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Ruling

Subject: Redeemable preference shares

Question 1

Are the RPS issued to the non-resident company debt interests of the taxpayer for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Subject to the application of Division 820 of the ITAA 1997, will the taxpayer be entitled to a deduction where losses are made on the financial arrangement (the RPS) pursuant to section 230-15 of the ITAA 1997? If so, will the taxpayer's entitlement to a deduction arise at the time when the losses are made on the RPS (e.g. when RPS dividends are paid)?

Answer

Yes. The losses will be deductible when losses are made on the RPS (i.e. when the dividends are paid).

Question 3

Does withholding tax apply pursuant to section 128B of the Income Tax Assessment Act 1936 (ITAA 1936) where dividends are paid on the RPS to the non-resident company?

Answer

Yes

This ruling applies for the following periods:

Year ended 31 December 2011

Year ending 31 December 2012

Year ending 31 December 2013

The scheme commenced on:

1 July 2011

Relevant facts and circumstances

Overview

The taxpayer has entered into the redeemable preference shares (RPS) arrangement to raise the funds necessary to provide an interest bearing loan to an offshore subsidiary (the subsidiary).

The provision of the interest bearing loan to the subsidiary is intended to fund the expansion of the subsidiary's business.

The loan was funded by issuing the RPS to a non-resident company.

Terms of the RPS

The Terms and Conditions of the RPS used in the Arrangement were as follows:

· Issue Price / Subscription Amount

· Each RPS will have a face value of $1.00 (Issue Price).

· The non-resident will subscribe for the RPS at a price equal to 100% of the Issue Price (Subscription Amount).

These amounts are collectively referred to as "the RPS Subscription Amount".

Redemption Date

The RPS have a mandatory redemption date of 9 years (the Redemption Date) from the issue date (subject to an Early Maturity Notice given by a Holder- discussed below).

On the Redemption Date, the taxpayer must redeem all outstanding RPS.

There is no, and will be no, arrangement for the rolling over or extension of the RPS.

Early Maturity Notice given by a Holder

The Holder has a right to redeem at any time all (or some) of the RPS in cash at the Redemption Amount subject to the Priority Arrangements that exist from time to time.

Redemption Amount

The Redemption Amount equals the Issue Price for each RPS less any amount of capital returned on that RPS prior to the Redemption Date.

Return of Capital / Buy-Back Feature

If prior to the Redemption Date the taxpayer determines in its absolute discretion that:

· there are insufficient profits to enable the redemption of a RPS out of profits; or

· that the taxpayer is either unable, or it is not in the best interests of the taxpayer to, redeem a RPS out of the proceeds of a new issue of shares,

· then, subject to compliance with Part 2J.1 of the Corporations Act, the taxpayer must use its best endeavours to procure a capital reduction and cancellation or buy-back of the RPS for an amount equal to the Redemption Amount by, or as soon as practicable and no later than 30 days after, the Redemption Date.

Priority Repayment of Capital

Repayment of the Issue Price of the RPS is in priority to the repayment of capital on any other class of shares in the event of a winding up of the taxpayer.

Dividend Entitlement

Subject to the Dividend Conditions, an RPS gives the Holder the right to receive a dividend in each Calculation Period in priority to all other classes of shares in the taxpayer.

The Dividend Conditions ensure that the right of the Holder to be paid the Dividend Entitlement is subject to the taxpayer's obligation to ensure that the payment of the dividend would not adversely affect the solvency of the taxpayer, the availability of distributable profits of the taxpayer and the absolute discretion of the board of directors of the taxpayer.

Voting

The holders of the RPS are generally not entitled to vote at a general meeting (except in prescribed circumstances which are aimed at ensuring the Holder's rights are sufficiently protected).

Priority Arrangements

Any financing arrangements in relation to which the taxpayer is a borrower or guarantor, from time to time, that the taxpayer notifies the Holder is to be included in this definition.

Any Priority Arrangements held by the taxpayer will not adversely affect the taxpayer's ability to redeem, buy-back or cancel the RPS at the Redemption Date

Other matters

The non-resident company will not hold the RPS at or through a permanent establishment in Australia.

The taxpayer has not made a functional currency election pursuant to item 1 of the table in subsection 960-60(1) of the ITAA 1997 for a currency other than the Australian dollar to be its applicable functional currency for Australian income tax purposes.

The taxpayer has not made, and will not make, an election under Subdivision 230-C, 230-D, 230-E or 230-F of the ITAA 1997 to apply any of the elective methods for taxation of financial arrangements.

Assumptions

The taxpayer will redeem the RPS on the Redemption Date.

The issue of the RPS will not cause the market value of the taxpayer to increase.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128A,

Income Tax Assessment Act 1936 subsection 128A(1AB) and

Income Tax Assessment Act 1936 paragraph 128A(1AB)(c).

Income Tax Assessment Act 1936 Section 128B,

Income Tax Assessment Act 1936 Subsection 128B(2),

Income Tax Assessment Act 1936 Subsection 128B(5),

Income Tax Assessment Act 1997 Division 230,

Income Tax Assessment Act 1997 Subdivision 230-B,

Income Tax Assessment Act 1997 Subdivision 230-C,

Income Tax Assessment Act 1997 Subdivision 230-D,

Income Tax Assessment Act 1997 Subdivision 230-E,

Income Tax Assessment Act 1997 Subdivision 230-F,

Income Tax Assessment Act 1997 Section 230-15,

Income Tax Assessment Act 1997 Subsection 230-15(2),

Income Tax Assessment Act 1997 Subsection 230-15(4),

Income Tax Assessment Act 1997 Subsection 230-15(4A),

Income Tax Assessment Act 1997 Subsection 230-15(5),

Income Tax Assessment Act 1997 Section 230-40,

Income Tax Assessment Act 1997 Subsection 230-40(1),

Income Tax Assessment Act 1997 Paragraphs 230-40(1)(b),

Income Tax Assessment Act 1997 Paragraphs 230-40(1)(f),

Income Tax Assessment Act 1997 Section 230-45,

Income Tax Assessment Act 1997 Subsection 230-45(1),

Income Tax Assessment Act 1997 Section 230-100

Income Tax Assessment Act 1997 Section 230-180,

Income Tax Assessment Act 1997 Subsection 230-180(1),

Income Tax Assessment Act 1997 Division 820,

Income Tax Assessment Act 1997 Section 820-1,

Income Tax Assessment Act 1997 Division 974,

Income Tax Assessment Act 1997 Subdivision 974-B,

Income Tax Assessment Act 1997 Section 974-15,

Income Tax Assessment Act 1997 Subsection 974-15(1),

Income Tax Assessment Act 1997 Section 974-20,

Income Tax Assessment Act 1997 Subsection 974-20(1),

Income Tax Assessment Act 1997 Paragraph 974-20(1)(a),

Income Tax Assessment Act 1997 Paragraph 974-20(1)(b),

Income Tax Assessment Act 1997 Paragraph 974-20(1)(c),

Income Tax Assessment Act 1997 Paragraph 974-20(1)(d),

Income Tax Assessment Act 1997 Paragraph 974-20(1)(e),

Income Tax Assessment Act 1997 Section 974-35,

Income Tax Assessment Act 1997 Subparagraph 974-35(1)(a)(i),

Income Tax Assessment Act 1997 Section 974-130,

Income Tax Assessment Act 1997 Subsection 974-135(1),

Income Tax Assessment Act 1997 Subsection 974-135(2),

Income Tax Assessment Act 1997 Subsection 974-135(3),

Income Tax Assessment Act 1997 Subsection 974-135(5),

Income Tax Assessment Act 1997 Section 974-160,

Income Tax Assessment Act 1997 Subsection 974-160(1),

Income Tax Assessment Act 1997 Section 995-1 and

Corporations Act 2001 Section 254K.

Reasons for decision

Question 1

The debt/equity rules in Division 974 of the ITAA 1997 characterise an interest in a company as equity or debt for the purpose of determining the taxation treatment of the return on the interest. 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) of the ITAA 1997 in relation to the entity.

The issue of the RPS constitutes a scheme for income tax purposes.

Based on the information supplied by the taxpayer, the RPS satisfies the debt test in subsection 974-20(1) and is a debt interest for the purposes of Division 974.

Question 2

Division 820 of the ITAA 1997 applies specific rules to foreign controlled Australian entities, Australian entities that operate internationally and foreign entities that operate in Australia (section 820-1 of the ITAA 1997). The deductibility of the losses on the RPS determined in accordance with Division 230 of the ITAA 1997 is subject to the application of Division 820.

The RPS satisfies the definition of a financial arrangement in subsection 230-45(1) of the ITAA 1997 and is therefore a financial arrangement to which Division 230 applies.

Accruals or realisation

Section 230-15 of the ITAA 1997 provides the basis for the tax treatment of gains and losses from financial arrangements however consideration first needs to be given to what tax-timing method is applicable. The taxpayer has not made any tax-timing elections under paragraphs 230-40(1)(b) to 230-40(1)(f) of the ITAA 1997 and therefore either the accruals or realisation methods contained in Subdivision 230-B of the ITAA 1997 will apply to the RPS.

The accruals method will apply where either the overall gains and losses or a particular gain or loss in respect of the financial arrangement is sufficiently certain in accordance with section 230-100 of the ITAA 1997. Where the gains and losses are not sufficiently certain, subsection 230-180(1) of the ITAA 1997 will apply the realisation method to the gains and losses.

Having regard to the information supplied by the taxpayer, subsection 230-180(1) will apply the realisation method to the gains and losses in the income year in which the gain or loss occurs.

Calculation of gains and losses

Subsection 230-15(2) of the ITAA 1997 allows a deduction for a loss you make from a financial arrangement to the extent that you make it in gaining or producing assessable income, or you necessarily make in carrying on a business for the purpose of gaining or producing assessable income.

The taxpayer is not entitled to a deduction under subsection 230-15(2) in relation to dividends paid under the RPS arrangement, as the dividends paid on the RPS are not incurred in gaining or producing assessable income of its business; rather the RPS dividends constitute a post derivation distribution of profits of the business.

However, subsection 230-15(4) of the ITAA 1997 does not prevent a loss from being deductible under subsection 230-15(2) on a financial arrangement that is a debt interest you issue merely because one or more of the financial benefits secure a permanent or enduring benefit.

Based on the information supplied by the taxpayer, the loss as a result of the payment of a RPS dividend is deductible as the funds raised by issuing the RPS are used to finance an interest bearing loan to the subsidiary, i.e. the funds from the issue of the RPS are used for the purpose of, gaining or producing assessable income (or carrying on a business for that purpose), and therefore, the assumptions in subsection 230-15(4A) of the ITAA 1997 prima facie supply a nexus for the purposes of subsection 230-15(2).

Subsection 230-15(5) of the ITAA 1997 will apply to limit the deductions able to be claimed under subsection 230-15(4A) to an amount not exceeding the benchmark rate of return for the debt interest increased by 150 basis points (the cap).

Conclusion

Each RPS dividend payment, subject to the cap, by the taxpayer will constitute a loss under the realisation method at the time of payment as the gains and losses of the RPS are not sufficiently certain at the time Division 230 of the ITAA 1997 starts to apply to the financial arrangement.

Question 3

Section 128B of the ITAA 1936 applies to income derived by a non-resident and includes interest that is paid to the non-resident by a resident of Australia (subsection 128B(2) of the ITAA 1936). The definition of interest in subsection 128A(1AB) of the ITAA 1936 includes an amount that is a dividend paid in respect of a non-equity share (paragraph 128A(1AB)(c) of the ITAA 1936).

The RPS issued by the taxpayer is a non-equity share. A dividend on a RPS paid to a non-resident by the taxpayer will be interest as defined by subsection 128A(1AB) that is paid to a non-resident by a resident of Australia.

Subsection 128B(5) of the ITAA 1936 provides that a person who derives income to which section 128B applies that consists of interest is liable to pay income tax upon that income at the rate declared by Parliament.