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Authorisation Number: 1011686836247

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Ruling

Subject: Debt/equity - stapled instruments

Questions

1. Will the ordinary shares and redeemable preference shares (RO Shares) issued by AA Pty Ltd (AAPL) to investors constitute related schemes for the purposes of section 974-155 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes.

2. If the ordinary shares and RO Shares are related schemes for the purposes of section 974-155 of the ITAA 1997 will the ordinary shares and RO Shares together give rise to a single debt interest in AAPL pursuant to section 974-15 of the ITAA 1997?

Answer: No.

3. If the Commissioner considers that the ordinary shares and RO Shares are not related schemes or are not treated as a single debt interest under section 974-15 of the ITAA 1997, will the ordinary shares issued to investors be characterised as equity interests in AAPL for the purposes of subsection 974-70(1) of the ITAA 1997?

Answer: Yes.

4. If the Commissioner considers that the ordinary shares and RO Shares are not related schemes or are not treated as a single debt interest under section 974-15 of the ITAA 1997, will the RO Share issued to investors by AAPL be characterised as debt interests in AAPL in accordance with subsection 974-15(1) of the ITAA 1997?

Answer: Yes.

This ruling applies for the following period

Substituted accounting period ending 31 December 2008 to 31 December 2018

Relevant facts

AAPL is the head company of an income tax consolidated group. AAPL has issued ordinary shares and redeemable ordinary shares (RO Shares) to four separate shareholder entities/investors. The RO Shares meet the requirement of 'redeemable preference share' in subsection 254A(2) and 254A(3) of the Corporation Act 2001 and are therefore redeemable preference shares for all intents and purposes.

The funds raised by AAPL from issue of the ordinary shares and RO Shares together with funds borrowed by AAPL have been used by AAPL to acquire business assets which will be operated by the AAPL group for the purposes of producing assessable income or used to refinance existing borrowed funds which were used for that purposes. The funds borrowed from are secured over the assets of the AAPL consolidated group and their interests under the deed of charge are represented by a Security Trustee.

Each ordinary share and RO Share are 'stapled'. That is, an RO Share cannot be issued to an entity unless at the same time an ordinary share is issued to that same entity. Further, an RO Share cannot be transferred, unless in the same transaction the ordinary share that was issued with the RO Share is transferred to the same person.

The RO Shares issued by AAPL to investors have a subscription price of $0.99 per share. The ordinary shares have a subscription price of $0.01 per share. Accordingly, the total issue price of each stapled RO Share and ordinary share is $1.00.

The RO Share holders are entitled to discretionary dividends on the RO Shares. The RO Shares have not fixed dividend entitlements. The directors are able to determine at their sole discretion whether to pay dividends on the RO Shares or the ordinary shares each year.

The RO Shares have full voting rights and rank pari passu with the ordinary shares in this respect.

The RO Shares are mandatorily redeemable on the last business day before the 10^th anniversary of the date of issue (the redemption date) for $1.00 per share and have preferential capital winding up rights.

Where certain circumstances arise, the RO Shares may at the holders/investors' option (where more than 50% of the RO Share holders agree) either be redeemed early in return for the issue of ordinary shares on a one for 99 basis or converted into ordinary shares in AAPL on a one for 99 basis.

The RO Shares are only able to be redeemed prior to the redemption date if this would not breach any agreement to which AAPL is a party. This additional requirement will not apply where the RO Shares are to be redeemed on the redemption date or converted into ordinary shares (where more than 50% of RO Share holders agree).

Where the RO Shares are to be redeemed out of profits on the redemption date and to the extent that payment of the redemption amount would result in a breach of any Finance Document as defined in any deed of charge to which AAPL is a party, then AAPL must pay the redemption amount to the Security Trustee holding that charge (or if more than one trustee, the holder of the highest ranking charge), not to the RO Share holders. The RO Share holders will forgo any entitlement to that amount and have agreed to hold the benefit of this provision for the benefit of the Security Trustee. The security trustee is not related in any way to AAPL.

The use of RO Shares was preferable to legal form debt as it allowed discretionary dividend payments giving AAPL flexibility to repatriate surplus cash. Further, the accounting treatment improved balance sheet presentation, and non-resident investors had a preference for dividends as opposed to interest receipts.

The main driver for stapling the interests was to overcome potential non-alignment of commercial interests between shareholders and investors holding different interests and thereafter seeking to maximise their rights to the detriment of others. AAPL has no other ordinary shares on issue that are not effectively stapled to the RO Share.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 974-15

Income Tax Assessment Act 1997 subsection 974-70(1)

Income Tax Assessment Act 1997 section 974-155

Reasons for decision

Question 1: Related schemes

The term "scheme" is defined in subsection 995-1(1) of the ITAA 1997. It has a broad meaning and includes any arrangement, scheme, plan, proposal, action, course of conduct, whether unilateral or otherwise. Thus, the issue of the ordinary shares and RO Shares by AAPL each fall within the definition of a scheme for the purposes of Division 974 of the ITAA 1997.

Subsection 995-1(1) also provides that "related scheme" has the meaning given by section 974-155 of the ITAA 1997. Applying the principles set out in section 974-155 the ordinary shares and RO Shares issued by AAPL are related schemes on any or all of the following grounds:

(a) the schemes are based on stapled instruments;

(b) one of the schemes depends for its effect on the operation of the other scheme; or

(c) one scheme complements or supplements the other.

In drawing this conclusion it is noted that the relationship between the two schemes goes well beyond one referring to the other or the existence of common parties.

Question 2: Related schemes - single debt Interest

Subsection 974-15(2) of the ITAA 1997 provides:

Two or more related schemes (the constituent schemes) are taken together to give rise to a debt interest in an entity if:

(a) the entity enters into, participates in or causes another entity to enter into or participate in the constituent schemes; and

(b) a scheme with the combined effect or operation of the constituent schemes (the notional scheme) would satisfy the debt test in subsection 974-20(1) in relation to the entity if the notional scheme came into existence when the last of the constituent schemes came into existence; and

(c) it is reasonable to conclude that the entity intended, or knew that a party to the scheme or one of the schemes intended, the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of a debt interest.

This is so whether or not the constituent schemes come into existence at the same time and even if none of the constituent schemes would individually give rise to that or any other debt interest.

The requirements of this subsection in relation to the issue of the ordinary shares and the RO Shares by AAPL (the notional scheme) are considered below.

Paragraph 974-15(2)(a) of the ITAA 1997

Paragraph 974-15(2)(a) of the ITAA 1997 is satisfied, in that the constituent documents clearly evidence that AAPL has entered into, participated in or caused other entities to enter into or participate in the notional scheme.

Paragraph 974-15(2)(b) of the ITAA 1997

Paragraph 974-15(2)(b) is satisfied as a scheme with the combined effect or operation of the notional scheme would satisfy the debt test in subsection 974-20(1) of the ITAA 1997. The reasons for this conclusion are outlined below.

Subsection 974-20(1) of the ITAA 1997 requires the following to be satisfied before a scheme can be said to give rise to a debt interest:

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 scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company).

a) the notional scheme is a financing arrangement for the entity.

The RO Shares and ordinary shares do not have to satisfy the financing arrangement requirement because they both satisfy Item 1 of the table in subsection 974-75(1) of the ITAA 1997 (an interest as a member or stockholder of the company).

b) the entity, or connected entity of the entity, receives or will receive a financial benefit or benefits under the notional scheme.

Paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes "anything of economic value". AAPL has therefore received the following financial benefits under the notional scheme.

The total financial benefit received by AAPL under the notional scheme is $1.00 per stapled instrument ($0.01 for each ordinary share and $0.99 for each RO Share).

(c) the entity has, or the entity or the connected entity of the entity each has, an effectively non-contingent obligation under the notional scheme to provide a financial benefit or benefits to one or more entities.

An "effectively non-contingent obligation" is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 974-135.

Subsection 974-135(1) of the ITAA 1997 states that there is an effectively non-contingent obligation to take action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action.

Subsection 974-135(3) provides inter alia that an effectively non-contingent obligation is an obligation that is not contingent on any event, condition or situation other than the ability or willingness of that entity or connected entity to meet the obligation.

The key terms and conditions that go to whether in substance or effect AAPL has an effectively non-contingent obligation to provide a financial benefit under the notional scheme are detailed below.

AAPL has an effectively non-contingent obligation in relation to the RO Shares component of the notional scheme to redeem each RO Share for its Redemption Amount. The Terms of Issue of ROS provides that unless redeemed early or converted the Company must redeem each RO Share on issue on the Redemption Date for its Redemption Amount. The Redemption Amount is $1.00 in respect of each RO Share.

However, AAPL's obligation to pay dividends on the RO Share is not effectively non-contingent. A holder of an RO Share is entitled to a dividend if the Directors in their absolute discretion declare such a dividend to be payable. Dividends are stated to be non-cumulative and the definition of Redemption Amount does not include any unpaid dividend component. Thus, dividends on the RO Share are clearly a contingent obligation.

It is noted that AAPL has no effectively non-contingent obligations in relation to the ordinary share component of the notional scheme. This is because the return of the ordinary share issue price is contingent as the shares in question are prima facie perpetual. The events allowing for a partial return of capital via a reduction in capital or a return of capital in a winding up are all contingent upon the existence of certain pre-requisites including the actual occurrence of those trigger events. Further, dividends payable on the ordinary shares are contingent on, amongst other things, the Company having profits and the Board exercising their discretion to pay a Dividend.

Thus, under the notional scheme AAPL only has an effectively non-contingent obligation in relation to the RO Shares, namely the obligation to redeem each RO Share for its Redemption Amount.

(d) it is substantially more likely than not that the benefit provided will at least equal the benefit received.

Section 974-35 of the ITAA 1997 sets out the manner in which the value of a financial benefit to be provided or received under the scheme is to be calculated.

Paragraph 974-35(1)(a) provides that the value of a financial benefit to be provided or received is to be calculated in nominal terms if the performance period ends no later than 10 years after the interest arising from the scheme is issued or, in present value terms if the performance period must, or may, end more than 10 years after the interest arising from the scheme is issued.

Subsection 974-35(3) defines the performance period as:

the period within which, under the terms on which the interest is issued, the effectively non-contingent obligations of the issuer, and any connected entity of the issuer, to provide a financial benefit in relation to the interest have to be met.

It is only effectively non-contingent obligations to provide and receive financial benefits that are taken into account for valuation purposes: refer subsection 974-20(4) of the ITAA 1997. As noted above the only effectively non-contingent obligations under the notional scheme is the receipt of $1.00 by the issuer and its corresponding effectively non-contingent obligation to redeem each RO Share for its Redemption Amount on its Redemption Date.

Redemption Date is the last business day before the 10^th anniversary of the Issue Date. Thus, as the performance period ends no later than 10 years after the interests arising from the notional scheme will be issued the effectively non-contingent financial benefits must be valued in nominal terms. Redemption Amount is $1.00 in respect of each RO Share.

Thus, valuing the effectively non-contingent financial benefits received ($1.00) and the financial benefits to be provided ($1.00) under the notional scheme in nominal terms will have the result that it is substantially more likely than not that the value of the financial benefits provided will at least be equal to the value of the financial benefits to be received.

(e) both the value provided and the value received are not both nil.

As outlined in (d) above the value provided and the value received are not both nil and this requirement is satisfied.

Therefore, all the requirements of the debt test have been satisfied in relation to the combined effect or operation of the notional scheme and as a consequence paragraph 974-15(2)(b) of the ITAA 1997 is satisfied.

Paragraph 974-15(2)(c) of the ITAA 1997

The instruments are legally stapled. The Constitution provides in part that "The intention is that, so far as the law permits, an ordinary share and a RO Share which are Stapled together will be treated as one security." In addition the combined legal rights and obligations created by all of the constituent documents ensures that AAPL is under an effectively non-contingent obligation to pay back an amount equal to the face value of both the RO Share and the ordinary share. The basis for the calculation of the Redemption Price was to include an amount equal to the issue price of both the RO Share and the ordinary share to ensure the debt test would be passed in respect of the RO Share irrespective of whether the related scheme provisions applied. A consideration of these factors in the totality of the arrangement including the rationale for structuring the staple in this manner, leads to the view that it is reasonable to conclude that AAPL intended the combined economic effects of the notional scheme to be the same as, or similar to, the economic effects of a debt interest. Accordingly paragraph 974-15(2)(c) of the ITAA 1997 is satisfied.

Conclusion re paragraphs (a) (b) and (c) of subsection 974-15(2) of the ITAA 1997

Prima facie, the notional scheme consisting of the RO Share stapled to the ordinary share satisfies paragraphs (a), (b) and (c) of subsection 974-15(2) of the ITAA 1997.

However, in light of this finding regard needs to be had to subsection 974-15(4) of the ITAA 1997.

Subsection 974-15(4) of the ITAA 1997

Subsection 974-15(4) of the ITAA 1997 provides:

Two or more related schemes do not give rise to a debt interest in an entity under subsection (2) if the Commissioner determines that it would be unreasonable to apply that subsection to those schemes.

Subsection 974-15(5) then provides:

Without limiting subsection 974-10(5), the Commissioner must, in exercising the power to make a determination under subsection (4), have regard to the following:

(a) the purpose of the schemes (considered both individually and in combination);

(b) the effects of the schemes (considered both individually and in combination);

(c) the rights and obligations of the parties to the schemes (considered both individually and in combination);

(d) whether the schemes (when considered either individually or in combination) provide the basis for, or underpin, an interest issued to investors with the expectation that the interest can be assigned to other investors;

(e) whether the schemes (when considered either individually or in combination) comprise a set of rights and obligations issued to investors with the expectation that it can be assigned to other investors;

(f) any other relevant circumstances.

The Commissioner is also to be guided by the objects provisions in section 974-10 of the ITAA 1997, in particular subsection 974-10(3) which requires, inter alia, that related schemes be taken into account in appropriate cases to ensure the test operates effectively on an economic substance of the rights and obligations arising under the schemes and to prevent the tests being circumvented by entities merely entering into a number of separate schemes instead of a single scheme.

The relevant factors that the Commissioner must have regard to in subsection 974-15(5) of the ITAA 1997 are considered below.

Considered individually the purpose of issuing the ordinary shares was to raise equity finance for AAPL and the purpose of issuing the RO Shares was to raise 'debt like' finance for AAPL. The use of RO Shares was preferable to legal form debt as it allowed discretionary dividend payments giving AAPL flexibility to repatriate surplus cash. Further, the accounting treatment improved balance sheet presentation, and non-resident investors had a preference for dividends as opposed to interest receipts.

The main driver for stapling the interests was to overcome potential non-alignment of commercial interests between shareholders and investors holding different interests and thereafter seeking to maximise their rights to the detriment of others.

The individual effect of the issue of the ordinary shares was to create an equity interest in AAPL whereas the individual effect of the issue of the RO Shares was to create a debt interest in AAPL. The reasons for structuring this debt finance using a RO Shares as opposed to straight debt have been mentioned above. When considered in combination, the effect of the notional is to create a notional debt interest in AAPL.

The ordinary shares carry those rights and obligations normally associated with an ordinary share investment. These include investors with the risks and benefits associated with ordinary equity instruments (bearing all residual risks of the company; voting rights and dividend entitlements contingent on economic performance and the exercise of the director's discretion). There are, however, certain restrictions on shareholder's transferring their ordinary shares (discussed below). The RO Share holder's rights differ from the ordinary shares in that the issuer is under an obligation to return the principle contributed in 10 years, if the holder does not convert its interest earlier. RO Shares rank ahead of ordinary shares in a winding up and give no right to share in any surplus assets or profits of the company. Again there are certain restrictions on the RO Shareholders transferring their interests. When considered in combination, these rights do not change.

A shareholder in AAPL can only assign its interests as a Stapled Security. Further, while stapling applies the number of issued Ordinary Shares at any time must equal the number of issued RO Shares. There are certain requirements dealing with whom a holder may transfer its interests to, including the granting of a pre-emptive right to the remaining holders to purchase the interests before they are disposed to a third party. As such, the schemes in combination (but not individually), provide the basis for an interest that is issued with the expectation that it can be assigned to other suitable investors subject to the pre-emptive right conferred on the remaining shareholders.

In addition to the above factors it is also noted that the stated driver for setting the Redemption Price at $1.00 for the stapled security was to ensure that the RO Share would satisfy the debt test in section 974-15 of the ITAA 1997 regardless of whether subsection 974-15(2) applied or not (as opposed to ensuring that the ordinary shares to which the redeemable shares were stapled would not be treated as an equity interest). It is also noted that if converted each RO Share will convert into 99 ordinary shares and that this conversion ratio of 1:99 reflects the converse of the initial dollar value contributed for each instrument at the implementation of the scheme.

It is also relevant to note that if the notional scheme characterisation was maintained AAPL would be rendered without any equity for tax purposes. AAPL has no other ordinary shares on issue that are not effectively stapled to the RO Share. Until these circumstances change if the notional scheme characterisation was maintained any after tax profits earned by the company could not be distributed as frankable dividends; this could lead to an unwarranted accumulation of franking credits in the company during the existence of the staple.

Lastly, the driver for the stapling was not tax driven. The stapling sought to ensure alignment of commercial interests to avoid shareholders having different rights and acting to the detriments of other shareholders. They all have a common interest in the company with the same mix per staple of rights to share in risk and reward arising from the venture over the period for which the instrument is stapled.

Conclusion

In view of the totality of all the above factors, none of which by itself is conclusive, the Commissioner has made a determination under subsection 974-15(4) of the ITAA 1997 by the issuance of this Ruling that it would be unreasonable to apply subsection 974-15(2) to the related schemes to treat them as giving rise together to a notional debt interest in AAPL. As such, the ordinary shares and RO shares together will not give rise to a single debt interest in AAPL pursuant to section 974-15 of the ITAA 1997.

Question 3: Ordinary shares - equity interests

The equity test

Subsection 974-70(1) of the ITAA 1997 provides that:

A scheme gives rise to an equity interest in a company if, when the scheme comes into existence:

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

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

These requirements in relation to the AAPL ordinary shares are considered below.

The issue of ordinary shares in AAPL is a "scheme" as this term is defined in subsection 995-1(1) of the ITAA 1997.

The AAPL ordinary shares satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as the rights and privileges conferred on the ordinary shareholder by the Constitution of AAPL give them an interest in the company as a member or stockholder of the company. This satisfies Item 1 of the table in subsection 974-75(1) of the ITAA 1997.

As Item 1 of the equity table in subsection 974-75(1) of the ITAA 1997 is satisfied the AAPL ordinary shares do not have to satisfy the financing arrangement requirement: refer to subsection 974-75(2) of the ITAA 1997.

Therefore, the AAPL ordinary shares satisfy the equity test in subsection 974-75(1) and they will give rise to an equity interest in AAPL provided the interest is not characterised as, and does not form part of a larger interest that is characterised as a debt interest in the company, or a connected entity of the company, under Subdivision 974-B of the ITAA 1997.

The debt test

The AAPL ordinary shares were issued fully paid up for an issue price of $0.01c per share. Under AAPL's Constitution dividend payments on ordinary shares are contingent as is the return of the issue price of the share. The events allowing for a partial return of capital via a reduction in capital or a return of capital in a winding up are all contingent upon the existence of certain pre-requisites and the occurrence of those events. Dividends payable on ordinary shares are contingent on, amongst other things, the Company having profits and the Board exercising their discretion to pay a Dividend.

As AAPL is not under an effectively non-contingent obligation to provide any financial benefits to its ordinary shareholders the debt test in section 974-20 of the ITAA 1997 is not satisfied.

Conclusion

As the AAPL ordinary shares pass the equity test but fail the debt test they will be equity interests for the purposes of subsection 974-70(1) of the ITAA 1997.

Question 4: RO Shares - debt interests

Subsection 974-15(1) of the ITAA 1997 provides that:

A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity.

The application of the debt test in section 974 20(1) of the ITAA 1997 to the RO Shares issued by AAPL is considered below.

a) the scheme is a financing arrangement for the entity.

The issue of the AAPL RO Shares do not have to satisfy the financing arrangement requirement because they satisfy Item 1 of the table in subsection 974-75(1) of the ITAA 1997 in that they give rise to an interest in AAPL as a member or stockholder of the company.

b) the entity, or connected entity of the entity, receives or will receive a financial benefit or benefits under the scheme.

Paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes "anything of economic value". AAPL has received the issue price of $0.99 for each RO Share issued and has therefore received a financial benefit under the scheme.

(c) the entity has, or the entity or the 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.

The relevant financial benefits that fall for consideration under section 974-135 of the ITAA 1997 are AAPL's obligation to:

i) pay dividends on the RO Share, and

ii) return the Redemption Amount.

The key terms and conditions in the AAPL Constitution that go to whether in substance or effect AAPL has an effectively non-contingent obligation in relation to these financial benefits are detailed below.

i) obligation to pay dividends

The Terms of Issue of ROS provides that a holder of an RO Share is entitled to a dividend if the Directors in their absolute discretion declare such a dividend to be payable. Dividends are also stated to be non-cumulative and the definition of Redemption Amount does not include any unpaid dividend component.

Dividends on the RO Share are thus clearly contingent on an event, condition or situation and are therefore not effectively non-contingent.

ii) obligation to return the Redemption Amount.

AAPL has an effectively non contingent obligation in relation to the RO Share to redeem each share for its Redemption Amount. The Terms of Issue of ROS provides that unless redeemed early or converted the Company must redeem each RO Share on issue on the Redemption Date for its Redemption Amount. The Redemption Amount is $1.00 in respect of each RO Share.

(d) it is substantially more likely than not that the benefit provided will at least equal the benefit received.

As noted above the only effectively non-contingent obligation in relation to the RO Shares is the effectively non-contingent obligation to redeem each share for its Redemption Amount on its Redemption Date.

Redemption Date is the last business day before the 10^th anniversary of the Issue Date. Thus, as the performance period ends no later than 10 years after their issue the effectively non-contingent financial benefits must be valued in nominal terms.

Thus, valuing the effectively non-contingent financial benefits received ($0.99) and the financial benefits to be provided ($1.00) it is substantially more likely than not that the value of the financial benefits provided will at least be equal to the value of the financial benefits to be received.

(e) both the value provided and the value received are not both nil.

As outlined in (d) above the value provided and the value received are not both nil and this requirement is satisfied.

Conclusion

Therefore, all the requirements of the debt test have been satisfied in relation to the RO Shares and as a consequence they will be characterised as a debt interest in AAPL under subsection 974-15(1) of the ITAA 1997.