Edited version of your private ruling

Authorisation Number: 1012457869259

Ruling

Subject: Taxation of financial arrangements, whether arrangements constitute single or aggregated arrangements

Question 1

Will the Company Y shares constitute a financial arrangement for Company G (as the head company of Company G tax consolidated group ('TCG') under subsection 230-50(1) of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer

Yes

Question 2

Will subsection 230-55(4) of the ITAA 1997 apply to treat the rights and obligations to receive or provide financial benefits under the agreement, the shareholders agreement and the Company Y shares as forming one aggregated arrangement for the TCG for the purposes of Division 230 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ending XX/XX/XXXX

Year ending XX/XX/XXXX

Year ending XX/XX/XXXX

Year ending XX/XX/XXXX

Year ending XX/XX/XXXX

Year ending XX/XX/XXXX

The scheme commences on:

Year ending XX/XX/XXXX

Relevant facts and circumstances

Company G is an Australian tax resident company and the head company of the TCG.

1. Company X is a wholly-owned subsidiary company of Company G and a member of the TCG.

2. Two third party companies (collectively referred to hereafter as 'the Counterparties') are non-residents of Australia for Australian tax purposes. At all times during the transaction, the Counterparties have not been associates (as defined in section 318 of the ITAA 1936) of each other nor of the TCG.

3. Company F is a foreign enterprise. Company F put out for tender a development project to construct and sell property ('the Project').

4. In XXXX, a consortium consisting of Company X and other companies, including the Counterparties (collectively referred to as 'the Consortium'), successfully bid for the Project and were appointed by Company F to carry out the Project.

5. Company C was incorporated on XX/XX/XXXX by the TCG to be the direct investor in Company Y. From incorporation to date, Company C has been an Australian tax resident company and a subsidiary member of the TCG.

6. On XX/XX/XXXX, the Counterparties entered into the agreement with Company C, the relevant and material terms of which were as follows:

(a) Company C and the Counterparties agreed to establish a company (Company Y) to undertake the Project and to enter into a shareholders agreement with the the Company Y Consortium Members.

(b) Company C was granted an option to sell its shares in Company Y to the Counterparties (or another person designated by the Counterparties) on a Transfer Date (designated date by Company C during the pre-agreed period in the agreement) for a purchase price effectively equal to a XX% per annum return on Company C's share subscription price, less any dividends paid by Company Y to Company C up to the date of transfer of the Company Y shares (the 'Put Option').

(c) The Counterparties were granted an option to require Company C to sell its shares in Company Y to them (or another person designated by the Counterparties) on a Transfer Date (designated date during the pre-agreed period in the agreement) for a fixed purchase price effectively equal to a XX% per annum return on Company C's share subscription amount, less any dividends paid by Company Y to Company C up to the date of transfer of the Company Y shares (the 'Call Option').

7. Company Y, was established shortly after execution of the agreement and the shareholders agreement. According to Australian legal concepts, Company Y is a company, the equity interests issued by Company Y are 'shares' and Company C is a 'shareholder' with respect to Company Y (as stipulated in the shareholders agreement). At all times during the transaction, Company Y has been a tax resident of the foreign country and has not been a tax resident of Australia for Australian tax purposes.

8. Company X made the first tranche equity contribution to Company Y. Company C then acquired Company X's interest in Company Y and made the second required tranche of equity contribution to Company Y. These steps resulted in Company C holding XX% of the share capital in Company Y. At all times from the incorporation of Company Y, the TCG has held XX% of the shares in Company Y and Company Y has been treated as a controlled foreign company (CFC) of the TCG in accordance with section 340(a) of the Income Tax Assessment Act 1936 ( ITAA 1936) with the TCG having a XX% attribution interest in Company Y. Company C's shares in Company Y have never been converted to preferred shares. At no time have the Counterparties controlled Company Y.

9. Company C funded its equity investment in Company Y (including its payment to acquire Company X's first tranche shares) by way of a loan secured by rights under the agreement and certain other assets, including the right to exercise the Put Option.

10. The loan matured on XX/XX/XXXX. At the outset of the transaction, it was expected that Company C would fund the loan repayment from the proceeds of exercising the Put Option. However, on XX/XX/XXXX, Company C did not exercise the Put Option, but instead repaid the loan using proceeds from a new loan facility obtained from a third party lender.

11. On or about the same time, the agreement was amended to extend the exercise date of both the Put Option and the Call Option by XX/XX/XXXX.

12. On XX/XX/XXXX (on or about XX after the commencement of the amended agreement), the exercise dates of both the Put Option and Call Option were again extended to XX/XX/XXXX.

13. On XX/XX/XXXX, the exercise date of the Put Option was extended to XX/XX/XXXX. The Call Option was not extended, but instead lapsed on XX/XX/XXXX.

14. Division 230 of the ITAA 1997 started to apply to the TCG from XX/XX/XXXX. The TCG validly elected (under subitem 104(2)) to apply Division 230 of the ITAA 1997 to the financial arrangements it held at XX/XX/XXXX and started to have before that date (its 'pre-existing financial arrangements').

15. The TCG has also made valid elections to apply the fair value method, the foreign exchange retranslation method, the hedging financing arrangements method, and the financial reports method (collectively referred to as the 'elective methods') under Division 230 of the ITAA 1997.

16. Company C does not form part of Company G's consolidated accounting group for the purposes of AASB 127. This is because Company C is classified as a non-consolidated Special Purpose Entity in accordance with AASB Interpretation 112. The agreement and various other agreements entered into by Company X limit Company G's decision making power and as such Company G does not control Company C for accounting purposes. As such, Company C's financial arrangements do not appear in Company G's consolidated financial reports. Further, Company C does not itself prepare financial reports in accordance with accounting principles, or comparable foreign standards. Accordingly, as the financial arrangements held by Company C are not recognised in the financial reports of a kind required for the elective methods to apply to Company C's financial arrangements, the elective methods do not apply to financial arrangements legally entered into by Company C.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part X

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 section 230-10

Income Tax Assessment Act 1997 section 230-50

Income Tax Assessment Act 1997 subsection 230-50(1)

Income Tax Assessment Act 1997 section 230-55

Income Tax Assessment Act 1997 subsection 230-55(4)

Income Tax Assessment Act 1997 paragraph 230-55(4)(a)

Income Tax Assessment Act 1997 paragraph 230-55(4)(b)

Income Tax Assessment Act 1997 paragraph 230-55(4)(c)

Income Tax Assessment Act 1997 paragraph 230-55(4)(d)

Income Tax Assessment Act 1997 paragraph 230-55(4)(e)

Income Tax Assessment Act 1997 paragraph 230-55(4)(f)

Income Tax Assessment Act 1997 subsection 230-45(1)

Income Tax Assessment Act 1997 section 230-60

Income Tax Assessment Act 1997 section 230-65

Income Tax Assessment Act 1997 subsection 230-460(1)

Income Tax Assessment Act 1997 subsection 230-460(12)

Income Tax Assessment Act 1997 Subdivision 974-B

Income Tax Assessment Act 1997 Subdivision 974-C

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)(b)

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 paragraph 974-70(1)(b)

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

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

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Summary

Yes. The Company Y Shares constitute a financial arrangement under subsection 203-50(1) of the ITAA 1997 as it is an equity interest pursuant to section 974-70 of the ITAA 1997 and is not a debt interest under subsection 974-15(1) of the ITAA 1997.

Detailed reasoning

Financial arrangement

The definition of 'financial arrangement' determines the unit of taxation in respect of which gains and losses are recognised under Division 230 of the ITAA 1997. To determine whether gains and losses arise under a financial arrangement, it is first necessary to establish whether the relevant rights and obligations under consideration give rise to an 'arrangement' that in turn meets the definition of a financial arrangement.

Equity Interest

Subsection 230-50(1) of the ITAA 1997 provides that you have a financial arrangement if you have an equity interest and also that the equity interest constitutes the financial arrangement.

Section 974-70 of the ITAA 1997 provides that a scheme will give 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) of the ITAA 1997 and is also not characterised as a debt interest under Subdivision 974-B of the ITAA 1997.

Subsection 995-1(1) of the ITAA 1997 provides that the term 'equity interest' takes it's meaning as per Subdivision 974-C of the ITAA 1997. The test as to whether the Company Y shares are an equity interest is found in subsection 974-75(1) of the ITAA 1997. Relevantly, item 1 of subsection 974-75(1) of the ITAA 1997 provides, 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:

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

The Company Y shares meet the equity test in this subsection as, pursuant to the terms of the shareholders agreement; they are an interest in the company as a member or stockholder of the company (Item 1 of subsection 974-75(1) of the ITAA 1997).

Debt Interest

Paragraph 974-70(1)(b) of the ITAA 1997 provides that where an interest satisfies both the debt and equity tests, it is to be treated as a debt interest. Accordingly, we must consider whether the Company Y shares meet the definition of a debt interest.

Subsection 974-15(1) of the ITAA 1997 provides that a scheme will give rise to a debt interest in an entity if the scheme satisfies the debt test. The test for a debt interest is found in section 974-20 of the ITAA 1997. Section 974-20(1) of the ITAA 1997 provides:

(1) 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).

It is not necessary for the taxpayer to satisfy the requirement in Subsection 974-20(1) of the ITAA 1997 as the Company Y shares are shares in the legal form pursuant to Item 1 of the table in subsection 974-75(1) of the ITAA 1997

Pursuant to paragraph 974-20(1)(b) of the ITAA 1997, under the shareholders agreement, the company will receive a financial benefit, being the equity contributions in Company Y at the time the Company Y Shares are issued.

Paragraph 974-20(1)(c) of the ITAA 1997 requires the entity, or the entity and a connected entity of the entity, to have an effectively non-contingent obligation ('ENCO') under the scheme to provide a financial benefit to one or more entities after the financial benefit in paragraph 974-20(1)(b) is received.

The issue of a share that is an equity interest in the issuer is not the provision of a financial benefit by the issuer. However, any periodic payments by the issuer to the holder, and a payment by the issuer to the holder to return the amount invested will be relevant financial benefits, if the issuer is under an effectively non-contingent obligation to provide them.

Company Y does not have an ENCO to pay any amounts to Company G as the distribution of profits are, under the shareholders agreement, contingent on various conditions including: the existence of a net profit for Company Y, requirements under applicable laws, requirements under the Financing Documents and the satisfaction of the approved capital needs as set forth in Company Y's annual company budget.

The Company Y shares, having satisfied the equity test contained in subsection 974-75(1) of the ITAA 1997 and not having satisfied the debt test in subsection 974-15(1) of the ITAA 1997 will be characterised as an equity interest.

Therefore, under subsection 230-50(1) of the ITAA 1997, the Company Y shares will constitute a financial arrangement for Company G.

Question 2

Summary

No. The rights and obligations to receive or provide financial benefits under the agreement, the shareholders agreement and the Company Y shares do not form one aggregated arrangement for the TCG.

Detailed reasoning

Paragraph 2.47 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Act 2009 (the EM) provides that generally a contract will constitute the relevant arrangement for TOFA purposes. However, section 230-55 of the ITAA 1997 contains grouping and disaggregation rules which may operate to group rights and obligations under a number of contracts into one arrangement or alternatively to disaggregate rights and obligations into a number of arrangements.

Subsection 230-55(4) of the ITAA 1997 lists the factors relevant to determining what rights or obligations constitute particular arrangements.

The way various rights and obligations are combined under subsection 230-55(4) of the ITAA 1997 is an objective enquiry, the purpose of which is to identify the correct 'unit of taxation' upon which the provisions of Division 230 apply.

Paragraph 230-55(4)(a): the nature of the rights and/or obligations

Paragraph 230-55(4)(a) of the ITAA 1997 requires consideration of the substance of the relevant rights or obligations. In other words, you must consider whether the legal form reflects the economic substance and if so, whether the nature of the rights and obligations are such that the separate agreements would not have been entered into without the other.

It is considered that the nature and substances of the agreements are such that it is unlikely that the agreement, shareholders agreement and Company Y Shares would have been entered into independently.

The rights and obligations in the Company Y shareholders agreement were created under the agreement as well as being created on the same day as the agreement. The shareholders agreement and agreement were entered into at the same time.

Therefore, this factor supports the notion that the arrangement constitutes an aggregated arrangement.

Paragraph 230-55(4)(b): their terms and conditions (including those relating to any payment or other consideration for them)

Under paragraph 230-55(4)(b) of the ITAA 1997 it is necessary to consider terms and conditions relating to payment and consideration. Where one amount is calculated and paid as consideration for a number of rights, this will tend to suggest an aggregation of those rights.

Company X and Company C were obligated to make equity contributions in Company Y. In exchange for the investment Company C received the right (but not the obligation) to sell their share in Company Y to the Counterparties.

In respect of this factor, the inter-relation of the various terms and conditions supports the notion that the arrangement constitutes an aggregated arrangement.

Paragraph 230-55(4)(c): the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved)

Paragraph 230-55(4)(c) of the ITAA 1997 requires consideration of the context surrounding the life-cycle of the rights or obligations from creation to the proposed exercise or performance - this is what is meant by "circumstances surrounding".

The objective purpose of the entities involved must be assessed when considering this factor. Subjective purpose is relevant but not determinative.

It is considered that in substance, the arrangement was effected to make an investment in a the Project and to provide the associated finance. This objective is achieved by the combined operation of the relevant agreements.

This factor supports the notion that the arrangement constitutes an aggregated arrangement.

Paragraph 230-55(4)(d): whether they can be dealt with separately or must be dealt with together

Paragraph 230-55(4)(d) of the ITAA 1997 requires consideration of whether rights or obligations can be dealt with separately or whether they must be dealt with together in accordance with the terms and conditions of the arrangement. Paragraph 19 of TR 2012/4 provides that when considering the factor under paragraph 230-55(4)(d) of the ITAA 1997 that the legal, rather than commercial, constraints are to be considered.

Legally, the agreement and the shareholders agreement including the Put and Call options can (and have) operated separately and independently of each other. The shareholders agreement can survive even after the agreement has been extinguished and the rights under the agreement can be assigned independently of the Company Y shares.

This factor supports the notion that the arrangement comprises of separate arrangements.

Paragraph 230-55(4)(e): normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole)

Paragraph 230-55(4)(e) of the ITAA 1997 requires consideration of the normal commercial understanding and practices in relation to the rights or obligations. Where normal commercial understandings and practices regard a number of rights or obligations as one aggregated whole, it will tend to suggest aggregation.

It is accepted that the share subscription in Company Y, the financing arrangements under the agreement and the Put and Call Options would, in normal commercial practice, be considered separate arrangements.

This factor supports the notion that the arrangement comprises of separate arrangements.

Paragraph 230-55(4)(f): the object of this Division

The objects of Division 230 of the ITAA 1997 are stipulated in section 230-10 of the ITAA 1997. The objects of Division 230 are:

· To minimise the extent to which the tax treatment of gains and losses from your financial arrangements distorts, by providing inappropriate impediments and stimulation, your trading, financing and investment decisions and your risk taking and risk management.

· To do so by aligning more closely the tax and commercial recognition of gains and losses from your financial arrangements in the following ways:

(i) By allocating the gains and losses to income years throughout the life of your financial arrangements on a reasonable basis.

(ii) By generally recognising gains and losses on revenue rather than capital account.

(iii) To appropriately take account of, and minimise, your compliance costs.

As established in Question 1 of this ruling, the Company Y Shares constitute a financial arrangement by virtue of being equity interests. However, Company G's shareholding in Company Y also represents a participation interest in a CFC under Part X of the ITAA 1936. As a result of the concurrent operation of Division 230 and Part X, subsections 230-460(1) and 230-460(12) of the ITAA 1997 operate to except the gains and losses arising from a direct participation interest in a CFC from the application of Division 230.

Furthermore, inferring from the design of Division 230 of the ITAA 1997, it is considered that it is intended that the limited application purpose for section 230-50 of the ITAA 1997 financial arrangements ought to take precedence over the purpose that Division 230 ought to apply to all cash settlable financial arrangements.

Therefore, the Company Y Shares (as an equity interest) should not be brought to account as part of an aggregated arrangement under Division 230 of the ITAA 1997, as their inclusion would override a specific exclusion to the TOFA regime that applies (section 230-460(12) of the ITAA 1997). It is considered that the Company Y Shares, for the purposes of Division 230, should be treated as a separate financial arrangement, rather than in conjunction with the agreement and the shareholders agreement s as part of an aggregated arrangement.

This factor supports the notion that the arrangement should be considered to comprise of separate arrangements.

Conclusion

On balance, after consideration of the factors listed in paragraphs 230-55(4)(a) to (f) of the ITAA 1997, it is concluded that the rights and obligations to receive or provide financial benefits under the agreement, the shareholders agreement and the Company Y Shares should not form one aggregated arrangement for the TCG.