Edited version of private ruling

Authorisation Number: 1011678057901

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Income tax implications of variation to funding and dividend arrangements

Question 1

Will an Agreement Loan from the B&C Partnership to A which will be made on a commercial arm's length basis and must be repaid, be treated as debt pursuant to section 974-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, an Agreement Loan from the B&C Partnership to A which will be made on a commercial arm's length basis and must be repaid will be treated as debt pursuant to section 974-15 of the
ITAA 1997.

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

Question 2

Will a Funding Loan made after 31 December 2010 from the B&C Partnership, which will be made on a commercial arm's length basis and must be repaid, be treated as debt pursuant to
section 974-15 of the ITAA 1997?

Answer

Yes, a Funding Loan made after 31 December 2010 from the B&C Partnership, which will be made on a commercial arm's length basis and must be repaid will be treated as debt pursuant to
section 974-15 of the ITAA 1997?

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

Question 3

Will the interest incurred by A in respect of the Agreement Loans made to it for its calls under the Agreement, including interest payments on Agreement Loans to replace working capital paid out as a dividend by A to its shareholders where working capital was used by A to fund its business, be deductible to A under section 8-1 of the ITAA 1997?

Answer

Yes, the interest incurred by A in respect of the Agreement Loans made to it for its calls under the Agreement, including interest payments on Agreement Loans to replace working capital paid as a dividend by A to its shareholders where working capital was used by A to fund its business will be deductible to A under section 8-1 of the ITAA 1997.

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

Question 4

Will the interest incurred by A in respect of the Funding Loans made to it (including interest payments on Funding Loans to replace working capital paid as a dividend by A to fund its business) be deductible to A under section 8-1 of the ITAA 1997?

Answer

Yes, the interest incurred by A in respect of the Funding Loans made to it (including interest payments on Funding Loans to replace working capital paid as a dividend by A to fund its business) will be deductible to A under section 8-1 of the ITAA 1997

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

Question 5

Will the Commissioner make a determination pursuant to section 177F of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of A in relation to the interest deductions on the Agreement Loans?

Answer

No, the Commissioner will not make a determination pursuant to section 177F of the ITAA 1936 in respect of A in relation to the interest deductions on the Agreement Loans.

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

Question 6

Will the Commissioner make a determination pursuant to section 177F of the
ITAA 1936 in respect of A in relation to the interest deductions on the Funding Loans?

Answer

No, the Commissioner will not make a determination pursuant to section 177F of the ITAA 1936 in respect of A in relation to the interest deductions on the Funding Loans.

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

Question 7

Will the Commissioner make a determination pursuant to subsection 204-30(3) of the ITAA 1997 in relation to the payment of Agreement Dividends in conjunction with the calls under the Agreement to B and C?

Answer

No, the Commissioner will not make a determination pursuant to subsection 204-30(3) of the
ITAA 1997 in relation to the payment of Agreement Dividends in conjunction with the calls under the Agreement to B and C.

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

Question 8

Will the Commissioner make a determination pursuant to subsection 204-30(3) of the ITAA 1997 in relation to the payment of Funding Dividends to B and C?

Answer

No, the Commissioner will not make a determination pursuant to subsection 204-30(3) of the
ITAA 1997 in relation to the payment of Funding Dividends to B and C.

This ruling applies for the following period/s:

Other/Substituted Accounting Period 1 January 2011 to 31 December 2011
Other/Substituted Accounting Period 1 January 2012 to 31 December 2012
Other/Substituted Accounting Period 1 January 2013 to 31 December 2013
Other/Substituted Accounting Period 1 January 2014 to 31 December 2014
Other/Substituted Accounting Period 1 January 2015 to 31 December 2015

The scheme commences on:

1 January 2006

The scheme that is the subject of the ruling:

1. Several years ago, A, B, C, D and the B&C partnership entered into a funding agreement (the Agreement). The terms of this agreement was central to the original ruling request issued several years ago.

2. Further ruling requests were made after various amendments to the arrangements leading to further rulings from the Tax Office.

3. The commercial objectives to the extension to the Agreement outlined in the background below are:

(a) to continue the dividend policy with respect to the payment of dividends by A vis-à-vis its funding requirements; and

(b) the continuation of the protocols for the funding of the capex requirements of entities in the ABCD venture between a non-resident company D and Australian company C. A is part of the ABCD venture and is jointly owned by B (an Australian company wholly owned by D) and C.

4. The parties have amended, subject to receiving a suitable ruling, the agreement to continue the terms of that arrangement. This involves the continuation of the agreement, and the continuation of Funding Dividends and Funding Loans. What these arrangements seek to achieve, as with the existing arrangements, are summarised as follows:

(a) capital expenditure requirements of ABCD entities can in certain circumstances trigger requirements of A to pay additional dividends to its shareholders. Further the parties may mutually agree that A will pay further dividends outside the requirements of the agreement;

(b) in respect of the capital expenditure requirements of A itself, an amount equivalent to these capex requirements (including working capital) or the dividend pursuant to the agreement or further dividends, may be lent to A (via the B&C Partnership with equity subscriptions from B and C into the partnership); and

(c) in relation to capital expenditure requirements of other ABCD entities the funding requirement could trigger a dividend (either under the agreement or as a result of further dividends). The capex requirements of these ABCD entities could be satisfied by an interest bearing loan from the ABCD members, the B&C Partnership or A. Alternatively, the parties could fund the capex requirements of these ABCD entities via an equity injection into the ABCD entity by its shareholders.

5. Relevant background information is provided below regarding:

(a) The operation of the Agreement and Funding Dividends;

(b) The anticipated capital expenditure on expansion projects;

(c) The Agreement arrangements; and

(d) Background on C and D's Australian groups.

6. Copies of all relevant documents were included in the ruling request.

7. Some changes to the agreement were made several years ago. One condition in particular in the agreement restricts the payment of dividends pursuant to the agreement. The shareholders have agreed in principle to relax this requirement.

8. The parties further amended the Agreement and loan arrangement.

9. The income tax issues on which the parties seek a ruling are the same issues as addressed in the previous rulings noted above. That is:

(a) Confirmation that loans provided to ABCD entities (including A) under the terms of the Agreements and Funding Loans are debt for Division 974 of the ITAA 1997 purposes;

(b) Confirmation that interest payable and paid by A in respect of loans provided under the capital funding arrangements set out in the Agreement or as a Funding Loan will be deductable to A;

(c) Confirmation that the dividend streaming provisions of Subdivision 204-D of the ITAA 1997 will not apply to dividend payments made by A under Agreement or as Funding Dividends; and

(d) Confirmation that the provisions of Part IVA of the ITAA 1936 will not apply to these capital funding arrangements and/or any related dividends.

Background Information

Commercial Objectives

10. Since the original ruling request several years ago ABCD's product market has experienced price decreases and overcapacity, in part due to the global financial crisis.

11. Within ABCD, several upgrades to their facilities have been made in the past few years.

12. Whilst there are no committed major projects, potential capex spend for ABCD exists in relation to:

(a) potential expansions and upgrades,

(b) large sustaining capex in the future.

13. In addition the ABCD enterprises will have ongoing capex requirements to sustain existing facilities.

14. The schedule and ordering of expansion and spend will depend on commercial issues such as cost and pricing of ABCD's product.

Dividends of A

15. A is the head company of a consolidated group.

16. Fully franked dividends are regarded as an important criterion for shareholders investing in C, and releasing franking credits of A via the proposed arrangement to which this ruling request relates will permit C to maintain franking of its dividends in the medium to long term.

17. C's board determines dividends paid to shareholders based on performance and expected business conditions. Its intention is, to the extent practicable, to fully distribute to shareholders all fully franked dividends received by C from ABCD. Dividend payments will be subject to current and expected business conditions.

18. To continue the formalisation of A's dividend practice and to accommodate ABCD's potential and proposed funding requirements (including A's own funding requirements), it is proposed that A, B, C, D and the B&C Partnership continue the agreement as amended and B and C enter into the amended B&C Partnership to facilitate funding of ABCD projects.

19. In the parties amended, subject to the receipt of a favourable ruling, the Agreement, the B&C Partnership Agreement and the loan arrangement. The amendment agreement for the Agreement provides that:

(a) some of the requirements to provide Agreement Loans be amended; and

(b) the Agreement to be a continuing agreement, with one year's notice from either party.

20. The B&C Partnership agreement was amended to tie in the notice of termination provisions to the termination of the Agreement.

21. Dividends are paid at the beginning of a quarter or month in respect of interim net income for all previous quarters since 1 January 200X less any amount of such income that has already been paid out as dividends.

22. The payment of dividends is, in summary, subject to:

(a) compliance with section 254T of the Corporations Act 2001 (Corporations Act);

(b) not causing A to be unable to pay its debts; and

(c) for dividends in excess of the minimum dividends, the ability to fully frank the dividend and the next scheduled minimum dividend.

Funding of ABCD Capital Requirements

23. As discussed at paragraph 12, ABCD is examining a number of other capex requirements within the ABCD joint venture. Also the ABCD enterprise entities will have ongoing capex requirements to sustain existing infrastructure and facilities.

24. Some of the future capital expansion will be funded directly and independently (that is, not via the B&C Partnership) by C and D or by ABCD entities where quarterly dividends are not sufficient to fund the calls.

B&C Partnership

25. Key terms of the Agreement Loans are that each loan will be:

(a) unsecured,

(b) used to fund the working capital requirements of the Borrower (including A), subject to an aggregate limit

(c) repayable by X

(d) subject to commercial arm's length interest rates

26. The amounts to be provided to A to fund A's capex including ongoing capex to sustain existing facilities, are anticipated to be provided by Agreement Loans as contemplated in the Loan Arrangement. The B&C Partnership is an Australian general law partnership with both B and C subscribing for equity in the partnership in their existing respective interests in A.

27. The B&C Partnership may then loan funds to A as a drawdown on the loan arrangement on commercial arm's length terms.

28. D is seeking to address an issue that arises as it consolidates in its accounts a 100% interest in A before making adjustments to eliminate minorities. Under current accounting, D would, on A borrowing funds, consolidate in the preparation of its accounts 100% of the debt shown on A's balance sheet, notwithstanding it only has a X% interest in A. This adversely impacts on the perceived gearing level of D.

29. The accounting for the B&C Partnership enables D to consolidate 100% of the A debt but also 100% of the asset being the loan from the B&C Partnership. This addresses the disproportionate accounting gearing impact.

Funding Dividends and Funding Loans

30. In addition, the shareholders in A (who are also the partners in the B&C Partnership) wish to have the ability to be able to mutually agree to pay further dividends from A and to make additional loans as Funding Loans to A of up to a cumulative limit. Naturally the parties will not agree to pay Funding Dividends where this would cause a breach of section 254T of the Corporations Act or cause A to be unable to pay its debts. The total value of loans made whether in accordance with the Agreement or not, is not to exceed the limit. These Funding Dividends and Funding Loans will be implemented by the movement of funds between bank accounts of the relevant entities.

31. The key differences between Funding loans and Agreement Loans are that the former will not be subject to the requirements of the agreement and may not necessarily be linked to available cash and they have a different repayment term.

32. In summary, the Funding Dividends and resulting Funding Loans may be made where:

(a) C and D (through its wholly owned subsidiary, B) agree to facilitate the payment of a dividend by A; and

(b) The resulting Agreement Loans and Funding Loans do not exceed the aggregate limit.

Shareholder background

D Group

33. The D group holds its interest in A interest through its wholly-owned Australian subsidiary B.

C Company

34. C holds a less than 50% interest in A

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1.

Income Tax Assessment Act 1997 paragraph 8-1(1)(a).

Income Tax Assessment Act 1997 paragraph 8-1(2)(a).

Income Tax Assessment Act 1997 section 25-90.

Income Tax Assessment Act 1997 Subdivision 204-D.

Income Tax Assessment Act 1997 section 204-30.

Income Tax Assessment Act 1997 subsection 204-30(3).

Income Tax Assessment Act 1997 paragraph 204-30(3)(a).

Income Tax Assessment Act 1997 paragraph 204-30(3)(b).

Income Tax Assessment Act 1997 paragraph 204-30(3)(c).

Income Tax Assessment Act 1997 paragraph 204-30(8)(f).

Income Tax Assessment Act 1997 section 701-1.

Income Tax Assessment Act 1997 paragraph 820-40(1)(a).

Income Tax Assessment Act 1997 Division 974.

Income Tax Assessment Act 1997 subsection 974-10(3).

Income Tax Assessment Act 1997 section 974-15.

Income Tax Assessment Act 1997 subsection 974-15(2).

Income Tax Assessment Act 1997 section 974-20.

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

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

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

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

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

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

Income Tax Assessment Act 1997 section 974-80.

Income Tax Assessment Act 1997 subsection 974-80(1).

Income Tax Assessment Act 1997 subsection 974-80(2).

Income Tax Assessment Act 1997 section 974-130.

Income Tax Assessment Act 1997 section 974-135.

Income Tax Assessment Act 1997 section 974-155.

Income Tax Assessment Act 1997 section 974-160.

Income Tax Assessment Act 1936 section 23AJ.

Income Tax Assessment Act 1936 subsection 51(1).

Income Tax Assessment Act 1936 Part IVA.

Income Tax Assessment Act 1936 subsection 177A(1).

Income Tax Assessment Act 1936 section 177C.

Income Tax Assessment Act 1936 paragraph 177C(1)(b).

Income Tax Assessment Act 1936 section 177D.

Income Tax Assessment Act 1936 paragraph 177D(a).

Income Tax Assessment Act 1936 paragraph 177D(b).

Income Tax Assessment Act 1936 section 177F.
Corporations Act 2001 section 254T.

Explanation: (This does not form part of the notice of private ruling)

Question 1

Detailed reasoning

Will an Agreement Loan from the B&C Partnership which will be made on a commercial arm's length basis and must be repaid, be treated as debt pursuant to section 974-15 of the ITAA 1997?

1. Division 974 of the ITAA 1997 sets out rules to define what should be categorised as 'equity' in a company and what is 'debt'. This distinction is important as it determines how to treat an amount paid by a company in respect of a financing interest that it has issued. If the amount paid is an equity interest it will be treated as a frankable dividend, however if it is a debt interest it will be treated as interest on a debt, which may qualify as a deduction under section 8-1 of the ITAA 1997.

2. In order to be a debt interest, a scheme must satisfy the debt test in section 974-20 of the
ITAA 1997. For the purposes of Division 974 of the ITAA 1997, the scheme in the case at hand can be described as consisting of each Agreement Loan made pursuant to the Agreement and in accordance with the terms of the loan arrangement. The basic principle in the Agreement is that A will pay dividends to the extent required to fund capital funding requirements of the ABCD venture, including A's own capital funding requirements. Generally, funding will be by way of (Agreement) loans from the B&C Partnership to A, or other ABCD entities. However, funding can also be by equity contributions or from external borrowings if certain limitations apply including the monetary limit on the B&C Partnership Loans.

3. The conditions for a scheme to satisfy the debt test are set out in subsection 974-20(1) of the ITAA 1997, as follows:

A *scheme satisfies the debt test in this subsection 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 or benefits under the scheme; and

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

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

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

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

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

The Debt test applied to the proposed arrangement

4. Paragraph 974-20(1)(a) of the ITAA 1997 contains the first condition, that is the scheme must be a 'financing arrangement' for the entity. A 'financing arrangement' is widely defined in
section 974-130 of the ITAA 1997 and includes 'a scheme entered into to raise finance for the entity'. The Agreement Loans to be loaned by the B&C Partnership under the loan arrangement would fall within this definition as their stated purpose is to provide finance for the capital expenditure requirements of ABCD entities including A. Therefore the first test in section 974-20 of the ITAA 1997 is satisfied.

5. The next test in paragraph (b) of subsection 974-20(1) of the ITAA 1997 requires the entity (or a connected entity) to receive a 'financial benefit' (greater than nil) under the scheme. A 'financial benefit' is also widely defined in section 974-160 of the ITAA 1997 to include anything of economic value, including property and services. Paragraph 2.164 of the Explanatory Memorandum to the New Business tax System (Debt and Equity) Bill 2001 states that in a simple example of a debt interest where money is loaned with an obligation to repay with interest, the financial benefit will be the sum of money being loaned. The receipt of the money and the obligation to repay it are to be looked at separately. Hence for the proposed arrangement, the financial benefit will be the funds drawn down by A or other ABCD entity for each Agreement Loan under the loan arrangement. Therefore A (or another borrowing ABCD entity) will receive a financial benefit for each loan, so this test is also satisfied.

6. The third test, in paragraph 974-20(1)(c) of the ITAA 1997, requires the entity to have (or the entity and a connected entity must both have) an 'effectively non-contingent obligation' under the scheme to provide financial benefit(s) to one or more entities after the time that entity received the financial benefit. The meaning of an 'effectively non-contingent obligation' is found in
section 974-135 of the ITAA 1997. Broadly, the term refers to an obligation that is not contingent on any event, condition or situation other than the ability or willingness of the relevant entity or connected entity to meet the obligation.

7. In the arrangement being considered, when A receives an Agreement Loan for capital expenditure under the Agreement, it will have to repay the loan no later than the repayment term plus interest calculated at commercial arm's length rates. The interest rate is calculated at commercial arm's length rates. Where another ABCD entity is the borrower an arm's length interest rate needs to be determined by the lender based on the borrower's credit status.

8. The above requirement for loan repayment with interest by A or another ABCD entity is non-contingent. That is, there are no contingencies in the terms of the Agreement or the Loan Arrangement under which ABCD entities including A could avoid having to repay the Agreement Loans with interest. The Agreement does allow for a temporary suspension of X business days of loan obligations in certain circumstances but this suspension is only for X business days and it does not change the ultimate obligation to repay all amounts by the repayment term.

9. The reference to the 'unwinding' of the funding mechanisms referred to in the Agreement in the event of a Tax Event does not mean that the loans would not have to be repaid. The loans must still be repaid by A (or whichever other ABCD entity had borrowed funds), even if the proposed funding arrangement was finalised early due to an unfavourable tax ruling.

10. From the above, it is concluded that the borrowing entities including A will have an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities. That is, the test in paragraph 974-20(1)(d) of the ITAA 1997 is satisfied.

11. The condition in paragraph 947-20(1)(d) of the ITAA 1997 requires it to be substantially more likely than not that the value of the financial benefit to be provided (under paragraph (c) above) under the scheme will be at least equal to the value of the benefit to be received (under
paragraph (b)).

12. As the amounts to be loaned to ABCD entities including A will be repayable in addition to commercial rates of interest, clearly the amount of the non-contingent obligation owed by the borrowing ABCD entity will exceed the value of the amount loaned to it. Hence this test will also be satisfied.

13. The final condition, in paragraph 974-20(1)(e) of the ITAA 1997, simply requires the value of the benefits received and provided to be more than nil. This was stated to be the case in the ruling request,

Related schemes

14. In determining the debt/equity characterisation it is also necessary to consider if there are related schemes in this case. For example, a series of Agreement Loans made by the B&C Partnership to A could be regarded as being a series of related schemes. If there is more than one scheme then the debt/equity test must be considered taking into account all the related schemes, and not just single transactions such as each loan to A (subsection 974-10(3) of the ITAA 1997).

15. In this case the Agreement Loans from the B&C Partnership to ABCD entities including A are preceded by calls and Agreement Dividends paid by A to its shareholders B and C. The Agreement Dividends are then loaned to A or other ABCD entities through the B&C Partnership. These preceding steps might be considered to be 'related schemes', which is defined broadly in section 974-155 of the ITAA 1997 as schemes which are 'related to one another in any way'.

16. However, even if the dividends paid by A are treated as related (integrated) with the Agreement Loans to ABCD entities under subsection 974-15(2) of the ITAA 1997, the combined operation of these 'schemes' is considered to still satisfy the debt test. The overall result continues to be that the ABCD entity has an effectively non-contingent obligation under the related schemes to provide a financial benefit which will exceed the value (of the Agreement Loans) received. The Agreement Dividends will not be reinvested as equity in the ABCD entity, but a related amount will be loaned and repaid on commercial terms.

17. Therefore whether or not there are related schemes in this case, the same conclusion applies. In either case the debt test will be passed and hence Agreement Loans made pursuant to the Agreement will each give rise to debt interests in A or in another borrowing ABCD entity.

Connected entity

18. Section 974-80 of the ITAA 1997 can apply in certain circumstances to re-characterise debt interests as equity interests, if equity interests arise from arrangements which fund returns through connected entities. From subsection (1), section 974-80 applies if:

(a) an interest carries a right to a variable or fixed return from a company; and

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

(c) apart from this section, the interest would not be an *equity interest in the company; and

(ca) the *scheme that gives rise to the interest is a *financing arrangement for the company; and

(d) there is a scheme, or a series of schemes, designed to operate so that the return to the connected entity is to be used to fund (directly or indirectly) a return to another person (the ultimate recipient).

19. Subsection 974-80(2) of the ITAA 1997 operates to treat the interest as an equity interest in the company if:

(a) the amount of the return to the ultimate recipient is in substance or effect *contingent on the economic performance (whether past, current or future) of:

the company; or

a part of the company's activities; or

(iii  a *connected entity of the company or a part of the activities of a connected entity of the company; or

(b) either the right itself, or the amount of the return to the ultimate recipient, is at the discretion of:

the company; or

(ii)  a connected entity of the company; or

(c) the interest in respect of which the return to the ultimate recipient is made or another interest that arises from the scheme, or any of the schemes, referred to in paragraph (1)(d):

gives the ultimate recipient (or a connected entity of the ultimate recipient) 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;

and if the interest does not form part of a larger interest that is characterised as a *debt interest in the entity in which it is held, or a *connected entity, under Subdivision 974-B. The return may be a return of an amount invested in the interest.

20. The Supplementary Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 states that section 974-80 of the ITAA 1997 is intended to apply:

only in those cases where the scheme or schemes are deliberately designed so that the return to the connected entity is in turn used to fund directly or indirectly a return to the ultimate recipient. This means, generally speaking, that section 974-80 would not apply unless there is a plan constituted by documented rights and obligations that provide for the direct or indirect funding of a return to the ultimate recipient. A lack of documentation would not preclude the application of the provision if the design was clear from the surrounding facts and circumstances. However, mere association between the parties would not be a sufficient indicator of the relevant design. (paragraphs 1.28 and 1.29)

21. In the case at hand, section 974-80 of the ITAA 1997 could only apply if the returns from the Agreement Loans (that is, the interest to be paid by A or another ABCD borrowing entity) were designed to fund an equity like return to connected entities of A, such as B and C, which in turn is to be used to fund a return to the ultimate recipient. The ultimate recipient presumably could be the shareholder of B, (that is, D) or the shareholders of C.

22. Nothing in the proposed arrangement indicates that the interest to be paid by A in respect of the Agreement Loans will be used to fund an equity return to D or C's shareholders. Dividends will continue to flow to B and to C under the proposed arrangement. In the case of C, the interest it receives (via the EP) will be used to fund its interest debts (relating to its borrowings to loan funds to ABCD entities (including A) via the B&C Partnership, in response to calls.

As there is nothing in the Agreement, or in any of the other information available to indicate any equity funding through connected entities, it is considered that section 974-80 of the ITAA 1997 would not apply in this case.

Conclusion

23. As the tests in section 974-20 of the ITAA 1997 are satisfied, the Agreement Loans made pursuant to the Agreement and in accordance with the terms of the Loan Arrangements will be treated as debt pursuant to section 974-15 of the ITAA 1997 and each give rise to a debt interest.

Question 2

Detailed reasoning

Will a Funding Loan made after 31 December 2010 from the B&C Partnership, which will be made on a commercial arm's length basis and must be repaid, be treated as debt pursuant to section 974-15 of the ITAA 1997?

1. The next question concerns whether a Funding Loan made after 31 December 2010 from the B&C Partnership to A, which will be made on a commercial arm's length basis and must be repaid, will be treated as debt pursuant to section 974-15 of the ITAA 1997.

2. The shareholder's of A, being B and C, wish to provide for A's post 1 January 200X capex by way of loans, which will facilitate dividends of the same amount. However they do not wish to be only able to do this when the Agreement requires Agreement Loans. Instead, they wish to also be able to do this when they agree it is appropriate, that is, when they mutually agree to pay a dividend (a 'Funding Dividend'). These dividends will be loaned back to A via the B&C Partnership as 'Funding Loans', not Agreement Loans under the Agreement.

3. Funding Loans will be similar to Agreement Loans in all material aspects when considering whether the funds should be categorised as debt or equity.

4. Unlike Agreement Loans, all Funding Loans will be made from the B&C Partnership to the A Group only, and not to any other ABCD entities.

5. Unlike Agreement Loans subject to the Agreement, Funding Dividends and Funding Loans will not be subject to the requirements of the Agreement and may not necessarily be linked to calls or available cash. Funding Loans made in response to a Funding Dividend will be linked to replacing the working capital employed by A which was paid out to as that dividend.

6. Funding Loans made after 31 December 2010 have a Repayment Term being less than P years of entering in the loan or in any case by 31 December 20XX and include commercial interest rates.

7. These differences are not considered material when concerning the categorisation of the loan as debt or equity. There are still no contingencies in the terms of Funding Loans made after 31 December 2010 where A would avoid having to repay the Funding Loans with interest.

8. Therefore, in principle the same conclusion applies in respect of the categorisation of Funding Loans as debt pursuant to section 974-15 as considered for Agreement Loans above.

Conclusion

9. The differences between Funding Loans and Agreement Loans are not significant in respect of their categorisation as debt or equity in Division 974 of the ITAA 1997. Accordingly, Funding Loans will also be treated as debt pursuant to section 974-15 of the ITAA 1997 as the tests in section 974-20 are satisfied and will each give rise to a debt interest.

Question 3

Will the interest incurred by A in respect of the Agreement Loans made to it for its calls under the Agreement, including interest payments on Agreement Loans to replace working capital paid out as a dividend by A to its shareholders where working capital was used by A to fund its business, be deductible to A under section 8-1 of the ITAA 1997?

Detailed reasoning

1. There are currently no committed major projects for ABCD however there are still potential Capex spending requirements in relation to potential expansions in existing infrastructure and facilities.

2. In order to accommodate ABCD's and in particular A's funding requirements, A and its shareholders C and B, and B's ultimate parent company D, entered into the Agreement several years ago. B and C also formed the B&C Partnership to facilitate funding of A and ABCD projects.

3. Under the Agreement, where A has sufficient profits and cash and a Call is made for the funding requirements of an ABCD entity, particularly A, A will make dividend distributions to its shareholders B and C to fund the call. The dividends were to originally be quarterly but may now also be distributed on a monthly basis. The latter entities in turn will loan (an 'Agreement Loan') the call amount to the ABCD entity (via the B&C Partnership) requiring the funds for capex relating to certain projects.

4. Funding requirements under the agreement are defined as referring to growth and sustaining capex payments and working capital requirements of A and associated entities.

5. The issue of interest deductibility in relation to Agreement Loans to A under the Agreement has previously been the subject of several private rulings. That most recent ruling concerned a similar arrangement to the current one, but since the previous ruling, amendments to the arrangement were made in conditional to the receipt of a favourable ruling. These differences as outlined in the facts of the scheme are not significant in determining the deductibility of interest on Agreement Loans to A.

6. The question to be ruled upon only concerns Agreement Loans to A, as it asks whether interest incurred by A will be deductible under section 8-1 of the ITAA 1997 in respect of an Agreement Loan made to it to for its calls under the Agreement, including interest payments on Agreement Loans to replace working capital paid out as a dividend by A to its shareholders where working capital was used by A to fund its business.

7. As stated in paragraph 6 of Taxation Ruling TR 2004/4, interest deductibility is typically determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put. This principle has been developed from case law including cases such as Fletcher & Ors v. Federal Commissioner of Taxation 9(1991) 173 CLR 1; 1 ATC 4950; (1991) 22 ATR 613, and Federal Commissioner of Taxation v. Energy Resources of Australia Limited 96 ATC 4536; (1996) 33 ATR 52.

8. The following comments were made by Gleeson CJ, Gummow, and Callinan JJ (Kirby J dissenting) in the High Court case Steele v. Federal Commissioner of Taxation (1997) 197 CLR 459; (1997) 41 ATR 139; 99 ATC 4242 (Steele's case):

interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of borrowed money during the term of the loan...it is therefore ordinarily a revenue item…where interest is a recurrent payment to secure the use for a limited term of loan funds, then it is proper to regard the interest as a revenue item, and its character is not altered by reason of the fact that the borrowed funds are used to purchase a capital asset.

9. Dixon J also stated in Texas Co (A'asia) Ltd v. FCT (1940) 63 CLR 382 at 468; 2 AITR 4 at 45; 5 ATD 298:

Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction.

10. In Steele's case, Kirby J did not accept that interest by nature is of income character, but in most circumstances it would be revenue. He thought each particular outgoing had to be evaluated, and interest could be capital (and therefore non-deductible under paragraph 8-1(2)(a) of the
ITAA 1997) if a capital asset did not produce any assessable income. In addition, interest on a loan taken out to finance the production of future assessable income may be incurred too early and hence preliminary to the income earning activities, or be too remote to be on revenue account.

11. Taxation Ruling TR 95/25 summarises general principles of interest deductibility under subsection 51(1) of the ITAA 1936, which are also relevant for section 8-1 of the ITAA 1997:

(a) The interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private or domestic nature. The test is one of characterisation and the essential character of an expense is a question fact to be determined by reference to all the circumstances.

(b) The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower. However, regard must be had to all the circumstances, including the character of the taxpayer's undertaking or business, the objective purpose of the borrowing, and the nature of the transaction or series of transactions of which the borrowing of funds is an element. In some cases, the taxpayer's subjective purpose, intention or motive may be relevant in deciding the deductibility of interest.

(c) A tracing of the borrowed money which establishes that it has been applied to an income producing use may demonstrate the relevant connection between the interest and the income producing activity. Normally this would be the case for non-business taxpayers. It might also be the case where a business makes a specific borrowing which goes to the structure of the business - for example, where a business makes a large borrowing to fund an offshore acquisition.

(d) A rigid tracing of the borrowed money will not always be necessary or appropriate (e.g., where the borrowing finances the replacement of funds withdrawn from the business by a person entitled to be paid those funds). In such cases the relevant question is whether borrowed funds are being used to replace another source of funding for business purposes.

The purpose of A's borrowing and the use of its borrowed funds

12. As noted above, interest deductibility is generally determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put. In the case at hand an Agreement Loan will be used to replace working capital used to pay a dividend, which relates to a call. A call will be based on A's funding requirements in accordance with the Agreement.

13. It is relevant to see what type of expenditure is included in calls. The Agreement shows that the requirements for a 'call' include growth and sustaining capital expenditure payments in addition to incremental working capital. Hence an Agreement Loan may partly be used to replace working capital, as well as expansion and sustaining capital expenditure.

14. The basic purpose for the Agreement Loans is to fund A's (and other ABCD entities) capital funding requirements. The meaning of 'incremental working capital' is not specified, however ordinarily any interest expense incurred relating to working capital used in the business is deductible. In regard to interest deductions for companies, Taxation Ruling TR 95/25 states that businesses usually need to maintain a pool of circulating capital to meet business needs. Paragraph 12 states:

there will usually be a need for a business to maintain a pool of circulating capital from which to meet the expenses of that business'. In these circumstances the deductibility of the interest expense cannot be determined by considering only the immediate reason for the making a payment and ignoring the overall purpose with which the liability was incurred…

15. Applying the above general principles and case law on interest deductibility to the proposed arrangement, it is noted that A's principal activities include facilities that are currently operating and producing assessable income so interest on funds borrowed to expand these facilities are directly connected to A's current operations. The necessary connection to future assessable income arising from the expansion projects is also clearly present.

16. The above case law and Taxation Rulings show that interest payments may qualify for deduction under section 8-1 of the ITAA 1997 despite the fact that the borrowed funds may be used to fund capital expenditure. Taxation Ruling TR 2004/4 notes that 'generally interest cannot be capital' (paragraph 26). As indicated by Kirby J in Steele's case, it may be possible in some circumstances for interest payments to be capital, such as where the capital asset does not produce assessable income, or where the interest is incurred too early in relation to future assessable income.

17. In the case at hand the interest may be incurred in advance of the production of assessable income due to the fact that large facilities take time to complete and become income producing. This raises the question of whether the interest will be incurred by A too soon before assessable income is produced for the interest payments to qualify for deduction.

18. From Steele's case, the interest will be incurred in gaining or producing assessable income (for the purposes of paragraph 8-1(1)(a) of the ITAA 1997) if it is 'incidental and relevant' to gaining or producing that future assessable income. In Steele's case the relevant assessable income was not expected until well into the future, but the majority view of the High Court was that contemporaneity is not legally essential, and that the interest expenditure was both incidental and relevant.

19. Examples of where courts have held that outgoings are not deductible because they were incurred too soon include the following:

§ expenses establishing a paper production industry were held to be preliminary and directed at deciding whether or not an undertaking would be established to produce assessable income (Softwood Pulp and Paper Ltd v. FC of T 76 ATC 4439; (1976) 7 ATR 101);

§ expenditure on research into developing and producing antibodies was not deductible as the company was not conducting the research as a business or an income producing activity but rather as a collaborator in a research project (Goodman Fielder Wattie Ltd. v. FC of T 91 ATC 4438; 22 ATR 26);

§ expenditure on research into the development of products made from tea tree oil was not deductible as the expenditure was not capable of being identified with the derivation of any assessable income (Howland Rose & Ors v. FC of T 2002 ATC 4200; 49 ATR 206).

20. In the above examples the expenditure was either preliminary to the income earning production or lacked any direct connection to income production. This is not the case for A's interest payments, where there is a direct connection to the taxpayer's existing and future income producing activities.

21. Even if the view is taken that the Agreement Loans will be funding the payment of A's Agreement Dividends, rather than the other way around, the interest would still be likely to be deductible under Taxation Ruling TR 2004/4 and Taxation Ruling TR 95/25. Taxation Ruling TR 95/25 confirms at paragraph 15 that interest on a borrowing by a company is likely to be deductible where the borrowing is used to fund the payment of a declared dividend to shareholders, where the funds representing the declared dividend are employed as capital or working capital in the business carried on by the company for the purpose of deriving assessable income.

A's overseas subsidiary

22. A also has a non-operating overseas subsidiary, and the taxpayers have previously stated that there may be some funding of that entity, but that the amount of this funding will be immaterial in the context of the whole group. Any funding to this entity will not be incurred in producing assessable income, as the only income A will receive from this entity will qualify as non-assessable non exempt dividends under section 23AJ of the ITAA 1936. Section 23AJ income is foreign dividends received in respect of a shareholding of at least 10%, that is, non-portfolio dividends.

23. As there is no connection to the production of assessable income, general deductibility under section 8-1 of the ITAA 1997 would not apply. However, as stated by the taxpayer, provided that section 25-90 of the ITAA 1997 applies, any interest relating to this funding will still be deductible. Section 25-90 specifically allows deductions for losses and outgoings relating to the derivation of dividends that fall within section 23AJ of the ITAA 1936, and it overcomes the general requirement in section 8-1 of the ITAA 1997 that a loss or outgoings must be incurred in gaining assessable income.

24. The only conditions for section 25-90 to allow interest deductions to A for Agreement Loans to its foreign subsidiary are as follows:

§ it must have incurred the interest expense in deriving income from a foreign source;

§ the income is *non assessable non-exempt income under section 23AI, 23AJ or 23AK of the ITAA 1936;

§ the amount is a cost in relation to a *debt interest issued by the entity that is covered by paragraph (1)(a) of the definition of debt deduction.

25. The meaning of a debt interest is generally determined in accordance with the debt/equity rules in Division 974 of the ITAA 1997. This condition will be met, in accordance with the previous conclusion that an Agreement Loan will be treated as debt. The other two conditions above will also be satisfied as the interest relates to a foreign subsidiary and the relevant income will consist of section 23AJ of the ITAA 1936 dividends.

26. From the above, it is concluded that section 25-90 of the ITAA 1997 would apply in relation to any interest incurred in relation to A's foreign subsidiary, so that the interest would be deductible.

27. It is also noted that as A is a Consolidated Group for income tax purposes, interest deductibility is determined based on the entire A Group. This is in accordance with the single entity rule in section 701-1 of the ITAA 1997.

Conclusion

28. Taking into account all of the above, it is concluded that interest incurred by A in respect of the Agreement Loans made to it for its calls under the Agreement will be deductible to A under section 8-1 of the ITAA 1997, or under section 25-90 of the ITAA 1997 in respect of any interest relating to section 23AJ of the ITAA 1936 income. The basis for this view is that the interest will be incurred in producing assessable income, will not be of a capital nature, and will not be incurred at a point too soon before the production of assessable income.

Question 4

Detailed reasoning

Will the interest incurred by A in respect of the Funding Loans made to it (including interest payments on Funding Loans to replace working capital paid as a dividend by A to fund its business) be deductible to A under section 8-1 of the ITAA 1997?

1. The next question concerns the deductibility of interest incurred by A in respect of Funding Loans paid to it from the B&C Partnership. The shareholder's of A, B and C, wish to provide for A's post 1 January 200X capex by way of loans, which will facilitate dividends of the same amount. However they do not wish to be only able to do this when the Agreement requires Agreement Loans. Instead, they wish to also be able to do this when they agree it is appropriate, that is, when they mutually agree to pay a dividend (a 'Funding Dividend). These dividends will be loaned back to A via the B&C Partnership as 'Funding Loans', not Agreement Loans under the Agreement.

2. Funding Loans will be similar to Agreement Loans in that both are on commercial arms length terms, including commercial interest rates. In addition, Funding Loans must be repaid in any case no later than 31 December 20XX if under a separate agreement to the original loan arrangements. As with Agreement Loans, there is a limit on the total of all Funding Loans, which is US$1 billion (for the combined total of all Enterprise and Funding Loans). B and C will not agree to pay Mutually Agreed Dividends where this would cause a breach of section 254T of the Corporations Act, or cause A to be unable to pay its debts. Another similarity between Agreement and Funding Loans is that both will be used for similar business purposes (to fund working capital requirements).

3. All Funding Loans will be made from the B&C Partnership to the A Group only, and not to any other ABCD entities.

4. Funding Loans will be used to fund A's capex or its working capital requirements, including the payment of dividends. In addition, A may lend or invest in other ABCD entities to satisfy their capex requirements. These loans or investments will be on an arm's length commercial basis and will only relate to specified capex in respect of infrastructure or a facility.

5. Unlike Agreement Loans subject to the Agreement, Funding Dividends and Funding Loans will not necessarily be linked to calls or available cash. Funding Loans made in response to a Funding Dividend will be linked to replacing the working capital employed by A which was paid out as that dividend.

6. Key differences between Funding Dividends/Funding Loans and Agreement Dividends/Agreement Loans are that the former will not be subject to the requirements of the Agreement and may not necessarily be linked to available cash and they have a different Repayment Term being less than P years of entering in the loan or in any case by 31 December 20XX if under a separate agreement to the original loan arrangement. However, these differences are not considered relevant concerning the interest deductibility issue as the funds from both will be used for similar business purposes. Therefore, in principle the same conclusion applies in respect of the deductibility under section 8-1 of the ITAA 1997 of interest incurred by A relating to Funding Loans as considered for Agreement Loans above.

Conclusion

7. The differences between Funding Loans and Agreement Loans are not significant in respect of interest deductibility. Accordingly, interest incurred by A in relation to Funding Loans to it will be deductible under section 8-1 of the ITAA 1997, or under section 25-90 of the ITAA 1997 in respect of any interest relating to section 23AJ of the ITAA 1936 income. As with the Agreement Loans, the basis for this view is that the interest will be incurred in producing assessable income, will not be of a capital nature, and will not be incurred at a point too soon before the production of assessable income.

Question 5

Detailed Reasoning

Will the Commissioner make a determination pursuant to section 177F of the ITAA 1936 in respect of A in relation to the interest deductions on the Agreement Loans?

1. A determination under section 177F of Part IVA of the ITAA 1936 will be made where there is a 'scheme' (subsection 177A(1) of the ITAA 1936), there is a 'tax benefit' in relation to the scheme (section 177C of the ITAA 1936), and it can be concluded that the scheme was entered into or carried out for the dominant purpose of enabling a relevant taxpayer to obtain the tax benefit (section 177D of the ITAA 1936). Having regard to these legislative provisions the Commissioner can make a determination that the whole or part of the amount of tax benefit is to be included in the assessable income of the taxpayer (section 177F of the ITAA 1936).

Scheme

2. 'Scheme' is defined in subsection 177A(1) of the ITAA 1936 as:

a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

b) any scheme, plan, proposal, course of action or course of conduct.

3. In the proposed arrangement, the scheme can be viewed as consisting of a Agreement Dividend by A to fund the call of that amount which relates to A's funding requirements, which is to be reinvested via the B&C Partnership to A as an Agreement Loan. The dividend and re-investment will result in franking tax credits to both C and B, and in interest deductions to be claimed by A.

4. It should be noted that there were previous private rulings issued to A on a similar issue to the current. The previous rulings also concerned Agreement Loans (and Funding Loans) made to A from the B&C Partnership pursuant to the Agreement. It was ruled that the Commissioner would not make a determination pursuant to section 177F of the ITAA 1936 in respect of the interest deductions on the Agreement Loans. It was also ruled that interest incurred by A, in relation to Agreement Loans to it, was deductible under section 8-1 of the ITAA 1997.

5. The difference between the Agreement Loan in the current scheme and the Agreement Loans considered in the previous ruling is that the Agreement has been subject to some changes. The key change is the change in the termination date of the Agreement to a continuing agreement to allow the Agreement to continue beyond the current period.

6. The changes to the Agreement and the arrangements do not appear to be significant in respect of the deductibility of interest incurred by A in relation to Agreement Loans, as Agreement Loans will continue to be on commercial arm's length terms, and must be repaid within Q years of the loans being entered into.

Tax benefit

7. Paragraph 177C(1)(b) of the ITAA 1936 provides that a taxpayer will obtain a 'tax benefit' if a deduction is allowable to the taxpayer in relation to a year of income, and the whole or part of that deduction would not have been allowable, or might reasonably be expected not to have been available, to the taxpayer in relation to the year of income if the scheme had not been entered into or carried out.

8. The 'reasonable expectation' test in subsection 177C(1) of the ITAA 1936 requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable (Federal Commissioner of Taxation v. Peabody (1994) 181 CLR 359; 123 ALR 451; 94 ATC 4663; 28 ATR 344).

9. It is considered that if the scheme had not been entered into and the Agreement Loans and Agreement Dividends were not made, the result would not satisfy the competing requirements of shareholders to receive franked dividends and to continue the funding of capital requirements in A. A reasonable alternate scheme would be one where external debt funding is used to fund capital requirements from a non-related party instead of Agreement Loans in conjunction with the continuation of dividends to shareholders. However this alternate scheme would not result in a material difference in tax benefits to the current scheme as the Agreement Loans are made at commercial arm's length rates and the external debt funding would still result in similar interest deductions for A.

10. On the facts advised and with consideration of section 8-1 of the ITAA 1997 it is considered reasonable to conclude that as a result of the scheme A would obtain a paragraph 177C(1)(b) of the ITAA 1936 tax benefit, being a deduction in respect of interest paid on an Agreement Loan from the EP. This conclusion is consistent with that in the previous rulings concerning Agreement Loans.

Purpose of the scheme

11. Section 177D of the ITAA 1936 applies to a scheme where it would be concluded that the scheme was entered into or carried out for the purpose of enabling a relevant taxpayer to obtain a tax benefit in connection with the scheme.

12. A is the relevant taxpayer as it would receive the tax benefit (paragraph 177D(a) of the
ITAA 1936).

13. In order to determine the purpose of the scheme it is necessary to consider the eight factors in paragraph 177D(b) of the ITAA 1936. These factors are to be considered objectively and a conclusion to be reached should be that of a reasonable person (Federal Commissioner of Taxation v. Spotless Services Ltd (1996) 186 CLR 404; 141 ALR 92; 96 ATC 5201; 34 ATR 183).

(i) The manner in which the scheme was entered into or carried out

14. The facts support a conclusion that the creation of the B&C Partnership was necessary for commercial purposes. Despite the contracting parties being related, the scheme will be carried out under normal commercial terms, with interest payable on the loans being at arms-length rates. While the same outcome could have been achieved by C and B lending directly to A, it would have created an accounting reporting problem for B's United States of America parent company D.

(ii) The form and substance of the scheme

15. The form and substance of the scheme is that the ABCD partners will contribute to the development of the business of A in exactly the same proportions to that previously undertaken. There will be a continuation of significant dividend payments by A which will enable shareholder C to continue to pay fully franked dividends to its shareholders, and also facilitate the expansion of A's business operations through the reinvestment of dividend payments as equity injections to the B&C Partnership and subsequent loans to A.

(iii) The time at which the scheme was entered into and the length of the period during which the scheme was carried out

16. The scheme was first entered into during the year ended 31 December 200X being when Agreement Loans were first available under the original Agreement. The scheme is to continue on a year by year basis after 1 January 2011 given the intention of the Amended Agreement to be a continuing agreement. Agreement Loans under the Amended Agreement are to be repaid within Q years of being made.

(iv) The result in relation to the operation of the ITAA 1936 or the ITAA 1997 that, but for Part IVA, would be achieved by the scheme

17. Interest deductions under subsection 8-1 of the ITAA 1997 would be allowable to A in respect of Agreement Loans made from the B&C Partnership.

(v) Any change in the financial position of the relevant taxpayer that has resulted, or will result, or may reasonably be expected to result, from the scheme

18. Prior to the scheme's implementation A has had very little debt and hence interest deductions have been low. Under the scheme proposed, A's gearing level will increase as the amount of borrowing increases, resulting in reduced income tax liabilities. However these are normal commercial results of the scheme and the level of borrowing is not expected by A to breach thin capitalisation limits.

(vi) Any change in the financial position of any person who has, or has had any connection with the relevant taxpayer, being a change that has resulted, or will result, or may reasonably be expected to result, from the scheme

19. Apart from a change in the manner of holding their investment in A, the scheme does not indicate any material change in the financial position of the connected entities (B and C).

(vii) Any other consequence for the relevant taxpayer or for any person referred to in (vi) of the scheme being entered into or carried out

20. As a result of the scheme the shareholders (B and C) will derive assessable income (after deduction of relevant partnership expenses) from the B&C Partnership on the Agreement Loan made to A.

(viii) The nature of any connection between the relevant taxpayer and any person referred to in (vi)

21. A is the operating company of a longstanding M%/N% incorporated joint venture vehicle of D (via B) and C.

22. Having considered the eight factors above, it can be concluded that A will enter into the scheme for the dominant purpose of funding expansion and investment opportunities whilst continuing to pay significant franked dividends to its shareholders. The scheme necessarily reflects the competing needs of its majority shareholder B in respect of the accounting reporting requirements, and C in respect of its need for continued receipt of franked dividends. The scheme does not facilitate a change in funding arrangements which is at odds with commercial reality.

Conclusion

23. Having regard to the facts of the case, relevant tax laws and rulings, Part IVA of the ITAA 1936 will not apply to the scheme. The scheme is to be entered into on normal commercial terms and has no indicators to which Part IVA would apply. This conclusion is consistent with that in the previous ruling which also concerned Agreement Loans (prior to the current changes in the Agreement). Therefore the Commissioner will not make a determination under section 177F of the ITAA 1936 to deny A interest deductions that will arise in respect of an Agreement Loan made to it to for its calls under the Agreement

Question 6

Detailed Reasoning

Will the Commissioner make a determination pursuant to section 177F of the ITAA 1936 in respect of A in relation to the interest deductions on the Funding Loans?

1. For the proposed Funding Loans arrangement, the scheme can be viewed as consisting of each Funding Dividend payment by A, which is to be reinvested via the EP to A as a Funding Loan. The dividend re-investment will result in franking tax credits to both C and B, and in interest deductions to be claimed by A.

2. The above scheme is similar to that considered for Agreement Loans. There is a large degree of commonality between Agreement Loans and Funding Loans, and both will be at commercial arm's length terms. The main differences are that Funding Loans will not be made pursuant to the Agreement and may be made more frequently, as needed and that the Repayment Term of Funding Loans differs being within P years of entering the loan or in any case by 31 December 20XX if made under a separate agreement to the existing loan arrangements. These differences are not material in relation to the issue of whether the Commissioner would make a determination under section 177F of the ITAA 1936.

3. Therefore, the same analysis as that for Agreement Loans above is considered to apply for each Funding Loan, and accordingly it is concluded that Part IVA will also not apply to the Funding Loan scheme, so that the Commissioner will not make a determination under section 177F of the
ITAA 1936 to deny A interest deductions arising under the Funding Loans.

Question 7

Detailed Reasoning

Will the Commissioner make a determination pursuant to subsection 204-30(3) of the ITAA 1997 in relation to the payment of Agreement Dividends in conjunction with the calls under the Agreement to C and B?

1. Section 204-30 of the ITAA 1997 is a general anti-streaming measure. It is designed to curb the unintended use of franking credits through streaming arrangements. It permits the Commissioner to make determinations where an entity streams one or more distribution whether in a single franking period or in a number of franking periods, in such a manner whereby:

a) an imputation benefit is, or apart from this section would be, received by a member of the entity as a result of a distribution or distributions; and

b) that member derives a 'greater benefit from franking credits' than another member of the entity; and

c) the other member of the entity receives a lesser imputation benefit, or receives no imputation benefits, whether or not the other member receives other benefits.

2. Streaming is the act of selectively directing the flow of franked distributions to those members that are best positioned to utilise imputation benefits to the exclusion of those members that are not. The result of such action by a company is the reduction or elimination of the intended wastage of franking credits, inherent in the design of the imputation system. A definite strategy designed to achieve this outcome would need to have been put in place by the company, before an arrangement could be classified as a streaming arrangement.

3. If section 204-30 of the ITAA 1997 applies, the Commissioner is vested with discretion under subsection 204-30(3) of the ITAA 1997 to make a determination in writing either:

a) that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member (paragraph 204-30(3)(a)) of the ITAA 1997; or

b) that no imputation benefit is to arise in respect of any streamed distributions made to a favoured member and specified in the determination (paragraph 204-30(3)c)) of the
ITAA 1997.

4. In the current circumstances, C, as a resident corporate tax entity, will be able to benefit from imputation credits received as a result of Agreement Dividends. The associated franking credits are to be utilised by C to frank its dividends. Similarly B, as a resident corporate tax entity, will be able to benefit from imputation credits received as a result of the Agreement Dividends.

5. However, as B is owned by D, a non-resident entity, B will be deemed to be an exempting entity. Consequently, as a result paragraph 204-30(8)(f) of the ITAA 1997, C (the favoured member) will be taken to have derived a greater benefit from franking credits than B (the disadvantaged member).

6. Regardless of the fact that C derives a greater benefit from franking credits than B, if the Commissioner is to make a streaming determination under subsection 204-30(3) of the
ITAA 1997, it must be possible to demonstrate that the distribution made by A has been so made as to result in the favoured member deriving greater imputation benefits and the disadvantaged member receiving lesser or no imputation benefits. However, in this case, A intends paying the Agreement Dividends proportionately between its members. Both C and B will receive their proportionate share of the franked distribution in accordance with their ordinary shareholdings in A. Despite C being able to derive a greater benefit from franking credits than B, A has demonstrated no preference for one over the other in making the distribution.

7. Consequently, it is not considered appropriate to make a determination under
paragraph 204-30(3)(a) or (b) of the ITAA 1997, to give rise to a franking debit in the franking account of A or to deny the whole, or any part, of the imputation benefits received by C or B. Hence the Commissioner will not make a determination pursuant to subsection 204-30(3) of the ITAA 1997 in relation to the payment of Agreement Dividends to C or B.

Question 8

Detailed Reasoning

Will the Commissioner make a determination pursuant to subsection 204-30(3) of the
ITAA 1997 in relation to the payment of Funding Dividends to C and B?

1. The same reasoning and conclusion as for Agreement Dividends above applies in relation to the payment of Funding Dividends. That is, A intends paying the Funding Dividends proportionately between its members, so that both C and B will receive their proportionate share of the franked distributions in accordance with their ordinary shareholdings in A. Despite C being able to derive a greater benefit from franking credits than B, A has demonstrated no preference for one over the other in making the distribution. Hence the Commissioner will not make a determination pursuant to subsection 204-30(3) of the ITAA 1997 in relation to the payment of the Funding Dividend to C or B.