Edited version of your written advice

Authorisation Number: 1012683618273

Ruling

Subject: Capital raising

Question 1

Will the Instruments be characterised as equity interests in the Company for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will dividends payable in respect of the Instruments constitute frankable distributions under section 202-40 of the ITAA 1997?

Answer

Yes

Question 3

Will section 204-30 of the ITAA 1997 apply to the issue of the Instruments (scheme)?

Answer

No

Question 4

Will section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme?

Answer

No

This ruling applies for the following periods:

1 July 2014 to 30 June 2018

The scheme commences on:

2014

Relevant facts and circumstances

The Company is proposing to offer the Instruments in order to raise capital and has requested the Commissioner rule based on the following matters:

• The offer will be made to the public at large and will not be restricted to a particular category of investors.

• Each Instrument will be issued for a set Australian dollar amount.

• During the term of the scheme, the Company will be a resident of Australia under the income tax law of Australia and of no other jurisdiction.

• The Company expects to have sufficient available profits from which to pay dividends, and to have net assets in excess of ordinary share capital, immediately before the payment of any dividends payable in respect of the Instruments.

• Dividends payable in respect of the Instrument will not be sourced, directly or indirectly, from the Company's share capital account or its non-share capital account.

• The share capital account of the Company will not become tainted within the meaning of Subdivision 197-A of the ITAA 1997 by the issue of the Instruments.

• The Company will not differentially frank distributions on the Instruments, or any other interest in the Company that is capable of giving rise to a frankable distribution, according to the tax status of the holders of those instruments or on any other basis.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1),

Income Tax Assessment Act 1936 section 177EA,

Income Tax Assessment Act 1997 section 202-40,

Income Tax Assessment Act 1997 section 202-45,

Income Tax Assessment Act 1997 section 204-30,

Income Tax Assessment Act 1997 Division 207,

Income Tax Assessment Act 1997 Division 974,

Income Tax Assessment Act 1997 subsection 960-120(1), and

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

Reasons for decision

Question 1

Summary

The Instrument will be characterised as equity interests in the Company for the purposes of Division 974 of the ITAA 1997.

Detailed reasoning

Division 974 of the ITAA 1997 is applied to determine whether an interest is a debt interest or an equity interest for tax purposes.

Subsection 995-1(1) of the ITAA 1997defines 'equity interest' in an entity to take on the meaning given by Subdivision 974-C of the ITAA 1997. The issue of the Instruments will satisfy the equity test in subsection 974-75(1) of the ITAA 1997 because it gives rise to an interest in a company as a member or stockholder of the company (item 1 of subsection 974-75(1) of the ITAA 1997).

Paragraph 974-5(4) of the ITAA 1997 provides that where an interest satisfies both the debt and equity test, it is to be treated as debt interest. Accordingly we must consider whether the Instruments meet the definition of a debt interest.

Debt test

Subsection 974-15(1) of the ITAA 1997 provides that a scheme gives rise to a debt interest in an entity if the scheme, at the time it comes into existence, satisfies the debt test in subsection 974-20(1) of the ITAA 1997. The notes to subsection 974-15(1) of the ITAA 1997 provide that a debt interest can also arise under subsection 974-15(2) in the context of related schemes, or section 974-65 of the ITAA 1997 as a result of the Commissioner's determination.

The debt test in subsection 974-20(1) of the ITAA 1997 provides that a scheme satisfies the debt 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).

Scheme is a financing arrangement for the entity - paragraph 974-20(1)(a) of the ITAA 1997

The scheme has satisfied item 1 of the table in subsection 974-75(1) of the ITAA 1997 and as a result, the scheme does not need to satisfy paragraph (a).

Entity receives or will receive a financial benefit or benefits under the scheme - paragraph 974-20(1)(b) of the ITAA 1997

Paragraph (b) states that there must be a financial benefit provided to the entity under the scheme. In section 974-160 of the ITAA 1997 it provides the following in regards to the meaning of financial benefit:

(a) means anything of economic value; and

(b) includes property and services; and

(c) includes anything that regulations made for the purposes of subsection (3) provide is a financial benefit;

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

The terms of the scheme involve the Company receiving a cash amount from the investors for each Instrument issued to them. Therefore, a financial benefit has been provided to the Company and paragraph (b) is satisfied.

Entity has an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits - paragraph 974-20(1)(c) of the ITAA 1997

Paragraph (c) requires that the entity, or a connected entity of the entity, has an effectively non-contingent obligation under the scheme to provide a financial benefit to one or more entities.

Section 974-135 of the ITAA 1997 provides when there is an effectively non-contingent obligation as follows:

(1) There is an effectively non-contingent obligation to take an action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation (see subsections (3), (4) and (6)) to take that action.

(2) Without limiting subsection (1), that subsection applies to:

(a) providing a financial benefit under the scheme; or

(b) terminating the scheme.

(3) 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 a connected entity of that entity), other than the ability or willingness of that entity or connected entity to meet the obligation.

…

With reference to the terms of the Instrument, the payment of a dividend is at the absolute discretion of the directors resolving to pay a dividend. In the event that a dividend is not paid, the Company has no liability to pay the unpaid amount and there is no interest accrued on an unpaid amount. Furthermore, the Instrument holders have no claim or entitlement in the event of non-payment and any non-payment does not constitute a default event.

In relation to the Instruments, the terms provide that there may be a conversion, redemption or resale.

Under a conversion, Instrument holders receive ordinary shares in the Company. Subsection 974-30(1) of the ITAA 1997 provides that the issue of an equity interest in the entity or a connected entity, or an amount that is to be applied in respect of the issue of an equity interest in the entity or connected entity, is not considered to constitute the provision of a financial benefit. As this is not a financial benefit, the act of conversion to an ordinary share would not result in paragraph 974-20(1)(c) of the ITAA 1997 being satisfied.

A redemption of the Instrument results in the redeeming of the Instrument for a cash amount. The circumstances in which redemption of the Instrument may occur do not suggest that the Company has an effectively non-contingent obligation to provide a financial benefit as it is contingent on the occurrence of certain events.

The resale mechanism provided for in the terms does not impose an effectively non-contingent obligation on the Company to provide a financial benefit by way of returning the face value on the resale of the Instrument.

The above analysis demonstrates that the Company does not have an effectively non-contingent obligation to provide a financial benefit by way of a distribution or a return of any part of the face value of the Instrument. The Company therefore does not have an effectively non-contingent obligation to provide any financial benefit under the scheme. As the requirements of paragraph 974-20(1)(c) of the ITAA 1997 are not satisfied, the issue of the Instruments will not give rise to a debt interest in the Company.

Based on the above, the Company does not have an effectively non-contingent obligation to provide any financial benefits with respect to the Instrument. Accordingly, the condition in paragraph 974-20(1)(c) of the ITAA 1997 is not satisfied. Therefore the Instrument does not give rise to a debt interest.

The scheme constituted by the issue of the Instrument satisfies the equity test in subsection 974-75(1) of the ITAA 1997, and the Instruments are not characterised as a debt interest under Subdivision 974-B of the ITAA 1997. Therefore, the issue of the Instruments gives rise to an equity interest in the Company under subsection 974-70(1) of the ITAA 1997.

Question 2

Summary

The dividends paid by the Company on the Instrument will constitute frankable distributions under section 202-40 of the ITAA 1997.

Detailed reasoning

Subsection 202-40(1) of the ITAA 1997 provides that a distribution is a frankable distribution to the extent that it is not unfrankable under section 202-45.

It is considered that a dividend payable to holders in respect of the Instrument is a dividend pursuant to the definition in subsection 6(1) of the ITAA 1936 and is thus a distribution as per item 1 of subsection 960-120(1) of the ITAA 1997. Therefore, the dividend will be a frankable distribution unless it is an unfrankable distribution under section 202-45 of the ITAA 1997.

Section 202-45 of the ITAA 1997 sets out the circumstances under which an amount or distribution is taken to be unfrankable. Based on the facts and assumptions provided, it is considered that none of those circumstances will apply to the distributions made by the Company in respect of the Instrument.

Question 3

Summary

Section 204-30 of the ITAA 1997 will not apply to the issue of the Instruments.

Detailed reasoning

Section 204-30 of the ITAA 1997 is an anti-streaming measure that applies if an entity streams distributions (or distributions and other benefits) in such a way that:

(a) an imputation benefit is, or apart from that section would be, received by a member of the entity as a result of the distribution(s); and

(b) the member would derive a greater benefit from franking credits than another member of the entity; and

(c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits.

Where section 204-30 of the ITAA 1997 applies, the Commissioner may make one or more of the determinations listed in subsection 204-30(3) of the ITAA 1997:

(a) that a specified franking debit arises in the franking account of the entity, for a
specified distribution or other benefit to a disadvantaged member;

(b) that a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member;

(c) that no imputation benefit is to arise in respect of the relevant distribution that is
made to a favoured member and specified in the determination.

It is reasonable to expect that holders will receive an imputation benefit because the distributions payable in respect of the Instruments are frankable distributions, which are expected to be fully franked.

The meaning of the word 'streams' is not defined for the purposes of section 204-30 the ITAA 1997. However, paragraph 3.28 of the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002 provides 'streaming is selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits'.

The Company will pay dividends on the Instruments subject to the directors of the Company, at their absolute discretion, resolving to pay a dividend. The Company expects to fully frank all dividends paid to the holders of the Instruments, regardless of the holders' tax attributes or their individual tax position.

Furthermore the Company has advised that it is not expected to change their dividend policy in relation to franking credits and dividend payout ratios in relation to the payment of dividends on ordinary shares or other preference shares of the Company as a result of the issue of the Instruments or any subsequent conversion, redemption or resale of the Instruments. All holders of the Instruments will receive the same franking credits, in accordance with the Company's dividend policy.

On the basis of the information provided, it is concluded that the requisite purpose of streaming does not exist in relation to the Instruments. Accordingly, section 204-30 of the ITAA 1997 will not apply to the Scheme.

Question 4

Summary

Section 177EA of the ITAA 1936 will not apply to the Scheme.

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes designed to obtain imputation benefits. In essence, it applies to schemes for the disposition of membership interests or an interest in membership interests, where a franked distribution is paid or payable or expected to be payable in respect of the membership interests or an interest in membership interests.

Where section 177EA of the ITAA 1936 applies, the Commissioner has a discretion pursuant to subsection 177EA(5) of the ITAA 1936 to make a determination to either debit the company's franking account or deny the imputation benefit on the distribution that flowed directly or indirectly to each shareholder.

Section 177EA of the ITAA 1936 applies if the five conditions in subsection 177EA(3) of the ITAA 1936 are satisfied:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

i. a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

ii. a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for section 177EA of the ITAA 1936, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

In relation to this scheme, the first four conditions, found in paragraphs 177EA(3)(a) to (d) of the ITAA 1936, are satisfied for the following reasons:

(a) the issue of the Instruments constitutes a scheme for the disposition of a membership interest (paragraph 177EA(3)(a) of the ITAA 1936). Pursuant to paragraph 177EA(14)(a) of the ITAA 1936, there will be a 'scheme for a disposition' of membership interests if there is a scheme that is involved in the issuing of membership interests or creating the interest in a membership interests. Therefore, as the Instruments are membership interests in the Company, paragraph 177EA(3)(a) of the ITAA 1936 is satisfied;

(b) frankable distributions are expected to be payable to the holders of the Instruments (paragraph 177EA(3)(b) of the ITAA 1936). The Commissioner accepts that dividends payable on the Instruments will be frankable distributions and not 'unfrankable' under section 202-45 of the ITAA 1997;

(c) franked dividends are expected to be paid to the holders of the Instruments (paragraph 177EA(3)(c) of the ITAA 1936). Furthermore, the Company has advised that it will continue its policy of fully franking all frankable distributions made by it, and the Company expects to fully frank any dividend paid on the Instruments.

(d) It is reasonable to expect that an imputation benefit will be received by the relevant taxpayers as a result of distributions made to holders of the Instruments, given that the Company expects to frank the distributions on the Instruments (paragraph 177EA(3)(d) of ITAA 1936).

The remaining condition is whether, having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit: paragraph 177EA (3)(e) of the ITAA 1936.

This is a test of objective purpose. Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936.

Having regard to the factors listed in subsection 177EA(17) of the ITAA 1936 and the relevant circumstances of the arrangement, the Commissioner is of the opinion that the purpose of the scheme is to meet the Company's financing requirements. Any imputation benefits obtained by the holders of the Instrument are considered incidental to this purpose.

Accordingly, section 177EA of the ITAA 1936 will not apply to the scheme.