Edited version of your written advice

Authorisation Number: 1012863700421

Date of advice: 31 August 2015

Ruling

Subject: Debt-equity rules, withholding tax, TOFA, Debt-forgiveness

Question 1

Does regulation 974-135F of the Income Tax Assessment Regulations 1997 (the ITAR 1997) apply to the obligation to pay principal and interest on the Notes such that the fact that the obligation is subject to the Non-Viability Trigger Event does not in itself prevent the obligation from being a non-contingent obligation?

Answer

Yes

Question 2

Does regulation 974-135D of the ITAR 1997 apply to the obligation to pay principal and interest on the Notes such that the fact that the obligation is subject to the Solvency Condition does not in itself prevent the obligation from being a non-contingent obligation?

Answer

Yes

Question 3

Will the Notes be debt interests in Taxpayer A under section 974-15 of the Income Tax Assessment Act 1997 (the ITAA 1997)?

Answer

Yes

Question 4

Will the Notes be "financial arrangements" for Taxpayer A under subsection 230-45(1) of the ITAA 1997?

Answer

Yes

Question 5

Will Taxpayer A be entitled to deductions for losses for interest payments on the Notes under subsection 230-15(2) of the ITAA 1997 to the extent the interest payments are incurred in deriving assessable income?

Answer

Yes

Question 6

Will the interest paid by Taxpayer A in respect of the Notes be "interest paid by a company in respect of a debenture" within the meaning of subsection 128F(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 7

Will the Write-off cause Taxpayer A to derive ordinary income under section 6-5 of the ITAA 1997?

Answer

No

Question 8

Will the Write-off cause Taxpayer A to derive a capital gain under section 102-20 of the ITAA 1997?

Answer

No

Question 9

Will the amount that is assessable under subsection 230-15(1) of the ITAA 1997 if the Notes are Written-off, be reduced under section 230-470 of the ITAA 1997 by the net forgiven amount'?

Answer

Yes

Question 10

Will the commercial debt forgiveness provisions in Division 245 of the ITAA 1997 apply to a Write-off so as reduce the tax attributes of Taxpayer A as specified in Subdivision 245-E of the ITAA 1997 by an amount equal to the value (as determined under section 245-55 of the ITAA 1997) of the outstanding amounts of principal and any accrued and unpaid interest?

Answer

Yes

This ruling applies for the following periods:

Commencing in the current income year for the term of the Notes.

The scheme commences on:

A particular income year

Relevant facts and circumstances

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.

The description of the scheme is based on information provided by Taxpayer A in the following documents, which are to be read in conjunction with the facts as set out below:

• Taxpayer A's request for a Private Binding Ruling (the Application);

• The Information Memorandum;

• the Terms of the Notes;

• the Deed Poll;

• Taxpayer A's 20WW-XXAnnual Report (the 20WW-XXAnnual Report);

• Taxpayer A's 20XX-YY Annual Report (the 20XX-YY Annual Report); and,

• further submissions from Taxpayer A in response to the ATO's request for further information.

In this ruling, unless otherwise defined, capitalised terms take the same meaning as in the Terms.

This ruling does not consider the Conditions contained in the Terms or the Draft IM which have not been stated in the ruling.

The Taxpayer

1. Taxpayer A is a registered public company limited by shares.

2. Taxpayer A is also a mutual owned credit union, whose customers constitute its members.

3. Taxpayer A's activities consist of providing financial products and services to its members, including loans and depository services.

4. Taxpayer A is an authorised deposit-taking institution (ADI) regulated by the Australian Prudential Regulatory Authority (APRA) in accordance with the Banking Act 1959.

5. Taxpayer A is an Australian resident for income tax purposes.

Regulatory environment

6. Amongst other things, APRA is responsible for establishing capital adequacy requirements which prescribe the minimum amount of capital that ADIs must maintain.

7. As stated in the Objectives and key requirements of [Prudential Standard APS 111 (APS 111)], "[APS 111] sets out the characteristics that an instrument must have to qualify as regulatory capital for an ADI..."

8. Pursuant to paragraph 8 of APS 111, regulatory capital consists of Tier 1 Capital or Tier 2 Capital. Tier 1 Capital comprises Common Equity Tier 1 Capital or Additional Tier 1 Capital.

9. The definition of Common Equity Tier 1 Capital is set out at paragraph 18 of APS 111, which states:

Common Equity Tier 1 Capital comprises the highest quality components of capital that fully satisfy all of the following characteristics:

(a) provide a permanent and unrestricted commitment of funds;

(b) are freely available to absorb losses;

(c) do not impose any unavoidable servicing charge against earnings; and

(d) rank behind the claims of depositors and other creditors in the event of winding-up of the issuer.

10. The definition of Additional Tier 1 Capital is set out at paragraph 27 of APS 111, which states:

Additional Tier 1 Capital comprises high quality components of capital that satisfy the following essential characteristics:

(a) provide a permanent and unrestricted commitment of funds;

(b) are freely available to absorb losses;

(c) rank behind the claims of depositors and other creditors in the event of winding-up of the issuer; and

(d) provide for fully discretionary capital distributions.

11. In relation to Tier 2 capital, paragraph 30 of APS 111 states:

Tier 2 Capital includes other components of capital that, to varying degrees, fall short of the quality of Tier 1 Capital but nonetheless contribute to the overall strength of an ADI and its capacity to absorb losses.

The Notes

12. Taxpayer A intends to raise capital that qualifies as Tier 2 Capital under the revised APS 111.

13. It is intended that this will be achieved by the issue of Notes through a public offering (for the purposes of section 128F of the ITAA 1936 regulated under the Corporations Act 2001.

14. Taxpayer A has confirmed that the issue of the Notes has not yet been approved by APRA, however, the Notes are intended to constitute Tier 2 Capital.

15. The Notes will be issued for the purpose of enabling Taxpayer A to satisfy its capital adequacy requirements.

16. The proceeds from the issue of the Notes will be used either to retire outstanding debt owed by Taxpayer A or for general financing purposes in carrying on Taxpayer A's business.

The Programme details

17. The Programme is intended to commence in the first or second quarter of the financial year commencing 1 July 20ZZ.

18. As provided for in the Draft IM, the Programme is limited to a specific amount AUD$.

19. The Notes are intended to be sold only to wholesale, institutional and sophisticated investors to whom the Notes can be issued without disclosure under Part 6D.2 of the Corporations Act 2001.

Relevant terms of the Notes

20. The proposed terms of the Notes are contained in the Terms. The relevant terms are stated below.

Principal

21. Taxpayer A envisages that each Note will have a principal value of more than $4,000 or $40,000; however, this will be set out in the relevant Pricing Supplement (refer to the definition of 'Issue Price' contained in the Terms).

22. The Notes will be denominated in Australian dollars (unless otherwise specified in the Pricing Supplement).

Term

23. The term of the Notes will be specified in the Pricing Supplement; however, this will not be longer than 30 years from the Issue Date (refer to the definition of 'Maturity Date' contained in the Terms).

24. Taxpayer A has stated that there is no right to extend the term of the Notes beyond this point.

Status and priority

25. A Condition sets out the status and ranking of the Notes as follows:

(a) [Notes] constitute direct, subordinated and unsecured obligations of the Issuer and will rank for payment in a Winding-Up as set out in [another Condition] ("Winding-Up").

(b) [Notes] of each Series rank pari passu among themselves.

(c) Holders do not have any right to prove in a Winding-Up in respect of [Notes], except as permitted under [another Condition] ("Winding-Up").

26. A Condition sets out the priority of the Notes in the event of a Winding-Up of Taxpayer A, as follows:

In a Winding-Up:

(i) Holders shall have no right or claim against the issuer in respect of the principal of, interest on or Additional Amounts relating to their [Notes], to the extent such [Notes] has been Converted or Written-off;

(ii) the claims of Holders against the Issuer in respect of [Notes] that have not been Converted or Written-off will:

A. be subordinated in right of payment to the claims of all Senior Creditors and all such claims of Senior Creditors shall be entitled to be paid in full before any payment shall be paid on account of any sums payable in respect of such [Notes];

B. rank equally with the obligations of the Issuer to the holders of other [Notes] that have not been Converted or Written-off, and the obligations of the Issuer to holders of Equal Ranking Instruments; and,

C. rank prior to, and senior in right of payment to, the obligation of the Issuer to holders of MEIs and other Junior Ranking Capital Instruments.

Interest

27. The Terms provide for the interest payments on the Notes to be based on a floating or fixed interest rate. Accordingly, the relevant Pricing Supplement will specify whether a Note is a Fixed Rate Note or a Floating Rate Note or a combination of both (refer the Terms).

28. Interest on Fixed Rate Notes is payable pursuant to a particular Condition, which states:

Each Fixed Rate Note bears interest on its outstanding principal amount from (and including) its Interest Commencement Date to (but excluding) its Maturity Date at the Interest Rate. Interest is payable in arrears on each Interest Payment Date.

29. Interest on Floating Rate Notes is payable pursuant to a particular Condition, which states:

Each Floating Rate Note bears interest on its outstanding principal amount from (and including) its Interest Commencement Date to (but excluding) its Maturity Date at the Interest Rate.

Interest is payable in arrear:

(a) on each Interest Payment Date; or

(b) if no Interest Payment Date is specified in the Pricing Supplement, each date which falls the number of months or other period specified as the Specified Period in the Pricing Supplement after the preceding Interest Payment Date (or in the case of the first Interest Payment Date, after the Interest Commencement Date).

30. The payment of interest for Fixed and Floating Rate Notes takes its meaning with reference to 'Interest Payment Date', which is defined in the Terms as follows:

Interest Payment Date means each date so specified in, or determined in accordance with, the Pricing Supplement (and adjusted, if necessary, in accordance with the applicable Business Day Convention if so specified in the Pricing Supplement)

31. The interest on Fixed Rate Notes is calculated pursuant to a particular Condition, which states:

Unless otherwise specified in the Pricing Supplement, the amount of interest payable on each Interest Payment Date in respect of the preceding Interest Period will be the Fixed Coupon Amount specified in the Pricing Supplement.

32. The interest on Floating Rate Notes is calculated pursuant to a Condition, which states:

The Interest Rate payable in respect of a Floating Rate Note must be determined by the Calculation Agent in accordance with these Conditions.

Redemption

33. A particular Condition sets out how redemption of the Notes is to occur, as follows:

Each [Note] will be redeemed by the Issuer on the Maturity Date at its Redemption Amount unless:

(a) the [Note] has been previously redeemed, Converted or Written-off; or

(b) the [Note] has been purchased and cancelled.

34. Taxpayer A also has the option to redeem all (but not some) of the Notes before maturity for taxation reasons (refer to the Terms) or regulatory reasons (refer the Terms).

35. Taxpayer A has the right to redeem some or all of the Notes before maturity as provided for in a particular Condition.

Solvency Condition

36. Payment of the principal or interest is not discretionary, but is conditional on Taxpayer A being Solvent at that time and remaining Solvent after making such payment. To this effect, a Condition, entitled 'Solvency Condition' relevantly states that:

Prior to a Winding-Up:

(a) the obligation of the Issuer to make any payment of principal or interest in respect of [Notes] shall be conditional upon the Issuer being Solvent at the time the payment or other amount owing falls due; and

(b) no amount is payable by the Issuer in respect of the [Notes] unless, at the time of and immediately after such payment, the Issuer is Solvent.

37. In the event that the Solvency Condition is not satisfied, the payments will accumulate without compounding, as further stated at a Condition:

Provided that [Notes] have not been converted or Written-off, any amount not paid due to this clause accumulates without compounding and remains a debt owing to the Holder by the Issuer until it is paid and shall be payable on the first to occur of:

(i) the date on which [the other clause] would not apply (whether or not such date is otherwise a payment date);

(ii) an Event of Default; and

(iii) the Issuer being Wound-Up.

38. Further to paragraph 37, a particular Condition states:

If a payment of principal or interest in respect of a [Note] is improperly withheld or refused or not paid when due and payable, such amount will accumulate (without compounding) until the date on which payment is made.

39. Furthermore, failure to make a payment due to the operation of the Solvency Condition is not an Event of Default, as stated in a Condition:

An event of default occurs in relation to the [Notes] of any Series if any of the following events occurs and is continuing (each an "Event of Default"):

(a) (non-payment) if default by the Issuer is made in the payment of any interest or principal due in respect of any [Notes] of the Series or any of them and such default continues for a period of seven days (in the case of interest) or three days (in the case of principal) (or such other period as may be specified in the Pricing Supplement) (for the avoidance of doubt, it will not be an Event of Default for [Notes] if all or any part of an amount that is due and payable is not paid because of the application of [another Condition] ("Solvency Condition")); or

(b) (Winding-Up) if the Issuer is being Wound-Up.

40. In the event of a Winding-Up, the Solvency Condition does not apply to defer the due date for payment as described in a particular Condition. Instead, the principal and interest will fall due and payable but subordinated to the claims of Senior Creditors as described in a Condition.

Non-viability condition

41. A "Non-Viability Trigger Event" is defined in the Terms as:

Non-Viability Trigger Event occurs when APRA notifies the Issuer in writing that it believes:

(a) Conversion or Write-off of all or some [Notes] or conversion or write down of all or some of the capital instruments of the Issuer is necessary because, without it, the Issuer would become non-viable; or

(b) a public sector injection of capital, or equivalent support, is necessary because, without it, the Issuer would become non-viable.

42. If APRA considers Taxpayer A would become non-viable, a particular Condition will apply as follows:

If a Non-Viability Trigger Event occurs, the Issuer must:

(iv) if the Pricing Supplement specifies that the primary method of loss absorption will be Conversion, then subject to [another] Condition ("No further rights"), Convert;

(v) if the Pricing Supplement specifies that the primary method of loss absorption will be Write-off without Conversion in accordance with [another] Condition ("No further rights"), Write-off;

(vi) if the Pricing Supplement specifies that the primary method of loss absorption will be Write-off with possible Conversion in accordance with [another] Condition ("No further rights"), Write-off or, if the Conversion Condition has been satisfied prior to the Non-Viability Trigger Event Date, Convert (as the case may be)

43. Taxpayer A has stated that the primary method of loss absorption for every Tranche or Series of Notes that is issued will be Write-off without Conversion. The relevant Pricing Supplement will not permit the Conversion process until such time as (i) the constitution of Taxpayer A is amended to permit Conversion (which is not currently the case) and (ii) Taxpayer A is satisfied (due to a change in law) that the ability of the Notes to Convert into Mutual Equity Interests (MEIs) will not prevent the Notes from qualifying as a debt interest for the purposes of the Income Tax Assessment Act 1997 (the ITAA 1997).

44. As the primary method of loss absorption will be Write-off without Conversion, a Condition gives effect to this process. This relevantly states:

If:

…

(b) the Pricing Supplement specifies that the primary method of loss absorption will be Write-off without Conversion in accordance with this Condition;

…

Then:

(d) the relevant Holders' rights and claims under these Conditions (including to payments of interest or the repayment of principal) in relation to such [Notes] or the percentage of the outstanding principal amount of such [Notes] are immediately and irrevocably terminated on the Non-Viability Trigger Event Date; and

(e) the outstanding principal amount of the [Notes] is reduced on that date by the outstanding principal amount of the [Notes] to be Converted or Written-off, as determined in accordance with certain Conditions ("Non-Viability Trigger Event") and any accrued and unpaid interest shall be correspondingly reduced.

Assumptions

45. The interest rate on each Note will be determined by reference to the Terms and the relevant Pricing Supplement, and will be equal to or greater than the Benchmark Rate of Return determined immediately before each Note is issued pursuant to section 974-145 of the ITAA 1997.

46. The primary method of loss absorption for every Tranche or Series of Notes that is issued will be Write-off without Conversion. For the avoidance of doubt, (i) this ruling only considers the Tranche or Series of Notes under which the relevant Pricing Supplement permits Write-off without Conversion as the primary method of loss absorption and (ii) the primary method of loss absorption is the only method of loss absorption under the relevant Pricing Supplement.

47. If the Notes are Written-off, the value of the balancing adjustment amount worked out under section 230-445(1) of the ITAA 1997 will be equal to the value of outstanding principal and any accrued and unpaid interest at that time.

48. If the Notes are Written-off, the value of the debt when it is forgiven under section 245-55 of the ITAA 1997 will be equal to the nominal value of outstanding principal and any accrued and unpaid interest at that time.

49. Taxpayer A will be a resident of Australia for the entire term of the Notes.

50. The Final Terms will be identical to the Terms.

Relevant legislative provisions

Income Tax Assessment Regulations 1997 regulation 974-135D

Income Tax Assessment Regulations 1997 regulation 974-135F

Income Tax Assessment Act 1997 section 6(5)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subdivision 104-C

Income Tax Assessment Act 1997 section 230-15

Income Tax Assessment Act 1997 section 230-40

Income Tax Assessment Act 1997 section 230-45

Income Tax Assessment Act 1997 section 230-55

Income Tax Assessment Act 1997 section 230-435

Income Tax Assessment Act 1997 section 230-445

Income Tax Assessment Act 1997 section 230-470

Income Tax Assessment Act 1997 section 245-10

Income Tax Assessment Act 1997 section 245-35

Income Tax Assessment Act 1997 section 245-40

Income Tax Assessment Act 1997 section 245-55

Income Tax Assessment Act 1997 section 245-65

Income Tax Assessment Act 1997 section 245-75

Income Tax Assessment Act 1997 section 245-85

Income Tax Assessment Act 1997 section 245-105

Income Tax Assessment Act 1997 sections 245-115 to 245-195

Income Tax Assessment Act 1997 section 974-15

Income Tax Assessment Act 1997 section 974-20

Income Tax Assessment Act 1997 section 974-35

Income Tax Assessment Act 1997 section 974-40

Income Tax Assessment Act 1997 section 974-50

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 section 974-135

Income Tax Assessment Act 1997 section 974-145

Income Tax Assessment Act 1997 section 974-160

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

Income Tax Assessment Act 1936 section 6(1)

Income Tax Assessment Act 1936 section 128F

Reasons for decision

Question 1

Does regulation 974-135F of the ITAR 1997 apply to the obligation to pay principal and interest on the Notes such that the fact that the obligation is subject to the Non-Viability Trigger Event does not in itself prevent the obligation from being a non-contingent obligation?

Summary

Regulation 974-135F of the ITAR 1997 will apply to the obligation to pay principal and interest on the Notes such that the fact that the obligation is subject to the Non-Viability Trigger Event will not in itself prevent the obligation from being a non-contingent obligation.

In this question, all legislative references are to the ITAA 1997 Regulations, unless otherwise specified.

Detailed reasoning

51. Regulation 974-135F states:

(1) This regulation applies to an obligation to pay the principal or interest on a relevant term subordinated note at a particular time on or after the day this regulation commences.

(2) For paragraphs 974-135(8)(a) and (b) of the Act, the fact that the obligation is subject to a non-viability condition does not in itself prevent the obligation from being a non-contingent obligation.

Notes are 'term subordinated notes'

52. The phrase 'term subordinated note' in subregulation 974-135F(1) is not defined in the ITAR 1997 or the ITAA 1997. However, the Explanatory Statement to the Income Tax Assessment Amendment Regulation 2012 (No. 2) (the 2012 Amendment) defines a 'term subordinated note' as follows:

A term cumulative subordinated note is a financial instrument generally used by companies to obtain finance. It has the following features:

• a fixed term by the end of which the note must be repaid; and

• payment is subordinated to the interests of more senior creditors.

53. The definition of 'term subordinated note' is satisfied for the following reasons:

• the Notes are being used by Taxpayer A to raise finance;

• the term of the Note will not exceed 30 years, at which time Taxpayer A is required to repay the outstanding principal and any accrued and unpaid interest; and,

• the Terms provide that in the event of a Winding-Up, any claims of the Holders will be subordinated in right of all Senior Creditors.

Notes are a 'relevant' 'term subordinated note'

54. For the purposes of subregulation 974-135F(1), a 'term subordinated note' will be 'relevant' if each of requirements in subregulation 974-135F(3) are satisfied. Subregulation 974-135F(3) states:

In this regulation, a term subordinated note is relevant if:

(a) it is issued by an entity regulated for prudential purposes by APRA or a subsidiary of an entity that is regulated for prudential purposes by APRA; and

(b) when it is issued:

(i) it does not constitute or meet the requirements of a Tier 1 capital instrument; and

(ii) it does not form part of the Tier 1 capital of the issuer of the note, and the reason for it not doing so is not that the instrument is in excess of the Tier 1 capital required for the purposes of prudential standards that deal with capital adequacy; and

(c) it has a term of no more than 30 years, and it does not include an unconditional right to extend the term of the note beyond a total term of 30 years; and

(d) it is subject to a condition that, unless a non-viability trigger event occurs, any payment of the principal or interest beyond the date on which it would otherwise be payable must accumulate (with or without compounding); and

(e) it does not give the issuer of the note an unconditional right to decline to provide a financial benefit that is equal in nominal value to the issue price of the note to settle the obligations under the note.

Note for paragraph (b)

Whether the note constitutes or meets the requirement of a Tier 1 capital instrument, or forms part of the Tier 1 capital of the issuer, is determined under the prudential standards that apply to the issuer.

55. For the reasons set out below, the Notes will be a 'relevant' 'term subordinated note'.

Paragraph 974-135F(3)(a)

56. Paragraph 974-135F(3)(a) is satisfied because the Notes are issued by Taxpayer A, who are an ADI (i.e. they are regulated for prudential purposes by APRA).

Paragraph 974-135F(3)(b)

57. Subparagraph 974-135F(3)(b)(i) is satisfied because the Notes will not meet the requirements of Common Equity Tier 1 Capital or Additional Tier 1 Capital, as they do not provide a permanent and unrestricted commitment of funds (as stated in paragraphs 18(a) and 27(a) of APS 111). This is because the term of the Notes is fixed and will not exceed 30 years.

58. If the Notes were not Tier 1 Capital but for the fact that the Notes are in 'excess of the of the Tier 1 Capital required for the purposes of prudential standards that deal with capital adequacy' then subparagraph 974-135F(b)(ii) would not be satisfied. However, as noted above, the Notes are not Tier 1 Capital, because they cannot qualify as Tier 1 Capital. Hence, subparagraph 974-135F(3)(b)(ii) is satisfied and, consequently, paragraph 974-135F(3)(b) is also satisfied.

Paragraph 974-135F(3)(c)

59. Paragraph 974-135F(3)(c) is satisfied because the maximum term of the Notes will be 30 years. Furthermore, Taxpayer A has stated that it will not have the unconditional right to extend the Notes beyond this 30 year period.

Paragraph 974-135F(3)(d)

60. Under the operation of a Condition, payments of principal or interest that are 'improperly withheld or refused or not paid when due and payable' will continue to accumulate (without compounding). Furthermore, in the event that the Solvency Condition operates, a Condition provides that payments will continue to accumulate; and, pursuant to another Condition, the mere non-payment due to the operation of a related Condition will not constitute an Event of Default.

61. It should be noted that the Non-Viability Trigger Event will constitute a non-viability trigger event for the purposes of subregulation 974-135F(5). Subregulation 974-135F(5) relevantly states:

In this regulation, a non-viability trigger event, in relation to a note, is any of the following:

(a) APRA or a comparable foreign regulator issues a notice, in writing, to the issuer of the note stating that conversion or write-off of capital instruments issued by the issuer is necessary because, without it, APRA or the foreign regulator considers that the issuer will become non-viable;

(b) APRA or a comparable foreign regulator determines, in writing given to the issuer of the note, that without an injection of capital, or equivalent support, from the public sector the issuer will become non-viable;

…

62. Under the definition of Non-Viability Trigger Event in the Terms, APRA will notify the issuer (i.e. Taxpayer A) if, without a Conversion or Write-Off of some or all of the capital instruments or Notes; or, without a public sector injection of capital, or equivalent support, the issuer would become non-viable. Hence, the Non-Viability Event as defined in the Terms would constitute a 'non-viability trigger event' for the purposes of subregulation 974-135F(5).

63. The occurrence of the Non-Viability Trigger Event will result in the Write-off of the Notes. This will result in the outstanding principal being reduced by the outstanding principal amount; and, any accrued and unpaid interest being correspondingly reduced. Hence, if a Non-Viability Trigger Event were to occur, principal and interest would not accumulate and will not be payable. As this scenario is within the contemplation of paragraph 974-135F(2)(d), paragraph 974-135F(2)(d) is satisfied.

Paragraph 974-135F(3)(e)

64. In respect of paragraph 974-135F(3)(e) the Explanatory Statement to the 2012 Amendment relevantly provides that the limitation in paragraph 974-135F(3)(e), 'reflects the concept of a liability for financial accounting purposes' and, 'accordingly, the limitation is designed to ensure that the regulation does not facilitate debt tax treatment for a note that is not a liability for financial accounting purposes'. With reference to a particular Condition, it is clear that even if the principal or interest is 'improperly withheld or refused or not paid when due and payable' it will continue to accumulate until payment is made. Hence, it would appear that this characteristic reflects the concept of a liability for financial accounting purposes. Consequently, paragraph 974-135F(3)(e) is satisfied.

65. As subregulation 974-135F(3) is wholly satisfied, the 'term subordinated notes' are a 'relevant' 'term subordinated note' for the purposes of subregulation 974-135F(1).

Regulation 974-135F has commenced

66. Regulation 974-135F was inserted by the by the 2012 Amendment which commences on the date after its registration. The Amendment was registered on 11 December 2012. As the Notes will be issued after this date, the obligation to pay principal or interest will commence after the regulation commences. Hence, subregulation 974-135F(1) is satisfied.

The Notes are subject to a non-viability condition

67. Subregulation 974-135F(2) requires that the obligation is subject to a 'non-viability condition'. In relation to a 'non-viability condition', subregulation 974-135F(4) states:

In this regulation, a condition applying to the obligation is a non-viability condition if the condition has the effect that the note must be written off or converted into ordinary shares of the issuer of the note or a parent entity of the issuer if a non-viability trigger event occurs.

68. Under the Terms, the occurrence of a Non-Viability Trigger Event will result in the Write-off of the Notes. This Write-Off arises by virtue of the Non-Viability Trigger Event occurring, which as stated at paragraphs 61 and 62 above, constitutes a non-viability trigger event as defined in subregulation 974-135F(5). Consequently, the Notes are subject to a non-viability condition for the purposes of subregulation 974-135F(2).

Conclusion

69. Pursuant to subregulation 974-135F(1), the regulation applies to the obligation to pay principal and interest on the Notes, which will constitute 'relevant' 'term subordinated notes' (within the meaning of subregulation 974-135F(3)). This obligation to pay principal and interest is subject to a non-viability condition within the meaning of subregulation 974-135F(4). However, pursuant to subregulation 974-135F(2), the fact that the obligation to pay principal and interest is subject to the non-viability condition, will not in itself prevent the Notes from being treated as a non-contingent obligation (in the words of paragraphs 974-135(8)(a) and 974-135(8)(b) of the ITAA 1997).

70. Therefore, regulation 974-135F will apply to the obligation to pay principal and interest on the Notes, such that the fact that the obligation is subject to the Non-Viability Trigger Event will not in itself prevent the obligation from being a non-contingent obligation.

Question 2

Does regulation 974-135D of the ITAR 1997 apply to the obligation to pay principal and interest on the Notes such the fact that the obligation is subject to the Solvency Condition does not in itself prevent the obligation from being a non-contingent obligation?

Summary

Regulation 974-135D of the ITAR 1997 will apply to the obligation to pay principal and interest on the Notes, such that the fact that the obligation is subject to the Solvency Condition will not in itself prevent the obligation from being a non-contingent obligation.

In this question, all legislative references are to the ITAR 1997, unless otherwise specified.

Detailed reasoning

71. Regulation 974-135D relevantly states:

(1) This regulation applies to an obligation to pay the principal or interest on a relevant term subordinated note at a particular time on or after 1 July 2001.

(2) For paragraphs 974-135(8)(a) and (b) of the Act, the fact that the obligation is subject to insolvency or capital adequacy conditions does not in itself prevent it from being a non-contingent obligation.

Notes are 'term subordinated notes'

72. The phrase 'term subordinated note' in subregulation 974-135D(1) is not defined in the ITAA 1997 Regulations or the ITAA 1997. However, the Explanatory Statement to the Income Tax Assessment Amendment Regulations 2010 (No. 3) (the 2010 Amendment) defines a 'term subordinated note' as follows:

A term cumulative subordinated note is a financial instrument generally used by companies to obtain finance. It has the following features:

• a fixed term by the end of which the note must be repaid; and

• payment is subordinated to the interests of more senior creditors.

73. For the reasons set out in paragraph 53 above, the Notes are 'term subordinated notes.'

Notes are a 'relevant' 'term subordinated note'

74. For the purposes of subregulation 974-135D(1), a 'term subordinated note' will be a 'relevant' 'term subordinated note' if each of the requirements in subregulation 974-135D(3) are satisfied. Subregulation 974-135D(3) states:

In this regulation, a term subordinated note is relevant if:

(a) at the time of its issue:

(i) it does not constitute or meet the requirements of a Tier 1 capital instrument; and

(ii) it does not form part of the Tier 1 capital of the issuer of the note, or a connected entity, and the reason for it not doing so is not that the instrument is in excess of the Tier 1 capital required for the purposes of prudential standards that deal with capital adequacy; and

(b) it has a term of not more than 30 years; and

(c) it does not include an unconditional right to extend the term of the note beyond a total term of 30 years; and

(d) it is subject to a condition that any payment of the principal or interest beyond the date on which it would otherwise be payable must accumulate (with or without compounding); and

(e) it does not give the issuer of the note an unconditional right to decline to provide a financial benefit that is equal in nominal value to the issue price of the note to settle the obligations under the note.

75. For the reasons set out below, the Notes will be a 'relevant' 'term subordinated note'.

Paragraph 974-135D(3)(a)

76. For the reasons set out at paragraph 57 and 58, paragraph 974-135D(3)(a) is satisfied.

Paragraphs 974-135D(3)(b) and 974-135D(3)(c)

77. For the reasons set out at paragraph 59 paragraph 974-135D(3)(b) and 974-135D(3)(c) is satisfied.

Paragraph 974-135D(3)(d)

78. Under the operation of a Condition, payments of principal or interest that are 'improperly withheld or refused or not paid when due and payable' will continue to accumulate (without compounding). Furthermore, in the event that the Solvency Condition operates, a particular Condition provides that payments will continue to accumulate; and, pursuant to another Condition, the mere non-payment due to the operation of another Condition will not constitute an Event of Default.

79. However, where a Non-Viability Trigger Event occurs this will result in the Write-off of the Notes. This will result in the outstanding principal being reduced by the outstanding principal amount; and, any accrued and unpaid interest being correspondingly reduced. Hence, if a Non-Viability Trigger Event were to occur, principal and interest would not be payable and would not continue to accumulate. Therefore, the satisfaction of paragraph 974-135D(3)(d) is predicated on the non-occurrence of a Non-Viability Trigger Event.

80. However, the fact that the paragraph 974-135D(3)(d) implicitly requires the non-occurrence of a Non-Viability Trigger Event, should not be fatal to satisfying this regulation. The Explanatory Statement to the 2010 Amendment states:

The purpose of the Regulations is to facilitate debt tax treatment of certain term subordinated notes. Under the notes, payment can be deferred in certain circumstances and holders are only entitled to payment after other debt holders have been paid. These notes are used to contribute to the capital adequacy of Authorised Deposit-taking Institutions (ADIs) for the purposes of prudential regulations.

81. Under the relevant prudential standard, APS 111, there is a requirement that Tier 2 Capital instruments, are written-off in the event of non-viability. From the discussion at paragraph 63 above, the Write-off of outstanding principal and any accrued and unpaid interest, in the event of the Non-Viability Trigger Event is consistent with the overarching purpose of regulation 974-135D and the prudential standards as it inherently ensures that losses are absorbed at the point of non-viability. Hence, the fact that the operation of paragraph 974-135D(3)(d) is predicated on the non-occurrence of a Non-viability Trigger Event, will not frustrate the satisfaction of paragraph 974-135D(3)(d).

82. Furthermore, due the operation of regulation 974-135F, the fact that the Notes are subject to a non-viability condition will not in itself prevent the Notes from being a non-contingent obligation. It therefore stands to reason, that this very non-viability condition, should therefore not preclude paragraph 974-135D(3)(d) from being satisfied. Consequently, notwithstanding the presence of the non-viability condition, paragraph 974-135(3)(d) is satisfied.

Paragraph 974-135D(3)(e)

83. For the reason set out at paragraph 64 above, paragraph 974-135D(3)(e) is satisfied.

84. As subregulation 974-135D(3) is wholly satisfied, the 'term subordinated notes' are a 'relevant' 'term subordinated note' for the purposes of subregulation 974-135D(1).

Regulation 974-135D has commenced

85. The obligation to pay principal and interest on the Notes will be after 1 July 2001 as the Notes will be issued after this date. Hence, subregulation 974-135D(1) is fully satisfied.

The Notes are subject to an insolvency condition

86. Subregulation 974-135D(2) requires that the obligation is subject to an 'insolvency or capital adequacy condition'. In relation to 'insolvency or capital adequacy conditions', subregulation 974-135D(4) states:

In this regulation, conditions applying to the obligation are insolvency or capital adequacy conditions if they have the effect that the issuer of the note is obliged or able to defer the payment of the principal or interest beyond the date on which it would otherwise be payable if, on that date:

(a) the issuer of the note is insolvent, or would become insolvent if the payment were made; or

(b) if the issuer of the note is an entity that is regulated by the APRA or a comparable foreign regulator--the issuer is in breach of its capital adequacy ratio or would be in breach if the payment were made.

87. Under a Condition, the obligation to pay principal or interest is contingent upon Taxpayer A remaining Solvent at the time the payment is made and remaining Solvent after such payment is made. In the event that Taxpayer A is not Solvent, payments will continue to accumulate without compounding with the payment to occur at the time the Solvency Condition is subsequently satisfied. Hence, the Notes are subject to an 'insolvency condition', within the meaning of paragraph 974-135D(4)(a) as this Condition operates to defer payments of principal and interest in the event that Taxpayer A is not Solvent or insolvent. Hence, the Notes are subject to an 'insolvency or capital adequacy condition' for the purposes of subregulation 974-135D(2).

Conclusion

88. Pursuant to subregulation 974-135D(1), regulation 974-135D applies to the obligation to pay principal and interest on the Notes, which will constitute 'relevant term subordinated notes' (within the meaning of subregulation 974-135D(3)). This obligation to pay principal and interest is subject to an 'insolvency or capital adequacy condition' within the meaning of paragraph 974-135D(4)(a). However, under subregulation 974-135D(2), the fact that the obligation to pay principal and interest is subject to an 'insolvency or capital adequacy condition', will not in itself prevent the Notes from being treated as a non-contingent obligation (in the words of paragraphs 974-135(8)(a) and 974-135(8)(b) of the ITAA 1997).

89. Therefore, Regulation 974-135D will apply to the obligation to pay principal and interest on the Notes, such that the fact that the obligation is subject to an 'insolvency condition' will not in itself prevent the obligation from being a non-contingent obligation.

Question 3

Will the Notes be debt interests in Taxpayer A under section 974-15 of the ITAA 1997?

Summary

The Notes will be debt interests in Taxpayer A under section 974-15 of the ITAA 1997.

In this question, all legislative references are to the ITAA 1997, unless otherwise specified.

Detailed reasoning

90. Subsection 974-15(1) states:

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.

The Notes are a 'scheme'

91. Subsection 995-1(1) defines a 'scheme' as follows:

scheme means:

(a) any * arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

92. An arrangement is also defined in subsection 995-1(1), as follows:

arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

93. The Notes are a 'scheme' because it is an 'arrangement' under which Taxpayer A undertakes to pay interest and principal under the terms of the Notes to the investors. These obligations are intended to be enforceable by legal proceedings.

The Notes satisfy the debt test

94. Subsection 974-20(1) sets out the test for a debt interest as follows:

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 * 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.

…

Paragraph 974-20(1)(a)

95. A 'financing arrangement', under paragraph 974-20(1)(a), is defined under subsection 974-130(1), which states:

A * scheme is a financing arrangement for an entity if it is entered into or undertaken:

(a) to raise finance for the entity (or a * connected entity of the entity); or

(b) to fund another scheme, or a part of another scheme, that is a * financing arrangement under paragraph (a); or

(c) to fund a return, or a part of a return, payable under or provided by or under another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a).

96. The Notes constitute a 'financing arrangement' as they are being issued to raise finance for Taxpayer A. The funds from the issue of the Notes will be used for general financing purposes in carrying on Taxpayer A's business. Hence, the scheme will be a 'financing arrangement' for the purposes of paragraph 974-20(1)(a).

Paragraph 974-20(1)(b)

97. A 'financial benefit' under paragraph 974-20(1)(b), is defined under section 974-160, which relevantly states:

(1) In this Act:

"financial benefit":

(a) means anything of economic value; and

(b) includes property and services; and

(c) includes anything that regulations made for the purposes of subsection (3) provide is a financial benefit;

even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.

(2) In applying subsection (1), benefits and obligations are to be looked at separately and not set off against each other.

98. Taxpayer A will receive a payment equal to the Issue Price when the investor first subscribes to the Notes, which will constitute a 'financial benefit' under section 974-160.

99. However, subsection 970-20(4) provides a qualification in relation to the financial benefit received by Taxpayer A under paragraph 974-20(1)(b). Subsection 974-20(4) relevantly states:

For the purposes of paragraph (1)(b) and subsections (2) and (3):

…

(b) a financial benefit to be received under the scheme by the entity or a connected entity is taken into account only if it is one that another entity has an effectively non-contingent obligation to provide.

100. An effectively non-contingent obligation (ENCO) is relevantly defined under section 974-135, as follows:

(1) There is an effectively non-contingent obligation to take an action under a * scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation (see subsections (3), (4) and (6)) to take that action.

(2) Without limiting subsection (1), that subsection applies to:

(a) providing a * financial benefit under the * scheme; or

(b) terminating the scheme.

(3) An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a * connected entity of that entity), other than the ability or willingness of that entity or connected entity to meet the obligation.

…

101. The financial benefit (i.e. the payment to Taxpayer A equal to the Issue Price) is an effectively non-contingent obligation (an ENCO) because the payment is not contingent on any event, condition or situation other than the investor's willingness to make the payment of the issue price.

102. Consequently, paragraph 974-20(1)(b) is satisfied as Taxpayer A has the obligation to receive the 'financial benefit' (i.e. the principal), which is an ENCO.

Paragraph 974-20(1)(c)

103. Under paragraph 974-20(1)(c), after Taxpayer A receives the financial benefit in the form of the Issue Price from the Holders, there is an obligation for Taxpayer A to make periodic interest payments in accordance with the Interest Payment dates and to redeem the outstanding principal at Maturity. However, due to taxation or regulatory reasons, redemption could occur earlier to Maturity. In this case, under certain Conditions, Taxpayer A is required to redeem the outstanding principal amount together with interest accrued up to (but excluding) the relevant date. Further to this, under another Condition, Taxpayer A is able to redeem some or all of the Notes of a Series before Maturity at an Early Redemption Date as specified in the Pricing Supplement. However, pursuant to this Condition the Early Redemption Date can only occur on or after the fifth anniversary of the issue date.

104. Although the obligation to pay interest may not extend for the entire term of the notes (due to the early redemption mechanisms in the Terms), there is an obligation to repay the principal and interest (up until the time of redemption, as the case may be). It is this obligation that must be a non-contingent obligation.

105. Section 974-135, provides clarity on what is a non-contingent obligation as stated at paragraph 100 above.

106. With reference to the Terms, the repayment of principal is conditional on the satisfaction of the Solvency Condition and the non-occurrence of a Non-Viability Trigger Event. To this effect subsection 974-135(8), provides that the regulations are able to make further provisions relating to the following:

(a) what constitutes a non-contingent obligation;

(b) what does not constitute a non-contingent obligation;

(c) what constitutes an * effectively non-contingent obligation;

(d) what does not constitute an effectively non-contingent obligation.

107. Pursuant to subsection 974-135(8), regulations 974-135F and 974-135D of the ITAR 1997 were made. Pursuant to regulation 974-135F of the ITAR 1997, with reference to paragraphs 51 to 70 above, the fact that the obligation to pay interest and principal is contingent upon the non-occurrence of a Non-Viability Trigger, will not prevent the Notes from being a non-contingent obligation. Similarly, pursuant to regulation 974-135D of the ITAR 1997, with reference to paragraphs 71 to 89 above, the fact that the obligation to pay interest and principal is contingent upon the satisfaction of the Solvency Condition, will not prevent the Notes from being a non-contingent obligation. Hence, the obligation is not contingent on any event, condition or situation aside from Taxpayer A's willingness to pay. This will therefore constitute an ENCO (under subsection 974-135(1)) as there is, in 'substance or effect', a non-contingent obligation. Consequently, Taxpayer A will satisfy paragraph 974-20(1)(c) by virtue of Taxpayer A having an ENCO to provide principal and interest on the Notes after the time it receives the financial benefit from investors.

108. It should be noted that if a Winding-Up were to occur, then under a particular Condition the claims of the Holders is subordinated in right of payment to the claims of all Senior Creditors. Although this may result in the Holders not being paid in full due to Taxpayer A not having sufficient assets, it will not operate to make this obligation contingent. This is because the subordination clauses preserve the obligation and operate to merely postpone enforcement of that obligation to a time that other creditors are paid.

109. Hence, Taxpayer A has an ENCO to make payments of principal and interest and will therefore satisfy paragraph 974-20(1)(c).

Paragraph 974-20(1)(d)

110. Under paragraph 974-20(1)(d) the value provided by Taxpayer A must be at least equal to the value received by Taxpayer A.

111. Regarding the 'value provided' subsection 974-20(2) states:

The value provided is:

(a) the value of the * financial benefit to be provided under the * scheme by the entity or a * connected entity if there is only one; or

(b) the sum of the values of all the financial benefits provided or to be provided under the scheme by the entity or a connected entity of the entity if there are 2 or more.

Note: Section 974-35 tells you how to value financial benefits.

112. Regarding the 'value received' subsection 974-20(3) states:

The value received is:

(a) the value of the * financial benefit received, or to be received, under the * scheme by the entity or a * connected entity of the entity if there is only one; or

(b) the sum of the values of all the financial benefits received, or to be received, under the scheme by the entity or a connected entity if there are 2 or more.

113. Further to subsection 974-20(2), section 974-35 states:

(1) For the purposes of this Subdivision:

(a) the value of a * financial benefit received or provided under a * scheme is its value calculated:

(i) in nominal terms if the performance period (see subsection (3)) must end no later than 10 years after the interest arising from the scheme is issued; or

(ii) in present value terms (see section 974-50) if the performance period must or may end more than 10 years after the interest arising from the scheme is issued; and

(b) the regulations may make provisions relating to the valuation of a financial benefit.

Assume scheme runs its full term

(2) The value of a * financial benefit received or provided under a * scheme is calculated assuming that the interest arising from the scheme will continue to be held for the rest of its life.

Note 1: Section 974-40 makes specific provision for cases in which there is a right or option to terminate the interest early.

Note 2: Section 974-45 makes specific provision for cases involving convertible interests.

Performance period

(3) The performance period is the period within which, under the terms on which the interest is issued, the * effectively non-contingent obligations of the issuer, and any * connected entity of the issuer, to provide a * financial benefit in relation to the interest have to be met.

114. Due to the operation of certain Conditions which provide for an earlier redemption, it is necessary to refer to section 974-40, which deals with the scenario whereby a specific provision provides for the right to terminate the interest at an earlier period. Section 974-40 relevantly states:

(1) This section deals with the situation in which a party to a * scheme has a right or option to terminate the scheme early (whether by discharging an obligation early, converting the interest arising from the scheme into another interest or otherwise).

Note 1: An example of terminating a scheme early by discharging an obligation early is terminating a loan by discharging the obligation to repay the principal (and any outstanding interest) early.

Note 2: In certain circumstances, conversion of an interest into another interest can terminate its life (see section 974-45).

(2) The existence of the right or option is to be disregarded in working out the length of the life of the interest arising from the * scheme for the purposes of this Subdivision if the party does not have an * effectively non-contingent obligation to exercise the right or option.

(3) If the party does have an * effectively non-contingent obligation to exercise the right or option, the life of the interest ends at the earliest time at which the party will have to exercise the right or option.

115. The Notes may be terminated at an earlier date to maturity for taxation reasons, regulatory reasons or at Taxpayer A's own discretion. In each of these scenarios, Taxpayer A would be able to terminate the scheme, by 'discharging the obligation', as provided for in subsection 974-40(1). However, the right to terminate could not be said to be an ENCO as it is dependent on the occurrence of a specified event (i.e. taxation or regulatory reasons) or at Taxpayer A's discretion. The effect of this is that the right to terminate the Notes is disregarded for the purpose of working out the length of the Notes, under subsection 974-40(2). Hence, the term of the Note is its entire length as specified in the Pricing Supplement.

116. Referring to the words of subparagraph 974-35(1)(a)(ii) the 'performance period' of the Notes, 'must or may end more than 10 years after the interest arising from the scheme is issued.' Under the Terms, the term of the Notes may therefore end more than 10 years (but will not exceed 30 years), at which point, the principal is to be repaid to the Holders. Hence, under subparagraph 974-35(1)(a)(ii) the Notes will need to be valued in present value terms.

117. Section 974-50 outlines the methodology for present value calculations. Section 974-50 relevantly states:

(1) Subject to the regulations made for the purposes of subsection (5), the value in present value terms of a * financial benefit to be provided or received in respect of an interest (the test interest) is calculated under subsection (4).

…

(4) The value of a * financial benefit in present value terms is:

" adjusted benchmark rate of return " is 75% of the * benchmark rate of return on the test interest.

" n " is the number of years in the period starting on the day on which the test interest is issued and ending on the day on which the * financial benefit is to be provided. If the period includes a part of a year, that part is to be expressed as the fraction:

118. Subsection 974-145(1) defines 'benchmark rate of return' as follows:

The benchmark rate of return for an interest (the test interest) in an entity is the annually compounded internal rate of return on an * ordinary debt interest that:

(a) is issued, immediately before the test interest is issued, by the entity, or an equivalent entity, to an entity that is not a * connected entity; and

(b) has a comparable maturity date; and

(c) is in the same currency; and

(d) is issued in the same market; and

(e) has the same credit status; and

(f) has the same degree of subordination to debts owed to the ordinary creditors of the issuer.

119. Under the assumption at paragraph 45 above, the interest rate on each Note will be determined by reference to the Terms and the relevant Pricing Supplement, and will be equal to or greater than the benchmark rate of return determined immediately before each Note is issued pursuant to section 974-145.

120. As the interest rate on each Note will be equal to or greater than the 'benchmark rate of return' immediately just before its date of issue, it is substantially more likely than not that the value provided under the Note will be at least equal to the value received, where the term of the Note is greater than 10 years, for the purposes of subsection 974-20(1)(d).

121. In the event where the term of the Notes is 10 years or less (where the Pricing Supplement specifies a term of 10 years or less), subparagraph 974-35(1)(a)(i) requires that the value of the financial benefits are to be calculated using nominal terms. As Taxpayer A is always required to repay the principal amount at the time of redemption, plus periodic interest payments; in nominal terms, the value of benefits provided will be at 'least equal to' the value of the financial benefits received. Hence, paragraph 974-20(1)(d) will be satisfied even where the Notes have a term of 10 years or less.

122. It should be noted that the fact that the Notes could have a floating or fixed rate, should not preclude the Notes from satisfying paragraph 974-20(1)(d). Subsection 974-35(5), relevantly states:

Benefit dependent on variable factor

If:

(a) a * financial benefit received or provided in respect of an interest depends on a factor that may vary over time (such as a variable interest rate); and

(b) that factor is one commonly used in commercial arrangements; and

(c) it would be unreasonable to expect any of the parties to the * scheme to know, or to anticipate accurately, the future value of that factor; and

(d) that factor has a particular value (the starting value ) when the scheme is entered into;

the value of the financial benefit is calculated assuming that the factor's value will retain the starting value for the whole of the life of the scheme.

Note: For example, the value of a return based on a floating interest rate is calculated on the basis that the interest rate remains the interest rate that is applicable when the scheme is entered into.

123. Section 974-35(5) is satisfied because:

• pursuant to paragraph 974-35(5)(a), the interest payments could be based on floating interest rate, which would cause the financial benefit to vary;

• pursuant to paragraph 974-35(5)(b), floating interest rates are commonly used in commercial debt arrangements;

• pursuant to paragraph 974-35(5)(c), the floating interest rates are determined by various external factors, so it would be unreasonable to expect the parties to accurately anticipate the future interest rate value; and,

• pursuant to paragraph 974-35(5)(d) the floating interest rate will have a particular starting value.

124. As provided in subsection 974-35(5), the value of a return is calculated using the interest rate at the time the scheme is entered into. Accordingly, this will not change the analysis of determining whether the value of the financial benefit provided is at least equal to the value of the financial benefit received. Hence, paragraph 974-20(1)(d) will be satisfied, even if the Notes use a floating rate to determine interest.

Paragraph 974-20(1)(e)

125. Subsection 974-20(1)(e) is satisfied as neither the value provided nor the value received will be nil. In both cases, an amount of money is provided by Taxpayer A and received by Taxpayer A.

126. Owing to the classification of the Notes as debt interests, the Notes cannot also be classified as equity interests. This is because paragraph 974-70(1)(b) of the ITAA 1997 provides that in order for an interest to be an equity interest, it cannot also be a debt interest.

Conclusion

127. As per the reasoning provided in paragraphs 94 to 126 above, the Notes will meet the requirements of the debt test in section subsection 974-20(1). As the subordinated Notes are the relevant scheme, the Notes will be debt interests in Taxpayer A under section 974-15.

Question 4

Will the Notes be "financial arrangements" for Taxpayer A under subsection 230-45(1) of the ITAA 1997?

Summary

The Notes will be "financial arrangements" for Taxpayer A under subsection 230-45(1) of the ITAA 1997.

In this question, all legislative references are to the ITAA 1997, unless otherwise specified.

Detailed reasoning

128. Subsection 230-45(1) states:

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) 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.

129. An arrangement is also defined in subsection 995-1(1), as follows:

arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

130. The Notes are an "arrangement" under which Taxpayer A undertakes to pay interest and principal under the terms of the Notes to the investors. These obligations are intended to be enforceable by legal proceedings.

131. The grouping and disaggregation rules at section 230-55 relevantly state:

(1) If you have a right to receive 2 or more * financial benefits, you are taken, for the purposes of this Division, to have a separate right to receive each of those financial benefits.

(2) If you have an obligation to provide 2 or more * financial benefits, you are taken, for the purposes of this Division, to have a separate obligation to provide each of those financial benefits.

(3) Subsections (1) and (2) apply for the avoidance of doubt.

…

132. Consequently, each Note would constitute an arrangement for the purposes of subsection 230-45(1). The definition of rights or obligations that are 'cash settlable', are relevantly stated at subsection 230-45(2):

…

(b) in the case of a right-you intend to satisfy or settle it by receiving money or a money equivalent or by starting to have, or ceasing to have, another * financial arrangement; or

(c) in the case of an obligation-you intend to satisfy or settle it by providing money or a money equivalent or by starting to have, or ceasing to have, another financial arrangement; or

…

133. With regard to each Note, Taxpayer A has the legal right to receive the issue price (upon subscription) and the legal obligation to make interest payments and redeem the principal at the redemption time. As the rights and obligations involve the receipt of money and the payment of money respectively, Taxpayer A will have a cash settlable right to receive or provide financial benefits. Furthermore, paragraphs 230-45(1)(d), 230-45(1)(e) and 230-45(1)(f) should not apply as the rights and obligations wholly apply to the receipt and payment of money. Consequently, each Note is a financial arrangement for Taxpayer A.

134. Therefore, the Notes will be financial arrangements for Taxpayer A under subsection 230-45(1).

Question 5

Will Taxpayer A be entitled to deductions for losses for interest payments on the Notes under section 230-15(2) of the ITAA 1997 to the extent the interest payments are incurred in deriving assessable income?

Summary

Taxpayer A will be entitled to deductions for losses for interest payments on the Notes under section 230-15(2) of the ITAA 1997 to the extent the interest payments are incurred in deriving assessable income.

In this question, all legislative references are to the ITAA 1997, unless otherwise specified.

Detailed reasoning

135. Subsection 230-15(2) states:

You can deduct a loss you make from a * financial arrangement, but only to the extent that:

(a) you make it in gaining or producing your assessable income; or

(b) you necessarily make it in carrying on a * business for the purpose of gaining or producing your assessable income.

136. Under the reasoning provided from paragraphs 128 to 134, the Notes are financial arrangements. While the word 'loss' is not defined for the purposes of subsection 230-15(2), the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2009 (the Tax Laws Amendment Bill 2009) relevantly provides:

3.9 Division 230 will not contain a definition of a 'gain' or a 'loss'. However, as a general rule a 'gain' or a 'loss' from a financial arrangement may be calculated as follows:

• Step 1 - calculate the money received from a financial arrangement including that received at maturity or upon disposal.

• Step 2 - calculate the cost of the financial arrangement including those expenses at maturity or upon disposal.

• Step 3 - deduct the amount at step 2 from the amount at step 1.

3.10 There will be a gain from a financial arrangement if the amount at step 3 is positive. On the other hand, there will be a loss from a financial arrangement if the amount at step 3 is negative.

137. Applying this methodology, the step 1 amount is the money received by Taxpayer A, which is the principal received. The step 2 amount, is the principal repaid on redemption and the interest payments over the term of the Notes. Prima facie, the step 3 amount should equal the interest payments which would represent the 'loss' made on the financial arrangement.

138. The interest payments are necessarily incurred in carrying on Taxpayer A's business as the interest payments are incurred under the terms of the Notes. As stated in paragraph 15 above, the issue of the Notes will enable Taxpayer A to satisfy its capital adequacy standards. However, as set out at paragraph 16 above, the proceeds arising from the issue of the Notes enable Taxpayer A to carry on its business. Hence, under paragraph 230-15(2)(b), losses for interest payments are necessarily incurred in gaining or producing assessable income.

139. Therefore, Taxpayer A is entitled to deductions for losses for interest payments on the Notes under subsection 230-15(2) to the extent the interest payments are incurred in deriving assessable income.

Question 6

Will the interest paid by Taxpayer A in respect of the Notes be "interest paid by a company in respect of a debenture" within the meaning of subsection 128F(1) of the ITAA 1936?

Summary

The interest paid by Taxpayer A in respect of the Notes is "interest paid by a company in respect of a debenture" within the meaning of subsection 128F(1) of the ITAA 1936.

In this question, all legislative references are to the ITAA 1936, unless otherwise specified.

Detailed reasoning

140. Subsection 128F(1) relevantly states that 128F

… applies to interest paid by a company in respect of a debenture …:

141. 'Interest' for the purposes of subdivision 11A (which includes section 128F) is relevantly defined in subsection 128A(1AB) as follows:

" interest " includes an amount, other than an amount referred to in subsection 26C(1):

(a) that is in the nature of interest; or

(b) to the extent that it could reasonably be regarded as having been converted into a form that is in substitution for interest; or

(c) the extent that it could reasonably be regarded as having been received in exchange for interest in connection with a washing arrangement; or

(d) that is a dividend paid in respect of a non-equity share; or

(e) if regulations under the Income Tax Assessment Act 1997 are made having the effect that instruments known as upper tier 2 capital instruments, or a class of instruments of that kind, are debt interests--that is paid on such a debt interest and is not a return of an investment;

but does not include an amount to the extent to which it is a return on an equity interest in a company.

142. As interest is payable on the Notes it will be 'interest' for the purposes of section 128F.

143. Subsection 128F(1) requires that the 'interest' is paid by a 'company'. A 'company' is relevantly defined in subsection 995-1(1) of the ITAA 1997 as:

" company " means:

(a) a body corporate; or

(b) any other unincorporated association or body of persons;

but does not include a partnership or a * non-entity joint venture.

144. The interest on the Notes is paid by Taxpayer A who are a body corporate registered under the Corporations Act 2001. Hence, 'interest' is paid by a 'company'.

145. Subsection 128F(1) requires that the interest paid by a company is 'in respect of a debenture'. A 'debenture' is relevantly defined in subsection 128F(9) as follows:

debenture, without affecting its meaning elsewhere in this Act, includes a promissory note or a bill of exchange (in addition to the things mentioned in the definition of debenture" in subsection 6(1)).

146. Debenture is defined in subsection 6(1) to mean:

" debenture" , in relation to a company, includes debenture stock, bonds, notes and any other securities of the company, whether constituting a charge on the assets of the company or not.

147. In relation to Taxpayer A (which is, relevantly, the company for the reasons stated at paragraph 144 above) the Notes are debentures as they are unsecured notes. The interest is paid in respect of these 'debentures'.

148. Therefore, the interest paid by Taxpayer A in respect of the Notes is 'interest paid by a company in respect of a debenture' within the meaning of subsection 128F(1) of the ITAA 1936.

Question 7

Will the Write-off cause Taxpayer A to derive ordinary income under section 6-5 of the ITAA 1997?

Summary

The Write-off will not cause Taxpayer A to derive ordinary income under section 6-5 of the ITAA 1997.

In this question, all legislative references are to the ITAA 1997, unless otherwise specified.

Detailed reasoning

149. Under a particular Condition, a Write-off will have the effect of reducing the outstanding principal amount by the outstanding principal amount of the Notes to be Converted or Written-off; and, for any accrued and unpaid interest to be correspondingly reduced. Therefore, Taxpayer A would make a prima facie gain equal to the value of the outstanding principal amount plus any accrued and unpaid interest on the Notes.

150. Under section 6-5, Taxpayer A's assessable income includes income according to ordinary concepts, which is called ordinary income.

151. The ITAA 1997 does not provide guidance on what constitutes 'ordinary income'. However, in Scott v Commissioner of Taxation (NSW) (1935) 3 ATD 142 Jordan CJ describes income (at 144) as a concept determined in accordance with the ordinary concepts and usages of mankind.

152. Various judicial decisions have identified a range of factors which characterise receipts as income, either from personal exertion, from property or from carrying on a business. A list of these factors is found in the High Court's judgment in GP International Pipecoaters v Federal Commissioner of Taxation (1990) 170 CLR 124 (GP Pipecoaters) at 138, where the High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by the periodicity, regularity or recurrence; sometimes by the character of the thing disposed of in exchange for the receipt, sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of the payment.

153. As stated at paragraph 15 above, the Notes have been issued in order to allow Taxpayer to satisfy its capital adequacy requirements. In the words of GP Pipecoaters, the purpose of issuing the Notes is so that Taxpayer A is able to strengthen its capital structure. Consequently, any gain arising upon a potential Write-off of the Notes should be treated as not arising on revenue account.

154. Consequently, the Write-off will not cause Taxpayer A to derive ordinary income under section 6-5 of the ITAA 1997.

Question 8

Will the Write-off cause Taxpayer A to derive a capital gain under section 102-20 of the ITAA 1997?

Summary

The Write-off will not cause Taxpayer A to derive a capital gain under section 102-20 of the ITAA 1997.

In this question, all legislative references are to the ITAA 1997, unless otherwise specified.

Detailed reasoning

155. Section 102-20 states:

You can make a * capital gain or * capital loss if and only if a * CGT event happens. The gain or loss is made at the time of the event.

156. Where the Notes are Written-off, the relevant CGT event will be captured under subdivision 104-C, as these events deal with the ending of a CGT asset. Under subdivision 104-C, each of these events requires a CGT asset to be present.

157. A CGT asset is defined in subsection 108-5(1) as follows:

A CGT asset is:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

158. The word 'property' is not defined, so it takes its ordinary meaning. Under the Macquarie Dictionary, property is relevantly defined as:

goods, lands, etc., owned

159. From the perspective of Taxpayer A as issuer, the Notes do not represent property because they merely confer an obligation upon Taxpayer A to make periodic interest payments and repay the principal at the time of redemption. Similarly, the Notes could not be said to be a 'legal or equitable right that is not property' for this very reason. Therefore, the Notes will not constitute a CGT asset for the purposes of section 108-5.

160. As there is no CGT asset, a capital gain or loss cannot occur. Therefore, the Write-off will not cause Taxpayer A to derive a capital gain under section 102-20.

Question 9

Will the amount that is assessable under subsection 230-15(1) of the ITAA 1997 if the Notes are Written-off, be reduced under section 230-470 of the ITAA 1997 by the 'net forgiven amount'

Summary

The amount that is assessable under subsection 230-15(1) of the ITAA 1997 if the Notes are Written-off, will be reduced under section 230-470 of the ITAA 1997 by the 'net forgiven amount'.

In this question, all legislative references are to the ITAA 1997, unless otherwise specified.

Detailed reasoning

Gain under section 230-15(1)

161. Section 230-470 relevantly states:

If a gain that you make from a * financial arrangement arises from the * forgiveness of a debt to which Subdivisions 245-C to 245-G apply, the gain is reduced by:

…

(b) if that section does not apply--the debt's * net forgiven amount.

Gain under a financial arrangement


162. As the Notes are financial arrangements (refer to paragraphs 128 to 134 above), the methods available to take a gain or loss into account, are stated in section 230-40. Paragraph 230-40(1)(f) relevantly states that one such method is:

…a balancing adjustment provided for in Subdivision 230-G.

163. Section 230-435 sets outs out when a balancing adjustment under subdivision 230-G can be made. Subsection 230-435(1) relevantly states:

(1) A balancing adjustment is made under this Subdivision if:

…

(b) all of your rights and/or obligations under a financial arrangement otherwise cease; or

…

164. Where a Write-off occurs, pursuant to a particular Condition, the relevant Holders' rights and claims under will be 'immediately and irrevocably terminated'. Correspondingly, the rights and obligations of Taxpayer A, in respect of the Notes that are Written-Off, will cease. Therefore, pursuant to paragraph 230-435(1)(d), Taxpayer A will be required to make a balancing adjustment.

165. The method statement for a balancing adjustment is set out in subsection 230-445(1). As stated at paragraph 47 above, if the Notes are Written-off, the value of the balancing adjustment amount worked out under section 230-445(1) will be equal to the value of outstanding principal and any accrued and unpaid interest at that time. Hence, the prima facie 'gain' under the financial arrangement, which is calculated in nominal terms as per section 230-75(1), is equal to the nominal value of outstanding principal and any accrued and unpaid interest.

The net forgiven amount

166. Section 245-35 sets out what will constitute a forgiveness of a debt. Section 245-35 relevantly states:

A debt is forgiven if and when:

(a) the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full; or

…

167. Where the Notes are Written-off, due to the operation of a particular Condition, Taxpayers A's obligations to pay the debt is 'released or extinguished'. Hence, a Write-off will constitute a forgiveness of a debt within the meaning of section 245-35.

168. In order for subdivision 245-C to 245-G to apply, the Notes must also satisfy the requirement of 'debts' as relevantly stated in section 245-10, as follows:

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

…

169. As Notes are financial arrangements (refer to paragraphs 128 to 134 above) under which interest is deductible (refer to paragraphs 135 to 139 above), the Notes are 'debts' within the meaning of paragraph 245-10(a).

170. Section 245-40 provides that where any paragraph of section 245-40 is met, subdivisions 245-C to 245-G will not apply. Section 245-40 relevantly states:

Subdivisions 245-C to 245-G do not apply to a * forgiveness of a debt if:

…

(b) the amount of the debt has been, or will be, included in the assessable income of the debtor in any income year; or

…

171. Due to the reasons stated in paragraphs 149 to 154 above, the Write-off will not result in ordinary income for Taxpayer A; and, for the reasons stated in paragraphs 155 to 160 above, the Write-off will not result in any capital gains arising for Taxpayer A. Furthermore, the gain which would be subject to Division 230 is reduced to the extent that the gain is captured by Division 245 (section 230-470). Hence, subdivision 245-G will apply to the forgiveness of a debt.

172. Section 245-55(1) states:

The value of your debt at the time (the forgiveness time ) when it is * forgiven is the amount that would have been its * market value (considered as an asset of the creditor) at the forgiveness time, assuming that:

(a) when you incurred the debt, you were able to pay all your debts (including that one) as and when they fell due; and

(b) your capacity to pay the debt is the same at the forgiveness time as when you incurred it.

173. As stated at paragraph 48 above, if the Notes are Written-off the value of the debt when it is forgiven under section 245-55 will be equal to the nominal value of outstanding principal and any accrued and unpaid interest at that time.

174. Section 245-75 sets out the meaning of 'gross forgiven amount'. Subsection 245-75(1) states:

The gross forgiven amount of a debt is:

(a) if section 245-65 does not apply to the debt--the value of the debt when it was * forgiven (worked out under section 245- 55, 245-60 or 245-61);

175. It should be noted that the offsetting provisions in section 245-65 will not apply to the debt, because under a particular Condition, where a Write-off occurs, Taxpayer A will not make any payment or provide any property to the Holders. Consequently, the 'gross forgiven amount' will equal the nominal value of outstanding principal and any accrued and unpaid interest.

176. The 'net forgiven amount' is calculated with reference, to section 245-85, which relevantly states:

(1) The * gross forgiven amount of your debt is reduced by the sum of the following amounts:

(a) any amount that, under a provision of this Act other than this Division, has been, or will be, included in your assessable income for any income year as a result of the * forgiveness of the debt;

…

(2) Subject to section 245-90, the amount remaining after reducing the * gross forgiven amount under subsection (1) is the net forgiven amount of the debt.

177. Due to the reasons stated above, the forgiveness of the debt will not result in any amount that has or will be included in Taxpayer A's assessable income.

178. Hence, the 'net forgiven amount' is equal to value of the 'gross forgiven amount'. The 'net forgiven amount' is equal to the nominal value of outstanding principal and any accrued and unpaid interest.

Reduction under section 230-470

179. Section 230-470 relevantly states:

If a gain that you make from a * financial arrangement arises from the * forgiveness of a debt to which Subdivisions 245-C to 245-G apply, the gain is reduced by:

…

(b) if that section does not apply--the debt's * net forgiven amount.

180. Hence, the balancing adjustment gain amount that arises if the Notes are Written-off, will be reduced under section 230-470 by the 'net forgiven amount.'

181. As the prima facie gain arising from the financial arrangement is equal to the 'net forgiven amount' there will be no assessable gain arising under subsection 230-15(1).

Question 10

Will the commercial debt forgiveness provisions in Division 245 of the ITAA 1997 apply to a Write-off so as reduce the tax attributes of Taxpayer A as specified in Subdivision 245-E of the ITAA 1997 by an amount equal to the value (as determined under section 245-55 of the ITAA 1997) of the outstanding amounts of principal and any accrued and unpaid interest?

Summary

The commercial debt forgiveness provisions in Division 245 of the ITAA 1997 will apply to a Write-off so as reduce the tax attributes of Taxpayer A as specified in Subdivision 245-E of the ITAA 1997 by an amount equal to the value (as determined under section 245-55 of the ITAA 1997) of the outstanding amounts of principal and any accrued and unpaid interest.

In this question, all legislative references are to the ITAA 1997, unless otherwise specified.

Detailed reasoning

182. Section 245-105 states:

(1) Your total net forgiven amount for the * forgiveness income year is the total of the * net forgiven amounts of all your debts that are * forgiven in that year.

Note 1: The total net forgiven amount may be reduced under section 707- 415.

Note 2: The total net forgiven amount of a partner in a partnership is affected by section 245- 215.

(2) Your * total net forgiven amount is applied, in accordance with sections 245- 115 to 245-195, for the * forgiveness income year.

183. For the reasons stated from paragraph 166 to 178 above, the 'net forgiven amount' is the outstanding amount of principal and any accrued and unpaid interest. The 'total net forgiven amounts' will therefore be the nominal value of all outstanding amounts of principal and any accrued and unpaid interest in respect of all of the Notes that are Written-off.

184. Pursuant to subsection 245-105(2) the 'total net forgiven amount' is applied in accordance with section 245-115 to 245-195. Hence, the commercial debt forgiveness provisions in Division 245 will apply to a Write-off so as reduce the tax attributes of Taxpayer A as specified in Subdivision 245-E by an amount equal to the value (as determined under section 245-55) of the outstanding amounts of principal and any unpaid and accrued interest.

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