowable deduction either under section 8-1 of the ITAA 1997 or under Division 230 of the ITAA 1997 (refer to the analysis in response to Question 11 below), the Notes are not debts to which Division 245 of the ITAA 1997 applies.

Forgiveness of a debt

90. Subdivision 245-B of the ITAA 1997 sets out what constitutes the 'forgiveness' of a debt for CDF purposes.

91. Relevantly, under paragraph 245-35(a) of the ITAA 1997 a debt is 'forgiven' if and when 'the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full.'

92. The Terms of the Notes require that the Notes be redeemed for the Redemption Price. Where Company B pays the full amount of the Redemption Price in full discharge of the debt owing then clearly there is no release, waiver or other extinguishment of the debt other than by repaying the debt in full. Accordingly, even if the Redemption Price is less than the Issue Price of the Notes, there is no 'forgiveness' of a debt under paragraph 245-35(a) of the ITAA 1997.

93. None of the other provisions in Subdivision 245-B of the ITAA 1997 specifying what constitutes the forgiveness of a debt are applicable to the redemption of Notes for the full Redemption Price owing.

Conclusion

94. Accordingly, the CDF rules in Subdivisions 245-C to 245-G of the ITAA 1997 will not apply to Company B in respect of any Notes that are redeemed for a Redemption Price that is less than the Issue Price of the Notes, because the Notes are not debts to which the CDF rules apply (under section 245-10 of the ITAA 1997) and, in any case, where Company B pays the full Redemption Price owing upon redemption of Notes there is no 'forgiveness' of a debt under Subdivision 245-B of the ITAA 1997.

Question 9

Summary

95. A gain or profit will not be assessable under section 6-5 of the ITAA 1997 for Company B in relation to the issue or redemption of Notes.

Detailed reasoning

Issuance of Notes

96. It is an accepted principle that there is no gain if an amount is received by a taxpayer as a contribution to capital.

97. In this case, the Notes are non-share equity interests in Company B, and the receipt of the subscription amounts upon issuance of the Notes is a contribution to capital.

Redemption of Notes

98. On a redemption of Notes, Company B will be required to pay an amount equal to the Redemption Price. The Redemption Price will vary, largely depending on the movement in the value of the Company B Investment Portfolio over the relevant period.

99. If a Redemption Premium is payable, then no economic gain arises for Company B. However, the Redemption Price may be less than the initial subscription price for the Notes - in particular, due to the Company B Investment Portfolio having declined in value.

100. It is considered that Company B should not be regarded as deriving an amount of ordinary income for the purposes of section 6-5 of the ITAA 1997 by reference to any economic gain that may be taken to arise for Company B on a redemption of the Notes for less than their initial subscription price. This is because any such economic gain that is realised by Company B on redemption of Notes should be treated as being 'capital' in nature and not 'income'. This is consistent with the fact that the Notes are perpetual and classified as equity interests for tax purposes.

101. Accordingly, any economic profit or gain realised by Company B on a redemption of Notes for less than their Issue Price should not be assessable as an amount of ordinary income under section 6-5 of the ITAA 1997. This is consistent with any Redemption Premium payable by Company B being non-deductible.

Question 10

Summary

102. The issue or redemption of Notes does not give rise to CGT event D1 for Company B pursuant to section 104-35 of the ITAA 1997.

Detailed reasoning

103. Neither the issue nor the redemption of Notes will give rise to a CGT event for Company B. Prima facie, the issue of Notes would trigger CGT event D1 for Company B. However, paragraph 104-35(5)(c) of the ITAA 1997 specifically provides that CGT event D1 does not happen if a company issues or allots equity interests or non-share equity interests in the company.

Question 11

Summary

104. Company B will not be required to recognise gains and losses under Division 230 of the ITAA 1997 in relation to the Notes.

Detailed reasoning

105. Pursuant to subsection 230-50(1) of the ITAA 1997, an equity interest is taken to constitute a 'financial arrangement'. Therefore, the Notes are a financial arrangement for Company B for the purposes of Division 230 of the ITAA 1997.

106. However, Company B will not be required to recognise any gains or losses under Division 230 of the ITAA 1997 in relation to Notes. This is because:

• Company B has not elected into any of the elective Division 230 taxing methods;

• the default accruals and realisation methods will not apply because the Notes are a financial arrangement under subsection 230-50(1) of the ITAA 1997 (refer paragraph 230-40(4)(e) of the ITAA 1997); and

• the default balancing adjustment method will not apply because the Notes are a financial arrangement under subsection 230-50(1) of the ITAA 1997 to which neither the fair value nor the financial reports method will apply (subsection 230-440(1) of the ITAA 1997).

107. Accordingly, Company B will not be required to recognise gains and losses under Division 230 of the ITAA 1997 in relation to the Notes.

Question 12

Summary

108. The Notes are 'traditional securities' as defined in section 26BB of the ITAA 1936.

Detailed reasoning

109. A 'traditional security' is defined in subsection 26BB(1) of the ITAA 1936 as a 'security' held by the taxpayer that:

(a) was acquired by the taxpayer after 10 May 1989;

(b) either:

1) does not have an 'eligible return'; or

2) has an eligible return that satisfies the conditions listed in subparagraph (b)(ii) of the definition of traditional security in subsection 26BB(1);

(c) is not a prescribed security within the meaning of section 26C of the ITAA 1936; and

(d) is not trading stock of the taxpayer.

110. Assuming that a Note held by an Investor is a 'security' (discussed below), paragraphs (a), (c) and (d) above will be satisfied. Specifically:

• the Investors acquired or will acquire the Notes after 10 May 1989;

• a Note is not a 'prescribed security under section 26C of the ITAA 1936 (which, broadly, covers certain securities issued by the Commonwealth); and

• the Notes are not trading stock of the Investors.

Security

111. The term 'security' is defined in subsection 26BB(1) of the ITAA 1936 by reference to subsection 159GP(1) of the ITAA 1936. Pursuant to subsection 159GP(1) of the ITAA 1936, 'security' means:

(a) stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(b) a deposit with a bank or other financial institution;

(c) a secured or unsecured loan; or

(d) any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

112. Paragraph (b) of the definition of security does not apply because the Notes are not a deposit with a bank or other financial institution. However, it is considered that the Notes are 'securities' under paragraph (a), (c) and/or (d) of the definition in subsection 159GP(1) of the ITAA 1936.

113. In this regard, in relation to paragraph (a) of the definition:

• 'debenture' is defined broadly in section 995-1 of the ITAA 1997 to include 'debenture stock, bonds, notes and any other securities of the company or trust, whether or not constituting a charge on its assets'. It is considered that the Notes fall within this definition of a 'debenture'; and

• it is also considered that if the Notes are not treated as 'debentures', they would be covered by the 'or other security' category in paragraph (a). The Notes to be issued by Company B should be covered by the 'or other security' category of paragraph (a) of the definition of 'security' in subsection 159GP(1) of the ITAA 1936 to the extent that they are not treated as debentures.

Although the Notes are perpetual, they will be redeemable at any time at the option of Investors (as well as Company B) and hence there is clearly an obligation on the part of Company B to pay an amount to the holder of a Note. In that respect, the Notes can be distinguished from perpetual debt instruments which cannot be redeemed/terminated at the option of the holders.

114. In relation to paragraph (c) of the definition, it is considered that the Notes are unsecured loans and thus also satisfy the definition of security under paragraph (c).

115. For paragraph (d) of the definition, only those contracts that have debt like obligations will usually fall under paragraph (d) (Taxation Ruling TR 96/14). It is considered that the Notes would be covered by paragraph (d) to the extent that they are not covered by paragraphs (a) or (c) of the definition of security. In this regard, Company B is obliged to pay the Redemption Price on redemption of a Note. That is, Company B has a debt-like obligation that is imposed on Company B at the time of issuing the Notes to make future payments to Investors and the fact that the amount ultimately payable is not calculated until the redemption date does not alter this position. The amount of the debt (i.e. the Redemption Price) is still calculable at any time. Also, while the Notes are perpetual, they will be redeemable at any time at the option of Investors (as well as Company B) and hence there is clearly an obligation on the part of Company B to pay an amount to the holder of a Note.

116. Accordingly, it is considered that the Notes meet the definition of 'security' in subsection 159GP(1) of the ITAA 1936.

Eligible return

117. A security will have an 'eligible return' if, at the time of its issue, it is reasonably likely that the sum of the payments under the security (excluding periodic interest) will exceed the issue price of the security. The amount of the excess in such circumstances is said to be an 'eligible return' (subsection 159GP(3) of the ITAA 1936).

118. Under the Terms, the only amount that Company B is obliged to pay in relation to the Notes is the Redemption Price payable on redemption. The calculation of the Redemption Price is dependent upon the Redemption Value for the Notes, which is directly linked to the value of the Company B Investment Portfolio at the relevant Calculation Date.

119. Where the Company B Investment Portfolio has performed poorly over the investment period, the Redemption Price payable may be less than the Issue Price.

120. At the time that the Notes are issued, the future performance of the Company B Investment Portfolio cannot be predicted with any certainty. Accordingly, it cannot be said that it is 'reasonably likely' that the sum of the payments made by Company B in respect of a Note will exceed the issue price of the Note and, as such, the Notes do not have an 'eligible return' as defined in subsection 159GP(3) of the ITAA 1936.

Conclusion

121. On the basis that the Notes are 'securities' as defined in subsection 159GP(1) of the ITAA 1936 and do not have an 'eligible return' under subsection 159GP(3) of the ITAA 1936, it is considered that a Note qualifies as a 'traditional security' pursuant to subsection 26BB(1) of the ITAA 1936.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).