Edited version of your written advice

Authorisation Number: 1013027008178

Date of advice: 17 June 2016

Ruling

Subject: Funding arrangement

Question 1

Will Loan F issued by Entity H to Entity J in accordance with the facility agreement be treated as a debt interest pursuant to section 974-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will Loan G issued by Entity H to Entity J in accordance with the facility agreement be treated as a debt interest pursuant to section 974-15 of the ITAA 1997?

Answer

Yes

Relevant facts and circumstances

Entity H will borrow funds from Entity J to fund its capital growth and expenditure requirements.

Entity H makes Distribution P and Distribution Q to Entity K and Entity L from time-to-time which enable Entity K and Entity L to provide funds to Entity J.

Entity J uses the funds received to provide Entity H with different types of loans from time-to-time under a facility agreement. Loan F and Loan G are loans made under an agreement that have different maturity dates of no longer than 10 years, and different terms.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 974-15(1)

Income Tax Assessment Act 1997 subsection 974-20(1)

Income Tax Assessment Act 1997 subsection 974-35(1)

Income Tax Assessment Act 1997 subsection 974-70(2)

Income Tax Assessment Act 1997 subsection 974-80(1)

Income Tax Assessment Act 1997 subsection 974-80(2)

Income Tax Assessment Act 1997 subsection 974-130(1)

Income Tax Assessment Act 1997 section 974-155

Reasons for decision

Legislative references are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless specified otherwise.

Question 1

Summary

Loan F issued by Entity H to Entity J in accordance with the facility agreement will be treated as a debt interest pursuant to section 974-15.

Detailed reasoning

A scheme gives rise to a debt interest in an entity under subsection 974-15(1) if, when the scheme comes into existence, it satisfies the debt test in subsection 974-20(1) in relation to the entity, and the scheme:

• does not, together with one or more other related schemes, constitute a larger interest that is an equity interest when the second (if together with one more) or the last (if together with two or more) schemes are entered into. Related schemes are discussed below

• is not materially changed such that it becomes an equity interest from the date of change pursuant to section 974-110, and

• section 974-80 does not operate to treat the scheme as an equity interest. Section 974-80 is discussed below.

If an interest satisfies both the debt test and the equity test, debt interest treatment prevails; paragraph 974-70(1)(b) and subsection 974-5(4).

The debt test

As stated above, subsection 974-15(1) provides that a scheme gives rise to a debt interest in an entity if the scheme satisfies the debt test in subsection 974-20(1) when the scheme comes into existence.

Subsection 974-20(1) states that:

A scheme satisfies the debt test in this subsection in relation to an entity if:

(a) the scheme is a *financing arrangement for the entity; and

(b) the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and

(c) the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when:

(i) the financial benefit referred to in paragraph (b) is received if there is only one; or

(ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and

(d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and

(e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3) are not both nil.

The scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company).

Note: Section 974-30 tells you when a financial benefit is taken to be provided to an entity.

Each of the requirements in paragraphs 974-20(1)(a) to (e) must be met for a scheme to satisfy the debt test. Each paragraph is considered in turn below:

Paragraph 974-20(1)(a) - scheme is a financing arrangement for Entity H

The relevant 'scheme' for the purposes of subsection 974-15(1) which draws on the definition in section 995-1 of 'any arrangement' is each Loan F that Entity H issues to Entity J pursuant to the facility agreement. See ATO Interpretative Decision ATO ID 2006/230: Income Tax: Revolving Credit Facility: Facility Agreement - debt interest.

Each Loan F that Entity H issues will not give rise to an 'interest' covered by item 1 of the table in subsection 974-75(1) which is concerned with:

… [a]n interest in the company as a member or stockholder of the company …

for the purposes of the words which follow paragraph 974-20(1)(e) which commence:

The scheme does not need to satisfy …

Therefore, the scheme that gives rise to each Loan F must satisfy the paragraph 974-20(1)(a) requirement.

Pursuant to subsection 974-130(1), a scheme is a financing arrangement for an entity if it is entered into or undertaken:

(a) to raise finance for the entity (or a *connected entity of the entity); or

…

Subsection 974-130(2) states that examples of schemes that are generally entered into or undertaken to raise finance are:

(a) a bill of exchange;
…

Note: Paragraph (a) is likely to be relevant for debt interests, ...

The scheme giving rise to each Loan F will be entered into or undertaken to raise finance for Entity H and is, accordingly, a financing arrangement in accordance with paragraph 974-130(1)(a).

Therefore, a scheme giving rise to each Loan F will satisfy the paragraph 974-20(1)(a) requirement.

Paragraph 974-20(1)(b) - receipt of financial benefits

Under the terms of the facility agreement, Entity H will make each Loan F of a minimum amount (together with any Loan G amounts) to Entity J and not exceeding (again together with any Loan G amounts) the facility agreement maximum limit.

Entity H will receive financial benefits when it issues each Loan F.

Therefore, the scheme giving rise to each Loan F will satisfy the paragraph 974-20(1)(b) requirement.

Paragraph 974-20(1)(c) - effectively non-contingent obligation to provide financial benefits

Obligation to provide principal and interest

Under the terms of the facility agreement, Entity H must repay the principal amount of each Loan F, including all outstanding accrued interest no later than the date which is no later than 10 years from when it issued the Loan F.

Therefore, Entity H has an effectively non-contingent obligation to repay the principal and provide interest including any accrued or outstanding interest at maturity. Accordingly, Entity H has an effectively non-contingent obligation to provide financial benefits under each Loan F.

Therefore the scheme giving rise to each Loan F will satisfy the paragraph 974-20(1)(c) requirement.

Paragraph 974-20(1)(d) - financial benefits provided will equal or exceed those received

Under paragraph 974-20(1)(d) and subsections 974-20(2) and (3), it has to be substantially more likely than not that the value of all the financial benefits that Entity H will provide under the scheme will be at least equal to the value of all the financial benefits that Entity H will receive under the scheme.

As the performance period of each Loan F is no later than 10 years from when it issued the Loan F, the value of the financial benefits are worked out in nominal terms; subparagraph 974-35(1)(a)(i).

Accordingly, the financial benefits that Entity H is required to pay on each Loan F will, in nominal terms, at least equal the financial benefits that Entity H will receive under each Loan F.  

Therefore the scheme giving rise to each Loan F will satisfy the paragraph 974-20(1)(d) requirement.

Paragraph 974-20(1)(e) - financial benefits provided and received are not both nil

Entity H will issue each Loan F (together with any Loan G amounts) of a minimum amount and not exceeding the facility agreement maximum limit. On issuing each Loan F, Entity H has an obligation to provide financial benefits of at least the principal amount of the Loan F. Accordingly, the financial benefits that Entity H will provide and receive in respect of each Loan F are not both nil.

Therefore the scheme giving rise to each Loan F will satisfy the paragraph 974-20(1)(e) requirement.

Debt characterisation

As each of the requirements in paragraphs 974-20(1)(a) to (e) are met in respect of each Loan F, each Loan F will give rise to a debt interest in Entity H.

So that each Loan F is not otherwise treated as an equity interest, we also consider the 'related schemes' provisions in subsection 974-70(2) and section 974-80 which are discussed in turn below.

Related schemes

Subsection 974-70(2) provides that:

Two or more related schemes (the constituent schemes) are taken together to give rise to an equity interest in a company if:


(a) the company enters into, participates in or causes another entity to enter into or

participate in the constituent schemes; and

(b) a scheme with the combined effect or operation of the constituent schemes (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

(c) it is reasonable to conclude that the company 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.

This is so whether or not 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.

Section 974-155 sets out the circumstances in which two or more schemes are treated as 'related schemes' for the purposes of subsections 974-70(2) and 974-15(2).

In the present case, each Loan F issued by Entity H and the membership interests in Entity H on which Distribution P is payable each constitute a scheme as defined in subsection 995-1(1).

The Commissioner considers that, given the broad definition of 'related schemes', each Loan F and the membership interests in Entity H may constitute 'related schemes' within the meaning of section 974-155.

The two related schemes will give rise to an equity interest in Entity H if each of the requirements in paragraphs 974-70(2)(a) to (c) are met.

Whether the schemes are related

Based on the Relevant facts and circumstances, at the time when the last scheme is entered into (each Loan F), the Commissioner considers that the parties did not intend, or did not know that another party to one or more of the schemes intended that the combined effects of the membership interests in Entity Hand each Loan F would have the effect of a larger interest that is an equity interest for the purposes of paragraph 974-70(2)(c).

Therefore, as one of the requirements of subsection 974-70(2) will not be present, it is not necessary to consider the application of paragraphs 974-70(2)(a) and (b), and the membership interests in Entity H and each Loan F will not constitute a larger interest that is an equity interest pursuant to this subsection.

Section 974-80

Subsection 974-80(1) states that section 974-80 operates when:

(a) an interest carries a right to a variable or fixed return from a company; and

(b) the interest is held by a connected entity of the company; and

(c) apart from this section, the interest would not be an equity interest in the company; and

(ca) the scheme that gives rise to the interest is a financing arrangement for the company; and

(d) there is a scheme, or a series of schemes, designed to operate so that the return to the connected entity is to be used to fund (directly or indirectly) a return to another person (the ultimate recipient).

Where all of the requirements of subsection 974-80(1) are satisfied, subsection 974-80(2) operates to treat the interest as an equity interest where one of the requirements in subsection 974-80(2) is satisfied.

It is arguable that all of the requirements of subsection 974-80(1) will be satisfied, other than paragraph 974-80(1)(d).

Paragraph 1.28 of the Supplementary Explanatory Memorandum to the New Business Tax system (Debt and Equity) Bill 2001 states:

The amendment of paragraph 974-80(1)(d) is a technical amendment that will ensure that the provision applies as intended, which is only in those cases where the scheme or schemes are deliberately designed so that the return to the connected entity is in turn used to fund either directly or indirectly a return to the ultimate recipient.

Having regard to the Relevant facts and circumstances, the Commissioner accepts that it cannot be concluded that the scheme is 'deliberately designed' to achieve such an outcome. See Taxation Determination TD 2015/10 Income tax: will paragraph 974-80(1)(d) of the Income Tax Assessment Act 1997 be satisfied merely because a company has issued a debt interest to a listed property trust within the same stapled property group?

As all of the requirements of subsection 974-80(1)(a) to (d) will not be present for each Loan F as the paragraph 974-80(1)(d) requirement will not be satisfied, subsection 974-80(1) will in turn not be satisfied. Accordingly, it is not necessary to consider the application of subsection 974-80(2).

Therefore, section 974-80 will not apply to treat each Loan F as an equity interest.

Conclusion

As each of the requirements in paragraphs 974-20(1)(a) to (e) are met in respect of each Loan F, the Loan F will give rise to a debt interest in Entity H.

Further, subsection 974-70(2) and section 974-80 will not apply to treat each Loan F as, or as part of a larger interest that is, an equity interest.

Question 2

Summary

Loan G issued by Entity H to Entity J in accordance with the facility agreement will be treated as a debt interest pursuant to section 974-15.

Detailed reasoning

In accordance with the Loan G terms, the Detailed reasoning provided above in Question 1 for each Loan F will also apply to each Loan G that Entity H issues to Entity J.

Each Loan G has a maturity date of no longer than 10 years of when Entity H issued the Loan G.

Conclusion

As each of the requirements in paragraphs 974-20(1)(a) to (e) are met in respect of each Loan G, a Loan G will be a debt interest in Entity H.

Further, the related schemes provisions and section 974-80 will not apply to 're-characterise' each Loan G as an equity interest.