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Ruling

Subject: Debt/Equity Interest

Question 1

Will the Convertible Redeemable Preference Shares (CRPS) be characterised as equity interests pursuant to Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

Yes

This ruling applies for the following periods:

Income year ended 30 June 2013

Income year ended 30 June 2014

Income year ended 30 June 2015

Income year ended 30 June 2016

The scheme commences on:

1 July 2012

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

The Company is an Australian incorporated unlisted public company. The Company is an Australian resident company for Australian income tax purposes and is the head company of an income tax consolidated group.

Proposed preference share facility

The Company is seeking to raise funds from external investors through the issue of CRPS.

The Company prepares an offer document which it updates and lodges with ASIC. This document is a product disclosure document that allows the Company to issue ordinary shares to non-sophisticated investors. It is proposed that when this document is updated this year (following the ATO's ruling) it will reflect the CRPS Facility and hence allow both sophisticated and non-sophisticated shareholders to participate in the CRPS. Without a product disclosure document in respect of ordinary shares, going forward, a placement of ordinary shares could only be made to sophisticated investors.

The advantage of this CRPS issue over the alternate funding options used to date are:

(i) provides investors with a potentially higher dividend return than that available on the ordinary shares

(ii) enables the Company to obtain equity funding at a higher amount per share issue than is currently being obtained using the DRP [Dividend Reinvestment Plan] program;

(iii) provides less risk to investors than available using project specific syndication arrangements because it provides exposure to all of the Company's projects rather than being tied to a single specific project;

(iv) the mechanism for conversion of the CRPS to ordinary shares significantly reduces the likelihood that the Company will have to replace this funding in the future;

(v) the dividend rate on the CPRS is less than the cost of debt funding thereby increasing overall profits and cash flow; and

(vi) the offer is open to both sophisticated and non-sophisticated investors thereby increasing the potential investor base and take up of this offer.

On the basis that these CRPS are classified as an equity interest, it is intended that any dividends to be paid by the Company on the will be capable to being franked dividends to the extent that the Company meets the other requirements for payment of a franked dividend as specified in Part 3-6 of the ITAA 1997.

Conversion to Ordinary Shares

A key feature of the proposed CRPS terms is the potential for their future conversion to ordinary shares. The terms specify the circumstances in which the holders of the CRPS can elect for the CRPS to either be redeemed or converted into ordinary shares on specified dates. In the event that no such election is made by the holders of the CRPS then the CRPS will mandatorily convert to ordinary shares at the end of the term.

The Company regularly values the ordinary shares of the company by using a net asset backing method (NAB). This calculation utilises the balances obtained from the audited financial statements.

It is the practice of the Company to offer ordinary shares under the DRP at NAB less a discount.

Assumption

As the share into which the CRPS will convert or be redeemed for is referred to as an "ordinary share" of the Company and because the CRPS has priority in payment of dividends to the "ordinary share" as well as in respect of invested capital on winding up or liquidation, the Commissioner is prepared to assume without formal analysis that the "ordinary share" is an equity interest and not a debt interest pursuant to Division 974.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 Subdivision 974-B

Income Tax Assessment Act 1997 Subdivision 974-C

Income Tax Assessment Act 1997 Subsection 974-5(4)

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

Income Tax Assessment Act 1997 Subsection 974-30(1)

Income Tax Assessment Act 1997 Section 974-70

Income Tax Assessment Act 1997 Subsection 974-75(1)

Income Tax Assessment Act 1997 Section 974-135(3)

Income Tax Assessment Act 1997 Section 974-135(6)

Income Tax Assessment Act 1997 Section 974-160

Income Tax Assessment Act 1997 Section 995-1

All references in this Ruling are to the ITAA 1997 unless otherwise indicated.

Reasons for decision

Summary

The CRPS will be characterised as equity interests pursuant to Subdivision 974-C.

Detailed reasoning

For instruments issued on or after 1 July 2001, Division 974 provides rules that govern the classification of debt and equity interests for tax purposes. If an interest satisfies both the debt test and the equity test, it is treated as a debt interest and not an equity interest (subsection 974-5(4)).

The test for an equity interest

The meaning of equity interest in a company is defined in section 974-70. Broadly, a scheme gives rise to an equity interest in a company if, when the scheme comes into existence:

· the scheme satisfies the equity test in subsection 974-75(1) in relation to the company because of the existence of an interest; and

· 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.

Scheme

The issue of the CRPS constitutes a scheme within the meaning of that term in section 995-1.

Equity test

Subsection 974-75(1), setting out the basic test for an equity interest, states the scheme will satisfy the equity test if it gives rise to an interest that is contained in the table in that subsection.

Item 1 in the table in subsection 974-75(1) provides that an interest in the company as a member or stockholder of the company will be an equity interest for the purposes of the equity test.

The proposed CRPS that the Company intends to issue are, for legal purposes, treated as part of the capital of the Company. Accordingly, as each CRPS is considered to be a share in legal form giving rise to a membership interest in the Company, item 1 in the table in subsection 974-75(1) is satisfied.

Debt interest

As the CRPS are equity interests as defined in section 974-70, it is necessary to consider the 'tie-breaker' provision outlined at subsection 974-5(4) to ascertain if the nature of the interest is also a debt interest. Where the nature of the interest is considered to also be a debt interest, the character of the interest will be taken as being a debt interest despite the fact that it is also an equity interest.

As the CRPS is an "Item 1 equity interest", the issue of whether it is a "financial arrangement" need not be considered (Subsection 974-20(1)).

The Company is the "entity" and it will receive a "financial benefit" being the subscription price for each CRPS pursuant to Paragraph 974-20(1)(b).

In this case, the CRPS will not be characterised as a debt interest because they fail to satisfy two elements of the debt test as set out in Paragraph 974-20(1)(c). That is:

1. there is no effectively non contingent obligation on the part of the (issuer) the Company (or the Company and a connected entity) to repay the investment amount (provide a financial benefit as defined in section 974-160) under the CRPS (as required by paragraph 974-20(1)(c)); and, as a result,

2. it cannot be said that the requirements of paragraph 974-20(1)(d) will be met (that is, it is not substantially more likely than not that the value of the financial benefit provided will equal or exceed the value of the financial benefit received).

Subsection 974-135(3) provides that an obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or its connected entity), other than the ability or willingness of that entity or its connected entity to meet the obligation. The dividend payments associated with the CRPS are not effectively non-contingent obligations of the issuer as they are contingent on the issuer paying a dividend to their ordinary shareholders.

In addition, if all or any part of a dividend is not paid by reason that no dividend is paid on ordinary shares or by reason that the directors of the Company choose not to pay the dividend; the Company will be under no obligation to pay the unpaid amount. No interest accrues in respect of the unpaid dividend. CPRS holders will have no claim or entitlement in respect of the unpaid dividend.

The effectively non-contingent nature of an obligation is not affected if the obligation is subject only to the ability or willingness of the issuer company to meet the obligation (subsection 974-135(3)) or if any contingency is so artificial or contrived as to suggest that the occurrence of the contingency is immaterially remote or a theoretical rather than a real possibility (subsection 974-135(6)). However, past profitability and the past payment of dividends do not result in the conclusion that there is sufficient certainty of future profitability or certainty as to future economic performance to support a view that a dividend will become payable. Accordingly, it cannot be concluded that there is an effectively non-contingent obligation to provide the required financial benefit.

Pursuant to subsection 974-30(1), the issue of an equity interest in the entity or a connected entity of the issuing entity, does not "constitute the provision of a financial benefit by an entity".

Therefore pursuant to subsection 974-20(1)(c) the value of any financial benefits provided will be zero because:

· in respect of the dividends they are not effectively non-contingent obligations; and

· in respect of the redemption amount, that obligation is payable only in equity interests of the Company and so are not considered to be "financial benefits provided".

As a result of the Company not having an effectively non-contingent obligation to provide a financial benefit that will equal or exceed the value of the financial benefits received (paragraph 974-20(1)(d), it follows that the debt test in section 974-20 has not been met. The analysis of the CRPS as an equity interest will not be affected by application of the debt test.

Conclusion

As the CRPS do not meet the debt test, they will remain an equity interest for the purposes of subdivision 974-C.