Edited version of private advice

Authorisation Number: 1052305374856

Date of advice: 13 September 2024

Ruling

Subject: Debt interest test

Question 1

Will the 2024 Company A Loan be classified as a debt interest in accordance with Division 974 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer

Yes.

Question 2

Do the Related Scheme rules in section 974-155, subsection 974-15(3) and subsection 974-70(2) of the ITAA 1997 operate to re-characterise the proposed 2024 Company A Loan for the purposes of Division 974 of the ITAA 1997?

Answer

No.

Question 3

Does any gain/loss arise to Company A or Company B as trustee for the Trust in relation to the repayment of the 2015 Company A Loan or the 2015 Trust Loan for the purposes of Division 230 of the ITAA 1997?

Answer

No.

Question 4

Will repayment of the 2015 Company A Loan give rise to a 'forgiveness' of a debt for the purposes of the commercial debt forgiveness provisions in Division 245 of the ITAA 1997?

Answer

No.

Question 5

Will repayment of the 2015 Company A Loan be subject to section 45B of the Income Tax Assessment Act 1936?

Answer

No.

This ruling applies for the following period:

DD MM YYYY

The scheme commenced on:

DD MM YYYY

Relevant facts and circumstances

The scheme that is the subject of this private ruling is identified and described in the following:

•         Company A Group structure received DD MM YYYY.

•         Company A Group's audited DD MM YYYY Financial Statements.

•         2015 Trust Loan Agreement and 2015 Company A Loan Agreement, both made on DD MM YYYY.

•         Circular Resolution of the Board of Directors dated DD MM YYYY.

•         Circular Resolution of the Board of Directors and loan agreement amendment request dated DD MM YYYY.

•         Proposed YYYY Person A and Person B and Trust Loan Agreement.

•         Proposed YYYY Trust and Company A Loan Agreement.

•         Unexecuted Promissory Note received DD MM YYYY.

Group Structure

Company A is the head company of a tax consolidated group (the Group). Company A is a private company. Its shareholders are Person A and Person B, who collectively (and directly) hold 80% of its shares. The remaining 20% of the shares are held as follows:

•         10% of shares are held by Company C, a company beneficially owned by Person C (Person A and Person B's son), and

•         10% of shares are held by Company D, a company beneficially owned by the estate of Person D (Person A and Person B's daughter, now deceased).

The businesses of the Group are property investment and development, equity investment (domestic and international) and technology research and development.

Trust

The discretionary trust is established for the purpose of facilitating the debt financing arrangements discussed in this private ruling. It has not historically performed any other trading activities or made any distributions. The trustee of the Trust is Company B, which is wholly owned by Person A and Person B.

The taxation of financial arrangements (TOFA) rules

Both Company A and Trust are subject to the TOFA rules in Division 230 of the ITAA 1997 as each exceeds the threshold exceptions in section 230-455 of the ITAA 1997.

Company A capital structure and related party borrowings

The capital funding structure of the Group as shown in its audited DD MM YYYY Financial Statements can be summarised as:

•         $xxx of equity contributed as share capital (from the shareholders noted above), and

•         $xxx of related party borrowings.

The $xxx of related party borrowings as at DD MM YYYY included a loan of $xxx from Trust to Company A that was entered into between the parties on DD MM YYYY (the 2015 Company A Loan) and a loan of $xxx from Company E. The Company E Loan was extinguished on DD MM YYYY.

The 2015 Company A Loan was entered into by the Group to repay historical related party debt that existed prior to DD MM YYYY. This loan is documented as interest free, with a repayment term that was initially x years, but subject to extension if agreed between the parties. Repayments of up to $xxx could have been requested by the lender each financial year prior to the repayment date. The parties agreed to extend the repayment date for the loan a number of times and that repayment date is now DD MM YYYY. Under the extension of the loan agreement, the annual repayments that the lender could request each financial year were also increased to $xxx. The Group classified the 2015 Company A Loan as debt for income tax purposes.

The Trust funded the 2015 Company A Loan with money it borrowed directly from Person A and Person B (the 2015 Trust Loan). This loan was also entered into on DD MM YYYY and is interest free. It has extended repayment terms that align with the extensions to the 2015 Company A Loan.

Various drawdown and repayments have been applied against both the 2015 Company A Loan and the 2015 Trust Loan during the period from DD MM YYYY to date. The outstanding principal in relation to both loans as at the date of this ruling request is:

•         2015 Company A Loan - $xxx

•         2015 Trust Loan - $xxx.

Proposed 2024 Refinancing

Person A and Person B continue to undertake estate planning in conjunction with their personal legal advisers. A key consideration which has arisen in this regard is how to address the 2015 Trust Loan and the 2015 Company A Loan leading up to their expiry in MM YYYY.

Person A and Person B have determined that the preferred approach is a refinancing of the existing loans with new loans that have a x-year term. The new loan agreements will allow for a further extension to the term of x years, should the x-year term not be sufficient to complete the relevant estate planning requirements.

The refinancing of the 2015 loans will occur by way of entering into the following new loan agreements:

•         $xxx loan from Person A and Person B to the Trust (the 2024 Trust Loan). This loan will be interest free, with an initial agreed termination date of x years following the date the loan is entered into, with an ability to extend the repayment date for a further x years if required. Repayments of up to $xxx may be requested each financial year prior to the repayment date.

•         $xxx loan from Trust to Company A (the 2024 Company A Loan). The term of this loan will be the same as the 2024 Trust Loan.

Company A will facilitate repayment of the 2015 loans by the issue of a Promissory Note by Company A. This would occur as follows:

•         Company A would issue a Promissory Note with a face value of $xxx to the Trust as repayment of the 2015 Trust Loan. This Promissory Note will be repayable on demand by the holder, or within a period of x years.

•         The Trust would subsequently transfer the Promissory Note to Person A and Person B in repayment of the 2015 Trust Loan.

•         Person A and Person B would then transfer the Promissory Note back to Trust as consideration for entering into the proposed 2024 Trust Loan;

•         Trust would then transfer the Promissory Note back to Company A as consideration for entering into the proposed 2024 Company A Loan. At this point, the Promissory Note will be cancelled.

Company A holds sufficient assets and access to capital to satisfy the face value of the Promissory Note if called upon and it will, therefore, have a market value equal to its face value.

Relevant legislative provisions

Income Tax Assessment Act 1936

•         Section 45B

Income Tax Assessment Act 1997

•         Division 230

•         Division 245

•         Division 974

Does Part IVA apply to this private ruling?

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 diverted profits 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 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-avoidancerule for income tax'.

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997, unless otherwise indicated.

Question 1

Will the 2024 Company A Loan be classified as a debt interest in accordance with Division 974?

Summary

The 2024 Company A Loan will be classified as a debt interest in accordance with the debt interest test under Division 974. The scheme is a financing arrangement and there is a financial benefit. Additionally, there is an effectively non-contingent obligation under the scheme to provide a financial benefit and the value provided will be at least equal to the value received.

Relevant Legislation

In accordance with subsection 974-15(1), a single scheme gives rise to a 'debt interest' in an entity when it comes into existence if it satisfies the debt test contained in section 974-20.

Subsection 974-20(1) provides that a scheme satisfies the debt test if:

a)     it is a financing arrangement for the entity;

b)      the entity or a connected entity receives or will receive some financial benefit under the scheme;

c)      the entity has, or both the entity and a connected entity have, an effectively non-contingent obligation (ENCO) under the scheme to provide financial benefit(s) to one or more entities after the time when the first of the financial benefits in (b) above is received, and

d)      it is substantially more likely than not that the value provided (as calculated by reference to subsection 974-20(3)) will be at least equal to the value received (as calculated by reference to subsection 974-20(2)).

Subsection 974-5(4) states that if an interest satisfies both the debt test and the equity test, it is treated as a debt interest and not an equity interest. Accordingly, it is not necessary to apply the equity test if the debt test has been satisfied.

Application to your circumstances

Scheme

Subsection 995-1(1) defines the term 'scheme' as meaning '(a) any arrangement; or (b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise'.

The term 'arrangement' is also defined in subsection 995-1(1). It is defined broadly, and means any arrangement agreement, understanding, promise or undertaking, whether express or implied and whether or not enforceable by legal proceedings.

The 2024 Company A Loan is a scheme. This requirement is satisfied.

Financing arrangement

Section 974-130 outlines that a scheme is a 'financing arrangement' for an entity if it is entered into or undertaken to raise finance for the entity or a connected entity, or to fund another financing arrangement.

A financing arrangement generally involves the contribution to an entity of capital in some form. For example, a basic financing arrangement would involve the provision of loan capital to an entity in return for the issue of a debt interest.

The 2024 Company A Loan is a financing arrangement. This requirement is satisfied.

Financial benefit

For the scheme to give rise to a debt interest, the issuing entity must also receive a financial benefit under the financial arrangement. Subsection 974-160(1) defines a financial benefit to include anything of economic value.

Under the 2024 Company A Loan, Company A will receive the loan amount, which is a financial benefit. This requirement is satisfied.

An 'effectively non-contingent obligation' (ENCO) to provide a future financial benefit

For the scheme to give rise to a debt interest, there must also exist an ENCO for the entity to provide a financial benefit.

Section 974-135 provides that an ENCO is an obligation that, in substance, is not contingent on any event, condition or situation other than the ability or willingness of the relevant entity or connected entity to meet the obligation.

Subsection 974-135(3) provides:

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.

Accordingly, Company A has an ENCO to repay the Trust by the repayment date, and that is not contingent on any event, condition, or situation other than the ability or willingness to meet the obligation. This requirement is satisfied.

Value of the financial benefit

The last element of the debt test requires that it be substantially more likely than not that the financial benefit to be provided by the entity will be at least equal to the value of the financial benefit received.

The financial benefit to be provided is what the entity has an ENCO to provide to the investor in relation to the interest. This can include the return of the initial investment amount.

The method of calculating the value of the financial benefit depends on the performance period of the arrangement. The performance period is the period within which, under the terms on which the interest is issued, the entity has to meet its ENCO in relation to the interest. If the term of the arrangement is 10 years or less, as per subparagraph 974-35(1)(a)(i), the value will be calculated in nominal terms. If the term is more or may be more than 10 years, then as per subparagraph 974-135(1)(a)(ii), the value of the benefit will be calculated in present value terms.

The Termination Date is defined at clause 1.1 of the 2024 Company A Loan Agreement as the date falling x years after the date of this document as may be extended pursuant to clause 5.2(b), which is still less than 10 years. Therefore, the value of the financial benefits received by the Trust are to be assessed in nominal terms.

Company A has an obligation to repay the Trust the loan principal. Accordingly, Company A has an obligation to pay the Trust an amount equal to the 2024 Company A Loan principal provided by the Trust.

This requirement is satisfied.

Conclusion

As all of the requirements in section 974-20 are satisfied, the 2024 Company A Loan is a debt interest in accordance with subsection 974-15(1).

Question 2

Do the Related Scheme rules in section 974-155, subsection 974-15(3) and subsection 974-70(2) operate to re-characterise the proposed 2024 Company A Loan for the purpose of Division 974?

Summary

The proposed 2024 Company A Loan is not re-characterised under the related scheme rules in section 975-155, subsection 974-15(3) and subsection 974-70(2).

Relevant Legislation and Application

Section 974-155 sets out the circumstances in which two or more schemes are treated as 'related schemes' for the purposes of subsections 974-70(2) and 974-15(2). Subsection 974-155(2) provides that, without limiting subsection 974-155(1), two schemes are related if one of the schemes would, from a commercial point of view, be unlikely to be entered into unless the other scheme was entered into.

Where two or more schemes constitute related schemes within the meaning of section 974-155, subsection 974-70(2) may 're-characterise' the related schemes as an equity interest (or subsection 974-15(2) may 're-characterise' the related schemes as a debt interest).

Importantly, two or more related schemes will not give rise to a debt interest where each of the schemes individually give rise to a debt interest; subsection 974-15(3).

Two or more related schemes may give rise to an equity interest under subsection 974-70(2) if:

a.    a company enters into, participates in or causes another entity to enter into or participate in the related schemes, and

b.    a scheme with the combined effect or operation of the related schemes would give rise to an equity interest in the company, and

c.    it is reasonable to conclude that the company intended or knew that a party to the scheme or one of the schemes intended, the combined economic effects of those schemes to the be the same as, or similar to, the economic effects of an equity interest.

Application to your circumstances

The 2024 Company A Loan and the 2015 Company A Loan may be related schemes under subsection 974-70(2) because the 2024 Company A Loan would likely not have been entered into unless the 2015 Company A Loan was first entered into.

Two or more related schemes may give rise to an equity interest

Three requirements must be satisfied for two or more related schemes give rise to an equity interest under subsection 974-70(2).

The second requirement is that a scheme with the combined effect or operation of the related schemes would give rise to an equity interest in the company under the equity interest test in subsection 974-75(1).

The third item in the table at subsection 974-75(1) provides that a scheme satisfies the equity test if it gives rise to an interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of return, is at the discretion of the company or a connected entity. The obligation to repay the principal under both the 2024 Company A Loan and the 2015 Company A Loan is absolute and not contingent on the exercise of any discretion. Furthermore, none of the other items in the table at subsection 974-75(1) apply.

The combined effect of the 2015 Company A Loan and 2024 Company A Loan will not give rise to an equity interest in Company A under the equity interest test in subsection 974-75(1). Therefore, even if the 2015 Company A Loan and the 2024 Company A Loan are related schemes, they will not give rise to an equity interest for the purposes of subsection 974-70(2).

Both the 2024 Company A and 2015 Company A Loans are individually classified as debt interests (in accordance with our answer to question 1), thus subsection 974-15(2) should have no application as section 974-15(3) provides that the related scheme rules do not apply if the schemes individually give rise to a debt interest.

Question 3

Does any gain/loss arise to Company A or Company B as trustee for the Trust in relation to the repayment of the 2015 Company A Loan or the 2015 Trust Loan for the purposes of Division 230?

Summary

No gain/loss arise to Company A or Company B in relation to the repayment of the 2015 Company A or the 2015 Trust Loan for the purposes of Division 230.

Relevant Legislation and Application

Division 230 is about the tax treatment of gains and losses from certain financial arrangements. Section 230-45 involves a 'financial arrangement' which, in its most basic form, is an arrangement pursuant to which a person has a right to receive or an obligation to provide a 'financial benefit' of a monetary value. Nevertheless, ordinarily an arrangement won't be a financial arrangement if it includes a significant right or obligation which isn't a financial benefit or isn't cash settlable.

The treatment of gains and losses from a financial arrangement are dealt with in section 230-15. As provided for in section 230-15, the TOFA rules only apply to gains and losses made from a financial arrangement. There are no gains or losses made under the financial arrangements described in this ruling, so the TOFA rules have no operation.

Question 4

Will repayment of the 2015 Company A Loan give rise to a 'forgiveness' for the purposes of Commercial Debt Forgiveness provision in the Division 245?

Summary

The repayment of the 2015 Company A Loan will not give rise to a 'forgiveness' for the purpose of Commercial Debt Forgiveness provision in Division 245.

Relevant Legislation and Application

Division 245 applies when a commercial debt (or part of a commercial debt) is forgiven.

Under subsection 245-35(a) a debt is forgiven when the debtor's obligation to pay the debt is released or waived or is otherwise extinguished other than by repaying the debt in full.

A debt is forgiven under section 245-35 if and when:

a.    the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full, or

b.    the period within which the creditor is entitled to sue for the recovery of the debt ends, because of the operation of a statute of limitations, without the debt having been paid.

A debt is a commercial debt under section 245-10 if interest, or an amount in the nature of interest, is not payable by the borrower 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 the borrower.

Division 245 will not apply because the 2015 Company A Loan is repaid and not forgiven.

Question 5

Will the repayment of the 2015 Company A Loan be subject to section 45B of the Income Tax Assessment Act 1936 (ITAA 1936)?

Summary

The repayment of the 2015 Company A Loan will not be subject to section 45B of theITAA 1936. There is no capital benefit that can be identified in this arrangement as the loan is coming from the shareholder, not the company.

Relevant Legislation

Section 45B of the ITAA 1936 applies where certain payments are made to shareholders in substitution for dividends. Subsection 45B(2) of the ITAA 1936 sets out the conditions under which the Commissioner may make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies with the effect that the payment is taken to be an unfranked dividend. These conditions are that:

•         there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936);

•         under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and

•         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 a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). The relevant circumstances of the scheme include the various matters listed in paragraphs 45B(8)(a)-(k) of the ITAA 1936 (paragraph (k) bringing into the various circumstances the eight matters referred to in subsection 177D(2) of Part IVA).

Application to your circumstances

The 2015 Company A Loan does not constitute a non-share equity interest as the term is defined in section 995-1 (which in turn refers to the definition of an 'equity interest' in a company).

The purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts distributed to shareholders of a company are treated as dividends for tax purposes if certain payments, allocations, and distributions are made in substitution for dividends.

The first requirement set out in paragraph 45B(2)(a) of the ITAA 1936 is that there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company.

The repayment of 2015 Company A Loan will not constitute the provision of a demerger benefit as defined in subsection 45B(4) of the ITAA 1936.

The repayment on 2015 Company A Loan will not constitute the provision of a capital benefit as defined in subsection 45B(5) as it is not the distribution of share capital to a person nor is it a non-share capital return that is taken to be the distribution of share capital to the person pursuant to subsections 45B(5) and 45B(7).

As the repayment of on 2015 Company A Loan does not constitute the provision of a capital benefit to a person for the purposes of paragraph 45B(2)(a) and subsection 45B(5), section 45B of the ITAA 1936 will have no application in respect of the repayment.