Edited version of your private ruling

Authorisation Number: 1012497784108

Ruling

Subject: Application of the TOFA rules to a replacement financial arrangement

Question 1

For the purposes of subsection 230-45(1) of the Income Tax Assessment Act 1997 (ITAA 1997) will the financial arrangement be treated as a new financial arrangement?

Answer

Yes.

Question 2

For the purposes of subsection 230-435(1) of the ITAA 1997, has the termination of the financial arrangement resulted in a balancing adjustment for the taxpayer?

Answer

Yes.

Question 3

For the purposes of subsection 230-60(1) of the ITAA 1997, has the taxpayer provided a financial benefit to the Bank by undertaking to enter into the replacement financial arrangement?

Answer

Yes.

Question 4

Will the financial benefit identified in question 3 be included at Step 2(a) of the balancing adjustment method statement in subsection 230-445(1) of the ITAA 1997?

Answer

Yes.

Question 5

Under the replacement financial arrangement will the taxpayer receive a financial benefit as defined under subsection 974-160(1) of the ITAA 1997, from the Bank, being the value of the financial arrangement the Bank agreed to terminate?

Answer

Yes.

Question 6

Will the financial benefit identified in question 5 be treated as part of a 'thing' for the purposes of subparagraph 230-120(1)(a)(iii) of the ITAA 1997?

Answer

Yes.

Question 7

Will the financial benefits provided and received under the thing identified in question 6 accrue over the term of the replacement financial arrangement in accordance with Subdivision 230-B of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 2012 - 30 June 2013

The scheme commences on:

The scheme has commenced

Relevant facts and circumstances

Application of the taxation of financial arrangements (TOFA) rules to the taxpayer

The TOFA rules apply to taxpayer's financial arrangements that it started to hold during the income year commencing 1 July 2010.

The taxpayer has not made:

(a) any TOFA transitional election; or

(b) an election to use any of the Division 230 elective methods.

The taxpayer applies the default accruals or realisation method (as applicable) in accordance with Subdivision 230-B of the ITAA 1997.

Entry into the original financial arrangement

The taxpayer has entered in to a number of financial arrangements in order to manage its exposure to interest rate movements on underlying borrowings used to finance its investments.

The taxpayer entered the original financial arrangement with the Bank.

The taxpayer and the Bank are unrelated parties and were dealing at arm's length in relation to the original financial arrangement.

The replacement financial arrangement was not contemplated by the parties when they agreed to enter the original financial arrangement.

Termination of the original financial arrangement and entry into the replacement financial arrangement

The taxpayer was in an unrealised loss position in respect of the original financial arrangement. In other words, had the taxpayer sought to terminate the financial arrangement, it would have been required to pay to the Bank an amount equal to its loss on the original financial arrangement.

The taxpayer was in loss position on the original financial arrangement on the date that the original financial arrangement was terminated.

The taxpayer and the Bank agreed to:

(a) terminate the original financial arrangement; and

(b) embed the loss to the taxpayer associated with the termination of the original financial arrangement into a new financial arrangement (replacement financial arrangement).

The arrangement was detailed by the Bank in a letter to the taxpayer and the parties' agreement was documented in a termination letter (in respect of the original financial arrangement) and a confirmation letter (in respect of the replacement financial arrangement).

The terms of the replacement financial arrangement were designed to compensate the Bank for the fact that the taxpayer was in a loss position in respect of the original financial arrangement.

Relevant legislative provisions

Division 230 of the Income Tax Assessment Act 1997

Subdivision 230-B of the Income Tax Assessment Act 1997

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

Subsection 230-45(2) of the Income Tax Assessment Act 1997

Subsection 230-55(4) of the Income Tax Assessment Act 1997

Section 230-60 of the Income Tax Assessment Act 1997

Subsection 230-60(1) of the Income Tax Assessment Act 1997

Section 230-100(3A) of the Income Tax Assessment Act 1997

Subsection 230-110(1) of the Income Tax Assessment Act 1997

Subsection 230-115(9) of the Income Tax Assessment Act 1997

Section 230-120 of the Income Tax Assessment Act 1997

Subparagraph 230-120(1)(a)(iii) of the Income Tax Assessment Act 1997

Paragraph 230-120(b) of the Income Tax Assessment Act 1997

Subsection 230-120(3) of the Income Tax Assessment Act 1997

Subdivision 230-G of the Income Tax Assessment Act 1997

Subsection 230-435(1) of the Income Tax Assessment Act 1997

Paragraph 230-435(1)(b) of the Income Tax Assessment Act 1997

Subsection 230-445(1) of the Income Tax Assessment Act 1997

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

Section 995-1 of the Income Tax Assessment Act 1997

Compounding accruals or approximation

Section 230-135 of the ITAA 1997 provides 'how to spread a gain or loss to which the accruals method applies'.

Anti-avoidance rules

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

Issue 1

Question 1

Summary

For the purposes of subsection 230-45(1) of the Income Tax Assessment Act 1997 (ITAA 1997) the replacement financial arrangement will be treated as a new financial arrangement.

Detailed reasoning

The Law

Division 230 ITAA 1997 financial arrangement

Section 995-1 of the ITAA 1997 defines a *Division 230 financial arrangement as:

A *financial arrangement is a Division 230 financial arrangement if Division 230 of the ITAA 1997 applies in relation to your gains and losses from the arrangement.

Subsection 230-45(1) of the ITAA 1997 provides the definition of a *financial arrangement for the purposes of Division 230:

You have a financial arrangement if you have, under an *arrangement;

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

(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) ....

Subsection 974-160 of the ITAA 1997 sets out what, for the purposes of the ITAA 1997 is a financial benefit.

974-160(1) In this Act:

Financial benefit

(a) means anything of economic value; and

(b) includes property and services; and

(c) ......

even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.

Subsection 230-45(2) of the ITAA 1997 sets out when a right to receive or an obligation to provide a financial benefit is cash settlable. Paragraph 230-45(2)(a) provides that a right to receive or an obligation to provide a financial benefit is cash settlable, if and only if, the benefit is money or a money equivalent.

To determine whether the tests for a financial arrangement are satisfied, the particular arrangement to be tested must first be determined.

Subsection 230-55(4) of the ITAA 1997 lists the matters that are relevant to identifying whether a number of rights and/or obligations are themselves an arrangement or two or more separate arrangements for the purpose of Division 230.

Taxation Ruling TR 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997) in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 of the ITAA 1997 discusses the operation of subsection 230-55(4) in determining whether a number or rights and/or obligations are themselves an arrangement or are two or more separate arrangements for the purposes of Division 230.

Regard must be had to all of the matters referred to in paragraph (a) to (f) of subsection 230-55(4) of the ITAA 1997 and we do not consider that this factor alone would support aggregation of the original and replacement financial arrangement.

Therefore, from the facts provided the replacement financial arrangement meets the definition of financial arrangement under section 230-45(1) of the ITAA 1997. The original financial arrangement and replacement financial arrangement are not aggregated under section 230-55(4) of the ITAA 1997.

Question 2

Summary

For the purposes of subsection 230-435(1) of the ITAA 1997, the termination of the original financial arrangement has resulted in a balancing adjustment for the taxpayer.

Detailed reasoning

The Law

Paragraph 230-435(1)(b) of the ITAA 1997 provides that a balancing adjustment is made under Subdivision 230-G if 'all of your rights and/or obligations under a financial arrangement otherwise cease;'.

Application of the facts to your circumstances

As determined at question 1 above, the replacement financial arrangement is a new financial arrangement. When the taxpayer and the Bank terminated the original financial arrangement and entered into the replacement financial arrangement, the taxpayer's rights and obligations under the original financial arrangement ceased. Therefore the taxpayer is required to make a balancing adjustment in accordance with paragraph 230-435(1)(b) of the ITAA 1997 in respect of the original financial arrangement in order to recognise its overall gain or loss on that financial arrangement.

Question 3

Summary

For the purposes of subsection 230-60(1) of the ITAA 1997, the taxpayer has provided a financial benefit to the Bank by undertaking to enter into the replacement financial arrangement.

Detailed reasoning

The Law

Section 230-60 of the ITAA 1997 determines when a financial benefit has been provided or received under a financial arrangement.

Application of the law to your circumstances

At the time the original financial arrangement came to an end, the taxpayer had an obligation under the original financial arrangement to pay an amount to the Bank. The taxpayer discharged this obligation by entering into the replacement financial arrangement.

The definition of a financial benefit under subsection 974-160(1) of the ITAA 1997 includes anything of economic value.

Therefore, for the purposes of subsection 230-60(1) of the ITAA 1997, the taxpayer has provided a financial benefit to the Bank by undertaking to enter into the replacement financial arrangement.

Question 4

Summary

The financial benefit identified in question 3 will be included at Step 2(a) of the balancing adjustment method statement in subsection 230-445(1).

Detailed reasoning

The Law

Section 230-445 of the ITAA 1997 provides the method statement to be used when making balancing adjustments for the purposes of section 230-435.

Step 2(a) of subsection 230-445(1) includes in the balancing adjustment 'the total of all the *financial benefits you have provided under the *financial arrangement.'

Application of the law to your circumstances

As determined in question 2 above, the taxpayer will make a balancing adjustment in accordance with paragraph 230-435(1)(b) of the ITAA 1997 in respect of the original financial arrangement in order to recognise its overall gain or loss on the financial arrangement.

In accordance with step 2(a) of subsection 230-445(1) of the ITAA 1997, the balancing adjustment will include the financial benefits provided to the Bank under the original financial arrangement.

Question 5

Summary

Under the replacement financial arrangement the taxpayer will receive a financial benefit as defined under subsection 974-160(1) of the ITAA 1997, from the Bank, being the value of the financial arrangement the Bank agreed to terminate.

Detailed reasoning

The definition of a financial benefit under subsection 974-160(1) of the ITAA 1997 includes anything of economic value.

Under the replacement financial arrangement the discharge of the existing obligation to pay the Bank an amount is a financial benefit received by the taxpayer under the replacement financial arrangement for an amount equal to the market value of that right. (Subsection 230-505(2) ITAA 1997).

Question 6

Summary

The financial benefit identified in question 5 will be treated as part of a 'thing' for the purposes of subparagraph 230-120(1)(a)(iii) of the ITAA 1997.

Detailed reasoning

The Law

Financial arrangements with notional principal

Section 230-120 of the ITAA 1997 provides special rules for determining the timing of gains and losses for TOFA purposes from financial arrangements which involve a notional principal.

When you have a notional principal contract, subsection 230-120(1) calls upon a taxpayer to separate the financial benefits that are calculated by reference to or are reasonably related to a notional principal from other things that are not calculated by reference to a notional principal.

The financial benefits that are provided by reference to or are reasonably related to a notional principal are referred to as "legs" (Paragraph 230-120(1)(a) ITAA 1997).

Paragraph 230-120(1)(b) requires that the financial benefits you start to have in relation to a leg of a arrangement that is a notional principal contract must be of equal value to the financial benefits you start to have in relation to the other leg of the same notional principal contract.

Anything else that you have in relation to the notional principal contract is referred to as a "thing". (Subparagraph 230-120(1)(a)(iii) ITAA 1997).

Application of the law to your circumstances

Applied to the financial arrangement that is the replacement financial arrangement, the taxpayer is deemed by paragraph 230-120(1)(b) of the ITAA 1997 to have two legs of equal value in respect of which financial benefits are to be provided or received.

Therefore, under the replacement financial arrangement, the financial benefit, being the discharge of existing obligation to pay an amount to the Bank is part of a 'thing' for the purposes of subparagraph 230-120(1)(a)(iii) of the ITAA 1997.

Question 7

Summary

The financial benefits provided and received under the thing identified in question 6 will accrue over the term of the replacement financial arrangement in accordance with Subdivision 230-B of the ITAA 1997.

Detailed reasoning

Under Division 230 of the ITAA 1997, the time when gains from financial arrangements are included in assessable income depends on the particular tax-timing method used to calculate the gains and losses. Where no tax-timing method elections have been made by an entity, the time at which the gains are included in assessable income is determined by reference to Subdivision 230-B of the ITAA 1997.

Subdivision 230-B of the ITAA 1997 contains the default TOFA tax-timing methods: the accruals and realisation methods. If gains and losses from a financial arrangement are sufficiently certain, Subdivision 230-B of the ITAA 1997 applies the accruals method to determine their amount and timing.

Further to question six above, if subsection 230-120(1) of the ITAA 1997 applies to a financial arrangement and the financial arrangement includes a thing, subsection 230-120(3) will then require that you work out the gains and losses from that thing.

If the accruals method applies to the gain or loss from a thing, you take into account the amount relevant to that thing in a manner that properly reflects the way in which the financial benefits in respect of that thing are calculated.

Sufficiently certain gain or loss

Section 230-100(3A) applies the accruals method to a gain or loss that arises from a financial arrangement if;

·the gain or loss arises from a financial benefit you are to receive or provide,

·that gain or loss becomes sufficiently certain at the time you receive or provide it and

·at least part of the period over which the gain or loss would be spread occurs after the time you receive or provide the benefit.

Subsection 230-110(1) of the ITAA 1997 tells you when you have a sufficiently certain overall gain or loss from a particular event and subsection 230-115(9) provides that a taxpayer is deemed to have a sufficiently certain right to receive a financial benefit when that benefit is received.

Section 230-130 of the ITAA 1997 applies the accruals method to work out the period over which a gain or loss is to be spread.

Application of the facts to your circumstances

As determined at question six above, section 230-120 of the ITAA 1997 applies to the replacement financial arrangement.

Subsection 230-120(3) then requires that gains and losses from each 'leg' of the arrangement and from each 'thing' of the arrangement are worked out separately from every other leg or thing.

With respect to the 'thing' that is not a 'leg' of the replacement financial arrangement the only financial benefit received by the taxpayer is the discharge of the obligation to pay an amount to the Bank under the original financial arrangement.

The taxpayer has agreed to provide the Bank financial benefits under the terms of the replacement financial arrangement.

The taxpayer received and agreed to provide those financial benefits upon entering into the replacement financial arrangement and those financial benefits are sufficiently certain at that time.

Applying the accruals method to that financial benefit has the result that at least a portion of the period over which it would be spread occurs after the financial benefit has been provided.

The gains and losses on this 'thing' are known with sufficient certainty. Consequently, the accruals method applies to determine the amount and timing of those gains and losses.

Pursuant to subsection 230-130 of the ITAA 1997, the period over which the gains and losses will be spread starts when you start to have the replacement financial arrangement and ends when the replacement financial arrangement comes to an end.