Edited version of your written advice

Authorisation Number: 5010052604945

Date of advice: 18 December 2018

Ruling

Subject: Deduction under section 230-15(2) of the Income Tax Assessment Act 1997 (ITAA 1997)

Question

Is the taxpayer entitled to claim a deduction under section 230-15(2) of the ITAA 1997 in relation to the payment of the amount to the Seller during the year ended 30 June 2017?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

During the year ended 30 June 20XX

Relevant facts and circumstances

The taxpayer is the head company of a consolidated group.

The Buyer is a wholly owned subsidiary of the taxpayer.

The Buyer entered into a Share Sale and Purchase Agreement (SPA) to acquire 100% of the Shares from the Seller, for the Purchase Price.

Completion of the sale and purchase of the Shares was conditional on satisfaction of, or waiver of the Condition.

An amount was agreed by the parties to the SPA following an initial offer, made by the Buyer. The parties agreed to increase the purchase price with the difference between the initial offer amount and the agreed purchase price serving as the amount.

Under the terms of the SPA the Buyer was required to provide to the Seller a bank guarantee for the specified amount in favour of the Seller from a financial institution, and in a form, approved by the Seller (Bank Guarantee).

Under the terms of the SPA a number of remedies were available in the case of a breach of the SPA.

The SPA could be terminated in accordance with the terms of the SPA.

The Seller held the right to immediately call for payment under the Bank Guarantee and retain the amount if the SPA was terminated before Completion in the circumstances permitted under the SPA.

Under the terms of the SPA, the Seller was required to return the undrawn Bank Guarantee to the Buyer:

The Bank Guarantee

The Bank issued the Bank Guarantee to the Seller. The Bank Guarantee was provided by the Bank at the request of the Buyer, in consideration of the Seller accepting the Bank Guarantee with respect to the SPA. In accordance with the terms of the Bank Guarantee, the Bank provided an unconditional undertaking to pay the Seller.

If the Seller demanded part payment under the Bank Guarantee, the Bank was required to issue a replacement undertaking.

The Bank Guarantee was issued by the Bank against an existing guarantee facility established by the taxpayer. The facility was established for the purpose of procuring the issue of guarantees to counterparties of the taxpayer. The key terms include:

● the guarantee facility is an uncommitted facility

● the tenure and price of each utilisation is agreed between the bank and the taxpayer

● the taxpayer indemnifies the Bank for payment in respect of any utilisation should a guarantee be called by the holder of a utilisation

● fees are payable only in respect of the utilisations under the facility.

Other rights and obligations

Under the terms of the SPA, the Buyer had other relevant rights and obligations, including but not limited to:

● the obligation to pay the Purchase Price to the Seller on the Completion Date

● the right to:

● receive from the Seller a refund and reduction in the Purchase Price, in certain circumstances after Completion

● receive from the Seller a refund and reduction of the Purchase Price for any monetary compensation received.

Termination of the SPA

The SPA was to be terminated prior to Completion. The Buyer wished to prevent the credit implications that would have resulted from the Seller calling for payment under the Bank Guarantee upon termination of the SPA.

Prior to termination of the SPA the Buyer entered into discussions with the Seller with respect to making a cash payment as an alternative to the Seller calling for payment under the Bank Guarantee.

No written agreement was entered into in relation to the making of a cash payment.

Prior to termination of the SPA the Buyer and the Seller confirmed the terms under which the Buyer would pay the amount directly to the Seller.

The Seller held the Bank Guarantee in escrow, pending written confirmation from the bank operating the nominated account that the amount had been received.

On the day after termination, the Seller returned the undrawn Bank Guarantee to the Bank. The Bank cancelled the Bank Guarantee on the same day.

Other

The taxpayer is subject to Division 230 of the ITAA 1997 with respect to gains and losses from a financial arrangement.

The taxpayer did not elect to use any of the elective tax timing methods under Division 230 of the ITAA 1997. Therefore, either the accruals method or the realisation method would apply to any gain or loss under Division 230 (subsection 230-40(4) of the ITAA 1997).

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 subsection 230-15(2)

Income Tax Assessment Act 1997 section 230-20

Income Tax Assessment Act 1997 subsection 230-40(4)

Income Tax Assessment Act 1997 paragraph 230-40(4)(e)

Income Tax Assessment Act 1997 section 230-45

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

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

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

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

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

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

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

Income Tax Assessment Act 1997 subsection 230-45(2)

Income Tax Assessment Act 1997 paragraph 230-45(2)(a)

Income Tax Assessment Act 1997 paragraph 230-45(2)(b)

Income Tax Assessment Act 1997 paragraph 230-45(2)(c)

Income Tax Assessment Act 1997 paragraph 230-45(2)(e)

Income Tax Assessment Act 1997 paragraph 230-45(2)(f)

Income Tax Assessment Act 1997 paragraph 230-45(2)(g)

Income Tax Assessment Act 1997 subsection 230-45(3)

Income Tax Assessment Act 1997 paragraph 230-45(3)(b)

Income Tax Assessment Act 1997 section 230-50

Income Tax Assessment Act 1997 section 230-55

Income Tax Assessment Act 1997 subsection 230-55(1)

Income Tax Assessment Act 1997 subsection 230-55(2)

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

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

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

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

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

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

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

Income Tax Assessment Act 1997 section 230-60

Income Tax Assessment Act 1997 subsection 230-60(1)

Income Tax Assessment Act 1997 subsection 230-60(2)

Income Tax Assessment Act 1997 Subdivision 230-B

Income Tax Assessment Act 1997 Subdivision 230-G

Income Tax Assessment Act 1997 subsection 230-440(1)

Income Tax Assessment Act 1997 Division 974

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

Income Tax Assessment Act 1997 section 974-160

Income Tax Assessment Act 1997 subsection 974-160(1)

Income Tax Assessment Act 1997 paragraph 974-160(1)(a)

Income Tax Assessment Act 1997 paragraph 974-160(1)(b)

Income Tax Assessment Act 1997 paragraph 974-160(1)(c)

Income Tax Assessment Act 1997 subsection 974-160(2)

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

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the taxpayer.

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

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

Summary

1. The SPA and the payment arrangement under which the Buyer paid the Seller the amount in return for the Seller forgoing its right to draw on the Bank Guarantee were separate arrangements.

2. The SPA did not meet the conditions in section 230-45 to be a financial arrangement. If it did meet the conditions to be a financial arrangement under section 230-45 (not considered), there were no methods available under subsection 230-40(1) that could be used to work out a gain or loss from the arrangement under Division 230.

3. The payment arrangement mentioned above was a financial arrangement under section 230-45.

4. In working out whether there is a gain or loss from the payment arrangement, the Buyer’s obligations to provide and its rights to receive financial benefits from the arrangement must all be taken into account.

5. Under the payment arrangement, the Buyer had:

● an obligation to provide financial benefits which included the payment of the amount to the Seller

● a right to receive financial benefits which included the financial benefit resulting from the Seller forgoing its right to call for payment of the amount from the Bank under the Bank Guarantee.

6. For the reasons stated above the payment will not result in a loss of the amount.

Detailed reasoning

7. Division 230 deals with the taxation treatment of gains and losses arising from certain financial arrangements.

8. 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.

9. Under subsection 230-45(1), an arrangement is a ‘financial arrangement’ if under that arrangement there is:

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

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

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

unless:

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

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

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

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

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

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

Note 1: Whether your rights and/or obligations under an arrangement constitute a financial arrangement can change over time depending on changes either to the terms of the arrangement or external circumstances (such as particular rights or obligations under the arrangement being satisfied by the parties). For example, a contract may provide for the transfer of a boat in 6 months time and payment of the contract price at the end of 2 years. Until the boat is delivered, there is no financial arrangement because of the operation of paragraphs (d), (e) and (f) above. Once the boat is delivered, there is a financial arrangement because those paragraphs are no longer applicable.

10. Therefore, the first step in applying Division 230 is identification of the relevant arrangement (subsection 230-45(1)). The term 'arrangement' is identified in subsection 995-1(1) as being '…any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.'

11. ‘Financial benefit’ is broadly defined by section 974-160 as meaning anything of economic value, including property and services. The Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (the Explanatory Memorandum), at paragraph 2.64, explains that economic value encapsulates money, money equivalent and non-monetary items.

Relevant arrangement

12. The SPA provided for the purchase of the Shares. Under the SPA the Buyer had an obligation to provide valuable consideration to the Seller with respect to the purchase of the Shares, namely:

● on the date of the SPA, to provide the Bank Guarantee, under which the Seller had a right to immediately call for payment of the amount if the SPA was terminated in accordance with the terms of the SPA

● on Completion of the SPA, pay the Purchase Price in immediately available and cleared funds.

13. For the purposes of Division 230, the legal rights and obligations which constitute a ‘financial arrangement’ as defined in section 230-45 is not a static concept and may change over time. Note 1 to subsection 230-45(1) indicates that an arrangement which is not a financial arrangement can become a financial arrangement for the purposes of Division 230.

14. Paragraph 10.6 of the Explanatory Memorandum states that the ending of the relevant rights/obligations under a financial arrangement can occur in a number of different ways, including through their discharge (of obligations) or satisfaction, expiry, close out, forfeiture or maturity.

15. A question as to the application of section 230-45 arises in relation to the time at which the Buyer had an obligation to pay and when that obligation was settled. In order to determine when the Buyer began to have a financial arrangement in relation to the amount paid to the Seller following termination of the SPA it is necessary to identify the relevant arrangement to be tested.

16. It will often be the case that what is determined to be the relevant arrangement is consistent with the form of the arrangement (that is, the rights and obligations under a particular contract).

17. However, paragraph 11 of Taxation Ruling TR 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997) in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 of the ITAA 1997 (TR 2012/4) states that what is an arrangement for the purposes of Division 230 does not merely depend on the legal form of the arrangement.

One arrangement or two separate arrangements?

18. The SPA sets out various rights and obligations between the Buyer and the Seller with respect to the acquisition of the Shares.

19. Although no written agreement was entered into in relation to the making of a cash payment directly to the Seller, the payment arrangement agreed to between the Buyer and the Seller during the period prior to termination of the SPA includes the following financial benefits:

● obligation to pay money, being the amount

● right to have the Bank Guarantee held in escrow pending confirmation of receipt of funds as security with respect to the Seller forgoing the right to immediately call for payment of the amount from the Bank under the Bank Guarantee

20. Section 230-55 applies to determine whether rights and/or obligations constitute a single arrangement or multiple arrangements for the purposes of Division 230.

21. In accordance with subsections 230-55(1) and 230-55(2), where a taxpayer has a right to receive, or an obligation to provide, two or more financial benefits, each right or obligation is taken to be a separate right or obligation for the purposes of Division 230.

22. Subsection 230-55(4) provides that: whether a number of rights and or obligations are themselves an arrangement or are two or more separate arrangements, is a question of fact determined by having regard to the factors specified in paragraphs 230-55(4)(a) to (f), as follows:

230-55(4) For the purposes of this Division, whether a number of rights and/or obligations are themselves an *arrangement or are 2 or more separate arrangements is a question of fact and degree that you determine having regard to the following:

(a) the nature of the rights and/or obligations;

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

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

(d) whether they can be dealt with separately or must be dealt with together;

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

(f) the objects of this Division.

In applying this subsection, have regard to the matters referred to in paragraphs (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.

23. Under section 230-55, a contract will often define the boundaries of an arrangement, especially where the form of the contract is consistent with its substance. Relevantly, paragraph 2.47 of the Explanatory Memorandum states:

…[T]he contract is typically viewed on a ‘stand alone’ basis. In this context, the contract is neither aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230.

24. The SPA, being a contract for the exchange of shares for money, satisfies this broad definition, and prima facie, the rights and obligations arising under the SPA will constitute a single ‘arrangement’.

25. In regard to the cash payment following termination of the SPA, it is noted that the rights and obligations under the payment arrangement arose as a result of a verbal agreement, which was entered into some time after the parties entered into the SPA. As the verbal agreement was not capable of varying or replacing the SPA under the terms of the SPA, the payment arrangement will, prima facie, be viewed as a stand-alone agreement.

26. The question is not whether the SPA is an ‘arrangement’ in its own right; it is whether the rights and obligations in relation to the purchase of the Shares under the SPA and the cash payment following termination of the SPA comprise one arrangement for the purposes of Division 230, is the arrangement to be tested against section 230-45. That is, it is necessary to consider whether the rights created in the Buyer as a result of the cash payment arrangement and the obligation to pay cash directly to the Seller should be treated as a single arrangement which is separate from the SPA or whether the payment arrangement and the SPA together form a single arrangement.

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

27. The SPA states that the Buyer agreed to buy the Shares from the Seller with the result that the Buyer would own 100% of the Shares.

28. On execution of the SPA, the Buyer acquired a bundle of contractual rights including the right to acquire 100% of the Shares on Completion of the SPA. Subject to satisfaction of the Condition, amongst other things, the Buyer had an obligation to pay the Purchase Price. Execution of the SPA created an obligation in the Buyer to provide the Bank Guarantee to the Seller.

29. The Buyer provided the Bank Guarantee to the Seller on the date of the SPA, to be held until such time as the Seller became entitled to call for payment of, and to retain, the amount under the Bank Guarantee, or the Seller was required to return the Bank Guarantee to the Buyer under to the terms of the SPA.

30. On execution of the SPA the Seller had a conditional right to call for payment of the amount under the Bank Guarantee and to retain the amount, upon termination of the SPA prior to Completion. On the date of the SPA, the right to retain the amount was merely impending, threatened, or expected. Nevertheless, as section 230-85 makes clear, rights and obligations are treated as such for the purposes of Division 230 even if they are subject to a contingency.

The Deposit and the Bank Guarantee

31. Under the terms of the SPA the Buyer provided a bank guarantee for the deposit to the Seller on the date of the SPA in the form of the Bank Guarantee.

32. The term ‘deposit’ is not a defined term and takes on its ordinary meaning. The Macquarie Dictionary ([Online], viewed 11 December 2018, www.macquariedictionary.com.au.) defines the term deposit as:

verb (t) 1. to put or lay down; place; put. …

4. to give as security or in part payment …

8. anything laid away or entrusted to another for safekeeping.

9. money placed in a financial institution.

10. anything given as security or in part payment.

33. Goods and Services Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions provides that a deposit is:

● money lodged in an account at a financial institution at call or at term;

● to lodge for safekeeping;

● initial down payment on a terms purchase;

● money paid as proof of intent to complete a contract.

34. In Commissioner of Taxation v Guy (1996) 67 FCR 68; 137 ALR 193 the court (at FCR 79) quoted a passage from Lord Browne-Wilkinson in Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573 where it was said that the special treatment afforded to the forfeiture of deposits in the context of contracts for the purchase of land (which would normally be unlawful because a penalty) derived from the ancient custom of providing an earnest for the performance of a contract.

35. Goods and Services Tax Ruling GSTR 2006/2 Goods and services tax: deposits held as security for the performance of an obligation at paragraph 19A states:

In Federal Commissioner of Taxation v. Reliance Carpet Co Pty Ltd [2008] HCA 22; (2008) 2008 ATC 20-028; (2008) 68 ATR 158 the High Court noted at paragraphs 22 to 27 that the term 'deposit' had several aspects. These aspects include that a deposit could: be counted towards the payment of the purchase price; be brought into account in assessment of damages; be a token provided by the purchaser as 'an earnest to bind the bargain'; and provide a form of security for performance by the purchaser.

36. The term ‘guarantee’ is not a defined term and takes on its ordinary meaning. The Macquarie Dictionary ([Online], viewed 11 December 2018, www.macquariedictionary.com.au) defines it as:

noun 1. a warrant, pledge, or promise accepting responsibility for the discharging of another's liabilities, as the payment of a debt.

2. a promise or assurance, especially one given in writing by a manufacturer, that something is of a specified quality, and generally including an undertaking to make good any defects under certain conditions.

3. someone who gives a guarantee or guaranty; guarantor.

4. someone to whom a guarantee is made.

5. that which is taken or presented as security. …

–verb (t) (guaranteed, guaranteeing)

7. to secure, as by giving or taking security.

8. to make oneself answerable for on behalf of one primarily responsible: to guarantee the carrying out of a contract.

9. to undertake to secure to another, as rights or possessions.

10. to serve as a warrant or guarantee for.

11. to engage (to do something).

12. (sometimes followed by from or against) to engage to protect or indemnify: to guarantee someone against loss.

13. to promise.

Paragraph 230-55(4)(a) analysis

37. The Bank Guarantee was a separate binding arrangement between the Seller and the Bank under which:

● the Bank provided an unconditional undertaking to pay the amount to the Seller

● the Seller held an unqualified right to demand payment of the amount.

38. Generally, where a cash is provided on execution of a contract the vendor holds the deposit as security until such time as completion of the contract occurs and on completion it becomes part of the purchase price payable under the contract (Taxation Ruling TR 1999/19 Income tax capital gains: treatment of forfeited deposits at paragraphs 35). If the contract is terminated prior to completion:

● the vendor may be required to return the deposit to the purchaser

● the deposit may be forfeited if the vendor is entitled to retain the deposit upon default under the terms of the contract.

39. Under the Bank Guarantee the Seller held an unconditional right to call for payment under the Bank Guarantee at any time until expiry, without reference to the SPA and the Seller was not required to prove a breach of the SPA or to pursue the Buyer for payment.

40. The terms of the SPA imposed restrictions on the Seller with respect to making a call for payment under the Bank Guarantee. Despite the restrictions imposed under the SPA, the unconditional nature of the Bank Guarantee would not have prevented the Seller from demanding payment of from the Bank under the Bank Guarantee at any time prior to expiry of the Bank Guarantee.

41. If a breach of the SPA with respect to the Bank Guarantee had occurred, in addition to any legal or equitable remedies available to the Buyer, the Buyer had recourse to remedies under the terms of the SPA.

42. Other than the obligation to provide the Bank Guarantee to the Seller on the date of the SPA, there were no additional terms or conditions under which:

● the Buyer had an obligation to pay the amount directly to the Seller

● the Seller had a right to demand payment of the amount directly from the Buyer.

43. Termination of the SPA resulted in the Seller becoming entitled to immediately call for payment from the Bank under the Bank Guarantee.

44. The Seller did not call for payment under the Bank Guarantee and the Buyer paid cash directly to the Seller as a result of the verbal agreement entered into between the Buyer and the Seller prior to termination of the SPA. The verbal agreement provided the Seller with an alternative method of receiving the amount it was entitled to demand from the Bank under the terms of the Bank Guarantee and the SPA. The payment arrangement created rights and obligations that the Buyer did not hold under the SPA. On entry into the payment arrangement, the Buyer promised to pay cash directly to the Seller in return for the Seller agreeing to forgo its rights under the SPA and the Bank Guarantee to call for payment from the Bank and placing the Bank Guarantee in escrow pending confirmation of receipt of the funds.

45. Therefore, the essential character of:

● the Bank Guarantee in relation to the purchase of the Shares is that of a deposit provided on the date of the SPA, to secure the rights the Buyer acquired under the SPA

● the payment directly to the Seller is that of a payment provided for the rights, and the resultant benefits, that the Buyer acquired as a result of the Buyer and the Seller entering into the payment arrangement.

46. In these circumstances, paragraph 230-55(4)(a) points towards the conclusion that the Buyer’s rights and obligations under the SPA should not be aggregated with the rights and obligations that arose as a result of the arrangement between the Buyer and Seller for the Buyer to pay the amount directly to the Seller on termination of the SPA.

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

47. The Condition was a condition precedent to the obligation of the parties to perform their obligations with respect to the Completion of the SPA. The conditions under which the Buyer and the Seller could terminate the SPA were conditions subsequent, upon which, in certain circumstances, they could each rely to avoid their obligations under the contract (ATO ID 2004/668 Income tax Capital gains tax : buy-sell agreement - time of CGT event A1 and Perri v Coolangatta Investments Pty Ltd (1982) 149 CLR 537, at 552, per Mason J, on the distinction between a condition precedent to the formation of a contract and a condition subsequent to the performance of a contract.)

48. The obligation to provide the Bank Guarantee on the date of the SPA forms part of the general consideration that the Seller receives under the SPA and is explicitly tied to rights and obligations created under the SPA in the Buyer. In the present case, the Buyer’s obligations under the SPA were contractually linked to the acquisition of title in the Shares. The Bank Guarantee, was the ‘consideration’ the Buyer provided to the Seller to secure its interest in the rights it acquired under the SPA.

49. The Seller held a conditional right to receive an amount on termination of the SPA prior to Completion, from the Bank. The Seller was required to hold the Bank Guarantee until the Seller became entitled to call for payment from the Bank under the Bank Guarantee, or until such time as the Seller was required to return the undrawn Bank Guarantee to the Buyer under the terms of the SPA.

50. Termination of the SPA resulted in the Seller becoming entitled to immediately call for payment from the Bank.

51. Generally, a contract sets out the agreed terms, conditions and method of payment of amounts due. The parties may agree to alternative payment methods under which a payment obligation may be settled. In this case, the Seller did not, at first instance, have a right to call for payment directly from the Buyer and the Buyer did not have an obligation to pay the amount directly to the Seller. Despite having no such right or obligation under the SPA:

● the Seller did not exercise the right it held to call for payment under the Bank Guarantee upon termination of the SPA

● the Buyer paid the amount directly to the Seller.

52. Given that the Buyer did not have an obligation under the SPA to pay the amount directly to the Seller and the Seller did not have a right to demand payment directly from the Seller, the promise to pay cash directly to the Seller would make no sense on its own and would add nothing to the rights and obligations of the Buyer and the Seller, unless the Buyer was given some additional right in relation to the promise to pay.

53. Under the terms of the Bank Guarantee and the SPA, the Seller held valuable rights to which enabled it to deal with the Buyer in relation to the cash payment arrangement.

54. The terms of the payment arrangement allowed the Buyer to transfer cash directly to the Seller in return for the Seller forgoing its rights under the terms of the SPA and the Bank Guarantee. That is, the cash payment was the consideration paid by the Buyer for the Seller foregoing its rights to demand payment from the Bank under the Bank Guarantee.

55. This factor indicates that for the purposes of Division 230, the Buyer’s obligations to pay cash directly to the Seller and the additional rights it acquired, under which the Seller agreed to forego its right to call for payment of the amount from the Bank under the Bank Guarantee constitute a single arrangement and that the rights and obligations with respect to the Bank Guarantee under the SPA constitute a separate arrangement.

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

56. The Bank Guarantee was a separate arrangement between the Seller and the bank, under which the Seller acquired valuable contractual rights. By providing the Bank Guarantee to the Seller on the date of the SPA, the Buyer placed the Seller in the same position they would have been in if a cash deposit had been provided to the Seller on the execution of the SPA.

57. Likewise, when viewed in light of the purpose of the Buyer, the right to receive the Shares can be seen as the receipt of a valuable right which compensates the Buyer for providing the unconditional Bank Guarantee, in lieu of paying the amount in cash directly to the Seller.

58. If the Seller had called for payment from the Bank under the Bank Guarantee, under the terms of the guarantee facility the taxpayer had with the Bank, the taxpayer would have the following obligations:

● pay fees with respect to utilisation of the facility

● pay the price agreed with respect to utilisation of the facility

● repay the amount paid by the Bank under the facility.

59. The payment arrangement came into existence as the result of discussions held between the Buyer and the Seller prior to termination of the SPA. Payment of cash directly to the Seller allowed the Buyer to avoid the creation of obligations under the guarantee facility.

60. Therefore, paragraph 230-55(4)(c) points towards the conclusion that the timing of the obligation to pay cash directly to the Seller on termination of the SPA reflects the fact that the payment was intended to avoid the costs associated with a utilisation under the guarantee facility.

61. Under paragraph 230-55(4)(c), these circumstances tend to indicate that the rights and obligations under the SPA and the rights and obligations under the cash payment arrangement should not be aggregated.

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

62. The rights held by the Buyer with respect to the cash payment following termination of the SPA impose an obligation on the Seller which restricts the rights it holds with respect to calling for payment under the Bank Guarantee. There are no other legal constraints which prevent the rights and obligations created under the SPA from being dealt with separately from those created under the payment arrangement. That is, the rights and obligations created under the payment arrangement are capable of making sense on their own.

63. Under paragraph 230-55(4)(d), the circumstances indicate that rights and obligations with respect to the cash payment directly to the Seller can be dealt with separately from the rights and obligations under the SPA.

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

64. The nature of the Buyer’s obligation to provide the Bank Guarantee and the lack of any further obligation to pay the amount directly to the Seller means that the Buyer settled its obligation on execution of the SPA. The Bank Guarantee was commercially understood to have been provided in settlement of the Buyer’s obligation in respect of securing the rights that the Seller created in the Buyer under the SPA in pursuit of a single commercial objective, being the sale and purchase of the shares, and thus forms a single arrangement.

65. The cash payment on termination of the SPA, despite no such obligation arising under the SPA was provided in settlement of the Buyer’s obligation with respect to Seller foregoing its right to immediately demand payment from the Bank under the Bank Guarantee. The Buyer’s commercial objective of entering into a payment arrangement, which was not provided for under the SPA, was to avoid the credit implications and costs associated with a utilisation of the guarantee facility, which would have resulted from the Seller calling for payment from the Bank as provided for under the SPA.

66. Under paragraph 230-55(4)(e), the circumstances of this criterion point towards the conclusion that the Buyer’s obligation to pay cash directly to the Seller and its rights and obligations under the SPA form separate arrangements which should not be aggregated.

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

67. In the present case, any loss made as a result of termination of the SPA would be recognised in the same income year, whether it was a capital loss or a loss which was subject to taxation under Division 230, for both taxation and commercial purposes.

68. Under paragraph 230-55(4)(f), treating the SPA and the payment arrangement as separate arrangements is not inconsistent with the objects of Division 230.

Conclusion

69. Having regard to the factors listed in subsection 230-55(4), it is concluded that the rights and obligations under the SPA, including the obligation to provide the Bank Guarantee on the date of the SPA are taken to be one single arrangement while the obligation to pay cash directly to the Seller on termination of the SPA are separate arrangements for the purposes of Division 230.

70. The obligation of the Buyer to pay the amount directly to the Seller arose as a result of the additional benefits the Buyer was entitled to receive under the payment arrangement entered into prior to termination of the SPA.

71. The obligation to provide the Bank Guarantee arose on the date of the SPA. The obligation was referrable to the legal or equitable rights granted under the SPA. The rights and obligations under the SPA were satisfied at the time the Buyer provided the Bank Guarantee to the Seller. The Buyer did not have any further obligation under the terms of the SPA on termination of the SPA.

72. The obligation the Buyer had to pay cash directly to the Seller on termination of the SPA, in return for the Seller forgoing its right to call for payment from the Bank under the Bank Guarantee on termination of the SPA and having the Bank Guarantee placed in escrow, was a separate legal or equitable obligation from the obligation that existed under the SPA.

Section 230-45 – financial arrangement

73. Under Section 230-45, an entity has a ‘financial arrangement‘ if under an arrangement, it has a cash settlable legal or equitable right to receive, and /or a cash settlable legal or equitable obligation to provide, a financial benefit, or has a combination of one or more such rights and /or obligations.

74. Subsection 995-1(1) provides:

financial benefit has the meaning given by section 974-160.

75. Section 974-160 provides:

(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.

76. The Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001, which introduced section 974-160, confirms the broad scope of the meaning of ‘financial benefit’.

77. Section 230 60 states that:

You are taken, for the purposes of this Division, to have (or to have had) a right to receive a *financial benefit under a *financial arrangement if:

(a) you have (or had) a right to receive the financial benefit in relation to the arrangement; and

(b) the financial benefit would not otherwise be treated as one that you have (or had) a right to receive under the arrangement; and

(c) the financial benefit plays an integral role in determining:

(i) whether you make a gain or loss from the arrangement; or

(ii) the amount of such a gain or loss.

Paragraph (a) applies even if the entity that provides the financial benefit is not a party to the arrangement.

78. Section 230-60 is concerned with the reasonable allocation of costs and proceeds of financial arrangements (Explanatory Memorandum paragraph 3.33). The Explanatory Memorandum states (at paragraphs 3.35 to 3.38):

3.35 … the costs of, and proceeds from a financial arrangement will also include other financial benefits received or provided (or those which the taxpayer is entitled to receive or obliged to provide) that play an integral role in determining whether the taxpayer will make a gain or a loss (or a gain or a loss of a particular amount) from the financial arrangement.

3.36 … a financial benefit received or provided (or a financial benefit which the taxpayer is entitled to receive or obliged to provide) will be integral to determining whether the taxpayer will make a relevant gain or loss from the financial arrangement if it is an essential part of determining that gain or loss or the amount of such a gain or loss. What is considered essential or integral will be determined by the nature or purpose of the financial benefit that is taken to be provided or received under the financial arrangement. …

3.38 More generally, what is considered to be integral or essential to determining whether the taxpayer makes a relevant gain or loss from the financial arrangement can be determined by commercially accepted principles and the relevant facts and circumstances of each arrangement. However, the costs of, or proceeds from, the financial arrangement, where they are integral to the calculation of a gain or loss from the arrangement, need not necessarily be provided or received from parties to the particular financial arrangement.

Cash settlable

79. Pursuant to subsection 230-45(2), a right to receive or obligation to provide a financial benefit will be “cash settlable” if:

● a benefit that is money or a money equivalent (a ‘money equivalent’ is ‘a right to receive money’ under subsection 995-1(1)), or

● a right or obligation that is intended to be satisfied or settled by receiving money or a right to receive money or by starting or ceasing to have another financial arrangement.

80. For the purposes of Division 230, cash settlable rights and obligations include those rights and obligations in relation to the receipt or payment of money or a money equivalent. However, cash settlable rights and obligations are not limited to monetary rights and obligations. In order to appropriately reflect the circumstances where ‘cash-like’ rights and obligations are dealt with in the same way as monetary rights and obligations, the definition of cash settlable rights and obligations include certain non-monetary financial benefits where it is possible that the way the arrangement is settled or dealt with will have the same effect as the provision or receipt of a financial benefit that is money or money equivalent (Explanatory Memorandum at paragraph 2.73).

81. The term ‘money’ in paragraph 230-45(2)(a) is not defined for the purposes of the Act. The term therefore takes on its ordinary meaning. ‘Money’ is defined in the Macquarie Dictionary as including:

1.gold, silver, or other precious metal pieces of convenient form stamped by public authority and issued as a medium of exchange and measure of value.

2.current coin.

3.coin or certificate (as banknotes, etc.) generally accepted in payment of debts and current transactions.

4. any article or substance similarly used.

5. a particular form or denomination of currency. 6. a money of account’.

82. In Elsinora Global Ltd v Healthscope Ltd (No. 2) [2006] FCA 18, Edmonds J stated at paragraph 55 that the concept of ‘money’ ‘belonging to’ someone in the context of section 255 of the ITAA 1936 would cover not only notes and coins as chattels in possession, but also bank notes and negotiable instruments as choses in action, commercially acceptable forms of payment such as bank transfers, credit and debit cards, and deposits and credit balances to current accounts with banks and comparable institutions.

Not insignificant

83. The existence of rights or obligations to receive or provide something that is not a financial benefit or which is not cash settlable may cause an arrangement to fail the definition of ‘financial arrangement’ on account of the exception contained in paragraphs 230-45(1)(d) to (f). This will be the case where such rights and/ or obligations are ‘not insignificant’ in comparison with the cash settlable rights and/ or obligations to receive a financial benefit under the arrangement (paragraph 230-45(1)(f)).

84. The Explanatory Memorandum, explains this exception as follows:

2.92 An arrangement…will not be precluded from being a cash settlable financial arrangement merely because the arrangement also consists of other rights and obligations that are insignificant when compared to those cash settlable rights and obligations comprising the financial arrangement. However, during any period any other, non-cash settlable, rights or obligations under the arrangement subsist and are not insignificant when compared to the cash settlable rights and/or obligations to financial benefits under the arrangement, the arrangement will not be a cash settlable financial arrangement. [Schedule 1, item 1, paragraphs 230-45(1)(d) to (f)]

2.93 The intent of this exception is to ensure that arrangements that predominantly relate to transactions that involve one side of the arrangement being of a monetary nature and the other side being non-monetary are excluded from the definition of a ‘financial arrangement’

85. Whether or not a right or obligation is ‘not insignificant’ is a question of fact and degree that must be determined by making a comparison with the other cash settlable rights and/ or obligations under the arrangement. In making this assessment, the arrangements that the exception is primarily directed towards should be kept in mind. The right or obligation in question must be significant in comparison with other rights and obligations under the arrangement in order to be excluded.

SPA

86. The Buyer’s rights and obligations under the SPA identified under subsection 230-55(4) are set out above.

87. Other than the obligation to provide the Bank Guarantee on the date of the SPA and obligation to pay the Purchase Price on Completion, the Buyer’s rights and obligations in relation to the acquisition of the Shares were not ‘cash settlable’, as the Buyer did not have a right to receive or an obligation to provide money or money equivalent (paragraph 230-45(2)(a)). Prior to termination of the SPA, the Buyer had no intention of settling or dealing with the rights by receiving money, money equivalent or a financial arrangement (paragraphs 230-45(2)(b), (c), (d), (e) and (g)) and there is no market for any financial benefit resulting from the exercise of those rights that has a high degree of liquidity (paragraph 230-45(3)(b)). Further, the Buyer’s rights and obligations in relation to the acquisition of the Shares were not ‘insignificant’ in comparison with its obligations to provide the Bank Guarantee on the date of the SPA and to pay the Purchase Price on Completion.

88. Under the terms of the SPA, the Buyer did not have any further obligation to provide something that was cash settlable on termination of the SPA. The right the Seller held to receive an amount under the Bank Guarantee upon termination of the SPA was cash settlable, in that the Seller was entitled to call on the Bank for payment the amount and the Bank had an obligation to settle the call by providing money to the Seller rather than the Buyer. The arrangement with respect to the cash payment was a separate arrangement under subsection 230-55(4). Therefore, on termination of the SPA the Buyer had no further obligations under the SPA.

89. As the conditions in paragraphs 230-45(1)(d), (e) and (f) were all satisfied from the time the SPA was entered into until it was terminated, the SPA did not satisfy the definition of a financial arrangement under section 230-45.

90. For completeness, the taxpayer has not made a choice to use any of the elective methods under Division 230 to calculate its gains and losses from its Division 230 financial arrangements. Accordingly, even if the SPA is capable of being a financial arrangement under section 230-50 (which has not been considered), neither Subdivision 230-B nor Subdivision 230-G would apply to it (paragraph 230-40(4)(e) and subsection 230-440(1)).

Payment on termination

91. The arrangement which remains following termination of the SPA, is the arrangement to pay cash directly to the Seller on termination of the SPA, identified under subsection 230-55(4), which consisted of:

● an obligation to provide a financial benefit of the cash payment

● a right to receive a financial benefit in the form of the Seller forgoing the right to call for payment from the Bank under the Bank Guarantee, secured by holding the Bank Guarantee in escrow pending confirmation of receipt of the payment.

92. The payment arrangement is tested under section 230-45 to determine whether it is a financial arrangement.

93. Under the payment arrangement the obligation to pay cash to the Seller satisfies the definition of ‘cash settlable’ as the benefit is money or money equivalent under paragraph 230-45(2)(a).

94. Under the payment arrangement, the Seller promised to forgo its right to call for payment from the Bank under the Bank Guarantee and provided security in relation to that promise by placing the Bank Guarantee in escrow.

95. In accordance with section 230-60, a gain or loss from a cash settlable financial arrangement can be determined by comparing:

● the financial benefits provided, or to be provided, as consideration for (or that are integral to) obtaining a cash settlable right to receive a financial benefit, with the financial benefits received, or to be received, as consideration for (or that are integral to) the satisfaction or other cessation of that right, and

● the financial benefits received, or to be received, as consideration for (or that are integral to) assuming a cash settlable obligation to provide a financial benefit, with the financial benefits provided, or to be provided, in consideration for (or that are integral to) the satisfaction or other cessation of that obligation.

96. Under subsection 230-60(2), a financial benefit is taken to have been received under a financial arrangement, even if the entity that provides the financial benefit is not a party to the arrangement, if:

● it is in fact provided or received under the arrangement; or

● it is provided or received in relation to the arrangement and it plays an integral role in determining whether the taxpayer makes a gain or loss from the arrangement or the amount of such gain or loss.

97. In this case, the financial benefit received by the Buyer for starting to have an obligation to pay cash directly to the Seller on termination of the SPA, is integral to the calculation of the gain or loss that was made from the Buyer’s outstanding obligation. In substance, the obligation to pay cash directly to the Seller was provided as consideration for the rights the Buyer acquired under the payment arrangement. Accordingly, the financial benefit plays an integral role in determining whether the taxpayer makes a gain or loss under the payment arrangement, in accordance with subsection 230-60(2).

98. The rights that the Seller held with respect to the amount under the SPA and the Bank Guarantee were financial benefits which were cash settlable. On entering into the payment arrangement with the Buyer, the Seller agreed to forgo the financial benefits it was entitled to receive as a consequence of holding those rights. As noted previously, the Buyer entered into the payment arrangement with the Seller to avoid the costs associated with the Seller calling for payment from the Bank as provided for under the SPA. As a result of the Seller forgoing the right to call for payment from the Bank in exchange for receiving a cash payment from the Buyer, the Buyer received something which had monetary worth or value under the payment arrangement, being the financial benefit, which flowed from avoiding the credit implications of repaying the amount utilised and incurring the costs of such a utilisation under the guarantee facility between the Bank and the taxpayer that would have resulted from the Seller exercising those rights.

99. Therefore, the Buyer’s rights and obligation under the payment arrangement are legal or equitable rights to receive and legal or equitable obligations to provide financial benefits which are cash settlable.

Conclusion

100. For the above reasons, the payment arrangement under which the Buyer paid cash directly to the Seller on termination of the SPA will meet the definition of a ‘financial arrangement’ under section 230-45.

Subsection 230-15(2)

101. As set out in the reasoning in relation to the application of subsection 230-55(4) and 230-45 above, the arrangement under which the Buyer paid cash directly to the Seller will be a financial arrangement under section 230-45.

102. The Buyer entered into the payment arrangement in the course of carrying on its business for the purpose of gaining or producing assessable income.

103. Therefore, the taxpayer would be entitled to a deduction under subsection 230-15(2) in relation to the cash payment which it made to the Seller on termination of the SPA, to the extent of a loss, if any, it made from that financial arrangement.

104. However, the payment will not result in a loss which equates to the amount paid to the Seller as the gain or loss from the financial arrangement will be determined by allocating the cost of the arrangement to any proceeds received from the financial arrangement, being the value of the financial benefit the Buyer received as a result of the Seller forgoing its rights under the SPA and the Bank Guarantee (section 230-60).

105. As the taxpayer has not made an election with respect to the payment arrangement, Subdivision 230-B will apply to determine the amount and timing of any loss or gain from the payment arrangement.

Conclusion

106. The taxpayer is entitled to claim a deduction under section 230-15(2) in relation to the cash payment arrangement under which the Buyer paid the amount directly to the Seller on termination of the SPA, to the extent of any loss made. However, whether there is a gain or loss from the payment arrangement, and the amount of such gain or loss, must be determined having regard to all the Buyer’s obligations to provide and its rights to receive financial benefits from that arrangement. This involves taking into account not only the costs of the payment arrangement but also the proceeds the Buyer received under it (section 230-60).

107. Therefore, the payment will not result in a loss that equates to the amount paid.

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