Edited version of your written advice

Authorisation Number: 1012972080167

Date of advice: 19 February 2016

Ruling

Subject: Issue of Subordinated Notes

Question 1

Will each series of Notes be debt interests within the meaning of subsection 974-15(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will each series of Notes be equity interests pursuant to subsection 974-70(1) of the ITAA 1997?

Answer

No.

Question 3

Will each series of Notes be a financial arrangement pursuant to section 230-45 of the ITAA 1997?

Answer

Yes.

Question 4

Will XYZ be entitled to a deduction pursuant to subsection 230-15(2) of the ITAA 1997 for any loss made from the interest paid on each series of Notes?

Answer

Yes.

Question 5

Will the accruals method apply to any loss made from the interest paid on each series of Notes pursuant to subsection 230-100(3) of the ITAA 1997?

Answer

Yes, to the extent that such a loss is not taken into account under the balancing adjustment in Subdivision 230-G of the ITAA 1997.

Question 6

Will subsection 230-15(5) or subsection 230-15(6) of the ITAA 1997 apply to limit the deductions in respect of each series of Notes under subsection 230-15(2) of the ITAA 1997?

Answer

No.

Question 7

Will XYZ be required to withhold an amount under section 12-245 of Subdivision 12-F of Part 2-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA) from interest payments made in respect of each series of Notes?

Answer

No.

Relevant facts and circumstances

1. XYZ is an Australian tax resident company.

2. XYZ is proposing to raise capital by issuing one or more series of fully-paid unsecured subordinated notes (the Notes).

3. The funds raised from the proposed issue of each series of Notes will solely support the general corporate purposes in carrying on its business for the purpose of gaining or producing assessable income.

4. XYZ proposes to make one or more institutional offers of the Notes to investors in accordance with an offering circular.

5. XYZ expects that in excess of 10 unrelated institutional investors will participate in each series of Notes issuance as a result of the marketing campaign undertaken by XYZ.

6. Each series of Notes will be issued in accordance with the specified Terms and Conditions (the Terms). With the exception of currency denomination and principal amount, the Terms will be the same for each series of Notes.

7. The following Terms apply to each series of Notes:

(i) The Notes will have a term of more than 10 years.

(ii) During the term of the Notes, XYZ will make interest payments semi-annually in arrears.

(iii) The interest rate will increase at a prescribed rate on the relevant dates set under the Terms.

(iv) Interest may be deferred at the discretion of XYZ and will accumulate and become due and payable subject to the Terms.

(v) The Notes will be redeemed by XYZ on the Maturity Date at their principal amount plus any interest accrued or deferred, unless redeemed earlier.

(vi) The Notes will be subordinated to all senior debt obligations of XYZ and rank ahead of ordinary shares in XYZ in a winding-up of XYZ.

(vii) The Notes will not be convertible into shares or carry any rights to acquire shares in XYZ.

8. XYZ is subject to the Taxation of Financial Arrangements (TOFA) rules in Division 230 of the ITAA 1997.

9. XYZ has not made and will not make any tax timing election for the purposes of the TOFA rules in Division 230 of the ITAA 1997.

Assumptions

10. XYZ will be a resident of Australia for income tax purposes when it issues and pays the interest on each series of Notes.

11. The value in present value terms of the financial benefits to be provided by XYZ in respect of each series of Notes (being the interest and principal repayments) are taken to equal or exceed the value in present value terms of the financial benefits received from the Holders in respect of each series of Notes for the purposes of Division 974 of the ITAA 1997.

12. XYZ will apply the proceeds from the proposed issue of each series of Notes solely in carrying on a business for the purpose of gaining or producing assessable income.

13. The increase in the interest rate at the relevant set dates pursuant to the Terms will not impose an effectively non-contingent obligation on XYZ to redeem the Notes at that time or any other time prior to the maturity date.

14. Each series of Notes will not be acquired by a connected entity (as defined in subsection 995-1(1) of the ITAA 1997) of XYZ.

15. Each series of Notes will be offered to at least 10 institutional investors that are carrying on a business of providing finance or investing or dealing in securities in the course of operating in a financial market and that are not associates (as defined in subsection 128F(9) of the ITAA 1936) of one another.

16. Each series of Notes will not be acquired either directly or indirectly by an associate (as defined in subsection 128F(9) of the ITAA 1936) of XYZ.

17. The interest in respect of each series of Notes will not be paid to an associate (as defined in subsection 128F(9) of the ITAA 1936) of XYZ.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1936 Section 128F

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 Division 974

Taxation Administration Act 1953 Section 12-245

Reasons for decision

All legislative references set out below are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Question 1

Debt interest

Subsection 995-1(1) states:

Debt interest in an entity has the meaning given by Subdivision 974-B of the ITAA 1997.

In Subdivision 974-B, subsection 974-15(1) provides:

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.

Scheme

A scheme is defined in subsection 995-1(1) to mean any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The proposed issue of each series of Notes constitutes a scheme for the purposes of subsection 974-15(1).

Debt test

Under subsection 974-15(1), a scheme gives rise to a debt interest in an entity if the scheme satisfies the debt test in subsection 974-20(1) when the scheme come into existence.

Pursuant to subsection 974-20(1), a scheme will satisfy the debt test 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 of benefits under the scheme; and

(c) the entity, 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 benefit 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;

(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.

Financing arrangement

Paragraph 974-20(1)(a) requires that the scheme is a 'financing arrangement' for the entity. Paragraph 974-130(1)(a) provides that a scheme is a 'financing arrangement' if it is entered into or undertaken to raise finance for the entity (or a connected entity of the entity).

Each series of Notes will raise finance for XYZ and, accordingly, is a financing arrangement in accordance with paragraph 974-130(1)(a).

Accordingly, paragraph 974-20(1)(a) is satisfied.

Receipt of financial benefit

Paragraph 974-20(1)(b) requires that the entity, or a connected entity receives or will receive a financial benefit or benefits under the scheme.

Paragraph 974-160(1)(a) provides that a 'financial benefit' means anything of economic value.

XYZ will receive the issue price from the issue of each series of Notes (that is, the principal amount). Accordingly, XYZ will receive a financial benefit.

It follows that paragraph 974-20(1)(b is satisfied.

Effectively non-contingent obligation to provide financial benefits

Paragraph 974-20(1)(c) requires that the entity, or the entity and a connected entity of the entity to have an 'effectively non-contingent obligation' (ENCO) under the scheme to provide a financial benefit or benefits to one or more entities after the time when the financial benefit(s) referred to in paragraph 974-20(1)(b) is or are received.

An 'effectively non-contingent obligation' is defined in subsection 995-1(1) to have the meaning given by section 974-135.

Relevantly, subsection 974-135(1) states:

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 a non-contingent obligation in accordance with subsection 974-135(3) if the obligation is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a connected entity of the entity), other than the ability or willingness of that entity or connected entity to meet the obligation.

Pursuant to subsection 974-135(2), the ENCO requirement applies to both the provision of financial benefits under the scheme and to the termination of the scheme.

In accordance with the Terms, XYZ will have an obligation under the scheme to provide the following financial benefits to the Holders:

• the principal amount of the Notes must be paid on Maturity Date (at the latest); and

• interest calculated on the principal amount of the Notes must be paid semi-annually in arrears (subject to optional deferral).

In determining whether XYZ's obligation is in substance or effect an 'effectively non-contingent' obligation regard is to be had to the terms, conditions and pricing of the Notes including the following matters:

Deferral of interest

XYZ's ability to defer interest payments under the Terms only goes to the timing of satisfying its obligation to pay such interest. There is no discretion for XYZ to legally avoid paying the interest altogether as is evident from the requirement that any outstanding deferred interest payments must be paid, at the latest, on Maturity Date together with the principal amount plus any interest accrued up to (but excluding) the Maturity Date.

Accordingly, the ability to defer the interest payments does not make XYZ's obligation to make such payments contingent.

Change in interest rate

Certain instruments that give the issuer an unfettered discretion to reset the interest rate to any rate (including zero) will not constitute debt interests for income tax purposes because the payment of interest is contingent upon the issuer choosing to reset the interest rate (see Taxation Determination TD 2006/1¹).

As set out in the Relevant facts and circumstances, the interest rate will increase at a prescribed rate on the relevant dates set under the Terms. XYZ does not have the discretion to reset the interest rate at any rate.

Therefore, the reset of the interest rate does not make XYZ's obligation to pay interest on the Notes contingent.

Subordination

The Terms provide that in the event of a winding-up, the Holders' rights will be subordinate to the claims of the Holders of senior obligations of XYZ.

The subordination provisions of the Notes do not affect the existence of XYZ's obligation to pay the principal amount and accrued interest on the Notes. The obligations will ultimately become due and payable, as evidenced by the Holders' ability to initiate proceedings for winding up of XYZ. The subordination merely operates to postpone enforcement of the obligation to a time that the senior obligations have been paid. The subordination of the Notes only relates to the priority on winding-up, rather than making XYZ's obligation to pay the principal amount and interest on the Notes contingent.

Accordingly, the subordination does not make XYZ's obligation to pay the principal amount and interest contingent.

Optional early redemption

Pursuant to the Terms, XYZ may redeem the Notes prior to Maturity Date.

Under the assumption (as set out in the Assumptions) that the increase in the interest rate will not impose an ENCO to redeem the Notes at that time or any other time prior to the Maturity Date, the optional early redemption does not make XYZ's obligation to pay interest on the Notes contingent.

Therefore, XYZ will have an ENCO to provide the financial benefits to the Holders of the Notes after the time the issue price from the issue is received.

Accordingly, paragraph 974-20(1)(c) is satisfied.

Substantial likelihood that financial benefits provided will at least equal those received

Under paragraph 974-20(1)(d) and subsections 974-20(2) and (3), it has to be substantially more likely than not that the value of the financial benefits that XYZ will provide under the scheme will be at least equal to the value of all the financial benefits that XYZ will receive under the scheme.

The value of the financial benefits is determined pursuant to subsection 974-35(1) as either in nominal terms or in present value terms, based on the performance period.

The value of financial benefits provided or received under a scheme is to be calculated in present value terms if the performance period ends more than 10 years after the interest arising from the scheme is issued (subparagraph 974-35(1)(a)(ii)).

Subsection 974-35(3) defines the performance period as the period in which the ENCOs of the issuer to provide a financial benefit in relation to the interest have to be met.

Given the performance period of each series of Notes will be more than 10 years, it follows that the financial benefits provided or received under the Notes must be valued in present value terms in accordance with subparagraph 974-35(1)(a)(ii).

The valuation of the financial benefits in present value terms is set out in section 974-50 and subsection 974-50(4) sets out the relevant formula. For the purposes of the Ruling, it is assumed that the value in present value terms of the financial benefits to be provided by XYZ in respect of each series of Notes (being the interest and principal repayment) will equal or exceed the value of the financial benefits received in respect of each series of Notes (being the issue price).

Accordingly, paragraph 974-20(1)(d) is satisfied.

Financial benefits provided and received are not both nil

Both the value of the financial benefits to be provided by XYZ and the value of the financial benefits to be received by XYZ will be greater than nil. Therefore, subsection 974-20(1)(e) is satisfied.

Conclusion

As each of the requirements of the debt test under subsection 974-20(1) are satisfied, each series of Notes will be debt interests in XYZ pursuant to subsection 974-15(1).

Question 2

Pursuant to subsection 974-70(1) of the ITAA 1997, a scheme gives rise to an equity interest in a company, if, when the scheme comes into existence:

a) the scheme satisfies the equity test in subsection 974-75(1) in relation to the company because of the existence of an interest; and

b) the interest is not characterised as, and does not form part of a larger interest that is characterised as, a debt interest in the company, or a connected entity of the company under Subdivision 974-B.

As each series of Notes are characterised as debt interests under Subdivision 974-B (as explained in the reasoning for Question 1), the requirement of paragraph 974-70(1)(b) will not be satisfied.

Therefore, each series of Notes will not be equity interests in XYZ pursuant to subsection 974-70(1).

For completeness - Related schemes - subsection 974-70(2)

The debt and equity test provisions include the concept of related schemes. It is relevant to consider whether two or more related schemes may give rise to an equity interest under subsection 974-70(2).

Under section 974-155, two schemes are related if they are related in a way other than merely because one scheme refers to the other or the schemes have a common party. Without limiting the definition, subsection 974-155(2) provides for situations where two schemes are related.

Having regard to the Relevant facts and circumstances, it is considered that there are no schemes related to the series of Notes that taken together give rise to an equity interest in XYZ. Accordingly, subsection 974-20(2) will not apply to characterise each series of Notes as equity interests.

For completeness - Section 974-80

In certain circumstances section 974-80 operates to reclassify an interest which is held in a company by a connected entity of that company as equity interests.

Section 974-80 deals with the situation where each of the requirements in paragraphs 974-80(1)(a) to (d) are present. Paragraph 974-80(1)(b) relevantly states:

This section deals with the situation in which:

...

(b) the interest is held by a *connected entity of the company; and

...

As it is assumed (as set out in the Assumptions) that each series of Notes will not be acquired by a connected entity (as defined in subsection 995-1(1)), it follows that each series of Notes will not satisfy the paragraph 974-80(1)(b) requirement. Therefore, the requirements of paragraphs 974-80(1)(a) to (d) will not all be present.

Accordingly, section 974-80 will not apply to treat each series of Notes as equity interests.

Question 3

Division 230 (Taxation of financial arrangements)(TOFA) is about the tax treatment of gains and losses from financial arrangements. XYZ is subject to the TOFA rules contained in Division 230.

Section 230-45 is the general test to determine whether you have a financial arrangement.

Pursuant to subsection 230-45(1), you have a financial arrangement if you have, under an arrangement identified pursuant to subsection 230-55(4), a 'cash settlable' right to receive or obligation to provide a 'financial benefit', or a combination of such rights and/or obligations, unless, broadly, you have not insignificant other rights to receive or obligations to provide something which is not a financial benefit, or the other rights or obligations are not cash settlable.

Subsection 230-55(4) determines the scope of that to which the section 230-45 test (and the subsection 230-50(2) test) applies, providing criteria by which it is determined whether a number of rights and/or obligations are themselves an 'arrangement' or are 2 or more separate 'arrangements' for the purposes of Division 230.

Having regard to the Relevant facts and circumstances, it is considered that each series of Notes will constitute one arrangement for the purposes of Division 230.

Paragraph 974-160(1)(a) provides that a 'financial benefit' means anything of economic value. Paragraph 230-45(2)(a) provides that a right you have to receive, or an obligation you have to provide, a financial benefit is 'cash settlable' if the benefit is money or a money equivalent (as defined in subsection 995-1(1)).

As set out under the Relevant facts and circumstances in relation to each series of Notes:

• XYZ will have the right to receive, in money, the principal amount of the Notes;

• XYZ will have an obligation to repay, in money, the principal amount of the Notes; and

• XYZ will have an obligation to pay, in money, interest on the Notes.

These rights and obligations are legal rights to receive and legal obligations to provide financial benefits because the principal amount and interest are of economic value. These rights and obligations are 'cash settlable' because they are required to be settled in money.

Accordingly, as each series of Notes will consist entirely of cash settlable legal rights to receive financial benefits and obligations to provide financial benefits, each series of Notes will be a 'financial arrangement' under subsection 230-45(1).

For completeness - Financial arrangement under section 230-50

Each series of Notes will not constitute a financial arrangement under section 230-50 as each series of Notes does not constitute equity interests for the purposes of section 974-70 nor section 974-80 as set out in the reasoning for Question 2 above.

For completeness - Subdivision 230-H (Exceptions)

Division 230 does not apply to gains and losses from certain financial arrangements that are subject to exceptions under Subdivision 230-H.

Having regard to the Relevant facts and circumstances, it is considered that none of these exceptions will apply to each series of Notes.

Question 4

Subsection 230-15(2) allows a deduction for:

… 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.

As set out in the reasoning for Question 3, each series of Notes will be a financial arrangement under section 230-45.

As set out in the Relevant facts and circumstances and Assumptions, XYZ will use the funds raised from the issue of each series of Notes solely in carrying on its business for the purpose of gaining or producing assessable income.

Therefore, XYZ will be entitled to a deduction pursuant to subsection 230-15(2) for any loss made from the interest paid on each series of Notes, as it will be made in gaining or producing assessable income or necessarily made in carrying on its business for the purposes of gaining or producing assessable income.

Question 5

Broadly, Subdivision 230-B applies the accruals method to determine the amount and timing of gains and losses from a financial arrangement if they are sufficiently certain for such accrual to be done and Subdivision 230-B applies the realisation method to determine the amount and timing of gains and losses if they are not sufficiently certain to be dealt with under the accruals method.

The accruals and the realisation methods under Subdivision 230-B are the default methods which apply to financial arrangements that are not subject to any of the elective tax timing methods of Division 230 (section 230-40).

XYZ has not made and will not make any such tax timing election. Accordingly, Subdivision 230-B will apply to each series of Notes. However, where the balancing adjustment under Subdivision 230-G is applied to take into account a gain or loss, that gain or loss cannot be taken into account under the methods set out in Subdivision 230-B (subsection 230-40(2)).

The accruals method under section 230-100 applies broadly to sufficiently certain gains and losses made from a financial arrangement.

The particular gain or loss approach (subsection 230-100(3)) is the default approach when applying the accruals method unless the taxpayer, if eligible, makes a choice to apply the accruals method to the overall gain or loss pursuant to paragraph 230-100(2)(c). As XYZ, if eligible, will not make that choice under paragraph 230-100(2)(c), the question arises as to whether any loss made from the interest paid on each series of Notes will be a sufficiently certain particular loss.

Pursuant to subsection 230-100(3), the accruals method will apply to a loss made from the interest paid on each series of Notes if:

• the loss arises from a financial benefit provided by XYZ under the arrangement; and

• the loss:

• is 'sufficiently certain' before, or at the time XYZ starts to have the arrangement and before the financial benefit is provided; or

• becomes 'sufficiently certain' after the time XYZ starts to have the arrangement and before the financial benefit is provided; and

• the benefit has not already been taken into account in applying the methods under Subdivision 230-B to another gain or loss from the arrangement.

Section 230-110 identifies when a gain or loss is a sufficiently certain particular gain or loss from a particular event. Subsection 230-110(1) relevantly provides that you have a sufficiently certain particular gain or loss from a financial arrangement at a particular time if it is sufficiently certain at that time that a gain or loss, of at least a particular amount, will be made upon the receipt or provision of a financial benefit, or upon the cessation of a right or obligation, under the arrangement.

Subsection 230-115(1) relevantly provides:

In deciding for the purposes of this Subdivision whether it is sufficiently certain at a particular time that you make, or will make, a gain or loss from a *financial arrangement:

(a) have regard only to:
(i) *financial benefits that you are sufficiently certain to receive; and
(ii) financial benefits that you are sufficiently certain to provide; and

(b) have regard to those financial benefits only to the extent that the amount or value of the benefits is, at that time, fixed or determinable with reasonable accuracy.

Subsection 230-115(2) provides:

A *financial benefit that you are to receive or provide is to be treated as one that you are sufficiently certain to receive or to provide only if:

(a) it is reasonably expected that you will receive or provide the financial benefit (assuming that you will continue to have the *financial arrangement for the rest of its life); and

(b) at least some of the amount or value of the benefit is, at that time, fixed or determinable with reasonable accuracy.

Relevantly, where a calculation of a financial benefit relies on a certain type of variable (such as an interest rate), the taxpayer is required to assume that the variable will remain constant at the value it had at the particular time at which the 'sufficiently certain' test in subsection 230-115(2) is applied (subsection 230-115(4)). Furthermore, where all of the financial benefits under the financial arrangement are denominated in a particular foreign currency, the financial benefits are not to be translated into the taxpayer's functional currency for the purposes of applying subsection 230-115(2) (subsection 230-115(8)).

As set out in the Terms, XYZ will be required to pay interest on the principal amount of each series of Notes. The interest will be calculated in accordance with the Terms and payable semi-annually in arrears by XYZ unless deferred and paid at Maturity Date at the latest.

Therefore, the interest amounts payable by XYZ will give rise to a particular loss and the loss will be a sufficiently certain particular loss at a particular time over the term of each series of Notes.

Accordingly, the accruals method will apply to any loss made from the interest paid on each series of Notes pursuant to subsection 230-100(3) to the extent that such a loss is not taken into account under the balancing adjustment in Subdivision 230-G.

Question 6

Generally, the deductibility of a loss made from a financial arrangement to which Division 230 applies is determined under subsection 230-15(2). This general test examines the nexus between a loss and income producing processes.

As discussed in the reasoning for Question 4, XYZ is entitled to a deduction under subsection 230-15(2) for any loss made from the interest paid on each series of Notes.

Subsection 230-15(4) modifies the operation of subsection 230-15(2). Pursuant to subsection 230-15(4), a loss made from a debt interest is not prevented from being deductible merely because the loss is contingent on economic performance or secures a permanent or enduring benefit. The loss must still otherwise satisfy the requirements of subsection 230-15(2) to be deductible under this provision.

If subsection 230-15(4) is relied upon to enable the nexus in subsection 230-15(2) to be satisfied, a loss is deductible under subsection 230-15(2) to the extent that the internally compounded internal rate of return on the debt interest does not exceed the benchmark rate of return plus 150 basis points pursuant to subsection 230-15(5) or as specified by regulation if made pursuant to subsection 230-15(6).

The interest paid on each series of Notes:

• will always be payable by XYZ at specified rate rather than the Notes carrying a return based on a percentage of XYZ's (or any other entity's) income or profit;

• will not be subject to available profits or cash flows; and

• although interest payments may be deferred, deferred interest accumulates and compounds and must be paid on the Maturity Date.

Having to regard to the Relevant facts and circumstances including the above facts, it is considered that the interest on each series of Notes:

• are not and will not be amounts which are 'contingent on the economic performance' (as defined in section 974-85) of XYZ, nor of a connected entity of XYZ for the purposes of subsections 230-15(4) to (6), and

• does not secure a permanent or enduring benefit for XYZ nor of a connected entity of XYZ.

Accordingly, any loss made from the interest paid on each series of Notes that is otherwise deductible under subsection 230-15(2) is deductible under subsection 230-15(2) without having to rely on subsection 230-15(4) and subsections 230-15(5) and (6) do not apply to limit the deduction available under subsection 230-15(2).

Question 7

Section 12-245 of Subdivision 12-F of Part 2-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA) imposes an obligation on an entity to withhold an amount from interest it pays.

Section 12-245 states:

An entity must withhold an amount from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936) it pays to an entity, or to entities jointly, if:

(a) the recipient or any of the recipients has an address outside Australia according to any record that is in the payer's possession, or is kept or maintained on the payer's behalf, about the transaction to which the interest relates; or

(b) the payer is authorised to pay the interest at a place outside Australia (whether to the recipient or any of the recipients or to anyone else).

On this basis, XYZ may be required to withhold an amount from interest payments made to the relevant recipients.

However, section 12-300 of Schedule 1 to the TAA provides for limits on the amount to be withheld.

Section 12-300 relevantly states:

This Subdivision does not require an entity:

(a) to withhold an amount from a dividend, from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936) or from a royalty if no withholding tax is payable in respect of the dividend, interest or royalty; or

(b)  ...

(Emphasis added)

In other words, where there is no liability to withholding tax, there is no obligation on the part of the payer to withhold an amount from the interest payments.

Section 128B of Division 11A of the Income Tax Assessment Act 1936 (ITAA 1936) deals with liability to withholding tax. Subsection 128B(3) of the ITAA 1936 however provides that section 128B does not apply to interest to which section 128F of the ITAA 1936 applies (paragraph 128B(3)(h)(iv)).

Section 128F of the ITAA 1936 provides an exemption from withholding tax for interest on certain publicly offered company debentures or debt interests. Interest paid by a company in respect of a debenture or debt interest in the company will satisfy subsection 128F(1) if:

(a) the company was a resident of Australia when it issued the debenture or debt interest; and

(b) the company is a resident of Australia when the interest is paid; and

(c) for a debt interest other than a debenture - the debt interest:

i. is a non-equity share; or

ii. consists of 2 or more related schemes where one or more of them is a non-equity share; or

iii. is a syndicated loan; or

iv. is prescribed by the regulations for the purposes of this section; and

(d) either:

i. the issue of the debenture or debt interest satisfied the public offer test set out in subsection (3) or (4); or

ii. for a syndicated loan - the invitation to become a lender under the relevant syndicated loan facility satisfied the public offer test set out in subsection (3A).

Company resident of Australia when debenture or debt interest is issued and when the interest is paid

As set out in the Relevant facts and circumstances and Assumptions, XYZ is a resident for Australian income tax purposes and will remain a resident when it issues and pays the interest on each series of Notes.

Therefore paragraph 128F(1)(a) and (b) of the ITAA 1936 will be satisfied.

Debt interest or debenture

Paragraph 128F(1)(c) will apply where the debt interest is not a debenture.

'Debenture' is defined subsection 128F(9) of the ITAA 1936 to include a promissory note or a bill of exchange, in addition to the definition of debenture outlined in subsection 6(1) of the ITAA 1936.

Relevantly, subsection 6(1) of the ITAA 1936 defines 'debenture', in relation to a company, to include debenture stock, bonds, notes and any other securities of the company, whether constituting a charge on the assets of the company or not.

XYZ will be issuing each series of Notes in the form of fully-paid unsecured subordinated notes. The Notes will be considered a debenture pursuant to subsection 6(1) of the ITAA 1936.

Accordingly, paragraph 128F(1)(c) of the ITAA 1936 will not apply to each series of Notes.

Public offer test

Paragraph 128F(1)(d) of the ITAA 1936 provides that the issue of the debenture must satisfy the public offer test set out in subsection (3) or (4). Subsection 128F(4) is not relevant as it applies to global bonds. Therefore each series of Notes must satisfy the requirements of subsection 128F(3). Subsection 128F(3) contains five public offer tests. One of these tests must be satisfied.

Paragraph 128F(3)(a) states:

The issue of a debenture or debt interest by a company satisfies the public offer test if the issue resulted from the debenture or debt interest being offered for issue:

(a) to at least 10 persons each of whom:

(i) was carrying on a business of providing finance, or investing or dealing in securities, in the course of operating a financial market; and

(ii) was not known, or suspected, by the company to be an associate (see subsection (9)) of any of the other persons covered by this paragraph; or

…

Offered for issue

In order to satisfy the public offer test, the issue of the debenture or debt interest must have resulted from the debenture or debt interest being 'offered' for issue.

The term 'offered' is not defined in the legislation. TD 1999/24² clarifies when a debenture will be considered to be offered for issue. TD 1999/24 relevantly states:

3. For the purposes of the introductory words of paragraphs 128F(3)(a) and 128F(3)(b), 'offered' is not limited to meaning 'offer' in the context of a contractual offer. Rather, the word includes invitations or inducements to potential investors to make offers. For example, the placement of an advertisement that the company wishes to issue debentures, is an attempt to induce offers from potential investors rather than an offer itself (in other words, it is an 'invitation to treat').

4. Therefore, the introductory words are satisfied where the debentures are advertised for issue or other invitations or inducements are made in accordance with their respective public offer test, giving potential investors the opportunity to make an offer to the company for the acquisition of the debenture/s.

XYZ will advertise the issue of each series of Notes via an offering circular to the market. The offering circular will outline the detailed terms of the Notes and will be published and made available to the potential investors. The issuing of the offering circular will constitute an invitation or inducement to potential investors and therefore constitute an offer for the purposes of subsection 128F(3) of the ITAA 1997.

Offered to at least 10 persons

Paragraph 128F(3)(a) states that the debenture or debt interest must be offered for issue to at least 10 persons that are carrying on a business of providing finance, or investing or dealing in securities, in the course of operating in financial markets, and are not known by the company to be associates of one another.

XYZ expects that in excess of 10 unrelated institutional investors will participate in the issuance of each series of Notes as a result of the marketing campaign undertaken by XYZ.

As each series of Notes are yet to be offered for issue, for the purposes of the Ruling, it is assumed that each series of Notes will be offered to at least 10 institutional investors that are carrying on a business of providing finance or investing or dealing in securities in the course of operating in a financial market and that are not known by XYZ to be associates (as defined in subsection 128F(9) of the ITAA 1936) of one another.

Therefore, as the first public offer test contained in paragraph 128F(3)(a) of the ITAA 1936 will be satisfied, the public offer test will be satisfied.

Subsections 128F(5) and 128F(6) of the ITAA 1936

Subsection 128F(5) deals with issues and invitations that always fail the public offer test. Subsection 128F(6) excludes the withholding tax exemption under section 128F for interest paid to certain associates of the issuing company.

In the present case subsections 128F(5) and 128F(6) will not apply as it is assumed that:

• each series of Notes will not be acquired either directly or indirectly by an associate (as defined in subsection 128F(9) of the ITAA 1936) of XYZ; and

• the interest in respect of each series of Notes will not be paid to an associate (as defined in subsection 128F(9) of the ITAA 1936) of XYZ.

Conclusion

Based on the above, section 128F of the ITAA 1936 will exempt the interest paid on each series of Notes from withholding tax under Division 11A of the ITAA 1936. Accordingly, XYZ will not be required to withhold an amount from interest paid on each series of Notes under section 12-245 of Schedule 1 to the TAA.

¹ Taxation Determination TD 2006/1: Income tax: for the purposes of Division 974 of the Income Tax Assessment Act 1997, if the issuer of an interest bearing instrument can change the rate of interest that will become payable to any rate (including zero) that it chooses at its sole discretion, does the issuer have an 'effectively non-contingent obligation' to provide 'financial benefits' as interest payments from the time that a change in the interest rate could take effect?

² Taxation Determination TD 1999/24: Income Tax: interest withholding tax exemption under section 128F of the Income Tax Assessment Act 1936 - how may a company satisfy the introductory requirements in paragraphs 128F(3)(a) and 128F(3)(b) that a debenture must be offered on a 'debenture by debenture' basis?

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