Edited version of your written advice

Authorisation Number: 1012844662966

Ruling

Subject: Application of Division 230

Question 1

Does the cross-currency swap arrangement with the Counterparty both before and after the effective date in 20xx of the Second Agreement constitute a single arrangement for the purposes of Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997), having regard to the relevant matters contained in subsection 230-55(4) of the ITAA 1997?

Answer

Yes

Question 2

If the answer to question 1 is yes, did the execution of the Second Agreement result in any gain being included in the MEC Group's assessable income pursuant to section 230-15 of the ITAA 1997 or any loss being deductible from the MEC Group's assessable income pursuant to section 230-15 of the ITAA 1997 in the 20xx income year?

Answer

No

This ruling applies for the following periods:

The 20xx income year

The scheme commences in:

The 20xx income year

Relevant facts and circumstances

Company A

Company A is a wholly owned Australian subsidiary of International Parent A.

Company A manages a diverse portfolio of businesses in a wide range of industries. Company A is the provisional head entity of a multiple entry consolidated group (the MEC Group).

Australian Subsidiary A is a wholly owned subsidiary of Company A and for income tax purposes is a member of the MEC Group.

Australian Subsidiary A acts as an in-house finance company of the group. This means that it conducts a treasury function for the Australian group.

The Cross-Currency Swap

Company A entered into a cross-currency swap contract (the Original Swap) with the Counterparty to hedge debt funding obtained by another member of the MEC group.

The debt funding obtained by the other member of the MEC Group was denominated in another currency, hence there was a need to hedge against movements in foreign currency.

There has been no change in the Original Loan balance since the inception of the loan.

To hedge against movements in the other currency on the Original Loan a swap was entered.

The Original Swap operated under an International Swaps and Derivatives Association (ISDA) Master Agreement between Company A and the Counterparty, which set out the standard terms that apply to all transactions entered into between the parties.

The Original Swap was established by legal agreement and created rights to receive and obligations to provide financial benefits in both Company A and the Counterparty.

The Taxation of Financial Arrangements provisions contained in Division 230 apply to the MEC Group.

The MEC Group has not made any elections under Division 230. The default timing methodologies contained in Subdivision 230-B apply to the MEC Group.

Historically, both Company A and Australian Subsidiary A have undertaken in-house finance functions for the Company A group. A decision was made that Australian Subsidiary A should move towards being the primary provider of in-house financing functions for the Company A group. A decision was made to transfer the Original Swap to Australian Subsidiary A.

The reason for the transfer was to align with the Company A group's objective to have, to the maximum extent possible, financial instruments and transactions of the group with third party financiers residing in one legal entity, being Australian Subsidiary A.

The Second Agreement

Company A and Australian Subsidiary A entered into the Second Agreement with the Counterparty, under which, Company A surrendered its rights and was released and discharged from its obligations under the Original Swap and Australian Subsidiary A became entitled to equivalent rights and assumed equivalent obligations as existed under the Original Swap.

With effect from the Second Agreement:

• Australian Subsidiary A had rights of substantially the same nature and character against, and owed obligations of substantially the same nature and character to, the Counterparty as Company A had immediately prior to the Second Agreement Time;

• The Counterparty had rights of substantially the same nature and character against, and owed obligations of substantially the same nature and character to, Australian Subsidiary A as they had with Company A immediately prior to the Second Agreement Time;

as if Australian Subsidiary A had been named as a party to the Original Swap instead of Company A.

With effect from the Second Agreement time, Company A and the Counterparty no longer had further rights against each other, or obligations to each other, in connection with the Original Swap.

At the Second Agreement time, the swap ceased to operate under the Original Master Agreement between Company A and the Counterparty and was treated as operating under a pre-existing ISDA Master Agreement between Australian Subsidiary A and the Counterparty. The terms and conditions applied by the Original Master Agreement between Company A and the Counterparty and the terms and conditions applied by the ISDA Master Agreement between Australian Subsidiary A and the Counterparty are substantially the same. A change in the reference to Master Agreement was made to ensure that the swap conformed with industry standards at the time. Although the swaps were governed by different master agreements, the change in these master agreements had no material change on the rights and obligations on the parties under the swap. As such, it can also be said that Company A and Australian Subsidiary A have substantially the same set of rights and obligations under the two agreements.

No payments were made by the Counterparty to Company A in respect of ending the Original Swap and beginning the Second Agreement.

No payments were made between Company A and Australian Subsidiary A in respect of ending the Original Swap and beginning the Second Agreement.

No payments were made by Australian Subsidiary A to the Counterparty to compensate The Counterparty for entering into the Second Agreement.

The financial institution that was counterparty to the original swap remained identical and was left in an unchanged economic and financial position after the transaction. The financial institution that is the counterparty to the swap is not part of the MEC group and is an independent third party.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 section 230-15

Income Tax Assessment Act 1997 section 230-45

Income Tax Assessment Act 1997 subsection 230-45(1)

Income Tax Assessment Act 1997 paragraph 230-45(1)(a)

Income Tax Assessment Act 1997 paragraph 230-45(1)(b)

Income Tax Assessment Act 1997 paragraph 230-45(1)(c)

Income Tax Assessment Act 1997 paragraph 230-45(1)(d)

Income Tax Assessment Act 1997 paragraph 230-45(1)(e)

Income Tax Assessment Act 1997 paragraph 230-45(1)(f)

Income Tax Assessment Act 1997 Subsection 230-55(4)

Income Tax Assessment Act 1997 paragraph 230-55(4)(a)

Income Tax Assessment Act 1997 paragraph 230-55(4)(b)

Income Tax Assessment Act 1997 paragraph 230-55(4)(c)

Income Tax Assessment Act 1997 paragraph 230-55(4)(d)

Income Tax Assessment Act 1997 paragraph 230-55(4)(e)

Income Tax Assessment Act 1997 paragraph 230-55(4)(f)

Income Tax Assessment Act 1997 Division 230B

Income Tax Assessment Act 1997 paragraph 230-100(2)(a)

Income Tax Assessment Act 1997 paragraph 230-100(2)(b)

Income Tax Assessment Act 1997 paragraph 230-100(2)(c)

Income Tax Assessment Act 1997 subsection 230-100(3)

Income Tax Assessment Act 1997 subsection 230-100(5)

Income Tax Assessment Act 1997 subsection 230-120(1)

Income Tax Assessment Act 1997 section 230-180

Income Tax Assessment Act 1997 subsection 230-180(1)

Income Tax Assessment Act 1997 subsection 230-180(2)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

When considered within the context of the factors contained in paragraphs 230-55(4)(a) to (f), the substance and form of the Second Agreement tends towards a finding that, on balance, the Original Swap and the Second Agreement should constitute one single financial arrangement for the purposes of section 230-45.

The substance and form of the Second Agreement tend towards an indication that while there has been a substitution from Company A to Australian Subsidiary A, the rights and obligations are substantially the same as they were under the Original Swap. In addition, those rights and obligations come home to the MEC Group at Termination Time, regardless of whether it was via Company A or Australian Subsidiary A, which further indicates that, in substance and form, there has been no real change in the time that the parties to the Second Agreement intended the gains or losses to be realised.

Also, the Second Agreement was entered into using the historical costs from the Original Swap, rather than the market value at Second Agreement time. That is, the Second Agreement refers to and adopts the same pricing of the Original Swap.

Detailed reasoning

The broad object of Division 230 is to bring to account gains and losses from financial arrangements. The unit of taxation for Division 230 is a 'financial arrangement'.

A 'financial arrangement' is defined in Subsection 230-45(1) as:

You have a financial arrangement if you have, under an *arrangement:

(a) a *cash settlable legal or equitable right to receive a *financial benefit; or

(b) a cash settlable legal or equitable obligation to provide a financial benefit; or

(c) a combination of one or more such rights and/or one or more such obligations;

unless:

(d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and

(e) for one or more of the rights and/or obligations covered by paragraph (d):

(i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or

(ii) the right or obligation is not cash settlable; and

(f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).

The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.

Subsection 230-55(4) identifies whether a number of rights and/or obligations constitutes an 'arrangement' or are '2 or more separate arrangements' for the purposes of Division 230.

Taxation Ruling 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997) in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 of the ITAA 1997 (TR 2012/4) outlines the Commissioner's view in determining whether a number of rights and/or obligations are themselves an arrangement or are 2 or more separate arrangements for the purposes of Division 230.

Paragraphs 10 and 11 of TR 2012/4 state -

10. Whether a number of rights and/or obligations are themselves an 'arrangement' or are '2 or more separate arrangements' is a question of fact and degree, that is determined having regard to the matters referred to in paragraphs 230-55(4)(a) to (f), both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other.

11. What is an arrangement for the purposes of Division 230 does not merely depend on the legal form of the arrangement.

Paragraph 13 further states -

13. In applying subsection 230-55(4), regard must be had to all of the matters referred to in paragraphs (a) to (f), although in a particular case, it may be that one matter is more influential than others. In having regard to the matters referred to in paragraphs (a) to (f), such regard must include a consideration of how the matters interact.

Paragraph 230-55(4)(a) 'the nature of the rights and/or obligations'

TR 2012/4 states at paragraph 15 that this requires a consideration of the substance of the rights and/or obligations.

The Second Agreement confirms that after the Second Agreement, Australian Subsidiary A has the same rights against, and owes the same obligations to, the Counterparty in connection with the transaction as if Australian Subsidiary A had been named as a party to the transaction instead of Company A. Overall, the rights and obligations of the MEC Group's position both pre- and post- Second Agreement remain substantially unchanged.

Paragraph 230-55(4)(b) 'their terms and conditions (including those relating to any payment or other consideration for them)'

The main differences which exist between the terms and conditions governing the Original Swap and the Second Agreement are that from the Second Agreement time:

• Australian Subsidiary A was substituted for Company A as a party to the arrangement; and

• A new ISDA Master Agreement applied between Australian Subsidiary A and the Counterparty.

Other than these changes, which were not material, there were no changes to the terms and conditions governing the Second Agreement.

Paragraph 16 of TR 2012/4 states that it is also necessary to consider the terms and conditions which relate to payment and/or consideration.

No consideration was paid or received between the parties at the Second Agreement time either in respect of the 'in the money' position which existed under one arm of the Original Swap at the time, or as consideration for effecting the Second Agreement. This pricing is only possible because the original rights and obligations of the parties continue post Second Agreement and the Counterparty remaining the same. In other words, the pricing of the Second Agreement is determined by reference to the Original Swap. This is a strong indicator that the rights and obligations under the Original Swap and Second Agreement form part of a single arrangement.

Paragraph 230 - 55(4)(c) 'the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved)

Paragraph 17 of TR 2012/4 states that this requires consideration of the context surrounding the life cycle of the rights and/or obligations from creation to what is proposed as exercise or performance.

The Original Swap was entered to hedge debt funding in another currency by another member of the MEC group. The maturity date of the Original Swap remains the same as the underlying Original Loan. The Original Loan is still on foot and therefore the reasoning behind requiring Original Swap to hedge against movements in the other currency on the Original Loan remains valid.

That is, the Second Agreement and the Original Swap were designed to hedge the same underlying risk (the Original Loan) for the originally intended coverage period and with substantially the same rights and obligations.

The Original Swap and the Second Agreement (agreed to by all three parties) are on identical terms as far as the final exchange amount, the maturity date, and historical pricing despite having different start dates. This was to facilitate the continuance of the rights and obligations which had already been established with the Counterparty and therefore give a seamless and cohesive arrangement, rather than create a separate arrangement.

This criterion tends to indicate that there is a single arrangement as the form and substance of the Original Swap and the Second Agreement share the same rights and obligations and hedge the same underlying risk in as seamless a way possible.

Paragraph 230 - 55(4)(d) 'whether they can be dealt with separately or must be dealt with together'

Paragraph 19 of TR 2012/4 states that this requires consideration of whether the rights and/or obligations can be dealt with separately or must be dealt with together in accordance with the terms and conditions of the arrangement. The enquiry under this paragraph is as to legal, rather than commercial, constraint.

The Original Swap and the Second Agreement were created sequentially, rather than existing concurrently. This criterion tends to indicate that there are two separate arrangements, however, it is not conclusive on its own.

Paragraph 230 - 55(4)(e) 'normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole)'

TR 2012/4 at paragraph 20 states that this requires a consideration of normal understandings and practices in relation to rights and/or obligations (including whether they are regarded commercially as separate things or as a group or series that forms a whole).

In this case, both Company A and Australian Subsidiary A are members of the MEC group and are treated as a single entity for income tax purposes. That is, the rights and obligations of Company A were discharged while substantially the same rights and obligations were imposed on Australian Subsidiary A via the Second Agreement. That is, when looking at the form and substance of the arrangement, there was no material change in the rights and obligations that ultimately remain with the MEC group.

The Second Agreement used the historical costs, rather than current market value costs at the Second Agreement time.

This criterion tends to indicate a single arrangement as the form and substance of Second Agreement does not follow the traditional structure of this type of agreement and instead evidences that the rights and obligations remain substantially the same with no compensation for either party for moving those rights and obligations from Company A to Australian Subsidiary A via the Second Agreement.

Paragraph 230 - 55(4)(f) 'the objects of this Division'

TR 2012/4 at paragraph 21 states that this requires consideration of the objects of Division 230 as set out in section 230-10. Broadly speaking, the objects of Division 230 are:

• to minimise tax distortions on commercial decision-making by, for gains and losses from financial arrangements, aligning tax recognition of such gains and losses with the reality of what gains and losses occur and when they occur;

• to align tax and commercial recognition of gains and losses from financial arrangements by ensuring the time of recognition of those gains and losses is reasonable, and by generally recognising such gains and losses on revenue account; and

• to appropriately take account of, and minimise, compliance costs.

There were no gains or losses to either the Company A MEC Group (via either Company A or Australian Subsidiary A) or to Company B at the Second Agreement time. Any gains or losses will come home to the Company A MEC Group upon the maturity of the Second Agreement (the Termination Time) which is scheduled to occur in the 20xx income year. This is the same time that any gains or losses would have come home to the Company A MEC Group under the Original Swap had there been no Second Agreement. Therefore the substance and form of the Second Agreement indicates that there has been no change to when the gains and losses should be recognised.

This criterion tends to indicate a single arrangement as the form and substance of the Second Agreement would be distorted if a balancing adjustment were to be assessed on the Original Swap at the Second Agreement time.

Conclusion

While the traditional structure of this type of agreement would indicate that there has been a substantial change in the rights and obligations, such as by the substitution of a new debtor or of a new creditor, that is clearly not the case with the Second Agreement. The material rights and obligations remain the same between Australian Subsidiary A and Company B under the Second Agreement as they did under the Original Swap between Company A and Company B. Furthermore, as Company A and Australian Subsidiary A are part of the Company A MEC Group, from an income tax perspective, the relevant taxpayers involved in the arrangements remain the same. That is, in substance and form there has been no real change in the tax position of the Company A MEC Group.

Additionally, the Second Agreement was entered into using the historic figures from the Original Swap, rather than by using the market value of the Original Swap at the Second Agreement time. This is further evidence that the substance and form of the Second Agreement was not meant to change the intended purpose of the Original Swap.

When considering the substance and form of the Second Agreement using the factors contained in paragraphs 230-55(4)(a) to (f) it is clear that Second Agreement tends towards a finding that, on balance, the Original Swap and the Second Agreement should constitute one single financial arrangement for the purposes of section 230-45.

Question 2

Summary

The MEC group has a single arrangement (the Swap) commencing with the Original Swap and followed by the Second Agreement which maintains the original end date of Original Swap. This single arrangement consists of separate legs, being the other currency legs and the AUD legs, which, when worked out separately and aggregated under paragraph 230-120(3)(b)(ii), the relevant gain or loss will be determined. The MEC Group did not derive a gain or loss in respect of the Swap during the 20xx income year. No amounts in respect of the Swap will be included in the MEC Group's assessable income for the 20xx income year pursuant to section 230-15, or allowable as a deduction pursuant to section 230-15.

Detailed reasoning

As the MEC Group has not made any elections under Subdivisions 230-C to 230-E to apply the elective tax methods, one of the default tax methods in Subdivision 230-B will apply. Therefore any gains or losses arising under the single arrangement constituting the rights and obligations contained in the Swap would be included in the MEC Group's assessable income or allowable as a deduction.

The Swap contains the following obligations to provide or receive the following benefits as a single financial transaction -

• The MEC group exchanged currency through a right to receive AUD and an obligation to provide the other currency.

• At the Second Agreement time, Company A ceased to have a right to receive the other currency and ceased to have an obligation to pay AUD while at the same time Australian Subsidiary A commenced holding substantially the same rights and obligations (using the historical prices under the Original Swap).

• At the Termination Time, Australian Subsidiary A (in the MEC Group) will have a right to receive the other currency in exchange for providing AUD to The Counterparty. The amounts under the Second Agreement are the same as those under the Original Swap, that is, the Second Agreement was not done at market value.

Subsection 230-120(1) applies to a financial arrangement with a notional principal, such as a swap where:

(a) the arrangement consists of these things:

(i) a leg, the *financial benefits to be provided or received in respect of which are calculated by reference to, or are reasonably related to, a notional principal;

(ii) another leg, the financial benefits to be provided or received in respect of which also are calculated by reference to, or are reasonably related to, a notional principal;

(iii) if the arrangement includes one or more other things - those things; and

(b) when you start to have the arrangement, the value of the notional principal in relation to one leg is equal to the value of the notional principal in relation to the other leg; and

(c) all or part of the notional principal in relation to each leg is provided or received at a time, regardless of whether that time is different in relation to each leg.

Example: A swap contract.

As discussed in question 1 above, the Swap is a single financial arrangement pursuant to subsection 230-55(4). That is, the rights and obligations of the Original Swap and the Second Agreement will be considered together to determine any gains or losses arising from the single Swap that commences with the Original Swap and is followed by the Second Agreement. There are two methods that could apply to the Swap to determine the amount and timing of gains and losses from the financial arrangement. This is the accruals method or the realisation method. Section 230-100 outlines when to apply the accruals method and when to apply the realisation method.

Accruals method

Paragraphs (a) to (c) of subsection 230-100(2) allow you to choose the accruals method to determine the gain or loss when there is a sufficiently certain overall gain or loss when you start to have the arrangement.

Subsection 230-110(1) states that you have a sufficiently certain gain or loss from a financial arrangement at the time when you start to have the arrangement only if it is sufficiently certain at that time that you will make an overall gain or loss from the arrangement of:

(a) a particular amount; or

(b) at least a particular amount.

At Termination Time, the amounts exchanged will be the same amounts as those exchanged on the Commencement Date. The value of these amounts will be determined by the spot foreign exchange rate at the Termination Time.

Therefore the accruals method cannot be chosen as the gain or loss from the Swap could not be sufficiently certain at the start time due to the fluctuation in the spot rate.

Section 230-100(3) states that the accruals method also applies to a gain or loss from a financial arrangement if:

(a) the gain or loss arises from a financial benefit that you are to receive or are to provide under the arrangement; and

(b) the gain or loss:

(i) is sufficiently certain before or at the time when you start to have the arrangement and before you are to receive the benefit; or

(ii) becomes sufficiently certain after the time when you start to have the arrangement and before you are to receive or provide the benefit; and

(c) the benefit has not already been taken into account in applying:

(i) the accruals method provided for in this Subdivision; or

(ii) the realisation method provided for in this Subdivision;

to another gain or loss from the arrangement.

The Swap uses the historical costs associated with the amounts exchanged at the Commencement Date rather than the market value of the amounts. At this time there is no sufficient certainty of the gain or loss from the Swap.

When the Second Agreement commenced at the Second Agreement time, historical costs were still adopted rather than the market value of the amounts. At this time there is no sufficient certainty of the gain or loss from the Swap.

Pursuant to section 230-110, there was no sufficiently certain gain or loss from the financial arrangement at the time of, or before the Second Agreement and therefore subsection 230-100(3) will not apply.

Realisation method

As the accruals method does not apply then subsection 230-100(5) states that the realisation method will apply. Section 230-180 outlines how the realisation method is to apply.

Subsection 230-180(1) states that if a gain or loss is to be taken into account using the realisation method, you are taken, for the purposes of section 230-15, to make the gain or loss for the income year in which the gain or loss occurs.

Subsection 230-180(2) outlines when a gain or loss from a financial arrangement is taken to occur. Broadly it is taken to occur in the income year during which the last of the financial benefits, rights and obligations that are factored into the calculation of the gain or loss are taken into account.

In the case of the Swap, this will be at the Termination Time. Accordingly, there will be no amounts in respect of the Swap which will be included in the MEC Group's assessable income for the 20xx income year pursuant to section 230-15, or allowable as a deduction pursuant to section 230-15.

Conclusion

Pursuant to the reasoning in section 230-180 it is clear that the MEC Group did not derive a gain or loss in respect of the Swap during the 20xx income year. Therefore, no amounts in respect of the financial arrangement (the Swap) will be included in the MEC Group's assessable income for the 20xx income year pursuant to section 230-15, or allowable as a deduction pursuant to section 230-15.

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).