Edited version of private advice

Authorisation Number: 1051773021103

Date of advice: 2 November 2020

Ruling

Subject: Application of the debt equity rules

Question 1

Do the Nominated Drawdowns under the loan facility give rise to debt interests within the meaning of section 974-15 of the Income Tax Assessment Act (ITAA 1997)?

Answer

No

Question 2

Are the Nominated Drawdowns included in the calculation of adjusted average debt under subsection 820-185(3) of the ITAA 1997?

Answer

No

This ruling applies for the following period(s)

Substituted Accounting Period 1 January 20XX to 31 December 20XX

The scheme commences on

In the income year beginning with 1 January 20XX

Relevant facts and circumstances

A is an Australian resident company and head of a tax consolidated group (TCG). The TCG comprises A and its wholly owned subsidiary B.

B entered into a loan facility with an unrelated foreign bank C to fund its investment in a project in Australia.

The terms of the loan facility are specified in an agreement between B as the Borrower and C as the Lender.

Under the loan facility, the drawdowns will not be fully repaid within 10 years (the Nominated Drawdowns).

The interest rate of each Nominated Drawdowns is less than 75% of the benchmark rate of return.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 section 974-15

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

Income Tax Assessment Act 1997 subsection 974-15(2)

Income Tax Assessment Act 1997 section 974-20

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

Income Tax Assessment Act 1997 paragraph 974-20(1)(a)

Income Tax Assessment Act 1997 paragraph 974-20(1)(b)

Income Tax Assessment Act 1997 paragraph 974-20(1)(c)

Income Tax Assessment Act 1997 paragraph 974-20(1)(d)

Income Tax Assessment Act 1997 paragraph 974-20(1)(e)

Income Tax Assessment Act 1997 section 974-35

Income Tax Assessment Act 1997 subparagraph 974-35(1)(a)(ii)

Income Tax Assessment Act 1997 subsection 974-35(3)

Income Tax Assessment Act 1997 section 974-50

Income Tax Assessment Act 1997 section 974-65

Income Tax Assessment Act 1997 subsection 974-65(1)

Income Tax Assessment Act 1997 subsection 974-65(2)

Income Tax Assessment Act 1997 section 974-130

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

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 section 974-140

Income Tax Assessment Act 1997 section 974-145

Income Tax Assessment Act 1997 subsection 974-145(1)

Income Tax Assessment Act 1997 paragraph 974-145(1)(a)

Income Tax Assessment Act 1997 paragraph 974-145(1)(b)

Income Tax Assessment Act 1997 paragraph 974-145(1)(c)

Income Tax Assessment Act 1997 paragraph 974-145(1)(d)

Income Tax Assessment Act 1997 paragraph 974-145(1)(e)

Income Tax Assessment Act 1997 paragraph 974-145(1)(f)

Income Tax Assessment Act 1997 subsection 974-145(2)

Income Tax Assessment Act 1997 section 974-155

Income Tax Assessment Act 1997 subsection 974-155(1)

Income Tax Assessment Act 1997 subsection 974-155(2)

Income Tax Assessment Act 1997 subsection 974-155(3)

Income Tax Assessment Act 1997 section 974-160

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

Income Tax Assessment Act 1997 subsection 820-185(3)

Income Tax Assessment Act 1997 section 995-1

Anti-avoidance rules

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or DPT tax benefit in connection with an arrangement.

If Part IVA applies the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

Subsection 974-15(1) 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 in relation to the entity.

(a)The scheme is a financing arrangement for A

Scheme is defined in subsection 995-1(1) of the ITAA 1997 as:

a) any arrangement; or

b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Pursuant to subsection 974-130(1) of the ITAA 1997, a scheme is a financing arrangement for an entity if it is entered into or undertaken to raise finance for the entity or its connected entity.

Each Nominated Drawdown is a scheme as defined and a financing arrangement for A, as the amounts advanced in respect of each Nominated Drawdown will be used for funding A's investment. Accordingly, the requirement under paragraph 974-20(1)(a) of the ITAA 1997 is met in relation to each Nominated Drawdown.

(b) A receives, or will receive, a financial benefit or benefits under the scheme

The term 'financial benefit' is defined broadly in subsection 974-160(1) of the ITAA 1997 to mean anything of economic value, including property and services.

Under each Nominated Drawdown, A will receive a financial benefit being the amount of each drawdown under the loan facility. Therefore, paragraph 974-20(1)(b) of the ITAA 1997 is satisfied.

(c) A has an effectively non-contingent obligation under the scheme to provide a financial benefit

Subsection 974-135(1) of the ITAA 1997 provides that there is an effectively non-contingent obligation to take an action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action.

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 (subsection 974-135(3) of the ITAA 1997).

A has an effectively non-contingent obligation to provide a financial benefit under the loan agreement, being the obligation to repay the loan according to the loan amortisation schedule.

As a result, paragraph 974-20(1)(c) of the ITAA 1997 is satisfied.

(d) It is substantially more likely than not that the value provided will be at least equal to the value received

The value of a financial benefit received or provided under the scheme is its value calculated in present value terms if the performance period must or may end more than 10 years after the interest arising from the scheme is issued (subparagraph 974-35(1)(a)(ii) of the ITAA 1997). Where the performance period must end no later than 10 years after the interest arising from the scheme is issued, the value is calculated in nominal terms (subparagraph 974-35(1)(a)(i) of the ITAA 1997).

The performance period is the period within which, under the terms on which the interest is issued, the effectively non-contingent obligations of the issuer have to be met (subsection 974-35(3) of the ITAA 1997).

The performance period of each Nominated Drawdowns is more than 10 years and therefore the value of financial benefits provided is calculated in present value terms in accordance to section 974-50 of the ITAA 1997.

The valuation of the financial benefits in present value terms is set out in section 974-50 which is based on the adjusted benchmark rate of return.

The adjusted benchmark rate of return is 75% of the benchmark rate of return on the test interest which is defined in section 974-145 of the ITAA 1997.

Using the adjusted benchmark rate of return in this case, it is not substantially more likely than not that the value provided will be at least equal to the value received.

As a result, paragraph 974-20(1)(d) of the ITAA 1997 is not satisfied.

(e) the value provided and the value received are not both nil.

The value provided and the value received by A under the scheme are not nil because:

•         the value of the financial benefit received will be the present value of the Nominated Drawdown; and

•         the value of the financial benefits to be provided will be the present value of the Nominated Drawdown and the applicable interest on the Nominated Drawdown.

Paragraph 974-20(1)(e) of the ITAA 1997 is satisfied.

Related schemes

As each Nominated Drawdown does not pass the debt test in subsection 974-20(1) of the ITAA 1997, it is necessary to consider whether there are two or more related schemes that together give rise to a debt interest under subsection 974-15(2) of the ITAA 1997.

Subsection 974-155(1) of the ITAA 1997 provides that two schemes are related to one another if they are related to one another in any way.

Subsection 974-155(2) of the ITAA 1997 provides that, without limiting subsection 974-155(1), two schemes are related if:

(a) the schemes are based on stapled instruments; or

(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; or

(c) one of the schemes depends for its effect on the operation of the other scheme; or

(d) one scheme complements or supplements the other; or

(e) there is another scheme to which both the schemes are related because of a previous application or applications of this subsection.

However, subsection 974-155(3) of the ITAA 1997 provides that two schemes are not related to one another merely because (a) one refers to the other; or (b) they have a common party.

Having regard to the facts and circumstances presented, the Nominated Drawdowns do not give rise to related schemes as defined in section 974-155 of the ITAA 1997.

Conclusion

The Nominated Drawdowns under the loan facility do not give rise to debt interests within the meaning of section 974-15 of the ITAA 1997.

Question 2

The method for calculating the adjusted average debt of inward investing entities (non-ADI) is set out in subsection 820-185(3) of the ITAA 1997:

Method statement

Step 1. Work out the average value, for that year (the relevant year), of all the *debt capital of the entity that gives rise to *debt deductions of the entity for that or any other income year.

Step 2. Reduce the result of step 1 by the average value, for the relevant year, of:

(a) if the entity is an *inward investment vehicle (general) or an *inward investment vehicle (financial) for that year-all the *associate entity debt of the entity; or

(b) if the entity is an *inward investor (general) or an *inward investor (financial) for that year-all the associate entity debt of the entity, to the extent that it is attributable to the entity's *Australian permanent establishments.

Step 3. If the entity is a *financial entity throughout the relevant year, add to the result of step 2 the average value, for the relevant year, of the entity's *borrowed securities amount.

Step 4. Add to the result of step 3 the average value, for the relevant year, of the *cost-free debt capital of the entity. The result of this step is the adjusted average debt.

Debt capital is defined in subsection 995-1(1) of the ITAA 1997 as 'any debt interests issued by the entity that are still on issue at the time'.

The drawdowns are not debt interests under section 974-15 of the ITAA 1997 and the Commissioner will not make a determination that the scheme gives rise to a debt interest having regard to the circumstance under subsection 974-65(2) of the ITAA 1997.

As the drawdowns are not debt interests under subdivision 974-B of the ITAA 1997, the average value of the drawdowns and any accrued interest on such drawdowns should not be included in the A TCG's debt capital, and in turn should not be included in the A TCG's adjusted average debt when determining whether the A TCG's group's debt levels exceed the maximum allowable amount.