Edited version of your written advice

Authorisation Number: 1012929197202

Date of advice: 18 December 2015

Ruling

Subject: Marketplace lending fund

Question 1

Will the Loan Units issued by the Fund constitute a debt interest as defined in section 974-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the Loan Units issued by the Fund constitute qualifying securities as defined in
subsection 159GP(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

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 Fund is a yet-to-be settled unit trust which is intending to register as a retail managed investment scheme under the Corporations Act 2001 and operate as (what is commonly referred to as) a marketplace lending fund.

Through an online marketplace lending platform, Members of the Fund will obtain an economic exposure to one or more loans by effectively matching returns paid on such loans to the Members based on their successful bids (less amounts retained by operators and managers). The key features of the Fund are set out below.

Potential Members subscribe to the Fund by applying for, and being initially issued with:

• one Foundation Unit in the Fund, carrying no right to any distributions of income from the Fund; and

• Cash Units in the Fund, carrying rights to capital but no rights to any distributions of income from the Fund.

Using the online lending platform, Members (being existing holders of units in the Fund) make bids by which they indicate that they are prepared to have an economic exposure to one or more loans. At the completion of a successful auction, where a potential loan has secured successful bids from one or more Members (and all legal documentation and conditions precedent to the loan have been completed/satisfied), the Responsible Entity will lend money in the amount of relevant successful bids to a special purpose lending company (Lending Co), under the terms of an agreement.

Upon receipt of an advance from the Responsible Entity, Lending Co will issue to the Responsible Entity a separate Loan Note in relation to each Member that made a successful bid, the face value of which will be the amount of the Member's successful bid. Collectively, those Loan Notes constitute a separate series referable to a loan.

Lending Co will provide the loan (funded by the cumulative proceeds of that series of Loan Notes) to a Borrower. The maximum term of a loan will be less than ten years.

A relevant number of Cash Units held by Members who have placed a successful bid in relation to the loan will be converted to Loan Units of a separate class in the Fund. Each class of Loan Units will be referable to a particular Loan Note issued by Lending Co and each series of Loan Notes will be constituted by multiple classes of Loan Units. The term 'referable' (as used in this paragraph) is a notional concept such that Members will not obtain a beneficial interest in any of the Loan Notes or loans. Instead, Members will have an undivided interest in the whole of the Fund.

The terms of the loan will essentially be reflected by the terms of the series of Loan Notes issued to the Fund. As such, cash received by Lending Co from a loan (that is, on repayment of principal and payment of interest by the Borrower) will be used by Lending Co to fund repayments of principal and payments of interest on referable Loan Notes to the Responsible Entity (less a margin). The rate of interest payable by Lending Co on Loan Notes issued to the Responsible Entity is equal to the interest rate specified on the relevant Member's successful bid, less the margin.

Lending Co's obligations to pay these amounts to the Responsible Entity are limited to the extent that the amounts payable by the Borrower in accordance with the loan have been paid by the Borrower to Lending Co. The termination date of a Loan Note will be same as the date on which the loan which is referable to the Loan Note matures, is terminated or cancelled (whichever is earlier).

Essentially, the terms of the Loan Units are matched to the terms of the referable Loan Notes and Members holding relevant Loan Units on the relevant distribution date are presently entitled to receive cash referable to the Loan Notes, as received by the Responsible Entity from Lending Co. Broadly, Loan Units will confer upon a Member distributable entitlements comprised of:

• an income entitlement equal to the share of the net income of the Fund that is referable to Loan Units of the relevant class held by the Member (a distributable income amount); and

• a capital entitlement equal to the share of all other amounts received by the Responsible Entity (other than net income) that is referable to Loan Units of the relevant class held by the Member (a distributable capital amount).

The payment of a Member's distributable entitlement will be satisfied by being issued a relevant number of additional Cash Units in the Fund.

The portion of the payment of a Member's distributable entitlement that is referable to the Member's distributable capital amount is to be treated as a reduction in the amount subscribed by the Member in the Loan Units of the relevant class. This will mean that the Loan Units will effectively be redeemable at the time when Loan Notes are repaid (which in all cases will not exceed 10 years).

On full repayment of the Loan Notes by Lending Co to the Responsible Entity, or indeed if no capital amounts are received by the Responsible Entity from Lending Co in respect of Loan Notes, the Loan Units of the Members that are issued in respect of a relevant class are redeemed by the Responsible Entity for a payment of nil.

A Member may withdraw Cash Units at their discretion by providing the Responsible Entity with a withdrawal notice, upon receipt of which the Responsible Entity must pay or cause to be paid to the withdrawing Member the relevant withdrawal amount.

A Member may make a request at any time to withdraw their Loan Units. Acceptance of that request is contingent on whether the Responsible Entity receives any applications from other Members to subscribe for Loan Units of that class for the withdrawing Member's nominated withdrawal amount.

Assumption

For the purposes of the definition of qualifying security in subsection 159GP(1) of Division 16E of the ITAA 1936, the term of the Loan Units, ascertained at the time of their issue to the Members, will (or is reasonably likely to) exceed one year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 16E of Part III

Income Tax Assessment Act 1936 subsection 159GP(1)

Income Tax Assessment Act 1936 paragraph 159GP(1)(a)

Income Tax Assessment Act 1936 paragraph 159GP(1)(b)

Income Tax Assessment Act 1936 paragraph 159GP(1)(c)

Income Tax Assessment Act 1936 paragraph 159GP(1)(d)

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 subsection 974-5(1)

Income Tax Assessment Act 1997 section 974-15

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

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

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

Income Tax Assessment Act 1997 section 974-135

Income Tax Assessment Act 1997 subsection 974-135(1)

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

Corporations Act 2001

Reasons for decision

Question 1

The provisions of Division 974 of the ITAA 1997 determine whether, for certain income tax purposes, an interest is a 'debt interest' or an 'equity interest' for tax purposes. These provisions do not impose tax, but rather categorise whether an interest is debt or equity based on "economic substance rather than mere legal form" (subsection 974-5(1) of the ITAA 1997).

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) of the ITAA 1997 in relation to the entity
(subsection 974-15(1) of the ITAA 1997).

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

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

(c) the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when:

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

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

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

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

The classification of a scheme as giving rise to a debt interest is done from the perspective of the issuer of the interest, in this instance the Responsible Entity.

For the purposes of paragraph 974-20(1)(c) of the ITAA 1997, section 974-135 of the ITAA 1997 sets out the rules for determining whether an obligation to take an action under a scheme is an "effectively non-contingent obligation". The relevant parts of section 974-135 in the context of the Loan Units are:

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.

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.

The Responsible Entity's requirement to pay amounts (of either income or capital) to the Member in respect of a Loan Unit will be contingent on the Responsible Entity receiving amounts in respect of referable Loan Notes from Lending Co. While a Member may request a withdrawal of their Loan Units, the withdrawal amount payable by the Responsible Entity to the Member in satisfaction of that request is contingent on the Fund's acceptance of the request.

At the time of issuing the Loan Units to a Member, each of the Responsible Entity's future obligations to make payments (i.e. provide financial benefits) to the Member in respect of those Loan Units are therefore contingent on an event, condition or situation other than the ability or willingness of the Responsible Entity to meet the obligation.

As such, at the time the Loan Units are issued the Responsible Entity will not have an effectively non-contingent obligation to provide a financial benefit under the arrangement and the requirement set out in paragraph 974-20(1)(c) of the ITAA 1997 will not be satisfied. The Loan Units issued by the Fund will therefore not satisfy the debt test in subsection 974-20(1) of the ITAA 1997, and will not constitute a debt interest as defined in section 974-15 of the ITAA 1997.

Question 2

Division 16E of Part III of the ITAA 1936 was enacted to prevent tax deferral opportunities which were available from certain discounted and deferred interest securities that satisfy the definition of a 'qualifying security'. Under Division 16E, the income and deductions from these qualifying securities are spread over the term of the security on a basis which reflects the economic gains and losses which have accrued at any point in time.

A 'qualifying security' is defined in subsection 159GP(1) of Division 16E of the ITAA 1936 as being any security:

(a) that is issued after 16 December 1984;

(b) that is not a prescribed security within the meaning of section 26C;

(ba) that is not part of an exempt series (see subsection (9A));

(c) the term of which, ascertained as at the time of issue of the security will, or is reasonably likely to, exceed 1 year;

(d) that has an eligible return; and

(e) where the precise amount of the eligible return is able to be ascertained at the time of issue of the security - in relation to which the amount of the eligible return is greater than 1½% of the amount ascertained by multiplying the amount of the payment or the sum of the payments (excluding any periodic interest) liable to be made under the security by the number (including any fraction) of years in the term of the security.

but does not, except as provided by subsection (10), include an annuity.

For the purposes of determining whether an arrangement is a qualifying security (as per the above definition), that arrangement must be a 'security', also defined in subsection 159GP(1) of the ITAA 1936 to mean any of the following:

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

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

(c) a secured or unsecured loan; or

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

The Loan Units, like units in unit trusts more generally, are not considered to satisfy the definition of security under paragraphs 159GP(1)(a), (b) or (c) of that definition.

On the face of paragraph (d) of the definition of security under subsection 159GP(1) of the
ITAA 1936, all contracts which evidence a liability to pay an amount may be securities. However, Taxation Ruling TR 96/14¹ which considers a number of interpretative matters regarding the application of subsection 159GP(1) of the ITAA 1936 clarifies the scope of paragraph (d) of the definition of security and confirms (at paragraph 30), having regard to paragraphs (a), (b) and (c) of the definition (and the common thread therein), that only those contracts that have debt like obligations will fall under paragraph (d) of the definition of security.

With specific regard to units in a public unit trust and in the context of paragraph (d) of the definition of security, TR 96/14 also relevantly states (at paragraph 39) as follows:

39. … where the manager of a public unit trust is required to buy-back and/or redeem units on terms set out in the trust deed, whether at the request of the unit holder or upon the determination of the trust, the obligation is contractual in nature. As that arrangement seems to be a contract under which there is a liability to pay an amount, it may satisfy the provisions of paragraph (d) of the definition, if, on the facts, it is found to be debt like.

It follows, as can be deduced from paragraph 39 of TR 96/14, that the Loan Units in the Fund may be held to be securities pursuant to paragraph (d) if the Constitution under which they are issued to Members gives rise to a contractual and debt like obligation or liability of the Responsible Entity to pay an amount to the Members.

An obligation to pay an amount was discussed by Edmonds J in FCT v Rawson Finances Pty Ltd 2012 ATC 20-333 (Rawson), where his honour noted:

The essence of a loan of money from A to B is a corresponding contemporaneous obligation on the part of B to repay the money transferred from A to B: Commissioner of Taxation v Radilo Enterprises Pty Ltd (1997) 72 FCR 300 at 313 per Sackville and Lehane JJ; Commissioner of Taxation v Firth (2002) 120 FCR 450 at [73] per Sackville and Finn JJ. Absent that obligation, the transfer of the money from A to B is something else - a gift, a payment by direction, a payment or repayment of an anterior obligation - but it is not a loan. The obligation of repayment is not proved by subsequent payment of the same amount, let alone a different amount, from B to A; that may be explicable by reference to another obligation or circumstance having nothing to do with the original payment from A to B. Rather, the obligation of repayment is proved by the terms of the contract under which the money was transferred from A to B.

Notwithstanding the Responsible Entity's contractual obligation under the terms of the Constitution to make payments of a Member's distributable entitlements owing to that Member in respect of their Loan Units or, where applicable, a payment of a withdrawal amount in respect of a Member's withdrawn Loan Units, it is considered that no relevant debtor/creditor relationship as is typically present under a debt like obligation is created between the Responsible Entity and a Member by the issue of the Loan Units in the Fund.

The Responsible Entity does not have a corresponding contemporaneous obligation to repay anything akin to a principal amount advanced by the Members to acquire the Loan Units (as contemplated in the Rawson judgement quoted above), but rather, and at best, there exists an obligation of the Responsible Entity to make distributions of income and capital.

A Member's entitlement to payments of distributable entitlements from the Responsible Entity under the terms of the Constitution, and in respect of their Loan Units in the Fund, are contingent in that they only arise upon the receipt of amounts owing to the Responsible Entity from Lending Co under the terms of the referable Loan Notes which, in turn, are contingent on the receipt of amounts owing to Lending Co from the Borrower under the terms of the loan. Similarly, a Member's entitlement to payment of a withdrawal amount from the Responsible Entity under the terms of the Constitution, and in respect of their Loan Units in the Fund, is contingent on the withdrawing Member providing a valid request to withdraw their Loan Units and the subsequent application from another Member to subscribe for Loan Units of that class at the withdrawing Member's nominated withdrawal amount. In neither of these scenarios does the Responsible Entity have an outstanding debt to be repaid at a fixed or determinable time or on demand (see paragraph 87 of Taxation Ruling TR 2002/16²).

Any shortfall in the amounts paid by the Responsible Entity to the Member will, critically, have nothing to do with the Responsible Entity's ability or willingness to pay, or any limited enforcement rights that the Member might have agreed to (as may be the case under a limited recourse loan), but will be due to something else - i.e. the actions of others (such as the Borrower and Lending Co).

For the reasons set out above the obligations between the Responsible Entity and the Members are not considered to be sufficiently debt like obligations to fall under paragraph (d) of the definition of security in subsection 159GP(1) of the ITAA 1936. As the Loan Units issued by the Fund are not considered to satisfy the definition of security under subsection 159GP(1) of the ITAA 1936, they do not constitute qualifying securities as defined in that same provision.

¹ Taxation Ruling TR 96/14 - Income tax: traditional securities.

² Taxation Ruling TR 2002/16 Income tax: the taxation consequences for taxpayers issuing certain stapled securities

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