Edited version of your written advice

Authorisation Number: 1051180002672

Date of advice: 25 January 2017

Ruling

Subject: Capital Raising

Question 1

Will the Instrument satisfy the definition of 'non-share equity interest' in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will each Distribution paid by the Company in respect of the Instruments be a 'frankable distribution' as defined in section 202-40 of the ITAA 1997?

Answer

Yes.

Question 3

Will section 204-15 of the ITAA 1997 apply to the Transaction?

Answer

No.

Question 4

Will section 204-30 of the ITAA 1997 apply to the Transaction?

Answer

No.

Question 5

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

Answer

No.

Question 6

Will the Commissioner make a determination under subsection 45C(3) of the ITAA 1936 in relation to the Transaction?

Answer

No.

Question 7

Will the Instruments constitute a 'commercial debt' under section 245-10 of the ITAA 1997?

Answer

No.

Question 8.1

Will the issue of the Instruments, the issue of Ordinary Shares on Conversion, or Redemption be assessable as ordinary income for the Company under section 6-5 of the ITAA 1997?

Answer

No.

Question 8.2

Will CGT event D1 happen to the Company on the issue of the Instruments or the issue of Ordinary Shares on Conversion?

Answer

No.

Question 9.1

Will the Instrument be considered a financial arrangement under subsection 230-50(1) of the ITAA 1997?

Answer

Yes.

Question 9.2

If the answer to question 9.1 is yes, will paragraph 230-40(4)(e) of the ITAA 1997 apply such that the default accruals and realisation method outlined in Subdivision 230-B of the ITAA 1997 will not apply to a gain or loss made in relation to the Instruments?

Answer

Yes.

Question 9.3

If the answer to question 9.1 is yes, will subsection 230-440(1) of the ITAA 1997 apply such that the balancing adjustment provisions in Subdivision 230-G of the ITAA 1997 will not apply to the Instruments?

Answer

Yes.

Question 10

Will section 197-5 of the ITAA 1997 apply to the issue of the Instruments or Ordinary Shares on Conversion?

Answer

No.

This ruling applies for the following periods:

A number of income years.

The scheme commences in:

A particular income year.

Relevant facts and circumstances

The description of the scheme is based on information provided by the Company in the following documents, which are to be read in conjunction with the facts as set out below:

● Request for a Private Binding Ruling from the Applicant (the Application)

● the Company's draft prospectus for the issue of the Instruments (the Prospectus)

● the draft terms for the Instrument (the Terms)

● the Instrument's draft trust deed (Trust Deed), and

● other correspondence received from the Applicant during December 2016 and January 2017.

The scheme involves the issuance of an Instrument by a Company (the Transaction). The Instrument is being issued by the Company to raise capital for compliance with the relevant capital adequacy requirements and to maintain the diversity of the Company's sources and types of funding

The key terms of the Instrument are set out below:

(i) the Instrument is non-cumulative, convertible, transferable, redeemable, subordinated, perpetual, unsecured and on issue is fully paid

(ii) the Instrument is convertible to ordinary shares in the Company and conversion is subject to certain conditions being satisfied

(iii) the Instrument may be redeemed or resold at face value in certain circumstances

(iv) holders do not have a right to request conversion, redemption or resale of the Instrument

(v) distributions on the Instrument are payable subject to the Company's discretion and certain conditions being satisfied

(vi) distributions on the Instrument are expected to be fully franked and, if any distribution is not franked or only partially franked, the distribution will be grossed-up to the extent that the franking percentage of the distribution is less than 100%

(vii) all holders of the Instrument will receive franked distributions irrespective of their tax attributes or their individual tax position, and

(viii) distributions payable in respect of the Instrument will not be debited to the Company's share capital account or non-share capital account.

On the issue of the Instruments, there is no amount credited to the Company's share capital account.

On conversion of the Instruments, the Company will credit an amount to its share capital account to record the issue of ordinary shares allotted and debit that amount to a receivable (asset) account.

The Company is subject to the taxation of financial arrangements provisions in Division 230 of the ITAA 1997. The Company has not elected to apply any of the elective methods under Division 230 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 subsection 45B(2)

Income Tax Assessment Act 1936 paragraph 45B(2)(a)

Income Tax Assessment Act 1936 paragraph 45B(2)(b)

Income Tax Assessment Act 1936 paragraph 45B(2)(c)

Income Tax Assessment Act 1936 paragraph 45B(5)(a)

Income Tax Assessment Act 1936 paragraph 45B(5)(b)

Income Tax Assessment Act 1936 subsection 45B(7)

Income Tax Assessment Act 1936 subsection 45B(8)

Income Tax Assessment Act 1936 subsection 45B(9)

Income Tax Assessment Act 1936 subsection 45C(3)

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 subsection 177EA(3)

Income Tax Assessment Act 1936 paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 paragraph 177EA(3)(e)

Income Tax Assessment Act 1936 subsection 177EA(5)

Income Tax Assessment Act 1936 paragraph 177EA(12)(a)

Income Tax Assessment Act 1936 paragraph 177EA(14)(a)

Income Tax Assessment Act 1936 subsection 177EA(17)

Income Tax Assessment Act 1936 paragraph 177EA(17)(f)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1936 subsection 6-5(1)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1936 paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 section 26-26

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1936 paragraph 104-35(5)(c)

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 Subdivision 197-A

Income Tax Assessment Act 1997 section 197-5

Income Tax Assessment Act 1997 Subdivision 202-C

Income Tax Assessment Act 1997 section 202-30

Income Tax Assessment Act 1997 section 202-40

Income Tax Assessment Act 1997 section 202-45

Income Tax Assessment Act 1997 section 203-25

Income Tax Assessment Act 1997 section 204-15

Income Tax Assessment Act 1997 subsection 204-15(1)

Income Tax Assessment Act 1997 Subdivision 204-D

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 subsection 204-30(1)

Income Tax Assessment Act 1997 subsection 204-30(3)

Income Tax Assessment Act 1997 subsection 204-30(6)

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 215-1

Income Tax Assessment Act 1997 section 215-10

Income Tax Assessment Act 1997 section 215-15

Income Tax Assessment Act 1997 section 215-20

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 paragraph 230-40(4)(e)

Income Tax Assessment Act 1997 subsection 230-45(1)

Income Tax Assessment Act 1997 section 230-50

Income Tax Assessment Act 1936 subsection 230-50(1)

Income Tax Assessment Act 1936 subsection 230-50(2)

Income Tax Assessment Act 1997 Subdivision 230-B

Income Tax Assessment Act 1997 Subdivision 230-F

Income Tax Assessment Act 1997 Subdivision 230-G

Income Tax Assessment Act 1997 subsection 230-440(1)

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 section 245-10

Income Tax Assessment Act 1936 paragraph 245-10(a)

Income Tax Assessment Act 1936 paragraph 245-10(b)

Income Tax Assessment Act 1936 paragraph 245-10(c)

Income Tax Assessment Act 1997 section 960-120

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 Subdivision 974-B

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

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

Income Tax Assessment Act 1997 subsection 974-20(4)

Income Tax Assessment Act 1997 subsection 974-30(1)

Income Tax Assessment Act 1997 Subdivision 974-C

Income Tax Assessment Act 1997 subsection 974-70(1)

Income Tax Assessment Act 1997 subsection 974-75(1)

Income Tax Assessment Act 1997 subsection 974-75(2)

Income Tax Assessment Act 1997 section 974-115

Income Tax Assessment Act 1997 section 974-120

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

Income Tax Assessment Act 1997 subsection 974-130(2)

Income Tax Assessment Act 1997 section 974-135

Income Tax Assessment Act 1997 subsection 974-135(1)

Income Tax Assessment Act 1997 subsection 974-135(3)

Income Tax Assessment Act 1997 subsection 974-135(7)

Income Tax Assessment Act 1997 subsection 974-160(1)

Income Tax Assessment Act 1997 section 974-165

Income Tax Assessment Act 1997 section 975-300

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

Reasons for decision

Question 1

Summary

The Instrument satisfies the definition of 'non-share equity interest' in subsection 995-1(1) of the ITAA 1997.

Detailed reasoning

A 'non-share equity interest' in a company is defined in subsection 995-1(1) of the ITAA 1997 to be an equity interest in the company that is not solely a share.

An 'equity interest', in the case of a company, is defined under subsection 995-1(1) of the ITAA 1997 to have the meaning that is given under Subdivision 974-C of the ITAA 1997.

Subsection 974-70(1) of Subdivision 974-C of the ITAA 1997 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) of the ITAA 1997 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, or a connected entity of the company under Subdivision 974-B of the ITAA 1997.

Equity test

A scheme satisfies the equity test in subsection 974-75(1) of the ITAA 1997 if it gives rise to one or more of the following:

Equity interests

Item Interest

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

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; or

(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.

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.

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 a *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.

'Scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 as being an arrangement or scheme, plan, action, course of action or course of conduct, whether unilateral or otherwise. The issue of the Instruments by the Company will constitute a scheme.

For a scheme that gives rise to an equity interest under Items 2 to 4 of the table in subsection 974-75(1) of the ITAA 1997, subsection 974-75(2) of the ITAA 1997 provides that the scheme must also be a financing arrangement.

The Instruments give rise to an equity interest under Item 2 of the table in subsection 974-75(1) of the ITAA 1997 as the Instruments carry a right to a variable or fixed return from the Company (distributions) that is contingent on the economic performance of the Company.

The Instruments also give rise to an equity interest under Item 3 of the table in subsection 974-75(1) of the ITAA 1997, as the Instruments carry a right to a return from the Company that is subject to the Company's discretion.

In addition, the Instruments will also qualify as equity interests under Item 4(b) of the table in subsection 974-75(1) of the ITAA 1997 as the Instruments may convert into an equity interest in Company upon the occurrence of certain events.

Scheme is a financing arrangement

As the Instruments give rise to an equity interest under Items 2, 3 and 4(b) of the table in subsection 974-75(1) of the ITAA 1997, the scheme must also be a financing arrangement for the purposes of subsection 974-75(2) of the ITAA 1997.

Subsection 974-130(1) of the ITAA 1997 provides that 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)

(b) to fund another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a), or

(c) 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).

Paragraph 974-130(2)(c) of the ITAA 1997 states that a convertible interest that will convert into an equity interest is an example of a scheme that would generally be entered into or undertaken to raise finance.

The scheme in the present case is a financing arrangement within the meaning of paragraph 974-130(1)(a) of the ITAA 1997.

Not a debt interest

'Debt interest' in an entity is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning that is given under Subdivision 974-B of the ITAA 1997. Subsection 974-15(1) of Subdivision 974-B of the ITAA 1997 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) of the ITAA 1997.

Subsection 974-20(1) of the ITAA 1997 provides 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).

(a) The scheme is a financing arrangement for the entity

As stated above, the scheme is a financing arrangement.

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

Paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes 'anything of economic value'. Subsection 974-20(4) of the ITAA 1997 provides that a financial benefit received under the scheme is taken into account only if it is one that the other entity has an 'effectively non-contingent obligation' to provide.

An 'effectively non-contingent obligation' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 974-135 of the ITAA 1997. Subsection 974-135(1) of the ITAA 1997 states that there is an effectively non-contingent obligation to take 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) of the ITAA 1997 further provides that an effectively non-contingent obligation is an obligation that is not contingent on any event, condition or situation other than the ability or willingness of that entity or a connected entity of the entity to meet the obligation.

Each Instrument is issued fully paid. The Company will therefore receive a financial benefit under the scheme, namely the issue price that the holders have an effectively non-contingent obligation to provide. Accordingly, this requirement of the debt test is satisfied.

(c) The entity has, or 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

Whilst a financial benefit includes anything of economic value, subsection 974-30(1) of the ITAA 1997 provides that the issue of an equity interest in the entity or a connected entity of the entity or an amount that is to be applied in respect of the issue of an equity interest in the entity or a connected entity of the entity does not constitute the provision of a financial benefit. Thus, the financial benefits to be provided by the Company pursuant to the conversion mechanism will not constitute the provision of a financial benefit by the Company.

Consequently, in deciding whether the Company has an effectively non-contingent obligation under the scheme to provide a financial benefit, the relevant items of economic value (and therefore financial benefits) pursuant to section 974-135 of the ITAA 1997 are the obligations on the Company to pay distributions and return any amount of the face value.

Obligation to pay distributions

The Company does not have an effectively non-contingent obligation to provide a financial benefit by way of the distributions as:

● the payment of any distribution is subject to certain conditions

● payments of distributions are within the absolute discretion of the Company and are non-cumulative in that if a distribution is not paid because of the conditions or because of any other reason, the Company has no liability to pay such distribution to the holder and the holder has no claim or right in respect of such non-payment

● non-payment of a distribution because of the conditions or any other reason does not constitute an event of default.

Accordingly, the Company does not have an effectively non-contingent obligation to provide a financial benefit by way of the Distributions.

Obligation to return any amount of the face value

Redemption

Whilst the Instruments are perpetual (and therefore the Company does not have an obligation to provide the face value), the Instruments' terms set out circumstances under which the Instruments may be redeemed for their face value.

However, the circumstances in which redemption may occur do not suggest that the Company has an effectively non-contingent obligation to provide a financial benefit for the following reasons:

● redemption is at the Company's option and the pricing, terms and conditions do not suggest that the Company will definitely elect to redeem the Instruments

● redemption is contingent on the occurrence of certain trigger events and the pricing, terms and conditions do not suggest that these trigger events are artificial or contrived or that the events will definitely occur during the time the Instruments are on issue, and

● redemption is contingent on certain approvals and the pricing, terms and conditions do not suggest that these approvals will necessarily be granted.

As the occurrence of redemption is contingent on certain events occurring and approvals, the Company does not have an effectively non-contingent obligation to provide a financial benefit in the form of the repayment of the face value of the Instruments on redemption.

Resale

The resale mechanism provided for under 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 Instruments for the following reasons:

● holders do not have a right to request resale of their Instruments at any time

● a resale is at the Company's election and the pricing, terms and conditions of the Instruments do not suggest that the Company will definitely elect to resell the Instruments, and

● a resale, if it were to occur, transfers all right, title and interest in such Instruments to the nominated purchaser. A resale does not obligate the Company to provide to the holder the amount invested.

Accordingly, the Company does not have an effectively non-contingent obligation to provide a financial benefit by way of returning the face value on the resale of the Instruments.

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 return any part of the face value. 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.

Conclusion

As the issue of the Instruments satisfies the equity test in subsection 974-75(1) of the ITAA 1997 and does not meet the requirements to be characterised as a debt interest under Subdivision 974-B of the ITAA 1997, the Instruments are treated as equity interests in the Company under Division 974 of the ITAA 1997. Each Instrument will constitute a 'non-share equity interest', as defined in subsection 995-1(1) of the ITAA 1997 as it is an equity interest in the Company that is not solely a share.

Question 2

Will each distribution paid by the Company in respect of each Instrument be a 'frankable distribution' as defined in section 202-40 of the ITAA 1997?

Summary

The distributions payable in respect of the Instruments will constitute frankable distributions under section 202-40 of the ITAA 1997 on the basis that they are not unfrankable under section 202-45 of the ITAA 1997.

Detailed reasoning

Subdivision 202-C of the ITAA 1997 details the circumstances in which a distribution can be franked. Section 202-40 of the ITAA 1997 provides that distributions and non-share dividends are frankable unless it is specified they are unfrankable under section 202-45 of the ITAA 1997.

As stated above in response to Question 1, the Instruments are non-share equity interests as defined in subsection 995-1(1) of the ITAA 1997. Accordingly, distributions on Instruments are non-share distributions in accordance with section 974-115 of the ITAA 1997.

Section 974-120 of the ITAA 1997 provides that all non-share distributions are non-share dividends, except to the extent to which the company debits the distribution against the company's non-share capital account or the company's share capital account. As distributions payable will not be debited to the Company's share capital account or its non-share capital account, section 974-120 of the ITAA 1997 will apply and the distributions will be frankable distributions to the extent they are not unfrankable 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. None of these circumstances will apply to distributions payable in respect of the Instruments.

Accordingly, distributions payable in respect of the Instruments will constitute frankable distributions under section 202-40 of the ITAA 1997 as they will not be unfrankable under section 202-45 of the ITAA 1997.

Question 3

Will section 204-15 of the ITAA 1997 apply to the scheme?

Summary

Section 204-15 of the ITAA 1997 does not apply to the scheme.

Detailed reasoning

Subsection 204-15(1) of the ITAA 1997 gives rise to a franking debit in the franking account of a corporate tax entity if:

(a) the exercise of a choice or selection by a *member of an entity (the first entity); or

(b) the member's failure to exercise a choice or selection;

has the effect of determining (to any extent) that another entity makes to one of its members a *distribution (the linked distribution) that is:

(c) in substitution (in whole or in part) for a distribution by the first entity to that member or any other member of the first entity; and

(d) unfranked, or *franked at a *franking percentage that differs from the first entity's *benchmark franking percentage for the *franking period in which the linked distribution is made.

For the purposes of the imputation system, holders will be treated in a manner similar to members of the Company by virtue of section 215-1 of the ITAA 1997 which provides that the imputation system applies to a non-share equity interest in the same way it applies to a membership interest, and to an equity holder in the entity who is not a member of the entity same way as it applies to a member of the entity.

The terms of the Instruments do not provide the holders with a choice or selection in relation to the payment of distributions, or the occurrence of conversion, resale or redemption.

As the requirements of subsection 204-15(1) of the ITAA 1997 are not satisfied, section 204-15 of the ITAA 1997 will not apply to give rise to a franking debit in the franking account of the Company.

Question 4

Will section 204-30 of the ITAA 1997 apply to the scheme?

Summary

Section 204-30 of the ITAA 1997 does not apply to the scheme.

Detailed reasoning

Section 204-30 of the ITAA 1997 is a general anti-streaming measure that applies if the conditions in subsection 204-30(1) of the ITAA 1997 are satisfied.

Subsection 204-30(1) of the ITAA 1997 states:

This section empowers the Commissioner to make determinations if an entity streams one or more *distributions (or one or more distributions and the giving of other benefits), whether in a single *franking period or in a number of franking periods, in such a way that:

(a) an *imputation benefit is, or apart from this section would be, received by a *member of the entity as a result of the distribution or distributions; 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, or will not receive any imputation benefits, whether or not the other member receives other benefits.

The member that derives the greater benefit from franking credits is the favoured member. The member that receives the lesser imputation benefits is the disadvantaged member.

Where the conditions in subsection 204-30(1) of the ITAA 1997 are met, the Commissioner may make one or more of the following 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 a distribution that is made to a favoured member and specified in the determination.

'Imputation benefit' is defined in subsection 204-30(6) of the ITAA 1997 to include an entitlement to a tax offset under Division 207 as a result of the distribution. It is reasonable to expect that holders will receive an imputation benefit because the distributions are frankable distributions, which are expected to be fully franked.

The term 'streaming' is not defined in the ITAA 1997. However, the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002, which introduced Subdivision 204-D states at paragraphs 3.28 to 3.29 that:

3.28 Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

3.29 The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

Based on the facts of this case, the Commissioner has concluded that the requisite element of streaming does not exist in relation to the franked distributions to be paid by the Company to the holders. Consequently, the Commissioner will not make a determination under section 204-30 of the ITAA 1997 to either impose a franking debt or deny the whole, or any part, of the imputation benefits received by a holder in relation to distributions paid in respect of the Instruments.

Question 5

Will section 177EA of the ITAA 1936 apply to the scheme?

Summary

Section 177EA of the ITAA 1936 does not apply to the scheme.

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies where a purpose of the scheme, other than an incidental purpose, is to enable the relevant taxpayer to obtain an imputation benefit. In those circumstances, subsection 177EA(5) of the ITAA 1936 enables the Commissioner to make a determination with the effect of either:

(a) imposing franking debits or exempting debits on the issuer's franking account, or

(b) that no imputation benefit is to arise on the distributions that flowed directly or indirectly to the relevant taxpayer.

Pursuant to subsection 177EA(3) of the ITAA 1936, the provision applies if the following conditions 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:

(c) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests, or

(d) 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

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

(f) 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

(g) 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.

The Commissioner considers that the conditions in paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied because:

(a) the issue of 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, a 'scheme for a disposition of membership interests or an interest in membership interests' includes a scheme that involves the issuing of membership interests. Paragraph 177EA(12)(a) of the ITAA 1936 provides that section 177EA of the ITAA 1936 applies to a 'non-share equity interest' in the same way as it applies to a 'membership interest'. The Instruments will be treated as 'membership interests' issued by the Company for the purposes of paragraph 177EA(3)(a) of the ITAA 1936;

(b) frankable distributions are expected to be payable to holders (paragraph 177EA(3)(b) of the ITAA 1936) and the Commissioner accepts the distributions will be frankable distributions under section 202-40 of the ITAA 1997 (see response to Question 2 above);

(c) franked distributions are expected to be paid to the holders (paragraph 177EA(3)(c) of the ITAA 1936); and

(d) it is reasonable to expect that an imputation benefit will be received by the holders (that is, the relevant taxpayers) given that the Company intends to frank the distributions (paragraph 177EA(3)(d) of ITAA 1936).

Accordingly, the remaining issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that a person, or one of the persons, who entered into or carried out 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).

The circumstances that 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. The relevant circumstances listed encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose. Due to the diverse nature of these circumstances, some may or may not be present at any one time in relation to a particular scheme.

Having regard to all the relevant circumstances of the scheme, it is considered that the purpose of enabling the holders to obtain an imputation benefit is not more than incidental to the Company's purpose of raising capital for the Company for compliance with the relevant capital adequacy requirements and to maintain the diversity of the Company's sources and types of funding.

Accordingly, section 177EA of the ITAA 1936 does not apply.

Question 6

Will the Commissioner make a determination under subsection 45C(3) of the ITAA 1936 in relation to the scheme?

Summary

The Commissioner will not make a determination under subsection 45C(3) of the ITAA 1936.

Detailed reasoning

In certain circumstances where section 45B of the ITAA 1936 applies to a scheme or transaction, subsection 45C(3) of the ITAA 1936 permits the Commissioner to make a further determination that a franking debit arises for the company, if the capital benefit paid under the scheme was for a purpose (other than an incidental purpose) of avoiding a franking debit.

Section 45B of the ITAA 1936 applies where certain capital benefits are provided to shareholders in substitution for dividends and the conditions in subsection 45B(2) of the ITAA 1936 are met.

The conditions in subsection 45B(2) of the ITAA 1936 are:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company; and

(b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and

(c) 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 a taxpayer (the relevant taxpayer) to obtain a tax benefit.

Each of these conditions is considered below.

Scheme for capital benefit

The issue of ordinary shares to holders on conversion will constitute a scheme under which the holders are provided with a capital benefit by the Company (paragraph 45B(5)(a) of the ITAA 1936). Similarly, redemption will also constitute a scheme under which the holders are provided with a capital benefit by the Company (paragraph 45B(5)(b) and subsection 45B(7) of the ITAA 1936).

Tax benefit

As the tax payable by a holder on conversion or redemption would be less than the tax payable if the holder had received an amount that was an assessable dividend, the holder will obtain a tax benefit under the scheme (subsection 45B(9) of the ITAA 1936).

Relevant circumstances

The application of section 45B of the ITAA 1936 therefore turns on the application of paragraph 45B(2)(c) of the ITAA 1936. Paragraph 45B(2)(c) of the ITAA 1936 requires the Commissioner to objectively consider the 'relevant circumstances of the scheme' as part of a consideration of whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling the relevant taxpayer to obtain a 'tax benefit'.

The relevant circumstances listed in subsection 45B(8) of the ITAA 1936 encompass a range of matters which, when taken individually or collectively, will reveal whether the requisite purpose exists or not. Due to the diverse nature of these circumstances, some may be of no consequence in ascertaining whether or not that purpose exists.

Having regard to the relevant circumstances, and based on the information provided and the qualifications of the ruling, it is considered that the purpose of enabling holders to obtain an imputation benefit is not more than incidental to the Company's purpose of raising capital for compliance with the relevant capital adequacy requirements and to maintain the diversity of the Company's sources and types of funding.

The allotment of ordinary shares in the Company on conversion of the Instruments is not in satisfaction of the holder's entitlement to distributions, but rather a product of the conversion of the Instrument according to its terms. Conversion simply represents a substitution of the type of equity interest held by the holder; an instrument paying franked distributions (the Instrument) will be replaced with another instrument paying franked distributions (ordinary shares in the Company). Any distribution entitlements on conversion of the Instrument will be separately paid as a distribution according to the Terms.

The amount paid to holders on redemption is limited to the amount equal to the face value of the Instrument. As such, redemption simply represents the return of the capital originally invested by the holder. Any distribution entitlements on redemption will also be separately paid as a distribution according to the Terms.

Accordingly, section 45B of the ITAA 1997does not apply to the Transaction and the Commissioner will not make a determination under subsection 45C(3) of the ITAA 1936.

Question 7

Will the Instruments constitute a 'commercial debt' under section 245-10 of the ITAA 1997?

Summary

The Instruments will not constitute a 'commercial debt' under section 245-10 of the ITAA 1997.

Detailed reasoning

Section 245-10 of the ITAA 1997 sets out the debts to which Division 245 applies:

Subdivisions 245-C to 245-G apply to a debt of yours if:

(a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

(b) interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

(c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2)(a), (b) and (c)) that has the effect of preventing a deduction.

Pursuant to section 26-26 of the ITAA 1997, a company cannot deduct a non-share distribution or a return that has accrued on a non-share equity interest.

As stated in response to Questions 1 and 2 above, the Instruments are non-share equity interests as defined in subsection 995-1(1) of the ITAA 1997 and distributions on the Instruments will be non-share distributions in accordance with section 974-115 of the ITAA 1997. Accordingly, the Instruments will not satisfy the requirements of paragraphs 245-10(a) and 245-10(b) of the ITAA 1997.

Under paragraph 8-1(2)(a) of the ITAA 1997, a taxpayer cannot deduct a loss or outgoing under section 8-1 of the ITAA 1997 to the extent that it is a loss or outgoing of capital, or of a capital nature.

The funds raised by the issue of Instruments are of a capital nature. Accordingly, the Company cannot deduct a loss or outgoing in respect of the Instruments pursuant to paragraph 8-1(2)(a) of the ITAA 1997. As a result, the Instruments do not satisfy the requirements of paragraph 245-10(c) of the ITAA 1997.

As section 245-10 does not apply to the Instruments, the Instruments will not constitute a commercial debt under section 245-10 of the ITAA 1997.

Question 8.1

Will the issue of the Instruments, the issue of ordinary shares on conversion, or redemption be assessable as ordinary income for the Company under section 6-5 of the ITAA 1997?

Summary

The issue of the Instruments, the issue of ordinary shares on conversion, and the redemption of the Instruments will not be assessable as ordinary income for the Company under section 6-5 of the ITAA 1997.

Detailed reasoning

Subsection 6-5(1) of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts, which is called ordinary income.

The periodicity, regularity and recurrence of receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82, Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693).

A receipt of capital is not ordinary income and thus not assessable under section 6-5 of the ITAA 1997.

Two essential characteristics of capital are that it should 'represent a permanent and unrestricted commitment of funds' and 'be freely available to absorb losses' (paragraph 96 of Taxation Ruling TR 2002/15). The raising of capital through the issue of perpetual notes represents a permanent and unrestricted commitment of funds. This is irrespective of whether the issuer or its consolidated group treats the funds as equity for accounting purposes and includes the funds as shareholder's equity in its balance sheet (paragraph 98 of Taxation Ruling TR 2002/15).

Issue of the Instruments

As discussed above in response to Question 1, the Instruments are non-share equity interests in the Company as defined in subsection 995-1(1) of the ITAA 1997. The receipt of the face value by the Company for the issue of the Instruments is regarded as a contribution to the capital of the Company. This does not have the characteristics of income according to ordinary concepts in accordance with section 6-5 of the ITAA 1997.

Conversion

On conversion each holder's rights in relation to each Instrument will be immediately and irrevocably terminated for an amount equal to the face value and the Company will apply the face value of each Instrument by way of payment for the subscription for the ordinary shares to be allotted and issued. Thus, conversion results in one equity interest being exchanged for another equity interest. This does not have the characteristics of income accordingly to ordinary concepts in accordance with section 6-5 of the ITAA 1997; rather it is only a re-expression of the holder's interest in the equity of the Company.

Redemption

On redemption the Company will be required to pay the face value to the holders. This is regarded as a return of capital and does not have the characteristics of income according to ordinary concepts in accordance with section 6-5 of the ITAA 1997.

Conclusion

Accordingly, the Company will not derive ordinary income under section 6-5 of the ITAA 1997 on the issue of the Instruments, the issue of ordinary shares on conversion, or on redemption of the Instruments.

Question 8.2

Will CGT event D1 happen to the Company on the issue of the Instruments or the issue of Ordinary Shares on Conversion?

Summary

CGT event D1 will not happen to the Company on the issue of Instruments or the issue of Ordinary Shares on Conversion.

Detailed reasoning

CGT event D1 happens if you create a contractual right or equitable right in another entity (section 104-35 of the ITAA 1997).

However, paragraph 104-35(5)(c) of the ITAA 1997 provides that CGT event D1 does not happen if a company issues or allots equity interests or non-equity shares in the company.

As discussed above in response to Question 1, the Instruments are equity interests under Division 974 of the ITAA 1997. Ordinary Shares in the Company are also equity interests under Division 974 of the ITAA 1997. Accordingly, CGT event D1 will not happen on the issue of the Instruments by the Company or the allotment of Ordinary Shares upon Conversion of the Instruments.

Question 9.1

Will the Instruments be considered a financial arrangement under subsection 230-50(1) of the ITAA 1997?

Summary

Each Instrument is a financial arrangement under subsection 230-50(1) of the ITAA 1936.

Detailed reasoning

For Division 230 of the ITAA 1997 to apply to a gain or loss, it is necessary to identify a financial arrangement. Subsections 230-45(1), 230-50(1) and 230-50(2) of the ITAA 1997 provide tests which specify when there is a financial arrangement.

Where an arrangement satisfies the definition of a financial arrangement under both section 230-45 and subsection 230-50(1), section 230-50 will take precedence (refer to Taxation Determination TD 2011/12).

Subsection 230-50(1) of the ITAA 1997 provides that an equity interest constitutes a financial arrangement. The term 'equity interest' is defined in Subdivision 974-C of the ITAA 1997. As discussed above in response to Question 1, the Instruments are equity interests in the Company under Division 974 of the ITAA 1997. Therefore, each Instrument will be a financial arrangement under subsection 230-50(1) of the ITAA 1997.

Question 9.2

If the answer to question 9.1 is yes, will paragraph 230-40(4)(e) of the ITAA 1997 apply such that the default accruals and realisation method outlined in Subdivision 230-B of the ITAA 1997 will not apply to a gain or loss made in relation to the Instruments?

Summary

The default accruals and realisation methods outlined in Subdivision 230-B of the ITAA 1997 will not apply to a gain or loss made in relation to the Instruments.

Detailed reasoning

Where the arrangement is a financial arrangement under section 230-50 of the ITAA 1997, paragraph 230-40(4)(e) of the ITAA 1997 provides that Subdivision 230-B of the ITAA 1997 (accruals and realisation method) does not apply to a gain or loss made from the financial arrangement.

As stated above in response to Question 9.1, each Instrument is a financial arrangement under subsection 230-50(1) of the ITAA 1997. Accordingly, paragraph 230-40(4)(e) of the ITAA 1997 applies such that the accruals and realisation method provided for in Subdivision 230-B of the ITAA 1997 will not apply to a gain or loss made from the Instruments.

Question 9.3

If the answer to question 9.1 is yes, will subsection 230-440(1) of the ITAA 1997 apply such that the balancing adjustment provisions in Subdivision 230-G of the ITAA 1997 will not apply to the Instruments?

Summary

The balancing adjustment provisions in Subdivision 230-G of the ITAA 1936 will not apply to the Instruments.

Detailed reasoning

Subsection 230-440(1) of the ITAA 1997 provides that a balancing adjustment is not made under Subdivision 230-G of the ITAA 1997 in relation to a financial arrangement at a time if:

(a) the arrangement is a financial arrangement under section 230-50 of the ITAA 1997, and

(b) neither the fair value method provided for in Subdivision 230-C of the ITAA 1997 nor the method of relying on financial reports provided for in Subdivision 230-F of the ITAA 1997 apply to the arrangement immediately before that time.

As discussed above in response to Question 9.1, each Instrument will be a financial arrangement under section 230-50 of the ITAA 1997.

As the Company has not made an election to apply any of the elective methods under Division 230, the fair value method provided for in Subdivision 230-C and the method of relying on financial reports provided for in Subdivision 230-F of the ITAA 1997 will not apply to the Instruments.

Accordingly, pursuant to subsection 230-440(1) of the ITAA 1997, the Company will not be required to make a balancing adjustment in relation to the Instruments.

Question 10

Will section 197-5 of the ITAA 1997 apply to the issue of the Instruments or ordinary shares on Conversion?

Summary

Section 197-5 of the ITAA 1997 will not apply to the issue of the Instruments or allotment of ordinary shares on Conversion.

Detailed reasoning

The share capital tainting provisions in Division 197 of the ITAA 1997 are integrity rules designed to prevent a company from disguising a distribution of profits as a tax-preferred capital distribution by transferring profits into its share capital account and subsequently making distributions from that account.

Unless one of the exclusions in Subdivision 197-A of the ITAA 1997 applies, section 197-5 of the ITAA 1997 provides that Division 197 applies to an amount (the transferred amount) that is transferred to a company's share capital account from another of the company's accounts, if the company was an Australian resident immediately before the time of the transfer.

If an amount, to which Division 197 of the ITAA 1997 applies, is transferred to a company's share capital account from another of the company's accounts, then under section 197-50 of the ITAA 1997 the company's share capital account becomes tainted.

The expression 'transferred amount' in section 197-5 of the ITAA 1997 is not defined in Division 197 or subsection 995-1(1) of the ITAA 1997. Paragraphs 4.12 and 4.13 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.3) Bill 2006 and the New Business Tax System (Untainting Tax) Bill 2006 provide guidance on when an amount is transferred from one account to another account:

4.12 An amount is transferred from one account to another account where that amount is moved from one account to another. This, in turn, requires the balance of the first account to be reduced, while the balance of the second account is increased by the same amount.

4.13 An amount is not transferred from one account to another account where the particular accounting entries result in the balances of both accounts increasing in size. Accordingly, an accounting entry of the form 'debit asset, credit share capital account' does not represent a transfer in the relevant sense. Furthermore, a transfer to the share capital account will not arise if an expense account is debited at the same time that the share capital account is credited.

On the issue of the Instruments, there is no amount credited to the Company's share capital account. Therefore, no amount will be transferred to the Company's share capital account (as defined in section 975-300 of the ITAA 1997) for the purposes of section 197-5 of the ITAA 1997.

On conversion of the Instruments, the Company will credit an amount to its share capital account to record the issue of ordinary shares allotted and debit that amount to a receivable (asset) account. The accounting journal entry will result in the balance of both accounts increasing in size. Accordingly, as the accounting entry is in the form of 'debit asset, credit share capital account', there is no transfer in the relevant sense. This is consistent with Interpretative Decision ATO ID 2009/136 where the Commissioner confirmed that the conversion of convertible debentures into ordinary shares did not constitute a transfer for the purposes of section 197-5 of the ITAA 1997.

Therefore, section 197-5 of the ITAA 1997 will not apply to the issue of the Instruments or the allotment of ordinary shares on Conversion.