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Authorisation Number: 1011839199962

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Advice

Subject: Prepayment of Rent

Question 1

If Entity A chooses to prepay the lease rentals to the facility owner under the lease, will Entity A be entitled to a deduction for the prepaid rent under section 8-1 of the ITAA 1997, as it is expenditure that is incurred in gaining or producing assessable income and is not capital in nature?

Advice/Answers

No.

Question 2

If Entity A is entitled to a deduction for the prepaid rent under section 8-1 of the ITAA 1997, will the proportion of the prepaid rent that will be deductible in a relevant year of income be deducted over 10 years in accordance with the formula in subsection 82KZMD(2) of the ITAA 1936?

Advice/Answers

As Entity A is not entitled to a deduction under section 8-1 of the ITAA 1997 for the prepaid rent, subsection 82KZMD(2) of the ITAA 1936 cannot apply.

Question 3

If Entity A chooses to prepay the lease rentals to the facility owner under the lease referred to in Question 1, will the interest payable by Entity A under the loan from the banks be deductible under Section 230-15 of the ITAA 1997?

Advice/Answers

Yes.

Question 4

Will investors that are trusts be regarded as carrying on an 'eligible investment business' if their only assets are their respective interests in Entity A?

Advice/Answers

Yes.

Relevant facts

Entity A is part of a group that will construct and operate a new facility for the facility owner. Under the relevant agreement, Entity A will lease the completed facility and be required to pay rent to the facility owner. Alternatively, Entity A may choose to discharge its obligation to pay rent by paying a single upfront lump sum to the facility owner which will be equal to the construction cost of the building.

Entity A will then sub-lease the building to Entity B but without the option to prepay the lease rentals.

Entity B with then sub-sub-lease the building to the facility owner.

Entity A will not have any option to extend the lease nor will it have an option to acquire the land upon which the building will be built.

If Entity A elects to pay a single upfront lump sum to the facility owner at the commencement of the lease, it will do so by issuing promissory notes to the facility owner.

The facility owner will then be obliged to make a Construction Payment to Entity B under the relevant agreement. The facility owner's obligation to pay the Construction Payment will be satisfied by endorsing the promissory notes in favour of Entity B.

Entity B will use the promissory notes, amongst other things, to repay the Construction Loan from Entity A by endorsing the relevant promissory notes in favour of Entity A.

Entity A will then extinguish the promissory notes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1936 subsection 8KZMD(2)

Income Tax Assessment Act 1936 subsection 102M

Income Tax Assessment Act 1997 section 230-15

Taxation Administration Act 1953 Schedule 1 Division 359

Does Part IVA apply to this ABA?

The Commissioner considers the arrangement you asked us to provide advice on does contain certain features, which may mean that Part IVA may apply to the arrangement.

Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to provide advice on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to provide advice on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement, which are relevant to determining whether Part IVA may apply.

Reasons for decision

Question 1

If Entity A chooses to prepay the lease rentals to the facility owner under the lease, will Entity A be entitled to a deduction for the prepaid rent under section 8-1 of the ITAA 1997, as it is expenditure that is incurred in gaining or producing assessable income and is not capital in nature?

Summary

No. Entity A will not be entitled to a deduction for the prepaid rent under section 8-1 of the ITAA 1997 as the outgoings incurred are capital or of a capital nature.

Detailed reasoning

Section 8-1 of the ITAA 1997 provides that:

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature: or

…

Positive limb

While there are features that may possibly detract from the purpose of the prepayment as being an outgoing incurred in gaining or producing Entity A's assessable income (discussed below under the negative limbs), Entity A will derive or is expected to derive assessable income from sub leasing the facility that will be greater than the prepayment outgoing (and total of all outgoings).

As the assessable income is greater than the outgoings incurred, the features of the arrangement are insufficient to conclude that the prepayment is not (even if somewhat colourably) used in an assessable income producing activity. Therefore, the prepayment is an outgoing incurred in gaining or producing Entity A's assessable income.

Negative limbs

The prepayment is clearly not an outgoing of a private or domestic nature, nor is it incurred in gaining or producing exempt income or non-assessable, non-exempt income.

It falls then to consider if the prepayment is an 'outgoing of capital, or of a capital nature'.]

'outgoing of capital, or of a capital nature' A loss or outgoing that satisfies one of the positive limbs of subsection 8-1(1) is not deductible if the loss or outgoing is of 'capital, or of a capital nature'.

The tests set out in Sun Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938-1939) 61 CLR 337 is whether the loss or outgoing relates to the taxpayer's 'profit yielding structure' (sometimes also referred to as the 'business entity' test).

Dixon J referred to three matters

'There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner which it is to be used, relied upon or enjoyed, and in this and under the former Head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.'

Dixon J concluded that the outgoings were on capital account for reasons including that the outgoings were of a large sum, were incurred to remove competition, and that the chief object of making the outgoings was strengthening and preserving the taxpayer's existing business organisation, and to acquire an asset.

The Commissioners view on the deductibility of prepaid rent is set out in Taxation Ruling No. IT 2317: Income tax: Deductibility of prepaid rent. IT 2317 is concerned with the decision of the Full Federal Court in FC of T v CreerT 2317 states in the relevant ruling paragraph s that:

'10. There are two elements in the decision of the Federal Court which warrant comment. The first is that it is necessary to go behind the description given to an outlay to ascertain the true nature of the payment. Where, as here, prepayment of outlays is made, an examination must be made to ensure that the payment truly accrues day by day and that the payment reflects a periodic outlay for use of property (in the case of rent), for the use of money (in the case of interest), or for the provision of services (in the case of fees) for periods which are commensurate with the payment. It does not matter that the payment may be made by instalments, as in this case, to give some semblance of recurrence if the true nature of the outlay is that it is a capitalised sum paid to secure use or enjoyment of an asset.

11. Should the prepaid outlay, on close examination, be seen to satisfy the test above so that it might not be possible to characterise it as a capital payment then it is necessary to have regard, as did the Federal Court in this case and in Ilbery's Case, to the purpose for which the prepaid outlay is made. If the prepayment is explicable for no reason other than to secure a taxation advantage then no deduction should be allowed. Where several purposes may be revealed then apportionment would have to be considered as in Ure's Case. There is no authority, which would permit a prepaid amount which is made for wholly deductible purposes to be allowed over the period to which the prepayment relates rather than in the year when the expenditure is incurred (made). The decision of the Supreme Court in F.C.T. v. Solling and F.C.T. v. Pepper 85 ATC 4518, 16 ATR 753 is an example of authority to the contrary effect (see Taxation Ruling No. IT 2237)

The true nature of the prepayment

Star City Decision

In the FC of T v Star City Pty Limited 2009 ATC 20-093 (Star City), Golberg J restated the three indicia identified in Sun Newspapers as the relevant criteria in the distinguishing between revenue and capital

Golberg J also stated at paragraph 17:-

'In Colonial Mutual Life Assurance Society Limited v Federal Commissioner of Taxation (1953) 89 CLR 428, Fullagar J said at 454:

"The questions which commonly arise in this type of case are (1) What is the money really paid for? -and (2) Is what it is really paid, in truth and in substance, a capital asset?"

Our view is that above the questions inform the matter at hand.

Further Golberg J said in relation to the two questions above and the indicia in Sun Newspapers:-

'18. These questions are to be answered not solely by reference to the documentation which records the obligation to make the payment but also by reference to the business and practical effects and consequences achieved.

19. The centrality of the identification of the "character of the advantage sought" to this test was recently restated by the High Court in Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35; (2006) 228 CLR 1 at 43. Crennan J (with whom Gleeson CJ, Gummow, Callinan and Heydon JJ agreed) said at 43:

"The characterisation of an outgoing depends on what it 'is calculated to effect', to be judged from 'a practical and business point of view'. The character of the advantage sought by the making of the expenditure is critical. (Citations omitted)"

(citations omitted)

20. The nature of the inquiry to be made in this context was considered by Allsop J in Tyco Australia Pty Ltd v Federal Commissioner of Taxation 2007 ATC 4799; (2007) 67 ATR 63 at 74, [2007] FCA 1055 at par [47] as follows:

"The mere identification of the correct description of the legal rights obtained or transferred by any transaction is generally too narrow a focus for the answering of the question. This is especially so once it is recognised that almost every commercial arrangement based on contract can be analysed jurisprudentially from the perspective of buying and selling rights or choses in action. Such rights are merely the legal or juridicial building blocks of relationships built from business and practical activity. The enquiry as to whether an outgoing is on capital or revenue account looks to the business and practical effects and advantages sought in the whole context ..."

(Citations omitted)

21. The Commissioner's case was that the Transaction Documents entered into by the parties indicated that, from a practical and business point of view, the characterisation of the advantage sought by Star City was not the quiet enjoyment of the relevant premises but rather was consideration for the grant of the licence and the right of exclusivity for the operation of the casino for 12 years.

24. Star City submitted that in the absence of any suggestion that any part of the documentation was a sham and any contention that the primary judge had erred in her conclusions as to the meaning and operation of the relevant documents, the characterisation of the prepayment could, and should, be determined by reference to the relevant Transaction Documents and principally the leases.

25. I do not accept that submission, and consider that the primary judge erred in concluding that the "surrounding circumstances" and "background" were irrelevant to the proper characterisation of the prepayment and that even if they were examined they did not alter the identification, or the character, of the advantage sought by the prepayment.

26. The starting point for my consideration is that the Court is not limited to the words and text of the leases, or indeed any of the Transaction Documents in characterising the nature of the prepayment and the advantage sought by its payment. The determination of that characterisation is to be undertaken from a practical and business point of view. That point of view is not confined to the words of the document pursuant to which the payment is made. As Dixon J observed in Hallstroms Proprietary Limited v Federal Commissioner of Taxation [1946] HCA 34; (1946) 72 CLR 634 at 648:

"What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process."

…63 In the present case there was no issue that any of the Transaction Documents was a sham. But there was an issue as to the label of "rent" which the parties had used to describe the lump sum prepayment of $120 million. In those circumstances, as recognised by the Full Federal Court in City Link Melbourne Limited v Commissioner of Taxation [2004] FCAFC 272; (2004) 141 FCR 69 at [46], and by the Full Federal Court in Federal Commissioner of Taxation v Broken Hill Pty Co Ltd [2000] FCA 1431; (2001) 179 ALR 593 at 601-602, labels are not determinative and surrounding circumstances may be resorted to determine the true characterisation of a payment in an appropriate case. I consider that the present case was one such case."

[emphasis added]

As stated above, the Commissioners view on the deductibility of prepaid rent is set out in IT 2317.

Paragraph 10 of IT 2317 :

'Where, …, prepayment of outlays is made, an examination must be made to ensure that the payment truly accrues day by day and that the payment reflects a periodic outlay for use of property (in the case of rent), for the use of money (in the case of interest), or for the provision of services (in the case of fees) for periods which are commensurate with the payment. It does not matter that the payment may be made by instalments, as in this case, to give some semblance of recurrence if the true nature of the outlay is that it is a capitalised sum paid to secure use or enjoyment of an asset.'

Application to the case

In answering the question as to whether or not the character of the outgoing incurred by Entity A in relation to the prepayment of 'rent' is one of capital:

'…[one] is not limited to the words and text of the leases, or indeed any of the Transaction Documents in characterising the nature of the prepayment and the advantage sought by its payment. The determination of that characterisation is to be undertaken from a practical and business point of view.'; and

'…labels are not determinative and surrounding circumstances may be resorted to determine the true characterisation of a payment in an appropriate case.'

The characterisation of the prepayment of 'rent' is not to be determined by reference to its 'label' but to what it truly represents. For example;

· the payment of 'rent', if prepaid, will equal the Construction Payment;

· the facility owner is only obliged to pay the Construction Payment if and to the extent that it receives the Rental Payment; and

· if the Rental Payment is not received in full or at all, the only remedy in respect of such non-payment is the relief from payment of the Construction Payment.

Therefore, we do not accept that the payments represent rent and thus the prepayment is not the prepayment of 'rent' for the occupation of the building from the facility owner.

The prepayment of rent is a loss or outgoing of capital, or of a capital nature as it secures the award of the contracts and the benefit of the exclusive arrangements to provide services relating to the design, build, finance, and maintaining the facilities of the building.

Division 230

For completeness, it is considered that Division 230 will not apply to the prepayment made under the lease. The arrangement under which the prepayment will be made will include not insignificant non-cash settlable rights, being the right to occupy under the lease agreement itself. Hence, the arrangement will not constitute a financial arrangement due the application of the negative limb of subsection 230-45(1) of the ITAA 1997.

Question 2

If Entity A is entitled to a deduction for the prepaid rent under section 8-1 of the ITAA 1997, will the proportion of the prepaid rent that will be deductible in a relevant year of income be deducted over 10 years in accordance with the formula in subsection 82KZMD(2) of the ITAA 1936?

Summary

As Entity A is not entitled to a deduction under section 8-1 of the ITAA 1997 for the prepaid rent, subsection 82KZMD(2) of the ITAA 1936 cannot apply.

Question 3

If Entity A chooses to prepay the lease rentals to the facility owner under the lease referred to in Question 1, will the interest payable by Entity A under the loan from the banks be deductible under section 230-15 of the ITAA 1997?

Summary

Yes. If Entity A chooses to prepay the lease rentals to the facility owner under the lease referred to in Question 1, the interest payable by Entity A under the loan from the banks will be deductible under section 230-15 of the ITAA 1997.

Reasons for decision

Under subsection 230-15(2) of the ITAA 1997, losses from financial arrangements are deductible to the extent that they are made in gaining or producing your assessable income or are necessarily made in carrying on a business for the purposes of gaining or producing assessable income.

The definition of 'financial arrangement' determines the unit of taxation in respect of which gains and losses are recognised under Division 230. In order to determine whether gains and losses arise under a financial arrangement, it is first necessary to establish whether the rights and obligations under the Financing Loan give rise to an 'arrangement' that in turn meets the definition of a financial arrangement.

Identification of the arrangement under subsection 230-55(4)

An 'arrangement' is defined in subsection 995-1(1) of the ITAA 1997 to include any arrangement, agreement, understanding, promise or undertaking. Section 230-55 of the ITAA 1997 modifies this broad notion of an arrangement by providing guidance as to which specific rights and obligations constitute the relevant arrangement for the purposes of Division 230 of the ITAA 1997.

Generally, under section 230-55 of the ITAA 1997, a contract will define the boundaries of an arrangement, especially where the form of the contract is consistent with its substance; refer to paragraphs 2.47 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (TOFA EM). That paragraph goes on to state:

…[T]he contract is typically viewed on a 'stand alone' basis. In this context, the contract is nether aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230.

Prima facie, the rights and obligations under the loan will constitute one arrangement. However, section 230-55 of the ITAA 1997 is not limited by the form of a single contract in the identification of an arrangement. Specifically, under subsection 230-55(4) of the ITAA 1997 regard must be had to a range of factors in order to determine whether a number of rights and/or obligations arise under one or more financial arrangements. The way various rights and obligations are combined under subsection 230-55(4) is an objective enquiry, the purpose of which is to identify the correct 'unit of taxation' in the context of Division 230 of the ITAA 1997.

It is considered having regard to each of the factors listed in subsection 230-55(4) of the ITAA 1997, that the loan is a single arrangement for the purposes Division 230 of the ITAA 1997. It is considered that the following matters support this conclusion:

· it would be commercially understood by the parties, in the context of the financing arrangement that Entity A has entered into, that in substance, Entity A has one continuing obligation as a result of the proposed transaction and performance of its rights and obligations under the loan. Commercially, the parties will consider that any draw downs will form one continuing obligation; and

· treating the rights and obligations under the loan as a single arrangement accords with the commercial nature of the arrangement, its economic substance and is consistent with the accounting treatment of the loan.

Is the arrangement identified a financial arrangement under Division 230?

The identified arrangement (the loan) must meet the definition of a 'financial arrangement' before it will be subject to Division 230 of the ITAA 1997. Subdivision 230-A of the ITAA 1997 provides the test for determining whether an arrangement is a 'financial arrangement'. An arrangement will be a financial arrangement if it satisfies the definition under section 230-45 of the ITAA 1997 (dealing with cash settlable rights and obligations to financial benefits) or the definition under section 230-50 of the ITAA 1997 (dealing with equity interest and rights and obligations to equity interests).

Broadly, an entity has a financial arrangement under subsection 230-45(1) of the ITAA 1997 if it has, under an arrangement a:

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

· cash settlable legal or equitable obligation to provide a financial benefit; or

· combination of one or more such rights and/or one or more such obligations.

Under the loan, Entity A will obtain funding for a number of purposes. Entity A's right to receive amounts under the loan, and its obligation to pay amounts of principal and interest under this loan, are rights and obligations to things which are 'financial benefits' within the meaning of section 974-160 of the ITAA 1997; specifically as the loan advances and the loan itself has economic value. Therefore, the loan on its terms will create legal rights and obligations to receive and provide financial benefits.

Under paragraph 230-45(2)(a) of the ITAA 1997, a right to receive or an obligation to provide a financial benefit is cash settlable if the benefit is money or money equivalent. As the loan advances and loan payments are monetary amounts, they will be financial benefits that are money. Therefore, Entity A's right to receive amounts under the loan and its obligation to repay amounts of principal drawn down and interest will be cash settlable.

It follows that the loan will satisfy the definition of a 'financial arrangement' under subsection 230-45(1) of the ITAA 1997.

Deductibility of losses under the loan

Under subsection 230-15(2), a loss that is made by Entity A by virtue of Subdivision 230-B is deductible if:

(a) it is made in gaining or producing your assessable income; or

(b) it is necessarily made in carrying on a business for the purpose of gaining or producing

assessable income.

It is considered that the losses Entity A will make will have a sufficient nexus to assessable income. As the loss under the loan represents a loss made under a financial arrangement which is made in gaining or producing assessable income, it will be deductible under section 230-15 of the ITAA 1997.

Question 4

Will investors that are trusts be regarded as carrying on an 'eligible investment business' if their only assets are their respective interests in Entity A?

Summary

Yes. Investors that are trusts will be regarded as carrying on an 'eligible investment business' if their only assets are their respective interests in Entity A.

Detailed reasoning

Outline of Division 6C

Division 6C of Part III (Division 6C) of the ITAA 1936 treats a public trading trust, its unit holders and its trustee as if the public trading trust is a company for some tax purposes.

Subparagraph 102R(1)(a)(iii) of the ITAA 1936 means such a public trading trust must be a trading trust. Subsection 102N(1) of the ITAA 1936 means that a unit trust is a trading trust in relation to a year of income if, at any time during that year, its trustee is carrying on a trading business, or controls (or is able to control, directly or indirectly) the affairs or operations of another entity in respect of that other entity carrying on a trading business.

Section 102N of the ITAA 1936 treats a unit trust as a trading trust in relation to a year of income in which the trustee carries on a trading business (that is, has any activity that is not an 'eligible investment business' as defined in section 102M of the ITAA 1936 and modified by sections 102MA, 102MB and 102MC of the ITAA 1936), or is able to control the affairs or operations of another person in respect of their carrying on of a trading business

Section 102M

Section 102M of the ITAA 1936 defines a trading business as a business that does not consist wholly of 'eligible investment business'. Section 102M defines 'eligible investment business' to mean, amongst other things, one or more of:

(a) investing in land for the purpose, or primarily for the purpose, of deriving rent; or

(b) investing or trading in any or all of the following:

(i) secured or unsecured loans (including deposits with a bank or other financial institution);

(ii) …

(c) investing or trading in financial instruments (not covered by paragraph (b) that arise under financial arrangement, other than arrangements excepted by section 102MA.

Paragraph 102M(a) - investing in land for the purpose, or primarily for the purpose, of deriving rent

The relevant question to be considered is whether the interests held by Entity A under the lease are held for the purpose, or primary for the purpose, of deriving rent.

In terms of the definition of 'eligible investment business' in section 102M of the ITAA 1936, the word 'primarily' carries its ordinary meaning. The Macquarie Dictionary, [Multimedia], version 5.0.0, 1/10/01 defines the word 'primarily' as '1. in the first place; chiefly; principally. 2. in the first instance; at first; originally'.

Therefore, the relevant test is whether the interest held under the Head Lease is 'chiefly' or 'principally' for the purpose of deriving rent. In this regard it is necessary to consider the circumstances surrounding the Head Lease and Sub-Lease.

The fact that the payment was described as 'rent' is not determinative of its true nature: F.C. of T. v. South Australian Battery Makers (1977-78) 140 CLR 645. In the 'total rent', whether payable as one lump sum or by instalments, was found not to be rent 'accruing per die in diem' or as a 'periodic outlay' covering use of the premises for 'periods commensurate with the payments' [see also Taxation Ruling Income Tax: Deductibility of Prepaid Rent; IT 2317].

As previously stated, we consider that the prepayment under the lease does not represent 'rent' for the occupation of the building. To the extent that the prepayment is a discounted sum of the lease rentals otherwise payable, it is in substance a discounted sum of an amortised loan.

Entity A also receives periodic payments (referred to as 'rent') from sub leasing the building. In much the same way as the periodic payments to be made by Entity A to the facility owner if Entity A were to choose not to make prepayment, the amount Entity A receives under those sub leases does not represent 'rent' for the occupation of the building but, in substance, reflects the regular payment of a loan.

Therefore, the periodic payments Entity A receives for sub leasing the building are not for the purpose, or primarily for the purpose, of deriving rent.

Paragraph 102M(b) - investing in or trading in relevant financial instruments.

Loan

The Commissioner's view on the meaning given to the term loan for the purposes of subparagraph 102M(b)(i) of the ITAA 1936 is stated in ATO ID 2010/16.

ATO ID 2010/16 states:

'The word 'loan' in paragraph (b)(i) is not a defined term in Division 6C of the ITAA 1936. Accordingly, the question of whether the On-Loan arrangement under the On-Loan Agreement, is properly characterised as a loan, will need to be determined by reference to its ordinary meaning.

The Macquarie Dictionary , 2001, rev. 3rd edn, The Macquarie Library Pty Ltd, NSW defines 'loan' as follows:

'...something lent or furnished on condition of being returned, especially a sum of money lent at interest'

Butterworths Concise Australian Legal Dictionary, 2004, 3rd edn, LexisNexis, NSW defines a 'loan' as:

'An advance of money; the provision of credit; the payment of an amount on behalf or at the request of a person where there is an obligation to repay the amount; or a transaction which in substance affects a loan of money.'

Judicial decisions suggest a similar interpretation. The decision in Inland Revenue Commissioners v. Rowntree and Co. Ltd [1948] 1 All ER 482 provides that for a facility to be characterised as a loan there must exist the legal relation of lender and borrower which gives rise to a loan of money in return for which there is a promise to repay.

In Re Securitibank Ltd (No.2) [1978] 2 NZLR 136, Richardson J stated at 167 that:

'... the essence of a loan of money is payment of a sum on condition that at some future time an equivalent amount will be repaid.'

Sackville and Lehane JJ in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd (1997) 72 FCR 300; (1997) 34 ATR 635; (1997) 97 ATC 4151 noted that:

'…a loan involves an obligation on the borrower to repay the sum borrowed.'

The Commissioner is of the opinion that the above definitions and case law provides the following understanding of the ordinary meaning of the word 'loan' for the purposes and is succinctly expressed by the definition of 'loan' found in Joseph, C 1989, Chitty on Contracts , 26th edn, Sweet & Maxwell, London (at page 3574):

'A contract of loan of money is a contract whereby one person lends or agrees to lend a sum of money to another, in consideration of a promise express or implied to repay that sum on demand, or at a fixed or determinable future time, or conditionally upon an event which is bound to happen, with or without interest.'

For the reasons stated above, it is reasonable to conclude that the periodic payments Entity A receives from sub leasing the building and referred to as 'rent', does not represent 'rent' for the occupation of the building but, in substance, reflects the regular payment of a loan.

Therefore, the activity that Entity A carries out in this respect is investing or trading in secured or unsecured loans (subparagraph 102M(b)(i) of the ITAA 1936) or alternatively, a similar financial transaction to that of a loan (subparagraph 102M(b)(xiii) of the ITAA 1936).

Entity A will also derive income from other loans and interest rate swaps which satisfy the financial instruments listed in paragraph 102M(b) of the ITAA 1936.

Paragraph 102M(c) - investing or trading in financial instruments

An eligible investment business is also carried on if it consists of 'investing or trading in financial instruments (not covered by paragraph 102M(b) of the ITAA 1936) that arise under financial arrangements other than arrangements excepted by section 102MA of the ITAA 1936. That is, if the arrangement is one that is not listed in paragraph 102M(b) of the ITAA 1936, the arrangement is not excluded from being an eligible investment business provided it does not satisfy any of the exceptions listed in section 102MA of the ITAA 1936.

As Entity A does not invest or trade in financial instruments which are not covered by paragraph 102M(b) of the ITAA 1936, paragraph 102M(c) of the ITAA 1936 is not necessary, i.e. the arrangements excepted by section 102MA of the ITAA 1936 do not need to be considered.