Edited version of private ruling

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Ruling

Subject: Debt buy back

The arrangement involves a taxpayer buying back its notes which are unsecured and have no final maturity (Notes). The funds from the issue of the Notes were used in the taxpayer's business.

The holders of the Notes have no right to demand repayment or redemption, except in the limited case of default.

The taxpayer bought back the Notes at a discount to their face value.

Question 1

Is the discount ordinary income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes

Question 2

Would section 26BB of the Income Tax Assessment Act 1936 (ITAA 1936) apply in respect of the Buy-back?

Answer: No

Question 3

Would section 104-25 of Part 3-1 of the ITAA 1997 apply to the taxpayer in respect of the buy-back?

Answer: Yes, however no capital gain or capital loss was made by the taxpayer when CGT event C2 happened.

Question 4

Would the commercial debt forgiveness provisions of Division 245 of Schedule 2C of the ITAA 1936 apply to result in a net forgiven amount in relation to the buy-back?

Answer: No

This ruling applies for the following period:

2009 income year

Reasons For Decision.

Question 1

The proceeds from the Notes were employed in the taxpayer's ordinary course of business. Since the funds raised in this case were employed in the ordinary course of the taxpayer's business, the gain arising from the buy-back is income according to ordinary concepts and is assessable income under section 6-5 of the ITAA 1997.

Question 2

Section 26BB applies to traditional securities acquired after 10 May 1989. Section 26BB treats a gain arising from the disposal or redemption of traditional securities by the holder of the securities as assessable income.

Section 26BB only has application in respect of the disposal of the traditional securities by the holder. Paragraph 4(xi) of Taxation Ruling TR 96/14 provides that the gain made by the issuer of a traditional security when redeeming the traditional security is not assessable under section 26BB. The basis for this view is that the issuer of a traditional security can not be the holder of a traditional security for the purposes of section 26BB.

Question 3

The Notes were not CGT assets.

The rationale of Taxation Determination TD3 to debts is relevant to these Notes.

TD3 provides that:

1. For CGT purposes, the borrower is not considered to have an asset. Accordingly, when the lender waives the debt, the borrower does not dispose of an asset and therefore makes no capital gain or loss.

2. No other CGT provisions apply to cause a capital gain or loss to the borrower when the lender waives the debt.

This view was endorsed in Taxation Ruling TR 96/23.

53. This is similar to a creditor forgiving or waiving a principal debtor's debt. There are no capital gains tax consequences for the debtor (see Taxation Determination TD3).

See also Taxation Ruling TR 2001/9

165. For CGT purposes, a borrower is not considered to own an asset: refer CGT Determination Number 3, at paragraph 1…

The decision in Integrated Insurance Planning Pty Ltd & Anor v FC of T 2004 ATC 4054 reinforces the Commissioner's view as expressed in TD3.

In his decision RD Nicholson J said:

128. An ``asset'' for the purposes of capital gains is defined in the relevant Act to mean ``any form of property and includes... a chose in action... (and) any other right'': s 160A(a). The rights which the applicants acquired as a consequence of the Deeds were a chose in action and/or a right and hence an asset. The position referred to in TR 2001/9 and CGT Determination Number 3 related only to a simple debt in which the taxpayer had no contractual right to a waiver upon achievement of the relevant contingent. The present position is therefore different because the taxpayer's rights gave them a CGT asset: s 105-5(1). They arose as the consequence of a CGT event D1.

After the buy-back of the Notes the rights associated with those Notes became CGT assets of the taxpayer. The ending of those rights by the cancellation of the notes later did cause CGT event C2 to happen. However, no capital gain or capital loss was made by the taxpayer when CGT event C2 happened.

Question 4

The taxpayer as issuer of the Notes had no enforceable obligation to pay the holders of the Notes the face value of the Notes before they were redeemed at a discount by mutual agreement. As such the Notes do not satisfy the definition in subsection 245-15(1) of Schedule 2C to the ITAA 1936 of a debt as being: 'an enforceable obligation imposed by law on a person to pay an amount to another person.'

In Tasman Group Services Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia 2008 ATC 20-002; [2008] FCA 23, (confirmed on appeal by the Full Federal Court 2009 ATC 20-138; [2009] FCAFC 148) Heerey J. considered the meaning of debt for the purposes of subsection 245-15(1) of Schedule 2C to the ITAA 1936.

Heerey J. decided at paragraph 31 that it is not necessary that a debt be immediately enforceable at the time of forgiveness in order to satisfy subsection 245-15(1) of Schedule 2C to the ITAA 1936.

The short answer is that there is still an enforceable obligation imposed by law to pay a creditor even if the time for payment is postponed or deferred. In terms of the legislative purpose of Div 245, there is just as much an economic benefit for a debtor if his creditor forgives a debt which is not yet due for payment as there is when the debt is due, or overdue.

This aspect of Heerey J's decision was confirmed by the Full Federal Court 2009 ATC 20-138, [2009] FCAFC 148.

However, in contrast to the loans considered by Heerey J, the Notes in this case were 'perpetual' and the holders of the Notes never had any future enforceable legal rights to compel the taxpayer to repay the face value of their Notes.

As explained at paragraph 73 of Taxation Ruling TR 2002/15 concerning perpetual notes:

On either view we consider that, at least prior to an event of default, there is no loan evidencing a debt due that the Holders can sue for in the sense set out in the judgment of Hill J in ANZ Savings.

Therefore, the Notes do not constitute debts for the purposes of subsection 245-15(1) of Schedule 2C to the ITAA 1936. Accordingly, the Buy-back of the Notes would not attract the operation of Division 245 of Schedule 2C to the ITAA 1936.