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Ruling

Subject: Issue of non-share equity

Question

Will distributions paid on the Hybrid Capital Instruments by Company B constitute unfrankable non-share dividends for the purposes of section 215-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No, the distributions paid on the Hybrid Capital Instruments by Company B will not constitute unfrankable non-share dividends for the purposes of section 215-10 of the ITAA 1997.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below.

1. The scheme the subject of this ruling is described below and is based on the following documents:

· request for Private Ruling;

· draft Terms and Conditions of the Hybrid Capital Instruments (Hybrid Capital Instruments terms);

· draft Offering Circular;

· draft Hybrid Capital Instruments Deed; and

· draft Subscription Agreement.

Company A and Company B

2. Company B is an Australian resident company and a wholly owned subsidiary of Company A. Company B is an authorised deposit-taking institution (ADI) regulated by the Australian Prudential Regulation Authority (APRA).

3. Company B is a subsidiary member of the tax consolidated group of which Company A is the head company (Company A TCG).

4. Company A is an Australian resident company with shares listed on the Australian Securities Exchange.

Group Treasury

5. X is Group Treasurer and Chief Financial Officer of Company B, and sits on the Group Treasury Management Committee. X is based in Australia.

6. Y is the Regional Head of Group Treasury in the continental regions,. As Regional Head, Y is responsible for all Group Treasury functions in those regions including secured and unsecured debt funding, liquidity management, capital management and treasury risk and liquidity management.

7. Y is based Offshore and is supported by a team there. Y reports directly to X.

8. Y (supported by a team offshore) is responsible for identifying opportunities in relation to capital management initiatives in the Offshore regions. In fulfilling this responsibility, Y identified and put forward for further consideration the transaction involving the issuance of the Hybrid Capital Instruments.

9. All liquidity requirements of the Company B Group are managed centrally by Group Treasury. Oversight is provided by a central management committee, which comprises of members of senior management and office holders of Company A and Company B (the "Oversight Committee").

10. Group Treasury executes all central funding activity for Company B and approves any approach by businesses for external funding sources or external funding programs.

Company B Offshore Branch

11. Company B has opened a branch Offshore (Company B Offshore Branch) which is registered under the relevant offshore act as having established a branch in the relevant locations offshore. Company B Offshore Branch is an Authorised person for the purpose of the relevant offshore act and is authorised and regulated by the relevant authority.

12. Company B Offshore Branch's registered office is in the particular location Offshore.

13. Company B Offshore Branch is divided into business units representing each of the principal operating groups of Company B.

14. Company B Offshore Branch does not have a specific funding base. Rather, Company B Offshore Branch relies on a pool of funds maintained by Company B, and the pool of funds is put to use as, and when, it is required.

15. To date, Company B has raised and managed all the capital required by Company B and its offshore operations.

16. Company B Offshore Branch has significant 'borrowings' from Company B.

17. Company B cannot identify when particular liabilities were incurred by Company B Offshore Branch, nor can Company B identify particular assets which were acquired by Company B Offshore Branch using funds representing those 'liabilities'.

Company B Offshore Branch Management Committee

18. Company B Offshore Branch has a Management Committee (the Offshore Committee) which consists of members of senior management of Company B Offshore Branch (including members of senior management of each business group with major operations in Company B Offshore Branch). The Offshore Committee has written terms of reference and meets at least quarterly (but may meet more often if required) in order to discharge its responsibilities.

19. The main objective of the Offshore Committee is to consider the impact of any material business proposal which involves Company B Offshore Branch.

20. The Offshore Committee must ensure that business proposals:

· are consistent with policies applying to Company B Offshore Branch;

· comply with relevant legal and regulatory requirements; and

· are appropriately monitored and reviewed on an on-going basis.

21. The Offshore Committee can authorise some new products and proposals.

The proposed transaction

22. Company B proposes to raise new Tier 1 capital through the issue of the Hybrid Capital Instruments to third party investors offshore.

23. In preparation for the issue of the Hybrid Capital Instruments, Company B has advised the following:

a. Company B, through Company B Offshore Branch, has engaged the offshore office of an Australian based law firm to draft and prepare the Hybrid Capital Instruments transaction documents;

b. Company B Group Treasury personnel, located Offshore, have prepared the first draft of the key documents and will have primary responsibility for reviewing the transaction documents and managing overall documentation process;

c. The Hybrid Capital Instruments transaction documents will be governed by the relevant country's law;

d. The key Hybrid Capital Instruments transaction documents and ancillary payment/settlement instructions will be executed by Company A and Company B Branch Offshore pursuant to powers of attorneys granted in Australia;

e. Company B Offshore Branch will engage Joint Lead Managers (JLMs), to market the Hybrid Capital Instruments to various investors.;

f. Senior Company B executives from Australia will market the Hybrid Capital Instruments;

g. Company B Offshore Branch will engage a note registrar to maintain the register. Company B expects that the register will be located and maintained in an overseas location but outside the Offshore location.

h. The Hybrid Capital Instruments will be held in certain clearing houses and, on instruction by Company B Offshore Branch, the note registrar will register the Hybrid Capital Instruments in the name of the nominee of the common depository for each clearing house. The Hybrid Capital Instruments will be represented by a single global certificate which will be deposited with the common depository for each clearing house.

i. The Global Hybrid Capital Instruments Certificate will be executed by Company B Offshore Branch pursuant to powers of attorneys granted in Australia and released to the depository on instruction from Company B Offshore Branch; and

j. The depository will hold the Hybrid Capital Instruments and the Global Hybrid Capital Instruments Certificate on behalf of the investors.

24. A number of external contacts will be managed out of Company B in Australia rather than Company B Offshore as these relationships are managed out of Australia. These include APRA, accounting auditors and investor relations.

25. The Hybrid Capital Instruments are convertible into Company A's Ordinary Shares.

Terms of the Hybrid Capital Instruments

26. The Hybrid Capital Instruments will be issued on the following main terms:

a. The Hybrid Capital Instruments are fully paid, unsecured, non-cumulative, junior subordinated notes;

b. The Hybrid Capital Instruments will rank senior to Company B Ordinary Shares, equally with all other Hybrid Capital Instruments in all respects and with holders of Equal Ranking Securities and subordinate to all Senior Creditors;

c. Company B Offshore Branch must Exchange all (but not some) of the Hybrid Capital Instruments for Company A Ordinary Shares on either:

i. the Scheduled Mandatory Exchange Date,

ii. a Deferred Mandatory Exchange Date, or

iii. the Final Mandatory Exchange Date,

on which the Mandatory Exchange Conditions of the Hybrid Capital Instruments terms (Mandatory Exchange Conditions) are satisfied, unless the Hybrid Capital Instruments have been or will be Redeemed or Exchanged before these dates;

d. Subject to the Hybrid Capital Instruments terms (Redemption conditions), by notice (a Redemption Notice) to Hybrid Capital Instruments Holders, the Issuer (Company B acting through Company B Offshore Branch) may, in its sole discretion, but with APRA's prior written approval, elect to redeem all (but not some) of the Hybrid Capital Instruments following the occurrence of a Tax Event or a Regulatory Event.

e. The Hybrid Capital Instruments cannot be Redeemed, Resold or Exchanged at the option of a Hybrid Capital Instruments Holder;

f. Company B Offshore Branch shall pay to a Hybrid Capital Instrument Holder an amount of interest on each Interest Payment Date (semi-annually) in respect of a Hybrid Capital Instrument;

g. The payment of any interest in whole or in part on any Interest Payment Date is subject to:

i. the Directors in their absolute discretion, determining that interest should not be paid to Hybrid Capital Instruments Holders;

ii. unless APRA otherwise agrees in writing, Company B having sufficient Distributable Profits available to pay the Interest;

iii. unless APRA otherwise agrees in writing, payment of the interest not resulting in Company B breaching APRA's capital adequacy requirements applicable to it;

iv. payment of the interest not resulting in Company B becoming, or being likely to become, insolvent; and

v. APRA not otherwise objecting to the payment of the interest.

h. Interest is non-cumulative.

i. If for any reason an amount of interest has not been paid in full on the scheduled Interest Payment Date (the Relevant Payment Date), a Dividend Restriction shall apply from that date until the next Relevant Payment Date unless the interest is paid within 20 Business Days of the Relevant Payment Date.

j. The Issuer is required to undertake to arrange for the management of eligible assets with a view to generating income to put towards the payment of interest on the Hybrid Capital Instruments.

k. Eligible assets are bonds issued by, loans to or other investments in subsidiaries of Company B resident outside Australia in which the Issuer invests and which are managed by it. As at the Issue Date, the eligible assets will comprise a bond issued by a subsidiary of the Issuer.

l. The Trust Deed contains provisions for convening meetings of the Hybrid Capital Instrument Holders to consider any matter in connection with the Hybrid Capital Instruments terms affecting their interests, including any variation of the Hybrid Capital Instruments terms which requires the consent of Hybrid Capital Instrument Holders.

m. The Hybrid Capital Instruments carry no right to participate in any offering of securities by any member of the Company A Group.

n. Subject to applicable law, Hybrid Capital Instruments Holders are not entitled to be provided with copies of:

i. any notice of general meetings of Company B or Company A; or

ii. other documents (including annual reports and financial statements) sent by Company B or Company A to holders of ordinary shares or securities (if any) in Company B or Company.

o. Hybrid Capital Instruments Holders will have no voting rights in respect of any member of the Company A Group.

The Transaction Documents

Subscription Agreement

27. The parties to the Subscription Agreement are Company B, Company A and each JLM.

28. Under the Subscription Agreement, Company B (acting through Company B Offshore Branch) agrees to issue and sell the Hybrid Capital Instruments in accordance with the agreement and the JLMs agree to subscribe for the Hybrid Capital Instruments by paying the purchase price with immediately available funds.

29. Each JLM may market and sell the Hybrid Capital Instruments on the secondary market. Company B and Company A will provide the material for making the offer to investors.

30. Each JLM must not offer, sell, distribute or transfer any Hybrid Capital Instruments, directly or indirectly to any person in Australia. Also, Each JLM must not offer, sell, distribute or transfer any Hybrid Capital Instrument, directly or indirectly; or distribute Offering Materials in relation to the Hybrid Capital Instruments in any jurisdiction except in accordance with the Subscription Agreement.

31. Each JLM is paid a fee for management and underwriting services.

Offering Circular

32. The Preliminary Offering Circular and the Offering Circular for the subscription for the Hybrid Capital Instruments on the secondary market will be supplied to the JLMs on the date of publication to facilitate the on-sale of the Hybrid Capital Instruments by the JLMs.

33. The Offering Circular states that the Issuer of the Hybrid Capital Instruments will be Company B (acting through its Company B Offshore Branch).

34. The use of the proceeds from the capital raising is to be the following:

The net proceeds from the issue of the Hybrid Capital Instruments will be used by the Issuer to return funds to Company B head office which will use the funds for general corporate purposes.

The Issuer undertakes to manage certain eligible investments with a view to generating income to put towards the payment of interest. The Issuer undertakes to dispose of or redeem these investments prior to any Redemption of the Hybrid Capital Instruments and use these proceeds towards payment of the Redemption Price.

Implementation Deed

35. Under the Implementation Deed upon the Exchange of the Hybrid Capital Instruments, in accordance with the Hybrid Capital Instruments terms, on the Mandatory Exchange Date, then immediately following completion of the transfer to Company A of the Hybrid Capital Instruments, a number of transactions will occur including as a first step: Company B, acting through Company B Offshore Branch, will redeem each Hybrid Capital Instrument for an amount equal to its principal amount (and shall undertake to redeem or dispose of its Eligible Assets and use these proceeds towards payment of the principal amount to Company A).

Approval Process of the Hybrid Capital Instruments

36. The Offshore Committee met to consider, and if thought fit, approve for recommendation to the Oversight Committee a proposal for a Hybrid Capital Issuance by Company B Offshore Branch.

37. Mr Y attended the meeting and briefed the members of the Offshore Committee on details of the proposal, including the size of the capital raising.

38. The Minutes of the meeting of the Offshore Committee (the Minutes) record that Y explained that a paper setting out the proposed transaction structure had already been submitted to APRA.

39. The use of the funds was not recorded in the Minutes, however, in the draft Memorandum, it was stated that 'the use of the funds raised will be managed and used by Company B Offshore Branch to invest in various offshore activities by Company B, through a combination of equity investments and loans'.

40. The Rationale for the capital raising is explained in the draft Memorandum in the following terms:

The proposed transaction, whilst significantly enhancing Company B's hybrid capital base, will provide additional capacity to fund the continued offshore growth of the group. It will also provide a natural hedge of the capital required to support the US$ denominated assets of the group, wherever held and assist in diversifying Company B's funding sources.

41. The Offshore Committee resolved that the raising of Hybrid Capital Instruments issued through Company B Offshore Branch is in the commercial interest and for the benefit of the Company B Offshore Branch and Company B as a whole. The Offshore Committee determined that the 'paper [Memorandum] tabled be approved for submission to the Oversight Committee subject to being finalised by Group Treasury'.

42. The Oversight Committee met and approved, in principle, the capital raising. As a consequence, a memorandum was sent to the Company B Board and the Company A Board to seek Board approval for the issuance. The proposal for use of funds mirrored the proposal as set out in the Memorandum.

43. The Company A and Company B Boards authorised the transaction and delegated authority to specified officers of Company B and Company A to undertake a number of tasks.

44. Y, in the role as Regional Head for Group Treasury in various offshore regions, is charged with the responsibility for project managing the issuance of the Hybrid Capital Instruments.

45. Company B confirmed that in undertaking the various steps and actions in relation to the Hybrid Capital Instruments issuance process, Y is doing so in the role as Regional Head for Group Treasury for various offshore regions and as a member of the Treasury Group who reports directly to X.

46. Y is to be supported by a number of Group Treasury employees based Offshore and a number of Group Treasury employees based in Australia.

Assumptions

47. During the term of the Proposed Transaction:

a. Company A will be the head entity of the Company A consolidated group, and Company B will be a subsidiary member of the Company A TCG, for Australian tax purposes;

b. Company B will be an ADI for the purposes of the Banking Act 1959 (Banking Act);

c. Company A and Company B will be residents of Australia under the income tax law of Australia; and

d. Company B Offshore Branch will be Company B's permanent establishment (as the term defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

48. Company B Offshore Branch is Company B's permanent establishment (as the term is defined in section 6(1) or the Income Tax Assessment Act (ITAA 1936)).

49. Amounts of interest payable on Hybrid Capital Instruments will not be debited to either of Company B's non-share capital account or Company B's capital account.

50. The Hybrid Capital Instruments will form part of Company B's Tier 1 capital within the meaning of the APRA's prudential standards.

51. The Issuer will not substitute another branch of Company B as issuer.

Relevant legislative provisions

Section 215-10 of the ITAA 1997

Detailed reasoning

The law

Section 215-10 of the ITAA 1997 permits certain non-share dividends paid by an ADI to be unfrankable subject to certain conditions being satisfied.

Subsection 215-10(1) of the ITAA 1997 provides:

A non-share dividend paid by an ADI (an authorised deposit-taking institution) for the purposes of the Banking Act 1959 is unfrankable if:

(a) The ADI is an Australian resident; and

(b) The non-share dividend is paid in respect of a non-share equity interest that:

(i) by itself; or

(ii) in combination with one or more schemes that are related schemes to the scheme under which the interest arises;

forms part of the ADI's Tier 1 capital either on a solo or consolidated basis (within the meaning of the prudential standards); and

(c) the non-share equity interest is issued at or through a permanent establishment of the ADI in a listed country; and

(d) the funds from the issue of the non-share equity interest are raised and applied solely for one or more purposes permitted under subsection (2) in relation to the non-share equity interest.

Subsection 215-10(2) of the ITAA 1997 sets out the permitted purposes in the following terms:

The permitted purposes in relation to the non-share equity interest (the relevant interest) are the following:

(a) the purpose of the business of the ADI carried on at or through the permanent establishment other than the transfer of funds directly or indirectly to:

(i) the Australian head office of the permanent establishment; or

(ii) any connected entity of the ADI, or of a connected entity of the ADI, located in Australia;

(iii) a permanent establishment of the ADI, or of a connected entity of the ADI located in Australia;

(b) the purpose of redeeming:

(i) a debt interest; or

(ii) a non-share equity interest;

that is issued, before the relevant interest is issued, at or through the permanent establishment and is held by a connected entity of the ADI that is an Australian resident.

(c) The purpose of returning funds to:

(i) the Australian head office of the permanent establishment; or

(ii) a permanent establishment of the ADI or of a connected entity of the ADI, located in Australia;

if the funds are contributed, before the relevant interest is issued, for use in the business of the ADI carried on at or through the permanent establishment.

Broadly, section 215-10 of the ITAA 1997 permits an Australian resident bank not to frank certain non-share dividends if the equity interest in respect of which the dividends are paid represents funds that are Tier 1 capital 'of' a permanent establishment of the ADI.

A 'permanent establishment' is defined for the purposes of section 215-10 of the ITAA 1997, via section 995-1 of the ITAA 1997, in section 6 of the income Tax Assessment Act 1936 (ITAA 1936). The definition provides that a 'permanent establishment' in relation to a person means:

[A] place at or through which the person carries on any business and ... includes a place where the person is carrying on business through an agent ...

Thus, a permanent establishment is a place where business is conducted by a person. To identify a permanent establishment, there needs to be identification of transactions which constitute the carrying on of a business at a place. A business is not carried on unless there is some repetition or continuity: see Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4717; (1990) 21 ATR 531.

Section 995-1 of the ITAA 1997 provides that an ADI is an authorised deposit taking institution within the meaning of the Banking Act. It therefore means a body corporate which has been authorised to carry on 'banking business'. Further, subsection 5(1) of the Banking Act provides that 'banking business' means:

(a) A business that consists of banking within the meaning of paragraph 51(xiii) of the Constitution; or

(b) A business that is carried on by a corporate to which paragraph 51(xx) of the Constitution applies and that consists, to any extent, of:

(i) both taking money on deposit (otherwise than as a part-payment for identified goods or services) and making advances of money; or

(ii) other financial activities prescribed by the regulations for the purposes of this definition.

To summarise, the business of an ADI is that of borrowing and lending money, or like financial transactions. The permanent establishment of an ADI will be a place at which it carries on banking business. Other business may also be carried on at the permanent establishment but at the very least some banking business, i.e. borrowing and lending money must be carried on at the permanent establishment. This can be inferred because section 215-10 of the ITAA 1997 is dealing with Tier 1 capital. Tier 1 capital is the equity capital an ADI must hold in regard to its banking liabilities to provide a cushion against losses of its banking business.

Paragraphs 215-10(1)(a) and (b)

The conditions of paragraphs (a) and (b) in subsection 215-10(1) of the ITAA 1997 are satisfied:

· Company B is an Australian resident;

· Company B is an ADI, and it conducts a banking business with personnel present to transact that business at a Offshore premises. Therefore, the ADI has a permanent establishment Offshore;

· the Hybrid Capital Instruments will be an equity interest for the purposes of section 974-70 of the ITAA 1997, and therefore it will be a non-share equity interest within the meaning of the term in 995-1 of the ITAA 1997;

· the semi-annual interest payable by Company B in accordance with the Hybrid Capital Instruments terms will be paid in respect of a non-share equity interest, and will be a non-share dividend as defined in 974-120 of the ITAA 1997; and

· the funds raised will form part of the ADI's Tier 1 capital.

Paragraphs 215-10(1)(c) of the ITAA 1997

Paragraph 215-10(1)(c) of the ITAA 1997 requires that the non-share equity interest must be issued at or through a permanent establishment of the ADI. The requirement that the non-share equity must be 'issued at or through' the permanent establishment necessitates that the issue should be a transaction of the business carried on 'at or through the permanent establishment'. Therefore, for the non-share equity interest to be issued at the permanent establishment it must be:

· offered and allocated to investors, in the course of the business conducted by the ADI in the listed country by personnel conducting the business at the permanent establishment;

· the transaction documents must be executed by personnel conducting the business at the permanent establishment;

· the transaction documents must provide that the non-share equity interest is transferred to the investor at the permanent establishment; and

· at the time of transfer, the foreign branch relinquishes all control over the non-share equity interest.

The ATO has concluded that the Hybrid Capital Instruments which Company B will issue will not be 'issued at or through' Company B Offshore Branch for the purposes of section 215-10 of the ITAA 1997. The issue is not a transaction of the business conducted at or through the permanent establishment. As such, the Hybrid Capital Instruments are not offered, allocated or transferred to investors by personnel conducting the business of the branch.

The issue of the Hybrid Capital Instruments was conceived by Y, Regional Head for Group Treasury in the Continental regions, who is located Offshore. Y put the proposal to the Offshore Committee. It is clear from the minutes of that meeting that Group Treasury, regionally headed by Y, was the architect of the capital raising proposal and that the funding needs of the bank as a whole was driving the capital raising.

Relevantly, when a member of the Offshore Committee sought to know the driver of the hybrid issue, Y responded by noting that it was part of a 'broader capital management strategy'. The size of the capital raising appears to have been determined by Group Treasury as well, suggesting that Group Treasury were determining the size on the basis of the bank's needs rather than the Company B Offshore Branch's needs.

Company B has put forward that although Y is part of Group Treasury, Y is acting for, and under the authority of Company B Offshore Branch. It is said that Y, in performing the Group Treasury functions, does so on behalf of the Company B Offshore Branch. However, this is inconsistent with the fact that Group Treasury is a whole of bank function that is separate from and distinct from the business conducted at a permanent establishment Offshore.

A bank's treasury is responsible for managing the bank's overall funding position, including ensuring that capital adequacy requirements are met, managing the interest rate risk, liquidity risk exposures of the bank, matching duration of borrowing with lending, maximising efficiency of employment of regulatory capital and return on capital employed. Those responsibilities will be discharged by the treasury for the bank as a whole.

In the case of Company B, it is clear that while members of the Group Treasury team are located in both Australia and Offshore, the treasury function is one that is managed from Australia, and key decision makers are in Australia.

The business conducted at the permanent establishment is separate and distinct from the function performed by Group Treasury. The proposal to raise funds through the issue of the Hybrid Capital Instruments did not arise in the course of business conducted at a branch. That is, the initiative did not arise from a need for capital to support the business activities of the branch. The Offshore Committee was only briefed on the proposal after a ruling application was submitted to the ATO and a submission was lodged with APRA . Further, when the change in the use of the funds was determined the decision was taken by Y without consulting the Offshore Committee.

The draft memorandum provides a succinct explanation of the rationale for Group Treasury instigating the proposed issuance of the Hybrid Capital Instruments:

The proposed transaction, whilst significantly enhancing Company B's hybrid capital base, will provide additional capacity to fund the continued offshore growth of the banking group. It will also provide a natural hedge of the capital required to support the US$ denominated assets of the bank, wherever held to assist in diversifying Company B's funding sources.

Such a statement is consistent with the conclusion that Group Treasury, in performing its functions for the bank as a whole was responsible for the capital raising. It is not surprising that, following Board approval of the proposal, the responsibility for the issuance was delegated to X and others. Y continues to be responsible for project managing the issuance of Hybrid Capital Instruments. Y will do so in his capacity as Regional Head for Group Treasury in the Continental Region and reporting to X.

Y has been supported by members of the Group Treasury both in Australia and Offshore. Company B Offshore Branch's only involvement appears to be the Offshore Committee 'final sign off' on the capital raising, including the use of the funds, and receiving on-going reports on the progress of the issuance from Group Treasury. The role of the Offshore Committee appears only to be a formality. The scant involvement of Company B Offshore Branch is consistent with a conclusion that the issue of the Hybrid Capital Instruments is not a capital raising that will be undertaken in the course of the business conducted by the Offshore permanent establishment.

Conclusion

While Y may be said to be located at the same place of the permanent establishment, it cannot be concluded that he is a person who conducts the business 'of' the permanent establishment, he is part of Group Treasury and his responsibilities in the Group Treasury are to be discharged for the bank as a whole. Accordingly, the requirement that the issuance be offered, allocated and transferred to investors, in the course of the business conducted by the ADI in the listed country by personnel conducting the business at the permanent establishment is not satisfied. Control and management of the issuance resides with Group Treasury, a centrally managed function of Company B.

Paragraph 215-10(1)(d) of the ITAA 1997

Paragraph 215-10(1)(d) of the ITAA 1997 requires that the funds raised from the issue of the non-share equity interest are raised and applied solely for one or more of the permitted purposes set out in subsection 215-10 (2) of the ITAA 1997 in relation to the non-share equity interest.

The permitted purposes in subsection (2) form a scheme in that each paragraph is concerned with whether the funds raised are used in the business of the permanent establishment. The first permitted purpose in paragraph 215-10(2)(a) of the ITAA 1997 is the direct use in the business carried at the permanent establishment. That is achieved by requiring use for the purposes of the relevant business other than the transfer of funds, directly or indirectly, to a connected entity, the head office or another permanent establishment of the taxpayer or a connected entity. The most likely such use is lending at the permanent establishment.

Paragraph 215-10(b) and (c) of the ITAA 1997 implement the replacement or refinancing principle: See FC of T v. JD Roberts 92 ATC 4380. That is, they permit the use of money to replace money already used in the business of the permanent establishment. Paragraph 216-10(2)(b) of the ITAA 1997 strictly refers to the refinancing of interests issued at or through the permanent establishment and held by a connected entity. Having regard to the context, there is an implied requirement that the use of the refinanced moneys be in the business of the permanent establishment.

Paragraph 215-10(2)(c) of the ITAA 1997 permits the purpose of the returning funds that are 'contributed, before the relevant interest is issued, for use in the business of the ADI carried on at or through the permanent establishment'. Paragraph (c) assumes that money will have already been contributed to the business. The replacement of that capital is thus also a permitted use because, on the refinancing principle, the refinancing of moneys already in a business is a use of those moneys in the business, though the actual cash goes out of the business.

'Contributed' is defined in the Macquarie Dictionary, [Multimedia], version 5:0.0, 1/10/01 to mean:

To give in common with others; give to a common stock or for a common purpose.

'Funds' is defined in the same dictionary to mean:

A stock of money or pecuniary resources.

Therefore, contributing funds can only mean to take actual moneys belonging to the taxpayer, or a connected entity of the taxpayer, and employ them in the business carried on at the permanent establishment. In the most basic case, it means the money supplied is lent at the permanent establishment to third parties, or the money supplied is used to buy a building, such as the place of business itself.

Section 215-10 of the ITAA 1997 refers to a purpose of 'returning' funds. A contribution might be described in the internal accounts of the taxpayer as a 'loan'. While it cannot actually be a loan, provided the moneys are advanced and used in the business of the permanent establishment, it is a contribution of those funds. The Explanatory Memorandum to the Bill which introduced former section 160APAAAA of the ITAA 1936, the precursor to section 215-10, supports that view: see paragraph 2.113.

In order to satisfy the test in paragraph 215-10(2)(c) of the ITAA 1997, it must be established that the moneys were contributed and are still in use in the business. However, because there is no actual debt between 'head office' and 'branch', it is difficult to see how such funds can be 'returned' if they have been lost. If the funds are lost or untraceable, it is not possible to actually return those funds.

Section 215-10 of the ITAA 1997 recognises that funds from the business of another permanent establishment may be contributed to the business of the permanent establishment in question. That is, an ADI might take money it used in New York and transfer it to the Offshore location for use there. The refinancing principle permits money from a fresh issue to be used to reverse that transaction. However, it does not follow that money that is transferred from New York to the Offshore location in order to be transferred to Singapore is money contributed to Offshore permanent establishment. If the money is transferred for the purpose of an on-transfer to Singapore that is not a transfer for use in the Offshore business, unless more appears. A notional loan with notional interest for the purposes of internal bookkeeping does not make it what it is not: a loan in the course of the Offshore business. Also, if money that was actually in the Offshore business and used there is then transferred to Singapore and used there, it is no longer funds contributed to the Offshore businesses; it cannot be returned.

It is to be expected that a banking business will have associated derivative transactions. However, there are usually entered into by an exchange of contracts without an advance of money. Funds could be contributed to the business of a permanent establishment to pay losses on derivatives. (But such funds could probably not be returned because it has been lost.) However, in the money derivatives, whilst assets, cannot represent money contributed to the business, simply because such assets are generated without the use of contributed funds.

Company B advised that the purpose of raising the funds from the issue of the Hybrid Capital Instruments was to return funds that had been previously contributed to the Company B Offshore Branch. It is not possible for Company B to identify when amounts described in the accounts of Company B as loans were 'incurred', nor can Company B identify assets that were acquired using those funds such that it could be established that there had been funds contributed to the business of the permanent establishment, and the funds are still in use in the business and are capable of being returned.

Conclusion

It necessarily follows from the conclusion that the Hybrid Capital Instruments are not issued at or through the permanent establishment, but instead raised by Group Treasury for general corporate use, that the funds raised are not capable of 'being returned' to Head Office by the Company B Offshore Branch. The funds raised can only be 'returned' by Company B Offshore Branch if the funds were first notionally transferred to Company B Offshore Branch by Group Treasury. This could only occur after the issue of the Hybrid Capital Instruments. In such circumstances the conditions of paragraph 215-10(2)(c) of the ITAA 1997 are not satisfied.

Even if it could be concluded that the Hybrid Capital Instruments were issued at the Company B Offshore Branch, paragraph 215-10(2)(c) of the ITAA 1997 is not satisfied because Company B cannot show that moneys have previously been contributed to the business at the permanent establishment and that those funds are capable of being returned.