Edited version of private advice

Authorisation Number: 1052079067793

Date of advice: 22 February 2023

Ruling

Subject: Taxation of financial arrangements

Question 1

Is the arrangement that is documented in the Detachable Warrant Deed Poll an 'arrangement' for the purposes of Division 230 of the Income Tax Assessment Act 1997 as a result of the application of the test in section 230-55 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

If the Answer to Question 1 is 'Yes', does the arrangement that is documented in the Detachable Warrant Deed Poll satisfy the definition of a 'financial arrangement', as defined in section 230-45 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

Year ended 30 June 20XX

Matters we have not ruled on

The private ruling is limited to the questions raised in the application.

We have not ruled on whether or not the issue of Ordinary Shares on equity settlement of the Warrants is deductible.

This matter is outside the scope of the questions, and it is not covered by the private ruling.

Relevant facts and circumstances

Company A is an Australian public company.

Company A previously had entered into loan facility agreements with a third party.

In 20AA, the third party requested that Company A provide a minimum repayment of the debt owing.

Firm A approached Company A with a debt solution to satisfy its existing debt with the third party. The Company A and Firm A agreement would replace Company A's existing debt with the third party and provide additional debt capacity for ongoing funding purposes.

Firm A was not prepared to provide funding to Company A without eliminating the risk (via the issue of warrants) of Company A not being able to repay the debt. As a method of avoiding shareholder dilution, Company A negotiated a cash settlable option on the warrants.

Company A and Firm A signed a Co-ordination Deed which contained the following components:

                  i.         A loan facility (the Facility); and

                 ii.        The issue of zero cost detachable warrants (the Warrants).

When the Co-ordination Deed was entered into, Company A had anticipated that it would have sufficient cash reserves at settlement date to make any payment required under the Warrants.

The Facility

In December 20AA, Company A entered into a Syndicated Facility Agreement (SFA) in respect of the Facility with Firm A (the Lender).

Company A was required to repay all loans in full within the agreed relevant period.

The rate of cash interest on each Loan under the Facility for each quarterly Interest Period was A% per annum.

In addition, payment in kind (PIK) interest accrued on each Loan under the Facility for each quarterly Interest Period at a rate of B%. Accrued PIK interest was capitalised and added to the principal amount of each Loan on the last day of each Interest Period.

Subject to certain requirements, the Lender could assign any of its rights and novate any of its rights and obligations to another bank or financial institution or to a trust, fund or other entity which is regularly engaged in or established for the purpose of making, purchasing or investing in loans, securities or other financial assets.

The Detachable Warrant Deed Poll

In November 20AA, Company A executed the Detachable Warrant Deed Poll (Deed Poll) which enabled the creation and issuance of the relevant number of Warrants to Firm A (the Warrantholder).

The Deed Poll contained the Warrant Conditions (the Conditions).

The number of Warrants issued under the Deed Poll was driven by Firm A's requirements.

The Warrants were non-exercisable for a period of 12 months, and would automatically lapse if not exercised within the agreed number of years.

Each Warrant conferred on the Warrantholder the right, upon exercise of the Warrant, to be paid cash within 10 business days of the exercise date of the Warrant.

The cash amount payable at cash settlement was calculated according to the formula:

CA = OS × V

Where:

CA meant the Australian dollar cash amount to be paid to the Warrantholder;

OS meant the number of Ordinary Shares corresponding to the Detachable Warrants exercised using the Exercise Ratio; and

V meant the VWAP of the Ordinary Shares in the 30 day period ending on (and including) the day prior to the Exercise Date

Company A also had the option to equity settle the Warrants. Company A had the sole discretion to equity settle by issuing, or procuring a transfer, to the Warrantholder of the number of Ordinary Shares corresponding to the Detachable Warrants exercised using the Exercise Ratio. The Exercise Ratio meant one Ordinary Share per Detachable Warrant.

Company A could only equity settle if:

•                In the case of an equity settlement effected by means of an issue of Ordinary Shares - Company A had sufficient capacity to issue the relevant allotted shares, or the shareholders had otherwise approved the issue of allotted shares.

•                In the case of an equity settlement effected by means of procuring a transfer of Ordinary Shares - the transfer did not contravene and was effective under the applicable law and the relevant Ordinary Shares were transferred free of any security interest or other encumbrance.

In addition, Company A had to apply for a quotation of the shares, and use best efforts to ensure that the shares were quoted on the ASX as soon as practicable after they are issued, and issue a 'cleansing statement' in accordance with the applicable law on settlement.

Company A only had 5 business days after the Exercise Date to notify the Warrantholder in writing that it wished to equity settle.

Company A had an obligation to pay an amount in respect of each Warrant equal to the Distributable Return on each Distribution Payment Date. Distribution Payment Date meant each day on which a dividend was paid. Distributable Return meant an amount equivalent to any dividend per Ordinary Share paid on a Distribution Payment Date on the number of Ordinary Shares which Company A would have been obliged to issue to the Warrantholder upon the exercise of that Detachable Warrant.

The Warrants did not carry a right to vote at a general meeting of Company A, unless provided for by the applicable law.

No monies were payable by the Warrantholder to be issued any Warrants.

A Warrantholder could transfer any Warrant it held, without the consent of Company A. The Warrants were distinct and transferable separately from any interest that the Warrantholder may have had in the Issuer.

Accounting treatment

The Facility and the Warrants issued under the Deed Poll were treated under the applicable accounting standards as separate arrangements in the audited financial statements of Company A.

The Warrants issued under the Deed Poll were treated as equity for accounting purposes, as Company A had the right to settle the Warrants by issuing Ordinary Shares on a fixed for fixed basis (one Ordinary Share for one Warrant).

Exercise of the Warrants

On XX December 20VV, Company A announced that it had secured a new facility with another third party, which had been partially drawn down to repay all loans drawn down from Firm A under the Facility.

On XX March 20XX, the Warrantholder delivered an exercise notice to Company A giving notice that it had elected to exercise all of its Warrants.

On XX March 20XX, Company A notified the Warrantholder that it had elected to equity settle the Warrants in accordance with the discretion that Company A had under the Conditions.

On XX March 20XX, Company A settled the Warrants by issuing XX million Ordinary Shares to the Warrantholder.

Other matters

The Ordinary Shares are listed on the ASX.

No Distributable Return was paid on the Warrants.

Company A has not previously issued any other warrants, and does not currently have any other warrant arrangements.

Company A has not made any TOFA elections.

Company A and Firm A are not related parties.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 230-45

Income Tax Assessment Act 1997 section 230-50

Income Tax Assessment Act 1997 section 230-55

Income Tax Assessment Act 1997 section 230-85

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 section 974-75

Income Tax Assessment Act 1997 section 974-130

Income Tax Assessment Act 1997 section 974-165

Reasons for decision

The following references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Question 1

Is the arrangement that is documented in the Detachable Warrant Deed Poll an 'arrangement' for the purposes of Division 230 of the Income Tax Assessment Act 1997 as a result of the application of the test in section 230-55 of the Income Tax Assessment Act 1997?

Summary

Pursuant to the test in section 230-55, the arrangement documented in the Deed Poll is an 'arrangement' for the purposes of Division 230.

Detailed reasoning

Division 230 deals with the tax treatment of gains and losses from financial arrangements.

In order to determine whether gains and losses arise under a financial arrangement, it is first necessary to identify the relevant 'arrangement'.

An arrangement is broadly defined under section 995-1 to mean any arrangement, agreement, understanding, promise or undertaking whether expressed or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

Section 230-55 provides additional guidance as to which specific rights and obligations should be combined to form the relevant arrangement to be tested for the purposes of the Division 230.

Subsection 230-55(4) provides that whether a number of rights and/or obligations are themselves an arrangement or are 2 or more separate arrangements is a question of fact and degree determined having regard to the following:

•                the nature of the rights and/or obligations

•                their terms and conditions (including those relating to any payment or other consideration for them)

•                the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved)

•                whether they can be dealt with separately or must be dealt with together

•                normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole), and

•                the objects of Division 230.

Taxation Ruling TR 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 provides the Commissioner's view on the application of subsection 230-55(4).

TR 2012/4 provides (at paragraph 6) that while it will often be the case that the arrangement is consistent with the legal form of the arrangement, subsection 230-55(4) can operate to identify as an arrangement something other than the rights and/or obligations under a particular contract. Whether a number of rights and/or obligations are themselves an arrangement, or are two or more separate arrangements, is a question of fact and degree that is determined having regard to the matters referred to in paragraphs 230-55(4)(a) to (f), both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other (TR 2012/4, paragraph 10).

The weight given each factor in subsection 230-55(4) depends on the circumstances of the particular case (TR 2012/4, paragraph 13).

The relevant rights and obligations of Company A under the Facility and the Deed Poll include:

(Note - For the purpose of the Facility, the above obligations arose on Company A drawing down on the Facility.)

In applying the factors at subsection 230-55(4) to Company A's rights and obligations under the Deed Poll and the Facility, the matters considered by the Commissioner included:

•         The nature of the Deed Poll and the Facility, and the rights and obligations which comprise them, are different. The Facility is a loan financing agreement, under which Company A has the obligation to repay the borrowed amounts and pay interest. The Warrants issued under the Deed Poll are in substance derivatives, as they carry the option to be settled by delivery of shares or by cash, and can be sold separately to the debt security they were attached to.

•         Under the terms of the Deed Poll, Company A received no consideration for issuing the Warrants, and there was no exercise price payable when the Warrantholder exercised them.

•         Company A entered the Facility for the purpose of repaying its third-party debt. Company A executed the Deed Poll as it was a requirement of Firm A that Company A issue the Warrants as part of entering the Facility.

•         The Deed Poll and the Facility were not contractually bound together and could be dealt with separately. Among other things, the Warrants issued under the Deed Poll and the Facility could be assigned to a third party separately, the termination of one did not automatically lead to the termination of the other, and the performance times differed.

•         The commercial effect of the Deed Poll and the Facility can be, and is typically, understood without reference to the other. Normal commercial understandings and practices in relation to the Warrants issued under the Deed Poll and the Facility are that they are separate arrangements, and the Warrants issued under the Deed Poll and the Facility were treated as separate for accounting.

•         Treating the Deed Poll and the Facility as separate arrangements would not defeat the objects of Division 230.

Having regard to the factors in subsection 230-55(4) and the matters in the paragraph above, on balance it is considered that for Division 230 purposes the Deed Poll gave rise to an arrangement which is separate to the Facility.

The Deed Poll therefore constitutes an arrangement for the purposes of section 230-55.

Question 2

If the Answer to Question 1 is 'Yes', does the arrangement that is documented in the Detachable Warrant Deed Poll satisfy the definition of a 'financial arrangement', as defined in section 230-45 of the Income Tax Assessment Act 1997?

Summary

The arrangement documented in the Detachable Warrant Deed Poll satisfies the definition of 'financial arrangement' as defined in section 230-45.

Detailed reasoning

For Division 230 to apply, the arrangement identified under section 230-55 must be a 'financial arrangement'.

Section 230-45 is the general test for a Division 230 financial arrangement. Section 230-50 provides a further two tests for determining a financial arrangement at subsection 230-50(1) and subsection 230-50(2).

As provided in the Detailed reasoning for Question 1, the arrangement documented in the Deed Poll constitutes an arrangement for the purposes of section 230-55. Therefore, the relevant arrangement being tested under section 230-45, subsection 230-50(1) and subsection 230-50(2) is the arrangement documented in the Deed Poll.

Is the Deed Poll a section 230-45 financial arrangement?

Pursuant to subsection 230-45(1), an entity will have a cash settlable financial arrangement where, under an arrangement:

•         the entity has one or more cash settlable legal or equitable rights to receive, and/or obligations to provide, a financial benefit; and

•         in comparison to these rights and/or obligations, the entity does not also have one or more non-insignificant rights and/or obligations that:

-       are not cash settlable; and/or

-       are not rights to receive, or obligations to provide, a financial benefit.

Subsection 230-45(2) specifies the circumstances in which a right to receive or obligation to provide a financial benefit that you have is cash settlable. Relevantly, paragraphs 230-45(2)(a), (b), (c) and (g) provide a financial benefit is cash settlable if and only if:

•         the benefit is money or a money equivalent (paragraph 230-45(2)(a))

•         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 (paragraph 230-45(2)(b))

•         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 (paragraph 230-45(2)(c)), or

•         you are able to settle the right or obligation as mentioned in paragraph (b) or (c) (whether or not you intend to satisfy or settle the right or obligation in that way) and you do not have, as your sole or dominant purpose for entering into the arrangement under which you are to receive or provide the financial benefit, the purpose of receiving or delivering the financial benefit as part of your expected purchase, sale or usage requirements (paragraph 230-45(2)(g)).

Where a reference in paragraph 230-45(2)(b) or (c) to a financial arrangement does not include a reference to something that is a financial arrangement under section 230-50.

Paragraph 974-160(1)(a) defines 'financial benefit' to mean anything of economic value, and includes property and services.

The Explanatory Memorandum to the Tax Law Amendment (Taxation of Financial Arrangements) Bill 2008 (the TOFA EM) provides at paragraph 2.6 that '...the time to determine whether an arrangement is a financial arrangement will be at the time the arrangement comes into existence or commences to be held...'

Section 230-85 provides that an obligation is treated as an obligation (likewise a right is treated as a right) for the purposes of Division 230 even if it is subject to a contingency. The TOFA EM explains (at paragraph 2.65) that an option can contain contingent rights to receive or obligations to provide.

Under the arrangement documented in the Deed Poll, Company A's obligation to settle the Warrants by providing a cash amount, or (at Company A's discretion) by providing Ordinary Shares, was contingent on Firm A exercising the Warrants. Pursuant to section 230-85, these contingent obligations will be treated as obligations for the purposes of Division 230.

Company A's contingent obligation to provide a cash amount on cash settlement will constitute a cash settlable obligation to provide financial benefits. Accordingly, paragraph 230-45(2)(a) will be satisfied.

Company A's contingent obligation to provide the Ordinary Shares will constitute a cash settlable obligation to provide financial benefits if paragraph 230-45(2)(g) is satisfied.

Paragraph 230-45(2)(g) applies where, under the same contract, a taxpayer has an obligation to either provide a non-monetary financial benefit or alternatively to provide a monetary payment in satisfaction of that obligation. In relation to paragraph 230-45(2)(g), the TOFA EM provides that:

2.87 Where a taxpayer has a right to receive, or an obligation to provide, a non-monetary financial benefit that it is able to settle by the receipt or provision of a monetary item, the right or obligation will be taken to be cash settlable if the taxpayer does not have the sole or dominant purpose of entering into the arrangement to receive or provide the relevant non-monetary financial benefit as part of its expected purchase, sale or usage requirements. [Schedule 1, item 1, paragraph 230-45(2)(g)]

2.88 For example, where a non-monetary financial benefit may be provided in satisfaction of a right under an arrangement, but the taxpayer is able to instead receive a monetary payment in satisfaction of that right, and the taxpayer is indifferent as to what it receives, the right will be a cash settlable right. The test of the taxpayer's intention is an objective one. [Schedule 1, item 1, paragraph 230-45(2)(g)]

Under the arrangement documented in the Deed Poll, Company A could settle the Warrants by providing monetary payment in the form of cash or it had the option to settle by providing non-monetary financial benefit in the form of Ordinary Shares. Company A did not have, as their sole or dominant purpose for entering into the arrangement under which they provided the Ordinary Shares, the purpose of delivering the Ordinary Shares as part of their expected purchase, sale or usage requirements.

Paragraph 230-45(2)(g) would therefore be satisfied.

Accordingly, Company A had cash settlable obligations to provide financial benefits under the Deed Poll, and it did not also have one or more non-insignificant rights and/or obligations that were non cash settlable and/or were not rights to receive or obligations to provide financial benefits. The arrangement documented in the Deed Poll will therefore constitute a cash settlable financial arrangement under section 230-45, subject to subsection 230-50(1) not applying.

Is the Deed Poll a subsection 230-50(1) financial arrangement?

Where an equity interest is cash settlable, it may satisfy both subsection 230-50(1) and subsection 230-45(1). Taxation Determination TD 2011/12 Income tax: where an equity interest is a financial arrangement which satisfies both subsections 230-45(1) and 230-50(1) of the Income Tax Assessment Act 1997, which provision applies? provides (at paragraph 10) that subsection 230-50(1) applies in preference to subsection 230-45(1).

Subsection 230-50(1) provides that you also have a financial arrangement if you have an equity interest. The equity interest constitutes the financial arrangement.

The test for an equity interest in a company is contained in section 974-70 of Subdivision 974-C.

Pursuant to subsection 974-70(1), a scheme gives rise to an equity interest in a company if:

(a)  the scheme satisfies the equity test in subsection 974-75(1), and

(b)  the interest is not characterised as a debt interest under Subdivision 974-B.

Paragraph 974-70(1)(a) provides that a scheme will give rise to an equity interest in a company if, when it comes into existence, it satisfies the equity test in subsection 974-75(1).

Relevantly, subsection 974-75(1) provides that a scheme satisfies the equity test in relation to a company if it gives rise to an interest set out in the table at subsection 974-75(1):

•         an interest in the company as a member or stockholder of the company (item 1 of the table at subsection 974-75(1)), or

•         an interest issued by the company that gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or a connected entity of the company, or is an interest that will, or may, convert into an equity interest in the company or a connected entity of the company (item 4 of the table at subsection 974-75(1)).

Section 974-75(2) requires that a scheme under item 2,3, and 4 also be a 'financing arrangement'.

Subsection 974-130(1) defines when a scheme is a financing arrangement. A scheme is a financing arrangement for an entity if it is entered into or undertaken:

•         to raise finance for the entity (or a connected entity of the entity) (paragraph 974-130(1)(a))

•         to fund another scheme, or a part of another scheme, that is a financing arrangement under paragraph 974-130(1)(a) (paragraph 974-130(1)(b)); or

•         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 974-130(1)(a) (paragraph 974-130(1)(c)).

The Commissioner discussed the definition of 'financing arrangement' for the purposes of applying the debt test in Taxation Determination TD 2004/83 Income tax: can the assignment of an intra-group debt or income stream to an entity that is not a member of the consolidated group give rise to a debt interest for the head company of the group under Division 974 of the Income Tax Assessment Act 1997? TD 2004/83 provides (at paragraphs 10-12) that 'finance' is not defined and '...accordingly takes its ordinary meaning relevant to the context...'. TD 2004/83 draws on the guidance of Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001, which states that '...the raising of finance generally entails a contribution to the capital of an entity, whether by way of money, property or services in respect of which a return is paid by the entity, be it contingent (connoting equity) or non-contingent (connoting debt)...' TD 2004/83 provides that it is therefore '...fundamental to the concept of a financing arrangement that there be a provision of resources for use in an entity's enterprise in exchange for some form of future return... the arrangement must, at the very least, involve the receipt of a financial benefit (as defined) and the contemplation of the provision of a financial benefit (as defined) on behalf of the entity being financed before it will be considered a financing arrangement...'.

The arrangement documented in the Deed Poll would satisfy item 4 of the table at subsection 974-75(1), as it is an interest issued by Company A which gave the Warrantholders a right to be issued with equity interests (being the Ordinary Shares) in Company A (item 4(a) of subsection 974-75(1)). In addition, the Warrants were interests that would, or may, convert into Ordinary Shares (item 4(b) of subsection 974-75(1)), as under the Conditions:

•         the Warrants issued under the Deed Poll must be or may be redeemed, repaid or satisfied by the issue or transfer of the Ordinary Shares (subparagraph 974-165(b)(i)), or

•         the Warrantholder has, or is to have, a right or option to have allotted or transferred, or otherwise to acquire, the Ordinary Shares, or a right or option to acquire the Ordinary Shares (paragraph 974-165(c)).

However, the arrangement documented in the Deed Poll would not satisfy the requirement under subsection 974-75(2). The Deed Poll would not be a financing arrangement for the purposes of section 974-130, as Company A did not receive any amount on the Warrants issued under the Deed Poll. The Warrants were issued for nil consideration, and no price was payable by the Warrantholder on execution of the Warrants.

Accordingly, the arrangement documented in the Deed Poll does not satisfy the equity test under section 974-75, and it would not be an equity interest.

As the arrangement documented in the Deed Poll is not an equity interest, it would not constitute a financial arrangement under subsection 230-50(1).

Is the Deed Poll a subsection 230-50(2) financial arrangement?

An arrangement may also be financial arrangement under subsection 230-50(2), which provides you have a financial arrangement if you have, under the arrangement, a legal or equitable right to receive something that is a financial arrangement under section 230-50, a legal or equitable obligation to provide something that is a financial arrangement under section 230-50, or a combination of one or more such rights and/or obligations. It also requires that the right, obligation, or combination does not constitute or form part of a financial arrangement under subsection 230-45(1).

Under the arrangement documented in the Deed Poll, Company A had the contingent obligation to provide Ordinary Shares. As the Ordinary Shares are equity interests which would constitute financial arrangements under section 230-50, paragraph 230-50(2)(a) would be satisfied.

However, pursuant to paragraph 230-50(2)(b), subsection 230-50(2) will not apply if the obligation forms part of an arrangement under subsection 230-45(1).

Accordingly, as the arrangement documented in the Deed Poll is a financial arrangement under subsection 230-45(1), it would not be a financial arrangement under subsection 230-50(2).

Conclusion

The arrangement documented in the Deed Poll is not a financial arrangement under section 230-50.

Accordingly, as Company A had cash settlable obligations to provide financial benefits, and it did not also have one or more non-insignificant rights and/or obligations that were non cash settlable and/or were not rights to receive or obligations to provide financial benefits, the arrangement documented in the Deed Poll constitutes a cash settlable financial arrangement under section 230-45.

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