Edited version of private advice

Authorisation Number: 1051598577608

Date of advice: 30 October 2019

Ruling

Subject: Application of Division 974 of the ITAA 1997

Question 1

In regards to the Redeemable Preference Shares (RPS) and ordinary shares (OS) on issue by Co A, will the proposed amendments to the terms of the RPS result in a material change for the purposes of subsection 974-110(1) of the ITAA 1997?

Answer

No.

Question 2

Will the proposed amendments to the terms of the RPS on issue by Co A result in a material change to the RPS or OS for the purposes of subsection 974-110(2) of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Co A is an Australian resident company.

Co A has on issue an equivalent paid up amount of OS and RPS.

The OS give rise to an equity interest in Co A for the purposes of paragraph 974-70(1)(a) of the ITAA 1997.

The RPS give rise to a debt interests in accordance with subsection 974-15(1) of the ITAA 1997.

Co A has proposed to amend the terms of the RPS.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 974-110(1)

Income Tax Assessment Act 1997 subsection 974-110(2)

Reasons for decision

All legislative references set out below are to the provisions of the Income Tax Assessment Act 1997 unless otherwise indicated.

Question 1

Summary

In regards to the RPS and OS on issue by Co A, the proposed amendments to the terms of the RPS will not result in a material change for the purposes of subsection 974-110(1).

Detailed reasoning

Section 974-110 contains rules which ensure that the general requirement under Division 974 that the debt and equity tests are applied to schemes at the time the scheme comes into existence does not prevent Division 974 applying where the scheme has changed in a material way.

In particular subsection 974-110(1) provides that if:

(a)   a *scheme or schemes give rise to a *debt interest (or an *equity interest) in a company; and

(b)   the scheme, or one or more of the schemes, are subsequently changed, including where one or more (but not all) of the schemes cease to exist; and

(c)   the scheme or schemes as they exist immediately after the change would give rise to an equity interest (or a debt interest) in the company if they came into existence when the change occurred; and

(d)   subsection (1A) does not apply to the change;

this Division applies after the change as if the scheme or schemes as they exist immediately after the change came into existence when the change occurred.

The effect of section 974-110 is to put an imperative on the issuer to retest the interest under Division 974 every time there is a change to an existing scheme to ensure it is not a material change that changes its classification under Division 974 from debt to equity or vice versa.

With respect to the OS, the OS will continue to be characterised as equity for tax as no changes are proposed to its terms and conditions thereby not invoking section 974-110.

With respect to the RPS, the interest will need to be retested under Division 974 to determine whether the proposed changes to the RPS effects a material change which reclassifies from debt to equity.

The RPS as it will exist immediately after the proposed change will be deemed to have come into existence when the change occurs to determine if it gives rise to a debt or equity interest: see paragraph 974-110(1)(c). That is, the debt and equity tests are applied at time of the proposed change.

In applying paragraph 974-110(1)(c), all changes to the terms and conditions of the RPS prior to the proposed change need to be taken into account: see subsection 974-110(3).

The RPS does not take the form of a loan as provided in paragraph 974-110(1A)(a) and subsection 974-110(1A) will not apply to the change: see paragraph 974-110(1)(d).

The debt test is contained in subsection 974-20(1) as follows:

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).

Based on the facts, all the requirements of the debt test have been satisfied in relation to the RPS at time of the proposed change, the RPS will give rise to a debt interest in Co A under subsection 974-15(1). Consequently, there is no effect of material change under section 974-110.

Accordingly the RPS will continue to be characterised as debt for tax purposes.

Question 2

Summary

The proposed amendments to the terms of the RPS on issue by Co A will not result in a material change to the Co A RPS or OS for the purposes of subsection 974-110(2).

Detailed reasoning

Subsection 974-110(2) provides that if:

(a)  a *scheme or schemes give rise to a *debt interest (or an *equity interest) in a company; and

(b)  the company subsequently enters into, participates in or causes another entity to enter into or participate in a new *related scheme; and

(c)  the scheme or schemes, together with:

                                (i)    the new related scheme; and

                               (ii)    any other related scheme that the entity (or company) enters into, participates in or causes another entity to enter into or participate in before the new related scheme is entered into;

would give rise to an equity interest (or a debt interest) in the company if they all came into existence when the new related scheme is entered into;

this Division applies after the new related scheme is entered into as if all the schemes referred to in paragraph (c) had come into existence when the new related scheme is entered into.

Based on the facts, the proposed changes to the terms and conditions of the RPS do not result in a new related scheme for the purposes of paragraph 974-110(2)(b) and therefore will not result in a material change to the RPS or OS for the purposes of subsection 974-110(2). Accordingly subsection 974-110(2) will not apply to reclassify the RPS or OS.