Edited version of private advice

Authorisation Number: 1052237781629

Date of advice: 10 April 2024

Ruling

Subject: Redeemable preference shares

Question 1

Will the redeemable preference shares (RPS2) to be issued by the Subsidiary and the ordinary shares in the taxpayer on issue to the Investors constitute related schemes for the purposes of section 974-155 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

If the ordinary shares issued by the taxpayer and RPS2 to be issued by the Subsidiary are related schemes for the purposes of section 974-155 of the ITAA 1997, will the ordinary shares and RPS2 together give rise to a single notional debt interest in the taxpayer pursuant to subsection 974-15(2) of the ITAA 1997?

Answer

Yes.

Question 3

If it is considered that the ordinary shares and RPS2 will together give rise to a single notional debt interest in the taxpayer under subsection 974-15(2) of the ITAA 1997, will the Commissioner make a determination under subsection 974-15(4) of the ITAA 1997 that it would be unreasonable to treat the schemes as related schemes giving rise to a single notional debt interest in the taxpayer under subsection 974-15(2) of the ITAA 1997?

Answer

Yes.

Question 4

Will RPS2 to be issued by the Subsidiary be characterised as a debt interest in accordance with section 974-15 of the ITAA 1997?

Answer

Yes.

Question 5

Will the ordinary shares on issue by the taxpayer be characterised as an equity interest in accordance with section 974-70 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

XX June 20YY to XX June 20YY

The scheme commences on:

XX June 20YY

Relevant facts and circumstances

The application

By application dated XX December 20YY, the taxpayer has lodged a request for a Private Binding Ruling (the Ruling) in relation to certain tax implications of a proposed issuance of redeemable preference shares to be undertaken by the Subsidiary (the Proposed Scheme).

The Proposed Scheme to which this Ruling applies has been ascertained from the following documents:

a.            Application for the Ruling dated XX December 20YY (Application)

b.            Amended Application for the Ruling dated XX February 20YY (Amended Application)

c.            Constitution of the Subsidiary (Subsidiary's Constitution)

d.            Executed Subordination Deed Poll (Current RPS SDP)

e.            Draft Subordination Deed Poll (RPS2 SDP)

f.            Draft RPS Subscription Agreement (RPS2 Subscription Agreement).

Overview of the taxpayer

The taxpayer is an Australian resident unlisted public company.

The taxpayer currently has 5 shareholders (collectively referred to as the 'Investors').

The taxpayer has elected to form an income tax consolidated group with its 4 wholly owned subsidiaries such that it is treated as a single entity for income tax purposes (taxpayer Group).

The current capital structure of the taxpayer includes:

g.            ordinary shares issued by the taxpayer

h.            redeemable preference shares issued by the Subsidiary (Existing RPS).

Ordinary shares in the taxpayer

The terms and conditions associated with the issue of ordinary shares in the taxpayer are governed by the taxpayer's Constitution and include such terms and conditions which are normally associated with ordinary shares, including:

i.            the right to receive dividends

j.            the right to participate in surplus capital on winding up

k.            the right to vote at any meeting of shareholders on the basis of one vote per share

l.            the right to appoint Directors.

Redeemable preference shares in the Subsidiary

Existing RPS

The Existing RPS were subscribed by the Investors on XX June 20YY, with the subscription proceeds applied to facilitate the redemption of certain redeemable preference shares then on issue in the Subsidiary.

The mandatory redemption date of the Existing RPS is XX June 20YY.

The key terms of issue for the Existing RPS are contained in the Subsidiary's Constitution and the Subscription Agreement for the Existing RPS (Existing RPS Subscription Agreement).

A relevant clause of the Existing RPS Subscription Agreement contains a rollover provision stating that on or before the Redemption Date, the Existing RPS may be replaced with a new issue of RPS (on the same terms as the RPS then on issue) where the holders of at least 75% (by value) of the Existing RPS then on issue pass an appropriate resolution to subscribe for the new issue of the RPS.

Although not a term of the Existing RPS Subscription Agreement, each RPS holder has separately agreed to subordinate their rights to the claims of Senior Creditors under the Current RPS SDP.

Proposed RPS (RPS2)

As the redemption date for the Existing RPS of XX June 20YY is nearing, the Board of the taxpayer has instructed management to investigate the options for refinancing the funding currently provided to the taxpayer Group.

Given expected differences in commercial terms, the rollover provision in the Existing RPS will not be utilised.

Instead, an issue of new RPS (i.e. RPS2) by the Subsidiary was determined to be the preferred option on the basis that it would be the simplest option to achieve the primary objective of obtaining certainty in relation to this funding in the required timeframe. The mechanism and terms of issue for debt funding would also be familiar to the relevant stakeholders including senior lenders to the taxpayer Group.

A relevant clause of the RPS2 Subscription Agreement specifies that there are conditions precedent to the subscription for new RPS (i.e. RPS2). These state that completion is conditional on:

m.            (Company resolution) the Board of the Subsidiary passing a resolution to:

              i.       declare a special dividend payable in cash on the Existing RPS Redemption Date to the holders of Existing RPS in an amount equal to the aggregate amount of the Redemption Premium payable on redemption of the Existing RPS

              ii.       apply the Subscription Proceeds in redemption of the Existing RPS and waive any requirement for the holders to provide a bank cheque for the subscription amount, and

n.            (constitution) the members of the Subsidiary approving an amendment to the Subsidiary's Constitution to provide for the terms of issue of RPS2.

Proposed RPS2 Terms

The terms of RPS2 are proposed to be substantially the same as the Existing RPS, with the following differences:

o.            new issue date

p.            new maturity date

q.            new coupon/dividend rate

r.            new option for Investors to subscribe for additional RPS2, on a pro-rata basis to their participation in the initial issue of RPS2, as a means for the taxpayer Group to obtain additional debt funding to further fund capital investment

s.            new mechanism for the buy-back of RPS2.

The key terms of issue for RPS2 are summarised below:

Table 1: RPS2 key terms

General rights under RPS2

The Subsidiary's Constitution provides the general rights of RPS2:

              i.       They are issued on the terms that they are liable to be redeemed.

              ii.       The directors in their absolute discretion may redeem any one or more redeemable preference shares of this class to the exclusion of other shares.

              iii.       They may be redeemed without notice to the holders.

              iv.       The directors may set any redemption price before issue, and if none is set the redemption price shall be the issue price excluding any amounts due.

              v.       An issue of shares made for the purpose of raising capital from which to redeem any redeemable preference share shall not need to be first offered to the holders of the shares to be redeemed except to the extent that they may hold shares other than the shares to be redeemed.

              vi.       Dividend rights, if any, shall be non-cumulative and non-preferential.

              vii.       On a winding up of the company, all shares shall be entitled to a pro-rata repayment of capital contributed.

Subordination Agreement

The holders of RPS issued by the Subsidiary from time to time will agree to subordinate their rights to the claims of senior creditors, according to the terms and conditions contained in the RPS2 SDP.

A relevant clause of the RPS2 SDP states that subject to an exception clause, no RPS may be redeemed, or bought back, by the Subsidiary until the Senior Debt is repaid in full.

The exception clause of the RPS2 SDP allows RPS to be redeemed or bought back by the Subsidiary on the Redemption Date:

t.            out of proceeds of a new issue of RPS in accordance with the Subsidiary's Constitution, and/or

u.            if the redemption, or buy-back, is made using funds which at that time are available for distribution.

Another relevant clause of the RPS2 SDP is an overriding clause and states that the RPS2 SDP applies despite any contrary agreement between the RPS2 holders and the Subsidiary or any other Financing Document.

Assumptions

The taxpayer's TCG is subject to the Taxation of Financial Arrangements (TOFA) regime in Division 230 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 974-15

Income Tax Assessment Act 1997 section 974-20

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 section 974-155

Reasons for decision

Question 1

Will the RPS2 to be issued by the Subsidiary and the ordinary shares in the taxpayer on issue to the Investors constitute related schemes for the purposes of section 974-155 of the ITAA 1997?

Summary

The RPS2 to be issued by the Subsidiary and the ordinary shares in the taxpayer on issue to the Investors will constitute related schemes for the purposes of section 974-155 of the ITAA 1997.

Detailed reasoning

1.            A scheme is defined in section 995-1 of the ITAA 1997 as 'any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct whether unilateral or otherwise.' On this basis, the ordinary shares issued by the taxpayer and RPS2 to be issued by the Subsidiary will each constitute a scheme.

2.            Section 974-155 of the ITAA 1997 sets out the circumstances where two or more schemes will be treated as related schemes for the purposes of characterisation under Division 974 of the ITAA 1997.

3.            Section 974-155 of the ITAA 1997 states (emphasis added):

(1)           Subject to subsection (3), 2 *schemes are related to one another if they are related to one another in any way.

(2)           Without limiting subsection (1), 2 *schemes are related to each other 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.

4.            It should be noted that only one of the points listed above in subsection 974-155(2) need apply for 2 schemes to be considered related.

5.            The Subsidiary's Constitution states that until redemption or buy-back, RPS2 are to be stapled to the ordinary shares in the taxpayer such that the Subsidiary is not entitled to issue RPS2 to a person unless, immediately following the issue, the proportion of ordinary shares in the taxpayer held by the person and the proportion of RPS2 held by the person, are equal.

6.            The Subsidiary's Constitution further provides that RPS2 cannot be transferred to a person unless, immediately following the transfer, the proportion of ordinary shares in the taxpayer held by the transferee and the proportion of RPS2 held by the transferee, are equal.

7.            Therefore, section 974-155 of the ITAA 1997 is satisfied on the grounds that the instruments are stapled and it is not required to further consider other grounds listed in subsection 974-155(2). Accordingly, RPS2 and the ordinary shares in the taxpayer are related schemes for the purposes of this section.

Question 2

If the ordinary shares issued by the taxpayer and RPS2 to be issued by the Subsidiary are related schemes for the purposes of section 974-155 of the ITAA 1997, will the ordinary shares and RPS2 together give rise to a single notional debt interest in the taxpayer pursuant to subsection 974-15(2) of the ITAA 1997?

Summary

The ordinary shares and RPS2 will together give rise to a single notional debt interest in the taxpayer pursuant to subsection 974-15(2) of the ITAA 1997.

Detailed reasoning

8.            In order for related schemes to give rise to a single debt interest, the notional scheme must satisfy the criteria in paragraphs 974-15(2)(a) to (c) of the ITAA 1997.

9.            Subsection 974-15(2) provides:

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

(a)          the entity 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 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

(c)          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.

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 debt interest.

10.            The requirements of these paragraphs in relation to the taxpayer Group are considered below.

Paragraph 974-15(2)(a) of the ITAA 1997

11.            Paragraph 974-15(2)(a) of the ITAA 1997 is satisfied because the taxpayer and its wholly owned subsidiary were or will be directly or indirectly involved in the issue of the ordinary shares and RPS2. The constituent documents clearly show that the taxpayer has the intention to enter into, participate in, or cause other entities to enter into or participate in the related schemes.

Paragraph 974-15(2)(b) of the ITAA 1997

12.            Paragraph 974-15(2)(b) of the ITAA 1997 requires that the notional scheme satisfies the requirements of the debt test in subsection 974-20(1) of the ITAA 1997, which states:

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.

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

Debt test for notional scheme

14.            These requirements of the debt test in relation to the notional scheme identified by the Commissioner, namely the ordinary shares on issue and RPS2, are discussed below.

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

15.            The ordinary shares and RPS2 do not have to satisfy the financing arrangement requirement because they satisfy item 1 of the table in subsection 974-75(1) of the ITAA 1997, being an interest as a member or stockholder of the company.

(b) receipt of a financial benefit

16.            Paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes 'anything of economic value'.

17.            The taxpayer and the Subsidiary received or will receive financial benefits in relation to the notional scheme, namely:

a.          the issue price for each ordinary share, and

b.          the issue price for each RPS2 (notwithstanding in effect it has just replaced one source of funding with another).

(c) effectively non-contingent obligation (ENCO) to provide a financial benefit

18.            This element of the debt test requires that the entity has an ENCO under the scheme to provide a financial benefit or benefits to one or more entities.

19.            Subsection 974-135(3) of the ITAA 1997 provides inter alia that an ENCO is an obligation that is not contingent on any event, condition or situation other than the ability or willingness of that entity or connected entity to meet the obligation.

Ordinary shares

20.            The taxpayer's Constitution specifies that the Directors have the power to declare dividends, and that dividends shall not be paid except out of profit of the company and do not bear interest as against the company. There is no ENCO to provide a financial benefit in respect of the ordinary shares as they are perpetual and any dividends payable thereon are contingent on the economic performance of the company.

RPS2

Redemption of RPS2

21.            There is an ENCO to provide a financial benefit in respect of the RPS2 component of the notional scheme given the operation of the Subsidiary's Constitution, namely:

a.          The Subsidiary must redeem RPS2 for their Redemption Amount on or before the 10^th anniversary of the issue date, subject only to complying with the requirements of the Corporations Act. Section 254K of the Corporations Act provides that a company may only redeem redeemable preference shares out of profits or the proceeds of a new share issue. While this would represent an impediment on the Subsidiary's ability to provide a financial benefit, subsection 974-135(5) of the ITAA 1997 specifically provides that an obligation to redeem a preference share is not contingent merely because there is a legislative requirement for the redemption amount to be met out of profits or the proceeds of a fresh issue of equity interests.

b.          in the event the Subsidiary cannot redeem RPS2 as it would contravene the requirements of the Corporations Act, the Subsidiary is obliged to immediately undertake such steps necessary to buyback or cancel each RPS2 for an amount equivalent to the Redemption Amount provided the Subsidiary is not required to issue shares.

c.          in the event the Subsidiary does not redeem each RPS2 on the Redemption Date, the Subsidiary must pay each RPS2 holder the Default Premium in cash. This payment obligation is in addition to the Subsidiary's obligation to pay the Redemption Amount.

22.            Given the Subsidiary must pay each RPS2 holder an amount at least equal to the Redemption Amount on the Redemption Date, the Subsidiary prima facie has an ENCO to provide a financial benefit under the RPS2 component of the notional scheme.

Effect of subordination on RPS2 ENCO conclusion

23.            Each RPS2 holder will agree to subordinate their rights to the claims of senior creditors according to the terms and conditions of the RPS2 SDP. This subordination agreement will be separate and is not contained in the RPS2 Subscription Agreement.

24.            The RPS2 SDP states that no RPS may be redeemed by the Subsidiary until the senior debt is repaid in full except for permitted receipts. Permitted receipts include the redemption of RPS at the redemption date out of proceeds from a new issue of RPS and/or using funds which at that time are available for distribution. The RPS2 SDP also contains an overriding clause that states that the RPS2 SDP applies despite any contrary agreement between the RPS2 holders and the Subsidiary or any other Financing Document.

25.            The subordination arrangement does not render the obligation of the Subsidiary to pay the Redemption Amount as contingent for the following reasons:

•         the Subsidiary's Constitution provides that the Subsidiary shall redeem the RPS2 as soon after the Redemption Date as it shall be permitted to do so.

•         even if the Senior Debt is not repaid in full by the Redemption Date, the RPS2 SDP permits the RPS2 to be redeemed in the circumstances set out in that clause.

•         these arrangements preserve the obligation of the Subsidiary to pay the Redemption Amount (or the Redemption Amount and a Default Premium) and operate merely to postpone enforcement of that obligation to a time after senior creditors are paid.

26.            It is worth noting that there are also dividend entitlements under the Subsidiary's Constitution. However, as the payment of such financial benefits are non-cumulative; and contingent on the availability of funds and the Subsidiary having received an interest payment from the taxpayer in respect of Notes issued by the taxpayer and held by the Subsidiary, there is no ENCO to provide such dividends.

(d) it is substantially more likely than not that the benefit provided will at least equal the benefit received

27.            Paragraph 974-20(1)(d) of the ITAA 1997 requires it to be substantially more likely than not that the value of the financial benefit provided to the ordinary shareholders of the taxpayer and the RPS2 holders under the notional scheme will be at least equal to the value of the financial benefit received by taxpayer Group under the notional scheme.

28.            Section 974-35 of the ITAA 1997 sets out the manner in which the value of a financial benefit to be provided or received under the scheme is to be calculated. Paragraph 974-35(1)(a) provides that the value of a financial benefit to be provided or received is to be calculated in nominal terms if the performance period ends no later than 10 years after the interest arising from the scheme is issued or, 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.

29.            Subsection 974-35(3) defines the performance period as:

the period within which, under the terms on which the interest is issued, the effectively non-contingent obligations of the issuer, and any connected entity of the issuer, to provide a financial benefit in relation to the interest have to be met.

30.            In addition, subsection 974-40(2) of the ITAA 1997 provides that the right or option of a party to terminate the scheme early is to be ignored in ascertaining the performance period unless those rights and obligations are themselves effectively non-contingent.

31.            As noted above, the Subsidiary has an ENCO to redeem RPS2 for their Redemption Amount on or before the 10th anniversary of the issue date (Redemption Date).

32.            As the performance period ends no later than 10 years after the interests arising from the notional scheme will be issued, the value of the Redemption Amount must be valued in nominal terms.

33.            Given the Redemption Amount is equal to the value of financial benefits received by the taxpayer under the notional scheme, it is substantially more likely than not that the benefit provided will at least equal the benefit received and this element of the debt test is met.

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

34.            Paragraph 974-20(1)(e) requires that the value of the amounts provided and received are both greater than nil.

35.            As outlined above, the value provided and the value received are not both nil and this requirement is satisfied.

Conclusion on paragraph 974-15(2)(b) of the ITAA 1997

36.            Paragraph 974-15(2)(b) of the ITAA 1997 is satisfied as all the requirements of the debt test have been satisfied in relation to the combined effect or operation of the notional scheme.

Paragraph 974-15(2)(c) of the ITAA 1997

37.            Paragraph 974-15(2)(c) requires that:

...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.

38.            The intention of the entity for the purposes of paragraph 974-15(2)(c) of the ITAA 1997 is to be concluded by a reasonable and independent observer based on the facts of the situation. Particular regard should be given as to whether the overall combined economic effects (not the legal effects) of the ordinary shares in the taxpayer and the RPS2 issued by the Subsidiary are similar to that of a debt interest.

39.            The taxpayer accepts that the RPS2 are debt interests and the ordinary shares are equity interests. These instruments have been stapled together by the taxpayer Group and are not able to be bought or sold separately. It follows that this stapled relationship would cause an independent observer to conclude that these instruments were intended to be considered together for the purpose of paragraph 974-15(2)(c) of the ITAA 1997. Consideration should be given to the relative values of these instruments. With the economic outlay for RPS2 being substantially greater than the ordinary shares, it is reasonable to conclude that parties to 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.

40.            For the reasons explained above, paragraph 974-15(2)(c) of the ITAA 1997 is satisfied.

Conclusion

41.            The notional scheme identified by the Commissioner will give rise to a single notional debt interest in the taxpayer pursuant to subsection 974-15(2) of the ITAA 1997.

Question 3

If it is considered that the ordinary shares and RPS2 will together give rise to a single notional debt interest in the taxpayer under subsection 974-15(2) of the ITAA 1997, will the Commissioner make a determination under subsection 974-15(4) of the ITAA 1997 that it would be unreasonable to treat the schemes as related schemes giving rise to a single notional debt interest in the taxpayer under subsection 974-15(2) of the ITAA 1997?

Summary

The Commissioner will make a determination under subsection 974-15(4) of the ITAA 1997 that it would be unreasonable to treat the schemes as related schemes giving rise to a single notional debt interest under subsection 974-15(2) of the ITAA 1997.

Detailed reasoning

42.            Subsection 974-15(4) of the ITAA 1997 provides:

Two or more related schemes do not give rise to a debt interest in an entity under subsection (2) if the Commissioner determines that it would be unreasonable to apply that subsection to those schemes.

43.            Subsection 974-15(5) then provides:

Without limiting subsection 974-10(5), the Commissioner must, in exercising the power to make a determination under subsection (4), have regard to the following:

(a)        the purpose of the schemes (considered both individually and in combination);

(b)        the effects of the schemes (considered both individually and in combination);

(c)        the rights and obligations of the parties to the schemes (considered both individually and in combination);

(d)        whether the schemes (when considered either individually or in combination) provide the basis for, or underpin, an interest issued to investors with the expectation that the interest can be assigned to other investors;

(e)        whether the schemes (when considered either individually or in combination) comprise a set of rights and obligations issued to investors with the expectation that it can be assigned to other investors;

(f)        any other relevant circumstances.

44.            The Commissioner is also to be guided by the objects provisions in section 974-10 of the ITAA 1997, in particular subsection 974-10(3) of the ITAA 1997 which requires, inter alia, that related schemes be taken into account in appropriate cases to ensure the test operates effectively on an economic substance of the rights and obligations arising under the schemes and to prevent the tests being circumvented by entities merely entering into a number of separate schemes instead of a single scheme.

45.            The relevant factors that the Commissioner must have regard to in subsection 974-15(5) of the ITAA 1997 are considered below.

The purpose of the schemes (considered both individually and in combination)

46.            Considered individually, the purpose of issuing the ordinary shares was to raise equity for the taxpayer and these ordinary shares governed by the taxpayer's Constitution include terms and conditions usually associated with ordinary shares such as:

•         the right to receive dividends

•         the right to participate in surplus capital on winding up

•         the right to vote at any meeting of shareholders on the basis of one vote per share

•         the right to appoint directors.

47.            Considered individually, the purpose of issuing the Existing RPS was to raise debt-like finance for the Subsidiary. RPS2 is to replace the Existing RPS scheme which is approaching its expiry date and is mandatorily redeemable by XX June 20YY. An issue of a new RPS was determined by the taxpayer Group to be the preferred option for refinancing the Existing RPS on the basis that it was the simplest alternative of those considered to achieve the primary objective of obtaining certainty in relation to the funding in the required timeframe. The terms of RPS2 were not in contemplation and were not determined at the time of the issuance of the ordinary shares.

48.            The ultimate purpose of the schemes in combination (issuing the ordinary shares and RPS2) is to fund the taxpayer Group's investments.

49.            This objective is achieved whether the schemes are carried out individually or in combination.

The effects of the schemes (considered both individually and in combination)

50.            Having regard to the individual effects of the schemes the effect of the issue of the ordinary shares is to create an equity interest in the taxpayer. The dividends paid on the ordinary shares will be frankable, but not deductible, for the taxpayer.

51.            The effect of the issue of RPS2 is to create a debt interest in the Subsidiary. The dividends paid on RPS2 may be deductible for the Subsidiary but only to the extent that the annually compounded internal rate of return does not exceed the benchmark rate of return for the interest increased by 150 basis points (the cap under subsection 25-85(5) of the ITAA 1997). They will not be frankable.

52.            When considered in combination, the effect of the schemes is to create a notional debt interest in the taxpayer. On this basis, and noting that this ruling is made on the basis that the taxpayer's TCG is subject to the TOFA rules in Division 230 of the ITAA 1997 in respect of its financial arrangements, the dividends paid on the ordinary shares and RPS2 may be deductible up to the previously mentioned cap in subsection 25-85(5) of the ITAA 1997 but they will not be frankable.

The rights and obligations of the parties to the schemes (considered both individually and in combination)

53.            The ordinary shares carry those rights and obligations normally associated with an ordinary share investment such as providing investors with the risks and benefits associated with ordinary equity instruments such as bearing all residual risks of the company; voting rights and dividend entitlements contingent on economic performance and the exercise of the director's discretion.

54.            There are, however, certain restrictions on shareholders transferring their ordinary shares (discussed below).

55.            The shareholder lenders and redeemable preference shareholders generally have the rights and obligations of unsecured lenders. Again, there are certain restrictions on the redeemable preference shareholders transferring their interests.

56.            When considered in combination, the holders of the combined notional interest in the taxpayer have a right to an effectively fixed return on the redeemable preference shares (including the right to the return of their capital) and a return contingent on the economic performance of the taxpayer on the ordinary shares.

Whether the schemes (when considered either individually or in combination) provide the basis for, or underpin, an interest issued to investors with the expectation that the interest can be assigned to other investors

57.            A shareholder in the taxpayer can only assign its ordinary shares by assigning the same proportion of its redeemable preference shares as they are stapled instruments. The Subsidiary's Constitution specifies that the Subsidiary is not entitled to issue a RPS2 to a person unless immediately following the issue, the proportion of ordinary shares in the taxpayer held by the person and the proportion of RPS2 held by the person, are equal. Furthermore, a RPS2 cannot be transferred to another person unless, immediately following the transfer, the proportion of ordinary shares in the taxpayer held by the transferee and the proportion of RPS2 held by the transferee, are equal.

58.            Therefore, there is nothing to prevent a shareholder from assigning its ordinary shares and RPS2 (together) to another investor. As such, the schemes in combination (but not individually) provide the basis for an interest that is issued with the expectation that it can be assigned to other investors.

Whether the schemes (when considered either individually or in combination) comprise a set of rights and obligations issued to investors with the expectation that the interest can be assigned to other investors

59.            As noted above, the schemes in combination (but not individually) comprise a set of rights and obligations issued to investors with the expectation that the interest can be assigned to other investors.

Other relevant circumstances

60.            In addition to the above factors other relevant circumstances considered by the Commissioner include:

•         the ordinary shares and RPS2 will be taken to have been issued separately (i.e. as part of different steps in the overall restructure)

•         the shareholders are independent, arm's length parties with respect to each other and the taxpayer Group. No shareholder can control the taxpayer Group and the taxpayer Group cannot control the objectives or actions of any shareholder

•         if the notional scheme gives rise to a debt interest and the Commissioner did not exercise his discretion, the taxpayer would be rendered substantially without equity for tax purposes, upon which it could pay after-tax profits in the form of franked dividends

•         if all the ordinary shares were characterised as debt interests, the profits of the taxpayer could not be distributed to these shareholders as frankable dividends. To the extent the taxpayer's profits were distributed on the ordinary shares, they could not be franked and the taxpayer could be denied a deduction for a part of the distribution under section 25-85 of the ITAA 1997. This would lead to an unwarranted accumulation of franking credits in the taxpayer.

Conclusion

61.            In view of the totality of all the above factors, none of which by itself is conclusive, the Commissioner will make a determination under subsection 974-15(4) of the ITAA 1997 that it would be unreasonable to treat the schemes as related.

Question 4

Will RPS2 to be issued by the Subsidiary be characterised as a debt interest in accordance with section 974-15 of the ITAA 1997?

Summary

RPS2 to be issued to the Investors will be characterised as a debt interest in accordance with subsection 974-15(1) of the ITAA 1997.

Detailed reasoning

62.            The rules for defining what constitutes equity and what constitutes debt in a company are set out in Division 974 of the ITAA 1997.

63.            Where an interest could be characterised as both a debt and equity interest, it will be treated as a debt interest. Accordingly, it is not necessary to apply the equity test if the debt test has been satisfied.

64.            Based on the analysis of the notional scheme in paragraphs 14 to 36 of Question 2 above, all the requirements of the debt test have also been satisfied in relation to RPS2 as a separate interest.

Conclusion

65.            Given all the requirements of the debt test have been satisfied in relation to RPS2, they will be characterised as a debt interest in the taxpayer under subsection 974-15(1) of the ITAA 1997. Accordingly, it is not necessary to apply the equity test.

Question 5

Will the ordinary shares on issue by the taxpayer be characterised as an equity interest in accordance with section 974-70 of the ITAA 1997?

Summary

66.            The ordinary shares issued to the Investors will be characterised as an equity interest in the taxpayer for the purposes of paragraph 974-70(1)(a) of the ITAA 1997.

Detailed reasoning

67.            The rules for defining what constitutes equity and what constitutes debt in a company are set out in Division 974 of the ITAA 1997. Where an interest could be characterised as both a debt and equity interest, it will be treated as a debt interest.

The equity test

68.            Subsection 974-70(1) of the ITAA 1997 provides that:

A scheme gives rise to an equity interest in a company if, when the scheme comes into existence:

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

(b)        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.

69.            These requirements in relation to the taxpayer's ordinary shares are considered below.

70.            It has been established in Question 1 that the issue of ordinary shares in the taxpayer is a 'scheme' under section 995-1 of the ITAA 1997.

71.            The taxpayer's ordinary shares satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as the rights and privileges conferred on the ordinary shareholder by the taxpayer's Constitution, subject to the limitations contained therein, include voting rights, dividend rights, and entitlements to surpluses upon a winding up.

72.            The taxpayer's ordinary shares thus give the holder an interest in the company as a member or stockholder of the company and satisfy item 1 of the table in subsection 974-75(1) of the ITAA 1997.

73.            As a consequence, there is no need to further consider other items in the table notwithstanding that the ordinary shares might also satisfy other items in the table as well (in particular items 2 and 3 of the table).

74.            Subsection 974-75(1) of the ITAA 1997 has effect subject to subsection (2) which 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 (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.

75.            The taxpayer's ordinary shares do not have to satisfy the financing arrangement requirement because, as mentioned earlier, they satisfy item 1 of the table in subsection 974-75(1) of the ITAA 1997.

76.            Therefore, the taxpayer's ordinary shares satisfy the equity test in subsection 974-75(1) and they will give rise to an equity interest in the taxpayer provided 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.

The debt test

77.            The application of the debt test to the taxpayer's ordinary shares is considered below.

The scheme is a financing arrangement for the entity.

78.            As mentioned earlier the ordinary shares do not have to satisfy the financing arrangement requirement because they satisfy item 1 of the table in subsection 974-75(1) of the ITAA 1997.

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

79.            The taxpayer has received the issue price for each ordinary share. The taxpayer has therefore received a financial benefit under the scheme as paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes 'anything of economic value'.

The entity has, or the entity or the 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.

80.            The relevant financial benefits that fall for consideration under section 974-135 of the ITAA 1997 are the taxpayer's obligation to:

i)         pay a dividend on these ordinary shares, and

ii)         return the issue price.

81.            The key terms and conditions in the taxpayer's Constitution that relate to whether in substance or effect the taxpayer has an ENCO in relation to these financial benefits are detailed below.

Obligation to pay dividends.

82.            There is no requirement on the taxpayer to pay dividends on its ordinary shares. Thus, any obligation to pay dividends is only a contingent obligation.

83.            The taxpayer's Constitution provides:

1)        The power to declare dividends and to pay interim dividends and to fix the time for payment thereof is vested in the Directors and notice of the declaration or payment may be given to members by advertisement or otherwise as the Directors determine.

2)        A dividend shall not be paid except out of the profit of the Company or pursuant to Section 191 and does not bear interest as against the Company.

Obligation to return the issue price

84.            Ordinary shares are by their nature perpetual. There is nothing in the pricing, terms or conditions of the scheme to indicate that shares would be bought back or that directors would wish to reduce the taxpayer's share capital. Thus, any obligation on the taxpayer to return any amount of the issue price of its ordinary shares to the shareholders is only a contingent obligation.

85.           ; As the taxpayer is not under an ENCO to provide any financial benefits to its ordinary shareholders, the debt test in section 974-20 of the ITAA 1997 is not satisfied.

Conclusion

86.            As the taxpayer's ordinary shares meet the equity test and do not meet the debt test, they will be equity interests for the purposes of paragraph 974-70(1)(a) of the ITAA 1997.