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Subject: capital raising

Question 1

Will the securities be characterised as 'equity interests' for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, the securities will be characterised as 'equity interests' for the purposes of Division 974 of the ITAA 1997.

Question 2

Will the Dividends payable in respect of the securities constitute frankable distributions under section 202-40 of the ITAA 1997 and not be unfrankable under section 202-45 of the ITAA 1997?

Answer

Yes, the Dividends payable in respect of the securities will constitute frankable distributions under section 202-40 of the ITAA 1997 and will not be unfrankable under section 202-45 of the ITAA 1997.

Question 3

Will section 204-30 of the ITAA 1997 apply to the scheme?

Answer

No, section 204-30 of the ITAA 1997 will not apply to the scheme.

Question 4

Will section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme?

Answer

No, section 177EA of the ITAA 1936 will not apply to the scheme.

Relevant facts and circumstances

The rulee is proposing to offer securities in order to raise capital.

The rulee has requested that the Commissioner provide the Ruling on the basis of the following matters:

· During the term of the transaction, the rulee will be a resident of Australia under the income tax laws of Australia and of no other jurisdiction.

· No dividends will be sourced, directly or indirectly, from unrealised or untaxed profits.

· Dividends payable in respect of the securities will not be debited to the rulee's share capital account or its non-share capital account.

Assumptions

The transaction documents will represent a complete and accurate description of the transaction, are intended by parties to have their legal effect and will be implemented in accordance with their terms.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 974.

Income Tax Assessment Act 1997 Section 202-40.

Income Tax Assessment Act 1997 Section 202-45.

Income Tax Assessment Act 1997 Section 204-30.

Income Tax Assessment Act 1936 Section 177EA.

Reasons for decision

Question 1

Subsection 995-1(1) of the ITAA 1997 provides that an equity interest in an entity has the meaning given by "in the case of a company- Subdivision 974-C..."

The equity test in Subdivision 974-C of the ITAA 1997

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

"A scheme gives rise to an equity interest in a company if, when it 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 securities are considered below.

Paragraph 974-70(1)(a): The securities must satisfy the equity test in subsection 974-75(1) in relation to the rulee

The equity test in subsection 974-75(1) of the ITAA 1997 is as follows:

"A scheme satisfies the equity test in this subsection in relation to a company if it gives rise to an interest set out in the following table:

The first requirement in the equity test is that there must be a scheme. 'Scheme' is defined in subsection 995-1(1) of the ITAA 1997 to include any arrangement or any scheme, plan, proposal, action, course of action or conduct. Therefore, the proposed issue of the securities (the Transaction) will be a scheme within this definition.

The next requirement of the equity test is that the scheme (the proposed issue of the securities) must give rise to an interest set out in the above table. The scheme will give rise to an interest in the company as a member or stockholder of the company (item 1 of the table) as the securities are fully paid, unsecured, perpetual, non-cumulative securities in the capital of the rule. It is therefore unnecessary to consider the other items in the table.

Subsection 974-75(2) of the ITAA 1997 provides:

"A *scheme that would otherwise give rise to an *equity interest in a company because of an item in the table in subsection (1) (other than item 1) does not give rise to an equity interest in the company unless the scheme is a *financing arrangement for the company."

As the scheme gives rise to an interest covered by item 1 of the equity table in subsection 974-75(1) of the ITAA 1997 the scheme need not also satisfy the requirement that it be a financing arrangement.

Paragraph 974-70(1)(b): The securities must not be characterised as debt interests in the rulee or a connected entity of the rulee under Subdivision 974-B of the ITAA 1997

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."

Subsection 974-20(1) of the ITAA 1997 prescribes the debt test as follows:

"A *scheme satisfies the debt test in this subsection in relation to an entity if:

(a) the scheme is a *financing arrangement for the entity; and

(b) the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and

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

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

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

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

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

The 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)."

The application of the debt test to the securities is considered below.

As the scheme gives rise to an interest covered by item 1 of the equity table in subsection 974-75(1) of the ITAA 1997, paragraph 974-20(1)(a) of the ITAA 1997 need not be satisfied.

The rulee will receive a financial benefit under the scheme. Accordingly, paragraph 974-20(1)(b) of the ITAA 1997 of the debt test is satisfied.

The rulee does not have an ENCO to provide a financial benefit by way of returning any part of the issue price. The rulee therefore has no ENCO to provide any financial benefit under the scheme and paragraph 974-20(1)(c) of the ITAA 1997 is consequently not satisfied. The debt test is thus failed as all requirements must be satisfied.

As the requirements of the equity test are satisfied and the debt test is failed, the issue of the securities will therefore give rise to an equity interest in the rulee under Division 974 of the ITAA 1997.

Question 2

Section 202-40 of the ITAA 1997 provides that:

"(1) A distribution is a frankable distribution, to the extent that it is not unfrankable under section 202-45.

(2) A non-share dividend is frankable distribution, to the extent that it is not unfrankable under section 202-45."

The distributions to be made by the rulee on the securities are dividends. Therefore, for the dividend to be a 'frankable distribution' within the above definition, it must be a 'distribution' or 'non-share dividend' that is not 'unfrankable' under section 202-45 of the ITAA 1997.

Section 202-45 of the ITAA 1997 provides the following list of distributions as unfrankable:

(a) (Repealed by No 101 of 2003)

(b) a distribution to which paragraph 24J(2)(a) of the Income Tax Assessment Act 1936 applies that is taken under section 24J of the Income Tax Assessment Act 1936 to be *derived from sources in a prescribed Territory, as defined in subsection 24B(1) of the Income Tax Assessment Act 1936 (distributions by certain *corporate tax entities from sources in Norfolk Island);

(c) where the purchase price on the buy-back of a *share by a *company from one of its *members is taken to be a dividend under section 159GZZZP of that Act - so much of that purchase price as exceeds what would be the market value (as normally understood) of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place;

(d) a distribution in respect of a *non-equity share;

(e) a distribution that is sourced, directly or indirectly, from a company's *share capital account;

(f) an amount that is taken to be an unfrankable distribution under section 215-10 or 215-15;

(g) an amount that is taken to be a dividend for any purpose under any of the following provisions:

(i) unless subsection 109RB(6) or 109RC(2) applies in relation to the amount - Division 7A of Part III of that Act (distributions to entities connected with a *private company);

(ii) (Repealed by No 79 of 2007)

(iii) section 109 of that Act (excessive payments to shareholders, directors and associates);

(iv) section 47A of that Act (distribution benefits - CFCs);

(h) an amount that is taken to be an unfranked dividend for any purpose:

(i) under section 45 of that Act (streaming bonus shares and unfranked dividends);

(ii) because of a determination of the Commissioner under section 45C of that Act (streaming dividends and capital benefits);

(i) a *demerger dividend;

(j) a distribution that section 152-125 or 220-105 says is unfrankable.

Having regard to the relevant facts and assumptions made in this Ruling, Dividends payable in respect of the securities will be 'frankable distributions' under section 202-40 of the ITAA 1997 and will not be unfrankable under section 202-45 of the ITAA 1997.

Question 3

Section 204-30 of the ITAA 1997 is a general anti-streaming measure that applies if an entity streams distributions (or distributions and other benefits) in such a way that:

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

b) the member would derive a greater benefit from franking credits than another member of the entity; and

c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits.

When these conditions are met, subsection 204-30(1) of the ITAA 1997 empowers the Commissioner to make one or more of the determinations listed in subsection 204-30(3) of the ITAA 1997:

a) that a specified franking debit arises in the franking account of the entity, for a
specified distribution or other benefit to a disadvantaged member;

b) that a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member;

c) that no imputation benefit arises in respect of the relevant distribution that is
made to a favoured member and specified in the determination.

Imputation benefit is defined to include an entitlement to a tax offset under Division 207 of the ITAA 1997 as a result of the distribution (see subsection 204-30(6) of the ITAA 1997). It is reasonable to expect that the preference shareholders will receive an imputation benefit because the distributions payable in respect of the securities are frankable distributions.

The remaining issue is whether there will be a streaming of distributions in the way described in section 204-30 of the ITAA 1997. The expression 'streams' is not defined in the ITAA 1997, however, the Explanatory Memorandum (EM) to the New Business Tax System (Imputation) Bill 2002 (Cth), which introduced subdivision 204-D of the ITAA 1997 states at paragraphs 3.28 to 3.29 that:

"3.28 Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

3.29 The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming."

In view of the facts provided by the rulee, it cannot be concluded that 'streaming' exists in relation to the franked distributions to be paid by the rulee to the holders. Accordingly, section 204-30 of the ITAA 1997 will not apply to the transaction.

Question 4

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies where one of the purposes (other than an incidental purpose) of a scheme is to enable a relevant taxpayer to obtain an imputation benefit. Where this purpose exists, subsection 177EA(5) of the ITAA 1936 empowers the Commissioner to make a determination that either:

1. franking debits or exempting debits will arise in the franking account of a corporate tax entity that is the distributing entity and a party to the scheme; or

2. no imputation benefit is to arise in respect of a distribution, or a specified part of a distribution, that flows directly or indirectly to the relevant taxpayer.

Pursuant to subsection 177EA(3) of the ITAA 1936, the provision applies if the following conditions are satisfied:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for section 177EA of the ITAA 1936, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer (the holders of the securities) to obtain an imputation benefit (paragraph 177EA(3)(e) of the ITAA 1936).

This is a test of objective purpose. Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936. The relevant circumstances, taken individually or collectively, could indicate the requisite purpose. Due to the wide range of these circumstances, some may or may not be present at any one time in any one scheme.

Having regard to the relevant objective circumstances of the scheme listed in subsection 177EA(17) of the ITAA 1936, the Commissioner considers that on balance, in the particular circumstances of this case, the purpose of enabling a relevant taxpayer to obtain an imputation benefit is not considered to be more than incidental to other purposes of the scheme.

Accordingly, the Commissioner will not make any determination under subsection 177EA(5) of the ITAA 1936.