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Ruling

Subject: Project X

This ruling applies for the following periods:

Multiple years

The scheme commences on:

1 July 2011

Issue 1

Will the Notes be equity interests within the meaning of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Issue 2

To the extent the interest on the Notes are deductible under subsection 230-15(2) of the ITAA 1997, will the deduction be denied on the basis that it is contingent on the economic performance of:

(i) Company A; or

(ii) part of Company A 's activities; or

(iii) a connected entity of Company A; or

(iv) a part of the activities of a connected entity of Company A?

Answer

No.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

BACKGROUND

Company B is the head company of the Company B tax Consolidated Group (Company B TCG).

The Application seeks a ruling on the taxation treatment of Notes. The Notes are to be issued by a subsidiary member of the Company B TCG in relation to a proposed transaction known as Project X.

DOCUMENTS

For the purposes of the private binding ruling, the Transaction (as described below) has been ascertained from the following documents:

The Application

Draft Note Subscription Agreement

TRANSACTION

Project X is a transaction which involves establishing an opportunistic investment mandate (the Mandate).

The Mandate is expected to involve investment in a number of projects (each a Project) over a Y year term.

Project X

Company A has established a special purpose vehicle (Project Company) to acquire the first project asset. Each Project will be held in a separate Project Company which will be 100% owned by Company A.

Company A and each Project Company will be a subsidiary member of the Company B TCG.

External funding will be raised from 3 sources:

· external bank debt (Bank Debt) funded directly at the Project Company level;

· Company A will raise debt from third party institutional investors through the issue of Notes. Company A will use the proceeds to make a loan (Project Loan) to the Project Company; and

· equity funding will be raised directly by the Project Company through the issue of Equity Notes to third party institutional investors.

The offer of Notes and Equity Notes will be aimed at institutional investors.

Company C will be appointed as the development manager (Development Manager) for each Project. Company C is a subsidiary member of the Company B TCG. Company C will be entitled to receive a base management fee and a performance fee for its services.

Company B will be required to establish an investment committee (Investment Committee) for the Projects.

In relation to the security arrangements that will be in place:

· the Bank Debt will have a first-ranking security over the assets of the relevant Project Company; and

· Note Lenders will be granted a second-ranking security over certain assets of each Project Company, subject to any necessary regulatory approvals being obtained.

Company B will co-invest in each Project alongside the external investors through the acquisition of Notes and Equity Notes. The entity that acquires Notes and Equity Notes will be a member of the Company B TCG.

Note terms

The terms and conditions of the Notes will be documented in the Note Subscription Agreement.

The Note Subscription Agreement provides:

Interest for each Interest Period accrues from day to day on the outstanding principal amount of each Loan at the rate of P% per annum.

To the extent there is not sufficient "Project Funding" (defined below) to fund an interest payment, the accrued but unpaid interest will be capitalised.

In relation to the repayment of the outstanding principal amount the Note Subscription Agreement then provides:

(a) Subject to paragraph (b), the Borrower shall repay the outstanding principal amount of each Loan (together with all other amounts outstanding under the Finance Documents) in full on the Repayment Date.

(b) If the Borrower receives any Project Funding prior to the Repayment Date it must promptly apply that Project Funding towards payment of the Secured Moneys.

The "Repayment Date" will be Y years from the issue of the Notes subject to early redemption at the option of Company A. The term may be extended in certain circumstances although there is a maximum term.

The payment of principal and interest on the Notes is subject to there being "Project Funding" which is essentially available cash generated by the underlying Projects (Available Cash Flow). The Available Cash Flow in relation to each Project means all cash receipts in relation to a Project and which is to be applied in accordance with the Note Subscription Agreement.

Broadly, the Note Subscription Agreement requires that Available Cash Flow be applied in the following order (the Payment Waterfall):

· costs and other expenses;

· amounts payable on the Bank Debt;

· amounts payable in relation to the Project Loan for that Project up to a certain threshold

· performance fee payable to Company C (up to a certain threshold) and the balance of any amount outstanding on the Project Loan

· amounts payable on the Equity Notes, for that Project, and the balance of any performance fee payable pro-rata.

All amounts repaid on the Project Loans will in turn be used by Company A to make principal and interest payments on the Notes.

Equity terms

The terms and conditions of the Equity Notes will be documented in the Equity Note Subscription

Agreement, the key terms of which include:

The principal amount owing on the Equity Notes will be payable on the repayment date under the Equity Note Subscription Agreement.

Interest will be payable at six monthly intervals to the extent of Available Cash Flow generated in the period after payment of all other amounts payable under the Payment Waterfall and any amount applied to repay the principal amount of the Equity Notes.

The initial issue price of the Equity Notes will be determined by the Investment Committee having regard to the estimated value of the Project (i.e. the higher the estimated value of the Project, the more potential Equity Note investors will be willing to pay).

Project Loans

The terms of each Project Loan will be set out in a Project Loan Agreement, the key terms of which will include:

Company A will use part of the subscription proceeds from the issue of the Notes to make a Project Loan to the relevant Project Company under a Project Loan Agreement.

Each Project Loan will have a term equal to the Notes, subject to early repayment.

The interest rate on each Project Loan will be P%.

The principal and interest payments on the Project Loans will be matched to reflect Available Cash Flow which is to be applied in accordance with the same Payment Waterfall documented in the Note Subscription Agreement.

Investment Committee

The Investment Committee will be established and conducted in accordance with the Investment Committee Charter. Key features of the Investment Committee Charter include:

The Investment Committee Charter sets out the investment strategy as follows:

The investment strategy is to invest in Australian property development projects which are expected to deliver:

(a) an IRR exceeding 20% per annum; and

(b) an internal rate of return net of tax and hedging expenses exceeding 16%.

The Investment Committee Charter sets out the conditions which must be satisfied before the Investment Committee is permitted to approve an investment. One of the conditions is that the investment meets the requirements of the investment strategy.

The Investment Committee will be responsible for overseeing the relevant Projects, including acquisition and disposal of investments, and ensuring the Development Manager manages the Project consistently with the investment strategy.

The Investment Committee will consist of four members, two appointed by the Company A and two independent members approved by Note Lenders (other than any Company B entity that is a Note Lender).

Security arrangements

The bank lenders will have a first-ranking security over the assets of each relevant Project Company.

The Note Lenders will be granted a second-ranking security over certain assets of each Project Company pursuant to a Deed of Charge.

The Equity Notes represent the equity component of the funding and so these obligations will be unsecured. The appointed agent of the Equity Note Holders will be required to enter into a Subordination Agreement that will acknowledge the subordination of all obligations on the Equity Notes in respect of a Project until all Bank Debt and the Project Loan in relation to that Project have been repaid.

Assumption

The Subordination Agreement, when enacted, will not alter any of the rights and obligations due by Company A to any Note Lender under the Note Subscription Agreement.

Relevant legislative provisions

Income Tax Assessment Act 1997

Subsection 230-15(2)

Subsection 974-70(1)

Subsection 974-75(1)

Subsection 974-75(2)

Section 974-130

Reasons for decision

Summary

The Notes will not be equity interests within the meaning of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)

Detailed reasoning

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 Notes are considered below.

"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. Thus, the proposed issue of the Notes will be a scheme within this definition.

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:

Equity interests

Item Interest

1 An interest in the company as a member or stockholder of the company.

2 An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is in substance or effect *contingent on the economic performance (whether past, current or future) of:

· the company; or

· a part of the company's activities; or

· a *connected entity of the company or a part of the activities of a connected entity of the company.

The return may be a return of an amount invested in the interest.

An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is at the discretion of:

· the company; or

· a *connected entity of the company.

The return may be a return of an amount invested in the interest.

An interest issued by the company that:

· gives its holder (or a *connected entity of the holder) a right to be issued with an *equity interest in the company or a *connected entity of the company; or

· is an *interest that will, or may, convert into an equity interest in the company or a connected entity of the company. "

Subsection 974-75(2) of the ITAA 1997 then 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."

Section 974-130 provides that a financing arrangement includes a scheme that is entered into or undertaken to raise finance for the entity or a connected entity of the entity. The Notes will be issued in order to raise finance for Company A and this requirement will be satisfied upon the issue of the Notes.

There is no clause in the Transaction Documents whereby the issue of Notes will give rise to an interest in Company A as a member or stockholder. As a consequence the requirements of Item 1 in the equity table are not satisfied.

There is no clause in the Transaction Documents in relation to the Notes which confer any conversion rights to either Company A, a connected entity of Company A or the Note Lender. There is also no clause which confers any right to be issued with an equity interest in Company A or a connected entity of Company A. As a consequence the requirements of Item 4 in the equity table are not satisfied.

The Note Subscription Agreement provides:

Interest for each Interest Period accrues from day to day on the outstanding principal amount of each Loan at the rate of P% per annum".

In relation to the repayment of the outstanding principal amount the Note Subscription Agreement then provides:

a) Subject to paragraph (b), the Borrower shall repay the outstanding principal amount of each Loan (together with all other amounts outstanding under the Finance Documents) in full on the Repayment Date.

(c) If the Borrower receives any Project Funding prior to the Repayment Date it must promptly apply that Project Funding towards payment of the Secured Moneys.

Thus Company A, or a connected entity of Company A, has no discretion as to either the right or the amount of the return due to the Note Lender under the scheme. As a consequence the requirements of Item 3 in the equity table are not satisfied.

Nor can it be said that the right, or the amount of the return, is contingent on the economic performance of Company A or a connected entity of Company A, or indeed any part of their activities. Under the Note Subscription Agreement the amount of interest due to the Note Lender is set at a fixed amount. There is no clause in the Transaction Documents relating to the Notes whereby the return due to Note lenders can increase should the success of the project exceed expectations. The same is true for any amount due to Note Lenders under the Note Subscription Agreement. As a consequence the requirements of Item 2 in the equity table are not satisfied.

Thus, paragraph 974-70(1)(a) of the equity test is not satisfied and, as a consequence, the Notes will not be characterised as an equity interest under Division 974 of the ITAA 1997.

Question 2

Summary

To the extent the interest on the Notes are deductible under subsection 230-15(2) of the ITAA 1997, the deduction will not be denied on the basis that it is contingent on the economic performance of:

o Company A; or

o part of Company A 's activities; or

o a connected entity of Company A; or

o a part of the activities of a connected entity of Company A

Detailed reasoning

Under the Note Subscription Agreement the amount of interest due to the Note lender is set at a fixed amount. There is no clause in the Transaction Documents relating to the Notes whereby the return due to Note Lenders can increase should the success of the project exceed expectations. The same is true for any amount due to Note Lenders under the Note Subscription Agreement.

Thus, a deduction will not be denied on the basis that it is contingent on the economic performance of:

o Company A; or

o part of Company A 's activities; or

o a connected entity of Company A; or

o a part of the activities of a connected entity of Company A