Edited version of your written advice

Authorisation Number: 1013019551226

Date of advice: 11 July 2016

Ruling

Subject: Debt / Equity Rules

Question 1

Will the loan notes ('Notes') to be issued by the issuing company ('the issuer') to the shareholders of that company ('Shareholders') be characterised as debt interests pursuant to Division 974?

Answer to Question 1

Yes

Question 2

Will the issuing of the Notes be a scheme related to the previous issuing of the shares in the issuer ('Shares') by that company under section 974-155?

Answer to Question 2

Yes

Question 3

If the answer to Question 2 is "yes", will the combination of the Shares and Notes together give rise to a debt interest pursuant to subsection 974-15(2)?

Answer to Question 3

No

Question 4

If the answer to Question 2 is "yes", will the combination of the Shares and Notes together give rise to an equity interest pursuant to section 974-70(2)?

Answer to Question 4

No

Question 5

Will a loss made by the issuer from the Notes be deductible under Division 230 to the extent that it is comprised of interest payable by the company to the Noteholders under the Notes?

Answer to Question 5

Yes

Question 6

If the answer to Question 5 is "yes", will the deductibility of that portion of the loss be denied under:

• Section 230-520 (value shifting provisions in Divisions 723, 725 or 727);

• Section 26-25 (failure to withhold); or

• Section 26-26 (non-share distributions)?

Answer to Question 6

No

Does section 177EA of Part IVA of the Income Tax Assessment Act 1936 apply to this ruling?

Section 177EA of Part IVA of the Income Tax Assessment Act 1936 is an anti-avoidance rule that can apply in certain circumstances if a taxpayer obtains an imputation benefit (including a franking credit received in a franked distribution) 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 a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling an imputation benefit to be obtained. If section 177EA applies the imputation benefit can be cancelled, for example, by disallowing the franking credit to the recipient of a franked distribution, and by raising a franking debit in the franking account of the issuer of the franked distribution.

We have not formed an opinion on whether section 177EA will apply to the arrangement that we have been asked to rule on, or to an associated or wider arrangement of which that arrangement is part. However, we consider that there is a significant risk that section 177EA may apply to the arrangement.

This ruling applies for the following periods:

Year ending xxxx

The scheme commences on:

1 July xxxx

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If the circumstances of the issuer are materially different from these facts, this ruling has no effect and the issuer cannot rely on it.

Overview

• As at 1 July 2015:

a. XX Pty Ltd and the issuer are Australian resident companies. The issuer is the head company of a tax consolidated group (the 'Group'), of which XX is a member, and has total assets of more than $300 million.

b. The issuer has xx million Shares on issue, issued prior to (date), which are ordinary shares and the sole equity on issue. The Shares give the Shareholders rights to returns that are contingent on the economic performance of the issuer and contingent on the discretion of the issuer in retaining or paying-out its profits depending on its investment requirements. The Shares also give voting rights and rights to the capital of the issuer to the Shareholders.

c. The Shareholders are Australian residents.

d. XX has $$$ million loan notes ('Original Notes') on issue to the Shareholders with a maturity date in 20xx.

e. The Shares, Original Notes and external bank debt finance the on-going operation of the business of the issuer.

• The issuer intends to undertake the following actions during the Relevant Period:

b. XX will redeem the Original Notes, creating a liability of $$$ million to the Shareholders.

c. The issuer will declare a fully franked dividend of $$ million to the Shareholders, creating a liability of $$ million to the Shareholders.

d. Following these two actions, the issuer will satisfy the liabilities on a certain date ('Issue Date') by issuing X million Notes to the Shareholders.

e. There will be no changes to the on-going operation of the business of the issuer.

• The purpose of the issuer in issuing the Notes is to provide the Shareholders with non-contingent returns from surplus cash that do not require franking credits, are independent of the Corporations Act 2001 and are favourable to the issuer's equity valuation.

• The payment of dividends in respect of the ordinary shares will continue to be contingent on the economic performance of the Group.

Main features of the Notes

• The following description is based on the draft of the Deed dated (date) ('Deed') provided by the issuer.

• Each Note will have a face value of $.

• On the Issue Date, each Shareholder will receive an amount of Notes such that the proportion of Notes held relative to the total number of Notes issued by the issuer is equal to the proportion of Shares held by the Shareholder relative to the total number of Shares on issue.

• The issuer must pay or capitalise interest for the Notes as follows:

b. The interest accrues for each quarterly period ('Interest Period') starting at the X day of the last month in each quarter to and including the X day of the last month of the following quarter, with exceptions for the first and last Interest Period. The first Interest Period commences on the Issue Date and continues until the X day of the last month of the quarter in which the Issue Date falls. The last Interest Period ends on and excludes (date) ('Maturity Date').

c. The accrued interest is calculated for each Interest Period at X% per annum converted based on the number of days in the Interest Period divided by 365, applied against the total face value of the Notes held and any previously capitalised interest.

d. The Interest Payment Date for an Interest Period is the 10^th business day after the last day of the Interest Period (or the Maturity date). No later than five business days before each Interest Payment Date, the issuer must elect one of the following outcomes to occur to the accrued interest for all of the Notes on the Interest Payment Date:

i. It will be paid in cash subject to restrictions ('Restrictions') where there must be cash available in the issuer for the payment and the payment must not give rise to a breach of or default of a debt held by the issuer;

ii. It will be capitalised; or

iii. A portion up to the Restrictions will be paid in cash and the remainder will be capitalised.

• The Notes and the Shares are not stapled. The Notes can be transferred independently of the Shares pursuant to the Deed. If a holder of Notes ('Noteholder') wishes to sell any of its Notes, it must first offer them to existing Noteholders before offering them to other buyers.

• The issuer must redeem the Notes subject to the following conditions:

b. The issuer must redeem all of the Notes on the Maturity Date.

c. The issuer cannot redeem the Notes prior to the Maturity Date unless it becomes insolvent. If there is an insolvency event as defined in the Deed, a Noteholder may issue a notice within 60 days of that event requiring redemption at an earlier date, at which the issuer must redeem all of the Notes. For any accrued interest for an Interest Period up to that date on all Notes, prior to redemption, the issuer must elect whether the accrued interest will be paid in cash subject to the Restrictions, capitalised, or paid in cash up to the Restrictions with the remainder capitalised.

d. On redemption, the Notes are automatically cancelled and may not be re-issued. The issuer must repay the total face value of the Notes plus any capitalised interest to the Noteholders by:

i. Paying in cash subject to the Restrictions; or

ii. If approved by the Noteholders, issuing new loan notes to the Noteholders with an aggregate face value at least equal to the total face value of the Notes plus any capitalised interest and on terms and conditions substantially the same as the Notes.

• The rights of each Noteholder under the Deed are subordinated in right of payment to the claims of the creditors of the issuer (other than the claims under the Notes, which rank equally with each other). In the event of a wind-up, the issuer's obligations to the Noteholders rank before their obligations to the Shareholders in their capacity as holders of a Share, but after any other obligations to other entities or as required by law to be made in priority.

Assumptions

In addition to the above facts, this ruling is also based on the assumptions set out below. If these assumptions are not correct, this ruling has no effect and the issuer cannot rely on it.

• The value of the financial benefits provided to the issuer by the Shareholders in return for the issue of the Shares was equal to the total share capital (as at 1 July 20YY) of $$$$.

• Apart from the conditions contained in the Deed, no further term or condition exists with respect to the sale, transfer or other disposal of Notes.

In the Relevant Period:

b. The issuer, XX, the Shareholders and Noteholders will continue to be Australian residents.

c. The issuer will not change the rights and obligations applicable to the Shares as a result of the issue of the Notes.

d. The Issue Date will occur such that the number of years between the Issue Date and the Maturity Date is at least 10 years.

e. The interest rate of X% for the Notes will be the benchmark rate of return that meets the conditions of section 974-145. The subsequent value of the accrued interest in present value terms under section 974-50 (assuming it will be paid at each Interest Payment Date) and the total face value of the Notes (assuming it will be paid on the Maturity Date) will be at least $$$.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 26-25,

Income Tax Assessment Act 1997 Section 26-26,

Income Tax Assessment Act 1997 Section 230-15,

Income Tax Assessment Act 1997 Section 230-45,

Income Tax Assessment Act 1997 Section 230-55,

Income Tax Assessment Act 1997 Section 230-455,

Income Tax Assessment Act 1997 Subdivision 230-H,

Income Tax Assessment Act 1997 Section 230-520,

Income Tax Assessment Act 1997 Section 701-1,

Income Tax Assessment Act 1997 Division 723,

Income Tax Assessment Act 1997 Division 725,

Income Tax Assessment Act 1997 Division 727,

Income Tax Assessment Act 1997 Section 974-10,

Income Tax Assessment Act 1997 Section 974-15,

Income Tax Assessment Act 1997 Section 974-20,

Income Tax Assessment Act 1997 Section 974-25,

Income Tax Assessment Act 1997 Section 974-35,

Income Tax Assessment Act 1997 Section 974-40,

Income Tax Assessment Act 1997 Section 974-50,

Income Tax Assessment Act 1997 Section 974-70,

Income Tax Assessment Act 1997 Section 974-75,

Income Tax Assessment Act 1997 Section 974-130,

Income Tax Assessment Act 1997 Section 974-135,

Income Tax Assessment Act 1997 Section 974-145,

Income Tax Assessment Act 1997 Section 974-155,

Income Tax Assessment Act 1997 Section 974-160,

Income Tax Assessment Act 1997 Section 995-1, and

Taxation Administration Act 1953 Subdivision 12-F in Schedule 1.

Relevant ATO view documents

Taxation Ruling TR2012/14

Other documents

Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001

Reasons for decision

These reasons for decision accompany the Notice of private ruling for XXXX. The abbreviations used in the Notice will be used in these reasons.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1:

Will the loan notes ('Notes') to be issued by the issuing company ('the issuer') to the shareholders of that company ('Shareholders') be characterised as debt interests pursuant to Division 974?

Answer

Yes

Detailed reasoning

Subdivision 974-B outlines the rules for debt interests. Several provisions in Subdivision 974-B are subject to the Income Tax Assessment Regulations 1997 made for the purposes of the Subdivision. They are not considered relevant in these circumstances.

Subsection 974-15(1) provides that a scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1). The term 'scheme' is defined broadly in subsection 995-1(1) to mean any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Subsection 974-20(1) provides that a scheme satisfies the debt test in relation to an entity if:

• The scheme is a financing arrangement for the entity; and

• The entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; and

• The entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation ('ENCO') 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

• It is substantially more likely than not that the value provided will be at least equal to the value received; and

• The value provided and the value received are not both nil.

Section 974-25 provides certain exceptions to the debt test in respect of short-term credit arrangements, which are not applicable in the current circumstances.

Subsection 974-130(1) provides that a scheme is a financing arrangement for an entity if it is entered into or undertaken:

• To raise finance for the entity (or a connected entity of the entity);

• To fund another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a); or

• To fund a return, or a part of a return, payable under or provided by or under another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a).

Subsection 974-135(1) provides that there is an ENCO 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 to take that action. Subsection 974-135(3) provides that an obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a connected entity of that entity) other than the ability or willingness of that entity or connected entity to meet the obligation. Paragraph 2.30 of the Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 ('Explanatory Memorandum') provides that if a right that a creditor has to a return may be said to be contingent on the debtor company being able to meet its debts when they fall due, that by itself will not be taken as meaning that the right is contingent on the economic performance of the company.

Subsection 974-160(1) provides that financial benefit means anything of economic value, including property and services, even if the transaction that confers the benefit on an entity also imposes an obligation on the entity. Subsection 974-160(2) provides that in applying subsection (1), benefits and obligations are to be looked at separately and not set off against each other.

Subsection 974-35(1) provides that the value of a financial benefit received or provided under a scheme is its value calculated in present value terms under section 974-50 if the performance period of the scheme must or may end more than 10 years after the interest arising from the scheme is issued.

Subsection 974-35(3) defines a performance period as the period within which, under the terms on which the interest is issued, the ENCOs of the issuer to provide a financial benefit in relation to the interest have to be met. Subsection 974-35(4) provides that an obligation is treated as having to be met within 10 years after the interest is issued if the issuer has an ENCO to terminate the interest within that 10 year period even if the terms on which the interest is issued formally allow the obligation to continue after the end of that 10 year period.

Subsection 974-35(2) provides that the value of a financial benefit received or provided under a scheme is calculated assuming that the interest arising from the scheme will continue to be held for the rest of its life. Section 974-40 provides that where a party to a scheme has an option to terminate the scheme early, this option is disregarded in working out the life of the interest if the party does not have an ENCO to exercise the option.

Section 974-50 provides that the value of a financial benefit in present value terms is calculated using the following formula for each financial benefit separately assuming that all amounts paid by an entity in respect of the interest are paid at the earliest time when the entity becomes liable to pay them. (formula provided)

Where:

• Adjusted benchmark rate of return is 75% of the benchmark rate of return on the test interest;

• In the formula provided, n is the number of years in the period starting on the day on which the interest is issued and ending on the day on which the financial benefit is to be provided. If the period includes a part of a year, that part is expressed as the fraction representing the number of days in that period divided by the number of days in that year (being a 12 month period).

Subsection 974-145(1) provides that the benchmark rate of return for an interest ('test interest') in an entity is the annually compounded internal rate of return on an ordinary debt interest that is issued immediately before the test interest is issued and has a comparable maturity date, currency, market, credit status and the same degree of subordination as the test interest. Subsection 974-145(2) provides that if no interest satisfies subsection (1), the benchmark rate of return is calculated based on an interest that is closest to the test interest adjusted appropriately for the differences.

The relevant scheme is the issue of the Notes by the issuer to the Noteholders. As the issuer will be undertaking the scheme to meet the Group's liabilities arising from the redemption of the Original Notes and the declaration of a dividend without affecting the on-going operation of its business, the scheme will be a financing arrangement for the issuer under subsection 974-130(1).

The issuer will receive $$$ million from the Noteholders. The issuer will have the following obligations to the Noteholders under the Notes which amount to financial benefits under section 974-160:

• the issuer must pay the accrued interest either at an Interest Payment Date or on redemption;

• the issuer must repay the total face value of the Notes on redemption.

These obligations will only be contingent on the issuer's ability to meet its other debt or legal obligations, and will not be otherwise contingent on any event, condition or situation including the economic performance of the issuer. Therefore, the Commissioner concludes that these obligations will be ENCOs for the purposes of section 974-135.

As these obligations may be payable at the Maturity Date, which is more than 10 years after the Issue Date, the performance period for the scheme will be more than 10 years under subsection 974-35(3).

The value of each financial benefit will be calculated in present value terms under subsection 974-35(1) assuming that the Notes will be held until the Maturity Date under subsection 974-35(2). Section 974-40 will not apply as the Noteholders' ability to terminate the Notes will be contingent on an insolvency event for the issuer.

Under section 974-50, the present value of the accrued interest (assuming it will be paid at each Interest Payment Date) and the total face value of the Notes (assuming it will be paid at the Maturity Date of the Notes) will be at least $$$.

Paragraph 974-20(1)(d) will therefore be satisfied, and the Notes will meet the debt test in section 974-20 and will be characterised as debt interests under section 974-15.

Question 2:

Will the issuing of the Notes be a scheme related to the previous issuing of the Shares by the issuer under section 974-155?

Answer

Yes.

Detailed reasoning

Subsection 974-155(1) provides that two schemes are related to one another if they are related to one another in any way. Subsection 974-155(2) outlines various circumstances in which schemes would be regarded as being related to each other. In this case, the most relevant of these are as follows:

(b) one of the schemes would, from a commercial point of view, be unlikely to be entered into unless the other scheme was entered into….

(d) one scheme complements or supplements the other.

Paragraph 2.54 of the Explanatory Memorandum confirms that schemes may be regarded as 'related' under one or more of the abovementioned criteria notwithstanding that the interests to which they give rise are detachable; that is, interests need not be stapled for the relevant schemes to be related under section 974-155.

'Scheme' is given a broad definition under section 995-1 to include 'any arrangement' and 'course of conduct'. The following may therefore be regarded as 'schemes' for the purposes of the ITAA:

• the issue of the Notes by the issuer to the Noteholders;

• the original issue of Shares to the Shareholders.

The issue of the Notes is connected to the shareholding. While the Notes may subsequently be sold by Noteholders to non-shareholders, the initial issue of the Notes is made only to Shareholders. Further, the proportion of Notes offered and held by a person is the same as the proportion of Shares held by that person relative to the number of Shares on issue: clause 2.4 of the Deed. Given that the shareholding is a prerequisite to the issue of the Notes, it would appear that the issue of the Notes would 'be unlikely to be entered into unless the other scheme was entered into'; and that both schemes in this regard complement or supplement each other.

Consequently the issue of the Notes is a scheme that is related to the scheme involving the previous issue of Shares for the purposes of section 974-155.

Question 3:

If the answer to Question 2 is "yes", will the combination of the Shares and Notes together give rise to a debt interest pursuant to section 974-15(2)?

Answer

No.

Detailed reasoning

Subsection 974-15(2) provides that two or more related schemes (the constituent schemes) together give rise to a debt interest in an entity if the following apply regardless of whether the constituent schemes come into existence at the same time and even if none of the constituent schemes would individually give rise to that or any other debt interest:

• The entity enters into, participates in or causes another entity to enter into or participate in the constituent schemes;

• A scheme with the combined effect or operation of the constituent schemes (the notional scheme) would satisfy the debt test in subsection 974-20(1) in relation to the entity if the notional scheme came into existence when the last of the constituent schemes came into existence; and

• It is reasonable to conclude that the entity intended, or knew that a party to the scheme or one of the schemes intended, the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of a debt interest.

The two constituent schemes will be the issuing of the Notes and the issuing of the Shares. The issuer will have entered into both schemes, satisfying paragraph 974-15(2)(a). Paragraph 974-15(2)(b) will also be satisfied as the debt test under section 974-20 will be satisfied, given that:

• The notional scheme will be a financing arrangement.

• The value of the financial benefits received by the issuer will be $$$ for the Notes plus $$$ for the Shares, or $$$ in total.

• The value of the ENCO on the issuer to pay the accrued interest and the total face value of the Notes will be at least $$$.

However the condition in paragraph 974-15(2)(c) will not be met in this case as it is not reasonable to conclude that the issuer intended the combined economic effect of the schemes to be the same as the economic effects of a debt interest. In reaching this conclusion, we have taken into account the following considerations:

• The Notes and the Shares are not stapled. While Share ownership is a precondition to the issue of the Notes, the Notes may be transferred independently of the Shares.

• The terms and conditions to which the Notes are subject, and the rights and obligations that arise from those terms, are different from the rights and obligations that apply in respect of the Shares.

• The Shares retain their character of equity; the payment of dividends in respect of the ordinary shares will continue to be contingent on the economic performance of the Group. The nature of the Shares in this regard will continue to be unaffected by the issue of the Notes; in other words, the introduction of the Notes will not change the nature of the Shares.

Question 4:

If the answer to Question 2 is "yes", will the combination of the Shares and Notes together give rise to an equity interest pursuant to section 974-70(2)?

Answer

No

Detailed reasoning

Subsection 974-70(1) provides that a scheme gives rise to an equity interest in a company if, when the scheme comes into existence:

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

• The interest is not characterised as, and does not form part of a larger interest that is characterised as, a debt interest in the company under Subdivision 974-B.

Subsection 974-75(1) provides that a scheme satisfies the equity test in relation to a company if it gives rise to an interest set out in the table in that subsection. The items in the table are:

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

Item 2. An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is in substance or effect contingent on the economic performance (whether past, current or future) of:

a. The company;

b. A part of the company's activities; or

c. A connected entity of the company or a part of the activities of a connected entity of the company.

The return may be a return of an amount invested in the interest.

Item 3. An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is at the discretion of:

a. The company; or

b. A connected entity of the company.

The return may be a return of an amount invested in the interest.

Item 4. An interest issued by the company that:

a. Gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or connected entity of the company; or

b. Is an interest that will, or may, convert into an equity interest in the company or a connected entity of the company.

Subsection 974-75(1) has effect subject to subsection 974-75(2). Subsection 974-75(2) provides that a scheme that would otherwise give rise to an equity interest in a company because of an item in the table in subsection 974-75(1) (other than Item 1) does not give rise to an equity interest in the company unless the scheme is a financing arrangement for the company.

Subsection 974-70(2) provides that two or more constituent schemes together give rise to an equity interest in a company if the following apply regardless of whether the constituent schemes come into existence at the same time and even if none of the constituent schemes would individually give rise to that or any other equity interest:

• The company enters into, participates in or causes another entity to enter into or participate in the constituent schemes; and

• The notional scheme would give rise to an equity interest in the company under subsection (1) if the notional scheme came into existence when the last of the constituent schemes came into existence; and

• It is reasonable to conclude that the entity intended, or knew that a party to the scheme or one of the schemes intended, the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of an equity interest.

Subsection 974-70(3) provides that subsection (2) does not apply if each of the schemes individually gives rise to an equity interest in the entity. As the Notes are debt interests and therefore not equity interests under subsection 974-70(1), this subsection does not apply.

The issuer will have entered into both constituent schemes following the Issue Date for the purposes of paragraph 974-70(2)(a). Paragraph 974-20(2)(b) is also satisfied in this case given that the notional scheme will pass the equity test in section 974-75 for the following reasons:

• The constituent schemes will both be financing arrangements; and

• The notional scheme will give the Shareholders a right to a return contingent on the economic performance of the issuer and at the discretion of the issuer.

However it is not reasonable to conclude that the issuer intended the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of an equity interest under paragraph 974-20(2)(c) for the following reasons:

• The Notes and the Shares are not stapled. While Share ownership is a precondition to the issue of the Notes, the Notes may be transferred independently of the Shares.

• The terms and conditions to which the Notes are subject, and the rights and obligations that arise from those terms, are different from the rights and obligations that apply in respect of the Shares.

• The Notes are in the nature of a Debt interest. The payment of interest to Noteholders arises from an ENCO; in contrast to the payment of dividends on the Shares, they are not dependent on the economic performance of the Group. The existence of the Shares does not affect the nature of the Notes; both retain their character as an equity interest and a debt interest respectively.

Therefore, the combination of the Shares and the Notes together will not give rise to an equity interest pursuant to section 974-70(2).

Question 5:

Will a loss made by the issuer from the Notes be deductible under Division 230 to the extent that it is comprised of interest payable by the issuer to the Noteholders under the Notes?

Answer

Yes

Detailed reasoning

In determining the answer to the question, the following issues are considered:

• Does Division 230 apply to the issuer?

• Is the arrangement involving the Notes a 'financial arrangement' under Division 230?

• Is the loss under the arrangement deductible under section 230-15 to the extent that it is comprised of interest payable to the Noteholders?

1) Does Division 230 apply to the issuer?

Division 230 applies to an entity unless it falls within one of the prescribed exceptions. On the facts provided, none of the exceptions under the Division applies in this case. In particular the issuer, as the head company of a tax consolidated group, does not satisfy the threshold exceptions under section 230-455.

The single entity rule for tax consolidated groups, under which subsidiary members are treated as part of the head company of the group rather than as separate income tax entities (section 701-1), is relevant to the application of section 230-455. Section 701-1 applies to section 230-455 to the effect that the entity that is tested for the threshold tests is the head company including all its parts (that is, the subsidiary members).

As the issuer had total assets of more than $300 million at the time Division 230 was introduced, the issuer fails the threshold test in section 230-455 and is consequently not excluded from the operation of Division 230.

Given that the issuer has satisfied the relevant thresholds for the application of Division 230, the Division will continue to apply irrespective of whether its turnover or value of assets subsequently fall below the threshold: subsection 230-455(9).

On the facts in this case, none of the other exceptions in Subdivision 230-H apply.

2) Is the arrangement involving the Notes a 'financial arrangement' under Division 230?

Subsection 230-45(1) defines financial arrangement as including:

• A cash settlable legal or equitable right to receive a financial benefit;

• A cash settlable legal or equitable obligation to provide a financial benefit; or

• A combination of one or more such rights and/or one or more such obligations.

Paragraph 230-45(2)(a) provides that a right to receive a financial benefit is cash settlable if the benefit is money or a money equivalent.

The proposed arrangement in this case will fall within the scope of a financial arrangement as defined in subsection 230-45(1) for the following reasons:

• The Notes will provide the issuer with $$$$. Specifically, they will provide the issuer with financial benefits of cash settlable legal rights to receive the total amount of $$$$, thereby satisfying the requirements of paragraph 230-45(1)(a).

• The issuer will also have obligations under the arrangement that fall within the scope of paragraph 230-45(1)(b). Specifically, the issuer will have the following obligations:

• To pay interest to the Noteholders on a quarterly basis - that is, to provide the cash settlable financial benefits as referred to in paragraph 230-45(2)(a), being monetary amounts comprising interest payable on the Notes.

• To redeem the Notes in 2031 by either a payment of cash or the issue of new loan notes. The redemption of Notes by way of a cash payment falls within the definition of a cash settlable financial benefit under paragraph 230-45(2)(a). The redemption of Notes by the issue of new loan notes also falls within the definition of a cash settlable financial benefit under paragraph 230-45(2)(c), as it includes the case in which the issuer satisfies its obligations by starting to have another financial arrangement.

• Being a combination of the rights and obligations described in paragraphs 230-45(1)(a) and paragraph 230-45(1)(b), the arrangement in this case will fall more appropriately within the description in paragraph 230-45(1)(c).

Under subsection 230-45(1), the financial arrangement will be taken to be that combination of rights and obligations to which the Notes give rise as covered by paragraph 230-45(1)(c).

One question that arises is whether the rights and obligations in this case will make up two or more separate financial arrangements for the purposes of Division 230. In this respect, section 230-55 provides as follows:

Subsection 230-55(1)

If you have a right to receive 2 or more *financial benefits, you are taken, for the purposes of this Division, to have a separate right to receive each of those financial benefits.

Subsection 230-55(2)

If you have an obligation to provide 2 or more *financial benefits, you are taken, for the purposes of this Division, to have a separate obligation to provide each of those financial benefits.

Subsection 230-55(3)

Subsections (1) and (2) apply for the avoidance of doubt.

In this case it is arguable that there will be several financial benefits provided and received, constituted by the issue of multiple Notes, each of which will carry its own financial benefits - namely the benefit the issuer will be entitled to receive from the amount of the loan under each Note, and the benefit the issuer will be obliged to provide on each Note in the form of interest at X% per annum.

However whether these financial benefits form a single arrangement or a number of arrangements is determined having regard to the various factors outlined in subsection 230-55(4):

Subsection 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.

In this case, the collective bundle of Notes issued under both Tranche A and Tranche B to all Noteholders pursuant to the Deed is a single arrangement between the issuer and the Noteholders for the purposes of Division 230.

In taking this view, we have taken into account the following considerations:

• Guidance on the application of subsection 230-55(4) is provided by 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' ('TR 2012/4'), which states that:

• The general principle that whether a number of rights and/or obligations are themselves an arrangement or are two or more separate arrangements, for the purposes of Division 230, is a question of fact and degree, that is determined having regard to the matters referred to in paragraphs 230-55(4)(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 criteria in these paragraphs are intended to interact; regard is not to be had merely to each criterion separately, and criteria focusing on legal form are intended to interact with criteria focusing on commercial substance: the findings of each are to be brought together to see what the comparison reveals. The criteria are to be read together rather than merely separately, and as providing an overall conclusion, not as an approach of mere mechanical arithmetic.

• It may be one view that each issue of Notes to a particular Noteholder constitutes a separate arrangement (that is, each issue of Notes to a particular Noteholder under the terms of the Deed represents an arrangement between the issuer and the relevant Noteholder which confers a separate bundle of rights to that Noteholder). Another view might be that Tranche A of the loan note issue is an arrangement in itself that is separate to the arrangement comprised by the loan note issue under Tranche B. The reason for this is that the loan note issue under Tranche A stems from the redemption of existing loan notes issued by XX; while the issue under Tranche B is made in satisfaction of a dividend which the issuer will declare to Shareholders. The loan note issue under Tranche B is proposed in order to increase the balance of loan notes on issue. However, the better view is that the collective bundle of Notes issued to all Noteholders under the terms of the Deed comprises a single arrangement between the issuer and the Noteholders for the following reasons:

• All Noteholders are bound by the same terms and conditions; the issuer and each Noteholder have identical rights and obligations as prescribed in the Deed. Viewed as a whole, the uniformity of rights and obligations arising from the terms and conditions in the single Deed, would suggest that they form one arrangement: see paragraph 230-55(4)(a) and paragraph 230-55(4)(b).

• Whether the purpose for the creation of the rights and obligations in question is to facilitate the release of surplus cash generated by the issuer, or for broader reasons relating to capital management, the proposed strategy remains a single co-ordinated one devised to implement these objectives. In this regard, the collective bundle of Notes issued to all Noteholders should be considered as a single arrangement: paragraph 230-55(4)(c).

• The issue of Notes is better understood when viewed as a whole; that is when seen from the overall perspective of the broader issue of Notes to all Noteholders under that single strategy (from which the objective of the strategy might more clearly be gleaned), than when viewed from a more isolated perspective that focuses on the issue of a separate bundle of Notes to a particular Noteholder: in this regard, see Note 2 to subsection 230-55(4).

• The arrangement in question does not include the issued Shares. In this respect we have considered the following:

• The Notes and the Shares are not stapled. They are not linked and can therefore be dealt with independently of each other.

• Different rights and obligations apply to the shareholding to those which govern the Notes. The nature of these rights and obligations are different, including for example the form, manner and circumstances in which returns are given to the investor under the Notes and under the Shares.

• The objectives behind the issue of the Notes and those behind the general Share issue are different.

• The commercial understanding and practices in relation to Shares are different from those in respect of Notes. The difference in the rights and obligations relevant to each, as mentioned above, is a reflection of the commercial difference between the two instruments. Accordingly, it is concluded that the arrangement in question does not include the issued Shares.

3) Is the loss under the arrangement deductible under section 230-15 to the extent that it is comprised of interest payable to the Noteholders?

The loss from the financial arrangement is deductible to the extent that it comprises the interest payments required to be made on the Notes. The reasons for this view are outlined below.

Subsection 230-15(2) provides that you can deduct a loss you make from a financial arrangement, but only to the extent that you make it in gaining or producing your assessable income or you necessarily make it in carrying on a business for the purpose of gaining or producing your assessable income.

On the facts of the present case, the conditions in subsection 230-15(2) are satisfied for the following reasons:

• The loss made from the financial arrangement, to the extent that it comprises interest payments in respect of the Notes, is incurred in return for - and as a necessary precondition of - the provision of $$$$ in working capital to the issuer.

• The finance is required to fund the ongoing operations of the issuer's business, being the operation of its business, which generates assessable income for the issuer.

• There is accordingly a sufficient nexus between the expenditure and the gaining or producing of assessable income for the purposes of subsection 230-15(2).

Subsection 230-15(4) provides that if a financial arrangement is a debt interest, the loss is not prevented from being deductible under subsection 230-15(2) in prescribed circumstances. While the financial arrangement comprising the rights and obligations under the Notes is also a 'debt interest', it is unnecessary to consider the application of subsection 230-15(4) as the payment of interest under the Notes is neither contingent on the issuer's economic performance (given that the interest is fixed at 9.5%); nor does it secure a permanent or enduring benefit to the issuer (given that it secures funding required for recurring operating expenses).

Question 6:

If the answer to Question 5 is "yes", will the deductibility of that portion of the loss be denied under:

• Section 230-520 (value shifting provisions in Divisions 723, 725 or 727);

• Section 26-25 (failure to withhold); or

• Section 26-26 (non-share distributions)?

Answer

No

Detailed reasoning

Section 230-520: Value shifting regime

Subsection 230-520(1) provides that a loss under Division 230 from a financial arrangement is disregarded to the extent that it is attributable to:

• A shifting of value that has consequences under Division 723; or

• A direct value shift that has consequences under Division 725; or

• An indirect value shift that has consequences under Division 727; or

• A shifting of value that has consequences analogous to those under Division 725 or 727 under a repealed provision of this Act or of the Income Tax Assessment Act 1936.

Based on the characteristics of the Notes and their holding by the Noteholders, the Commissioner concludes that subsection 230-520(1) will not be applicable in these circumstances.

Section 26-25: Failure to withhold

Subsection 26-25(1) provides that interest cannot be deducted if an amount required to be withheld under Subdivision 12-F in Schedule 1 to the Taxation Administration Act 1953 ('TAA') is not withheld. Subdivision 12-F in Schedule 1 to the TAA contains provisions creating withholding requirements for interest payments made to overseas persons, received for foreign residents or derived by a lender in carrying on a business through overseas permanent establishments.

As the Noteholders are Australian residents, subsection 26-25(1) will not be applicable in these circumstances.

Section 26-26: Non-share distributions

Subsection 26-26(1) provides that a company cannot deduct a non-share distribution or a return that has accrued on a non-share equity interest. Section 974-115 defines a non-share distribution as a distribution made on a non-share equity interest to the holder of the interest.

Subsection 995-1(1) defines a non-share equity interest as an equity interest in a company that is not solely a share. As the Notes are not equity interests, subsection 26-26(1) will not be applicable in these circumstances.

Subsection 26-26(2) provides that a company cannot deduct a dividend paid on an equity interest in the company as a general deduction. As the deduction will arise under Division 230, this will not apply in these circumstances.