Edited version of your private ruling

Authorisation Number: 1012460161928

Ruling

Subject: Syndicated loan facility and deductibility of underwriting fee

Relevant facts and circumstances

The applicant is the head company of a tax consolidated group and submitted an application for a private ruling (the application) on the tax treatment of aspects of its syndicated loan facility.

The Appendix to the application comprised copies of three documents relating to the syndicated loan facility, as follows:

· Fee Letter with attached Term Sheet

· Commitment Letter; and

· Syndicated Facility Agreement.

Two entities were jointly the Mandated Lead Arrangers, Underwriters and Bookrunners (MLAUBs) in relation to underwriting the applicant's Syndicated Facility Agreement (SFA).

The application sets out the following facts in respect of the Underwriting Fee:

Under a syndicated loan arrangement, the borrower can appoint an arranger that agrees to 'underwrite' the required facility. 'Underwriting' is where the arrangers guarantee the entire commitment, and then syndicate the loan. If the arrangers cannot fully subscribe the loan, they are forced to absorb the difference

The applicant requested that the arranger (the MLAUBs) underwrite the availability of the funds. In consideration for this guarantee, the applicant agreed to pay the MLAUBs the Underwriting Fee.

The Underwriting Fee relates to the underwriting of the Commitment Amount. The applicant considered this to be payment by for the provision of a service, being the underwriting and not the establishment of the facility.

The Fee Letter states that the applicant agreed to pay the MLAUBs an Underwriting Fee on the date of the SFA. The Underwriting Fee was calculated as a percentage of the Total Commitment Amount.

A condition of the Commitment Letter is that the applicant requires prior written consent from the MLAUBs for an assignment.

The Commitment Letter stated that the Commitment Documents set out the entire agreement between the parties with respect to the matters which they address.

The Term Sheet sets out the broad terms and conditions of the syndicated loan facility and states that the Facilities have termination dates four years from the signing of the Facility Agreement.

The SFA defines the purposes for which each Facility may be applied.

In the SFA, the rate of interest on each loan will be an aggregate of the Margin and the applicable bank bill rates.

Utilisation (draw down) is effected by the applicant tendering a certificate evidencing compliance with the Guarantor Coverage Test.

The terms and conditions of the draw downs are established when each draw down is entered into (according to clauses in the SFA).

The common link is the overall credit limit, as is the calculation of the interest rate on each Loan, within the Facilities.

The application includes the following details:

As noted in the Commitment Letter, the commitment was fully credit approved by the MLAUBs and was not subject to any further approvals.

The applicant was entitled to select an interest period of 1, 2, 3, 4, 5 or 6 months or any other period that the Agent agreed with the applicant that would apply to a Loan and agreed to repay the Loan on the last day of the Interest Period.

No TOFA elections under Division 230 have been made by the applicant.

The applicant provided the further information, as follows:

The quantum of the Underwriting Fee did not affect either the interest rate charged on the Facility, the total amount available under the Facility or the format of the Facility.

The funding proposals included the relevant terms for the Facility including for the Underwriting Fee. The funding proposals provided for the Facility to either be underwritten or not and the terms of the Facility included in the proposals were the same irrespective of whether the Facility was underwritten or not.

At the time of the underwriting the applicant had upcoming business funding requirements and had not yet secured a source to fund those requirements, therefore the preparedness of the MLAUBs to provide the funding was essential.

The applicant paid the Underwriting Fee to obtain certainty that, if required, it would be able to draw down funds up to the Commitment Amount irrespective of the MLAUBs securing syndication of the Facility.

By paying the Underwriting Fee, the applicant was able to ensure that the Commitment Amount would be available in advance of the MLAUBs securing syndication of the Facility.

In the event that the SFA was not entered into, the MLAUBs would be required to obtain funds for the applicant up to the Commitment Amount.

The applicant confirmed that the phrase 'forced to absorb the difference' meant that in the event the MLAUBs could not syndicate the Facility, then the underwriters would be required to make available the difference between the funds available under the Commitment Letter and the funds actually provided by MLAUBs.

The terms and conditions of the SFA offered to the applicant operate as a pre-determined credit limit and the applicant is not obligated to make any drawdown. Further, the applicant may draw down different amounts from the Facilities at varied Interest Periods.

Question 1

Is each draw down under the syndicated facility agreement a separate 'financial arrangement' under subsection 230-55(4) of the ITAA 1997?

Answer

Yes.

Question 2

(a) Is the Underwriting Fee a cost of the draw downs under section 230-60 of the ITAA 1997?

(b) Does the Underwriting Fee play an integral role in determining whether the applicant makes a gain or loss under the draw downs under section 230-60 of the ITAA 1997?

Answer

(a) No.

(b) No.

Question 3

Will the Underwriting Fee be treated as expenditure incurred for borrowing money under section 25-25 of the ITAA 1997?

Answer

No.

Question 4

Will the Underwriting Fee be deductible in the year ended 30 June 2012 (i.e. in the income year it was incurred/paid) under section 8-1 of the ITAA 1997?

Answer

Yes.

The scheme commences

Post 1 July 2010

Relevant legislative provisions

Income Tax Assessment Act 1936, Part IVA

Income Tax Assessment Act 1997, section 8-1

Income Tax Assessment Act 1997, section 25-25

Income Tax Assessment Act 1997, Division 230

Income Tax Assessment Act 1997, subsection 230-20(2)

Income Tax Assessment Act 1997, subsection 230-20(3)

Income Tax Assessment Act 1997, subsection 230-20(4)

Income Tax Assessment Act 1997, section 230-45

Income Tax Assessment Act 1997, subsection 230-45(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, section 230-60

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

Reasons for decision

Question 1

Is each draw down under the syndicated facility agreement a separate 'financial arrangement' under subsection 230-55(4) of the ITAA 1997?

Answer

Yes.

Detailed reasoning

Division 230 of the ITAA 1997 provides for the taxing of gains and losses arising on certain financial arrangements that a taxpayer starts to have in income years commencing on or after 1 July 2010 and operates in priority to other tax provisions (subsections 230-20(2), 230-20(3) and 230-20(4) of the ITAA 1997).

Arrangement

The first step in applying Division 230 of the ITAA 1997 is identification of the relevant arrangement (subsection 230-45(1) of the ITAA 1997. The term 'arrangement' is identified in subsection 995-1(1) of the ITAA 1997 as being '…any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.'

The Explanatory Memorandum (EM) which accompanied the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 states at paragraph 2.47 that the various rights and obligations subsisting under a contract will typically constitute the relevant arrangement for the purposes of Division 230 of the ITAA 1997. When determining what is the relevant arrangement a contract is neither aggregated with another contract (or contracts), nor disaggregated into component parts.

Subsection 230-55(4) of the ITAA 1997 provides that: whether a number of rights and or obligations are themselves an arrangement or are two or more separate arrangements, is a question of fact determined by having regard to the factors specified in paragraphs 230-55(4)(a) to (f) of the ITAA 1997, as follows:

230-55(4)

For the purposes of this Division, whether a number of rights and/or obligations are themselves an *arrangement or are 2 or more separate arrangements is a question of fact and degree that you determine having regard to the following:

(a) the nature of the rights and/or obligations;

(b) their terms and conditions (including those relating to any payment or other consideration for them);

(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);

(d) whether they can be dealt with separately or must be dealt with together;

(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);

(f) the objects of this Division.

In applying this subsection, have regard to the matters referred to in paragraphs (a) to (f) both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other.

The factors

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

The applicant has entered into a facility agreement with the MLAUBs for a syndicated loan facility, upon it satisfying a number of conditions precedent. These conditions will be satisfied on each valid draw down, as utilisation (draw down) is effected by the applicant tendering a certificate evidencing compliance with the Guarantor Coverage Test.

The Facilities have pre-determined credit limits arising under the facility agreement and are each of a nature such that they create further rights and obligations on each draw down, which have the effect of differentiating the loans by purpose, term and interest rate.

The structure of the syndicated loan facility is similar to Example 9 - Multi-Option Facility Agreement (separate arrangements) in Taxation Ruling TR 2012/4 in that there is:

· no specific project

· an overall credit limit approved by the agreement

· credit limits for individual products (Facilities)

· with each product having its own rights and obligations; and

· operating independently.

The Facilities are set out in the SFA and are in effect compartmentalised by broad descriptors of their purpose which range from general corporate purposes to acquisitions and financial guarantees and to refinancing existing financial indebtedness to capital expenditure. Furthermore, each draw down may have separate maturity dates and interest rates.

The circumstances discussed above tend to indicate that each draw down is a separate arrangement.

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

Subject to the terms of the SFA, lenders have made funds available to the applicant according to the terms and conditions of the Facilities. The applicant has the right to request funds and the lenders have a contingent obligation to provide them, subject to the former providing a valid utilisation certificate and thereby satisfying conditions placed on the particular Facility and Tranche for the draw down (as discussed under the previous sub-heading).

There is no draw down schedule for the syndicated loan facility but rather as a consequence of the agreement, the availability of funds for specified purposes capped at various amounts within an overall total. There is no certainty that funds will be drawn down nor is the timing of any draw down known.

As a consequence of these circumstances the interest rates and the terms of the loan draw downs that occur will be variable and, as previously mentioned, they will not be subject to a schedule, which when taken into consideration with the other characteristics of this criterion (paragraph 230-55(4)(b)) suggest that the draw downs are separate arrangements.

The terms and conditions of the draw downs are established when each of the draw downs is entered into. The interest period of each draw down is selected at the time a Utilisation Request is made, and is separate for each Facility's draw down. The common link is the overall credit limit, as is the calculation of the interest rate on each Loan. The applicant has stated:

… the terms and conditions of the SFA that was offered to the applicant operates as a pre-determined credit limit and the applicant is not obligated to make any drawdown. Further, the applicant may draw down different amounts from the Facilities at varied Interest Periods.

The circumstances of the terms and conditions tend to indicate that each draw down is a separate 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)

All draw downs will be subject to the purposes set out in the Term Sheet and in the SFA, which in effect compartmentalises the draw downs according to purpose, as stated above. This tends to indicate that there are a variety of purposes for each of the Facilities.

The scope of the first Facility, makes clear that the syndicated loan facility does not make funds available for a sole purpose nor any form of draw down schedule and therefore all funds within a facility may not be utilised. For example, one of the purposes of one of the Tranches is 'general corporate purposes' which provides the applicant with flexibility in loan creation, exercise and performance, within the overall terms and conditions of the agreement. In view of this and other characteristics of the facility it is to be expected that draw downs will occur at different times and for different purposes and subject to a range of periods and rates of interest. The aspects of this criterion ((paragraph 230-55(4)(c)) suggest each draw down is a separate arrangement.

The circumstances surrounding the creation of the rights and obligations, and their proposed exercise and performance, are that the applicant has arranged a framework (with an overall credit limit) within which it can enter into various draw downs with the MLAUBs for a range of purposes at different times. This tends to indicate that each draw down is a separate arrangement.

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

As stated in the discussion under previous sub-headings, draw downs within different tranches are in effect compartmentalised and there are limits imposed according to purpose and this is imposed formally in the process for utilisations. Utilisation is effected by the applicant tendering a certificate evidencing compliance with the Guarantor Coverage Test which must satisfy the terms and conditions of either Facility, and within the applicable tranches and provisions.

Within these constraints there is further separation as a result of funding across a four year period, without predetermined timing of the draw downs, across the range of purposes the SFA serves. As a result, a variety of periods and different interest rates will result, all of which suggests each draw down is a separate arrangement.

The rights and obligations under each draw down may be dealt with separately and do not need to be dealt with together. For example, the repayment of each draw down under a particular Facility loan is calculated separately with respect to interest and repayment dates. Amounts under the Working Capital Tranche may be reborrowed; in contrast, no amounts under another Facility may be reborrowed. The amount owed on an old advance under the Working Capital Tranche may be reduced by amounts owed on a new advance. This tends to indicate that each draw down is a separate arrangement.

On balance, the circumstances of this criterion tend to indicate that each draw down is a separate arrangement.

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)

Given the compartmental arrangement of the facilities and the tranches within them, the draw downs will be staggered over the four year term and within that period for a variety of terms and interest rates, therefore normal commercial understandings and practices would regard each draw down as a separate arrangement.

Normal commercial understandings and practices are that each draw down is a separate arrangement in its own right. Each draw down is accounted for separately, and has terms that are agreed to at the time the utilisation request is made. This tends to indicate that each draw down is a separate arrangement.

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

Treating each draw down as a separate arrangement is not inconsistent with the objects of Division 230. The tax recognition of each draw down as a separate arrangement will not tend to distort commercial decision making (rather the funds are merely available if required) and appropriately reflects the commercial substance of the arrangement (paragraph 104 of TR 2012/4). This tends to indicate that each draw down is a separate arrangement.

Conclusion

For Division 230 purposes, subsection 230-55(4) will identify each draw down as a separate arrangement.

In sum, the matters referred to in the paragraphs (a) to (f) point to the flexibility and multi-option nature of the syndicated loan facility, as described in Example 9 - Multi-Option Facility Agreement (separate arrangements) in TR 2012/4.

The commercial substance of the draw downs is that they represent the spectrum of the operations of the applicant, a consolidated group for tax purposes and a multifarious commercial operation. Treating the rights and obligations of the draw downs under the SFA as separate arrangements is in accord with the applicant's business and normal commercial understandings and practices and is not inconsistent with the objects of Division 230.

Is each draw down a financial arrangement?

Section 230-45 of the ITAA 1997 states:

230-45(1) You have a financial arrangement if you have, under an *arrangement:

(a) a *cash settlable legal or equitable right to receive a *financial benefit; or

(b) a cash settlable legal or equitable obligation to provide a financial benefit; or

(c) a combination of one or more such rights and/or one or more such obligations;

unless:

(d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and

(e) for one or more of the rights and/or obligations covered by paragraph (d):

(i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or

(ii) the right or obligation is not cash settlable; and

(f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).

The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.

As previously stated, 'arrangement' is defined very broadly in subsection 995-1(1) of the ITAA 1997. The draw downs would fall within that broad definition of an arrangement as the preceding discussion of the criteria for subsection 230-55(4) has made clear that the draw downs meet the criteria of '… any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.'

In order for the arrangement to be a financial arrangement, it must give rise to a cash settlable legal or equitable right to receive a financial benefit or a cash settlable legal or equitable obligation to provide a financial benefit.

Subject to the terms of the SFA, the applicant has the right to request funds and the lenders have a contingent obligation to provide them. The applicant is obliged to pay principal and interest in respect of the draw downs pursuant to sections of the SFA. As the draw downs and, in turn, the principal and interest payments will be satisfied by payment of money, the arrangement gives rise to legal or equitable obligations to provide cash settlable financial benefits.

Accordingly, each draw down is a financial arrangement pursuant to section 230-45 of the ITAA 1997 and as determined above, a separate arrangement under subsection 230-55(4) of the ITAA 1997.

Question 2

(a) Is the Underwriting Fee a cost of the draw downs under section 230-60 of the ITAA 1997?

(b) Does the Underwriting Fee play an integral role in determining whether the applicant makes a gain or loss under the draw downs under section 230-60 of the ITAA 1997?

Answer

(a) No.

(b) No.

Detailed reasoning

Applicant's view

The applicant has argued that 'the Underwriting Fee was not provided in satisfaction of the rights of the applicant to draw down funds under the Facilities', rather it was a payment for guaranteeing the Commitment Amount and syndication of the facility. As stated in the application:

…the underwrite is effectively an "insurance fee" charged by the MLAUBs if they were unable to syndicate the Commitment Amount and does not create a right under which the applicant is able to draw down amounts under the SFA.

The applicant cites paragraph 3.36 of the EM in discussing what is integral to a gain or loss from a financial arrangement:

What is considered essential or integral will be determined by the nature or purpose of the financial benefit that is taken to be provided or received under the financial arrangement.

The applicant considered that the payments of principal and interest are clearly integral to determining whether a gain or loss will arise under a draw down (the relevant financial arrangement). However, the cost of the Underwriting Fee incurred by the applicant is distinguished on the basis that it does not relate to the draw downs, but instead is 'a cost to the MLAUBs underwriting the Commitment Amount before the SFA was entered into'. That is, it is a cost of ensuring that the funds were available.

The applicant concludes that because the Underwriting Fee is neither a cost of the draw downs nor integral to determining their gains or losses, it falls outside the scope of Division 230.

(a) Is the Underwriting Fee a cost of the draw downs under section 230-60 of the ITAA 1997?

Legislation

Financial benefit provided under financial arrangement

230-60(1)

You are taken, for the purposes of this Division, to have (or to have had) an obligation to provide a *financial benefit under a *financial arrangement if:

(a) you have (or had) an obligation to provide the financial benefit in relation to the arrangement; and

(b) the financial benefit would not otherwise be treated as one that you have (or had) an obligation to provide under the arrangement; and
(c) the financial benefit plays an integral role in determining:

(i) whether you make a gain or loss from the arrangement; or

(ii) the amount of such a gain or loss.

Paragraph (a) applies even if the entity to which you provide the financial benefit is not a party to the arrangement.

Note: This means that the financial benefits you provide to acquire the financial arrangement (whether to the issuer, a previous holder or a third party) are taken to be financial benefits you provide under the arrangement. The financial benefits you provide may include, for example, fees paid or the forgoing of rights to receive a financial benefit.

Financial benefit received under financial arrangement

230-60(2)

You are taken, for the purposes of this Division, to have (or to have had) a right to receive a *financial benefit under a *financial arrangement if:

(a) you have (or had) a right to receive the financial benefit in relation to the arrangement; and

(b) the financial benefit would not otherwise be treated as one that you have (or had) a right to receive under the arrangement; and

(c) the financial benefit plays an integral role in determining:

(i) whether you make a gain or loss from the arrangement; or

(ii) the amount of such a gain or loss.

Paragraph (a) applies even if the entity that provides the financial benefit is not a party to the arrangement.

Explanatory Memorandum

Section 230-60 of the ITAA 1997 is concerned with the reasonable allocation of costs and proceeds of financial arrangements (EM paragraph 3.33). The EM states (at paragraphs 3.35 - 3.40):

3.35 …Specifically, the costs of, and proceeds from a financial arrangement will also include other financial benefits received or provided (or those which the taxpayer is entitled to receive or obliged to provide) that play an integral role in determining whether the taxpayer will make a gain or a loss (or a gain or a loss of a particular amount) from the financial arrangement.

3.36 …What is considered to be essential or integral will be determined by the nature or purpose of the financial benefit that is taken to be provided or received under the financial arrangement.

3.37 Such integral financial benefits may include the costs incurred to acquire the financial arrangement (including, for example, any application or processing charges, in addition to the specific consideration for the relevant rights and obligations under the arrangement) and amounts received on transfer or cessation of all or part of the financial arrangement. …

3.38 More generally, what is considered to be integral or essential to determining whether the taxpayer makes a relevant gain or loss from the financial arrangement can be determined by commercially accepted principles and the relevant facts and circumstances of each arrangement. …

3.39 It is possible that a financial benefit could be considered integral to more than one financial arrangement. An example would be where a fixed and indivisible fee is to be provided to acquire either one or more financial arrangements. In this circumstance, it will be necessary to apportion on a reasonable basis the actual amount of the financial benefit between the financial arrangements. This will ensure that the gain and loss from each financial arrangement reflects the proper apportionment of the financial benefit. [Schedule 1, item 1, section 230-65]

3.40 Also a financial benefit may be provided or received as consideration for starting or ceasing to have one or more things which themselves are not financial arrangements. Where this occurs the amount of financial benefit needs to be apportioned, between the financial arrangement and other things on a reasonable basis. This means that only that part of the amount of the financial benefit that plays an integral role to the financial arrangement is taken to be received or provided under the arrangement. [Schedule 1, item 1, section 230-65]

The nature or purpose of the applicant providing a financial benefit (paying the Underwriting Fee) was to ensure that the funds were available. Underwriting was necessary because of the applicant's lack of credit history and uncertainty as to whether it would be able to obtain funds to refinance its debt facilities and capital expenditure.

National Tax Liaison Group (NTLG) TOFA issue 176

The NTLG Finance and Investments Sub-group considered the issue of establishment fees under a facility agreement where the facility agreement and each draw down are separate financial arrangements: NTLG TOFA issue 176, Borrowing costs incurred on entering into a facility agreement.

Whether or not certain fees may be regarded as integral to both the facility agreement and subsequent draw downs (which could be separate financial arrangements) was an issue before the NTLG. On one view, there should be a bifurcation of the fee to both the facility agreement and subsequent draw downs. On another view, fees considered in the example are not integral to the facility agreement alone (and not to any subsequent draw down).

This issue has been finalised and the findings are published on the Australian Taxation Office's (ATO's) NTLG website reflecting that in some instances there will be a clear and proximate connection between the fee and the facility agreement or draw down. In the current matter the question is whether the Underwriting Fee has a sufficient connection (in the sense of being integral) to the gains and losses in respect of the draw downs.

The Underwriting Fee is a separate financial arrangement that enables the applicant to ensure funds are available for its commercial purposes. Furthermore, there is no schedule of draw downs under either Facility. In these circumstances and with the benefit of the NTLG finding (noting that establishment fees are considered too remote where there is no schedule of draw downs) we conclude that the Underwriting Fee is not 'integral' to calculating gains or losses under section 230-60 of the ITAA 1997.

Question, (2 (a)), considers draw downs as the relevant arrangements.

Pursuant to section 230-60 of the ITAA 1997, the relevant financial arrangement is the payment of the Underwriting Fee (cash settlable financial benefit) by the applicant for the guarantee that the Commitment Amount would be made available to it by the MLAUBs until such time as the SFA would be entered into. The Underwriting Fee payment was integral to the guarantee that the Commitment Amount would be available to the applicant; in contrast, it is not integral to the calculation of the gain or loss made on each draw down. Each draw down is a separate arrangement unrelated to the Underwriting Fee.

Accordingly, the Underwriting Fee is not a cost of the draw down under section 230-60 of the ITAA97.

(b) Does the Underwriting Fee play an integral role in determining whether the applicant makes a gain or loss under the draw downs under section 230-60 of the ITAA 1997?

Detailed reasoning

As stated in answer to Question 2(a), the Underwriting Fee was integral to the guarantee that the Commitment Amount would be available to the applicant; in contrast, it is not integral to the calculation of the gain or loss made on each draw down. Each draw down is a separate arrangement unrelated to the Underwriting Fee.

Accordingly, the Underwriting Fee does not play an integral role in determining whether the applicant makes a gain or loss under the draw downs, under section 230-60 of the ITAA 1997.

Question 3

Will the Underwriting Fee be treated as expenditure incurred for borrowing money under section 25-25 of the ITAA 1997?

Answer

No.

Applicant's view

The applicant argues that the Underwriting Fee is not expenditure incurred for the borrowing of money under section 25-25 of the ITAA 1997. Instead, the payment of the Underwriting Fee was consideration paid by the applicant to the MLAUBs to ensure that the funds would be available. It was a fee paid for the provision of a service, being the Underwriting, and not the establishment of the Facility.

Detailed reasoning

Legislation

Section 25-25 of the ITAA 9797 states the following:

SECTION 25-25  Borrowing expenses  

25-25(1)

You can deduct expenditure you incur for ^*borrowing money, to the extent that you use the money for the ^*purpose of producing assessable income. In most cases the deduction is spread over the ^*period of the loan.

Subsection 25-25(1) of the ITAA 1997 allows a deduction for expenditure incurred by the taxpayer for borrowing money to the extent that the borrowed money is used for the purpose of producing assessable income.

The Underwriting Fee was paid in order to ensure that funds would be available in the event that the Facility was unable to be syndicated in time to meet the applicant's commercial requirements, or if only part of the Facility (i.e. not all of the Facility as stated in the Commitment Letter) was able to be syndicated.

As the SFA was entered into earlier than anticipated it was not necessary to call upon the Underwriting of funds for which the Underwriting Fee was paid. As no funds were provided to the applicant pursuant to the Underwriting Arrangement (rather, the funds were provided pursuant to the SFA), it cannot be said that the Underwriting Fee was an expense incurred by the taxpayer in borrowing money for the purpose of producing assessable income.

Accordingly, the Underwriting Fee will not be treated as an expense incurred in the borrowing of money under section 25-25 of the ITAA 1997.

Question 4

Will the Underwriting Fee be deductible in the year ended 30 June 2012 (i.e. in the income year it was incurred/paid) under section 8-1 of the ITAA 1997?

Answer

Yes.

Applicant's view

The applicant submits that the Underwriting Fee was a cost incurred by it, in relation to underwriting the Commitment Amount. The funds which were subsequently provided under the SFA were for general working purposes, used to fund certain acquisitions, and to refinance existing debt. The Underwriting Fee was therefore wholly incurred in carrying on a business for the purposes of gaining or producing assessable income.

The applicant submits that the negative limb of section 8-1 of the ITAA 1997 does not prevent the Underwriting Fee from being deductible. Applying the three considerations stated in Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337, the taxpayer reached the following conclusions:

· Character of the advantage sought - The Underwriting Fee was paid by the applicant for the provision of underwriting services by the MLAUBs; guaranteeing that the Commitment Amount would be available to it. There was no enduring benefit provided under the underwriting arrangement as the SFA was subsequently entered into. That is, the benefits arose in respect of the SFA.

· Manner in which the benefit used was to be relied upon - no benefit was obtained under the underwriting agreement as the borrowings were provided under the SFA.

· The means adopted to obtain it - the Underwriting Fee was a one off cost. Generally, only recurring expenditures are considered to be revenue in nature. The taxpayer submits that no weight be given to this consideration.

Detailed reasoning

Legislation

SECTION 8-1  General deductions  

8-1(1)  

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a ^*business for the purpose of gaining or producing your assessable income.

Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.

History

S 8-1(1) amended by No 90 of 2000

8-1(2)  

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(d) a provision of this Act prevents you from deducting it.

8-1(3) A loss or outgoing that you can deduct under this section is called a general deduction.

Note: If you receive an amount as insurance, indemnity or other recoupment of a loss or outgoing that you can deduct under this section, the amount may be included in your assessable income: see Subdivision 20-A.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, outgoings of a capital, private or domestic nature, or that relate to the earning of exempt income are not deductible.

Section 8-1 of the ITAA 1997 requires there be a connection or nexus between the loss or outgoing and the earning of assessable income in order for the outgoing to be deductible.

Purpose of the loss or outgoing

Expenditure will satisfy the positive limbs of section 8-1 of the ITAA 1997 (paragraphs 8-1(1)(a) and 8-1(1)(b)) if its essential character is that of expenditure that has a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income: Lunney v. Commissioner of Taxation (1958) 100 CLR 478; (1958) 11 ATD 404 at CLR 498-499; ATD 412-413.

The characterisation of particular expenditure is by its nature a question of fact. It involves an enquiry about what the expenditure was for and what it was intended to achieve in relation to the taxpayer's income earning activities or business from a practical and business point of view: Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation (1980) 49 FLR 183; 80 ATC 4542; (1980) 11 ATR 276 (Magna Alloys) at ATC 4549 and 4551; ATR 284 and 287 and Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190 at CLR 648; ATD 196.

Application to the taxpayer's circumstances

The Underwriting Fee was a cost incurred by the applicant in relation to underwriting the Commitment Amount. The funds which were subsequently provided under the SFA were for general operational purposes. The circumstances surrounding the creation of the rights and obligations, and their proposed exercise and performance, are that the applicant arranged a framework (with an overall credit limit) within which it could enter into various draw downs for different purposes when operationally required. The Underwriting Fee was therefore wholly incurred in carrying on a business for the purposes of gaining or producing assessable income (paragraph 8-1(1)(b)).

A similar agreement is that dealt with by Taxation Determination TD 2002/18 (TD 2002/18) in which a deduction under section 8-1 of the ITAA 1997 is allowable for underwriting fees paid as part of a harvest payment agreement. TD 2002/18 (page 1) deals with the circumstances where a grower enters into a harvest payment agreement or payment agreement, as follows:

the grower can elect to receive harvest advance drawing amounts or drawing amounts as a loan prior to receiving any distributions from a pool and have future pool distributions applied against the outstanding loan balance.

By paying a commercial underwriting fee, the grower can ensure a third party accepts the risk of any shortfall in pool distributions that would otherwise impact on the grower. As stated in TD 2002/18, 'in these circumstances there is sufficient nexus between the underwriting fee and the derivation of assessable income for the purposes of section 8-1' of the ITAA 1997.

Similarly, the applicant paid the Underwriting Fee in relation to underwriting the Commitment Amount. The funds which were subsequently provided under the SFA were for the applicant's operational expenses (as has been discussed in answer to the previous questions, in particular Question 1).

As in TD 2002/18, the applicant's circumstances are that 'there is sufficient nexus between the Underwriting Fee and the derivation of assessable income for the purposes of section 8-1' of the ITAA 1997.