ATO Interpretative Decision
ATO ID 2004/389
Income Tax
Consolidation - modified market value and a third party debt/equity swapFOI status: may be released
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This ATO ID has been updated to improve clarity, and to remove references to related ATO ID 2004/387 and related ATO ID 2004/388 as these have been withdrawn. A reference to TR 2004/9 has been added as this explains the Commissioner's view on the meaning of the phrase 'injection of capital' and also contains analysis of debt/equity swaps.
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Does a debt/equity swap, undertaken between 3 parties, constitute an event for the debtor under paragraph 707-325(4)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) for the purpose of the rule to prevent the inflation of modified market value ('anti-inflation rule')?
Decision
Yes. A debt/equity swap undertaken between 3 parties is considered to be an event for the debtor as described in paragraph 707-325(4)(a) of the ITAA 1997.
Facts
The finance company of a consolidatable group, Fin Co (the debtor), borrows funds from an unrelated third party, Bank Co (the creditor).
Under a subsequent arrangement, the head company of the consolidatable group, Head Co, issues shares to Bank Co, in exchange for the discharge of the outstanding debt. The arrangement takes place after 8 December 2000 and less than four years prior to Head Co forming a consolidated group.
The transaction increases the market value of Fin Co.
Reasons for Decision
The basic rule for working out the modified market value of an entity that becomes a member of a consolidated group is contained in subsection 707-325(1) of the ITAA 1997. It provides that the modified market value of an entity at the joining time is the market value of the entity at that time based on certain assumptions.
Subsection 707-325(2) of the ITAA 1997 provides that if:
there are one or more events described in subsection 707-325(4) of the ITAA 1997;
that occurred in the four years before the time an entity becomes a member of a consolidated group; and
the modified market value of the entity calculated under subsection 707-325(1) of the ITAA 1997 exceeds what it would have been if none of those events occurred,
then the modified market value worked out under subsection 707-325(1) of the ITAA 1997 is reduced by the amount worked out under subsection 707-325(3) of the ITAA 1997.
Subsection 707-325(4) of the ITAA 1997 contains the events that are referred to in subsection 707-325(2) of the ITAA 1997. Paragraph 707-325(4)(a) of the ITAA 1997 identifies one of the events as an injection of capital into the entity or an associate of the entity.
An injection of capital that occurred in the four years before the joining time can only be disregarded if it is made:
into a listed public company through a dividend reinvestment scheme (paragraph 707-325(5)(a) of the ITAA 1997), or
in association with the acquisition of shares under an employee share scheme meeting certain conditions (paragraph 707-325(5)(b) of the ITAA 1997), or
on or before 8 December 2000 (section 707-329 of the Income Tax (Transitional Provisions) Act 1997).
The distinguishing features of a 3 party debt/equity swap are such that the creditor releases the debtor from the obligation to repay the debt (or part of the debt) in exchange for an associate of the debtor issuing equity (usually shares) to the creditor. Under the arrangement, the creditor acquires membership interests in the associate in return for releasing the debtor from a debt of equivalent value.
This arrangement is considered to be an event as described in paragraph 707-325(4)(a) of the ITAA 1997 for the purposes of the anti-inflation rule. The event is an injection of capital into an associate of the debtor. The anti-inflation rule is triggered as the modified market value of the debtor exceeds what it would have been had the arrangement not taken place. The wealth of the debtor has increased by virtue of it no longer having an obligation to repay loan funds.
As Head Co has issued shares to Bank Co, an event of an injection of capital into Head Co has occurred. The event triggers the anti-inflation rule with regard to Fin Co as the injection occurs in Head Co (an associate of Fin Co under section 318 of the Income Tax Assessment Act 1936) and had the effect of increasing Fin Co's modified market value at the joining time over what it would have been had the transaction not taken place. As the transaction took place after 8 December 2000 and in the four years prior to Head Co forming a consolidated group, this event is not disregarded for purposes of the anti-inflation rule.
A reduction in the modified market value of Fin Co may be required under subsection 707-325(2) of the ITAA 1997.
This arrangement also constitutes an event with regard to Head Co. However, in the absence of any other events involving Head Co, the anti-inflation rule is not triggered for Head Co as its modified market value at the joining time is not greater than it would otherwise have been had the arrangement not taken place. The value attributable to Head Co beneficially owning Fin Co (where the increase in value is reflected) is disregarded in determining Head Co's modified market value by paragraph 707-325(1)(c) of the ITAA 1997.
Date of decision: 23 April 2004Year of income: Income year ended 30 June 2003
Legislative References:
Income Tax Assessment Act 1997
section 707-325
subsection 707-325(1)
paragraph 707-325(1)(c)
subsection 707-325(2)
subsection 707-325(3)
subsection 707-325(4)
paragraph 707-325(4)(a)
subsection 707-325(5)
paragraph 707-325(5)(a)
paragraph 707-325(5)(b)
section 318 Income Tax (Transitional Provisions) Act 1997
section 707-329
Related Public Rulings (including Determinations)
Taxation Ruling TR 2004/9
Keywords
Acquisition of shares
Associate
Consolidatable group
Consolidation
Consolidation - event
Consolidation - losses
Consolidation - reduction
Debt waivers
Injection of capital
Joining entity
Modified market value
ISSN: 1445-2782