Edited version of private advice

Authorisation Number: 1052361748476

Date of advice: 12 March 2025

Ruling

Subject: Cross-border refinancing

Question 1

Do the Existing Interest-Free Loans satisfy the debt test in section 974-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

Question 2

Do the Existing Interest-Bearing Loans satisfy the debt test in section 974-20 of the ITAA 1997?

Answer 2

Yes.

Question 3

Do the Convertible Notes (CNs) satisfy the debt test in section 974-20 of the ITAA 1997?

Answer 3

No.

Question 4

Do the CNs satisfy the equity test in subsection 974-70(1) of the ITAA 1997?

Answer 4

Yes.

Question 5

Are the CNs financial arrangements under section 230-50 of the ITAA 1997?

Answer 5

Yes.

Question 6

Are the CNs and New Interest-Bearing Loans considered 'related schemes' that are required to be aggregated under section 974-155 of the ITAA 1997?

Answer 6

No.

Question 7

Did Refinancing 1 give rise to a commercial debt forgiveness under section 245-35 of the ITAA 1997?

Answer 7

No.

Question 8

Did Refinancing 1 give rise to a deemed commercial debt forgiveness under section 245-37 of the ITAA 1997?

Answer 8

No.

Question 9

Did a balancing adjustment arise under Subdivision 230-G of the ITAA 1997 from the repayment of the Existing Interest-Free Loans?

Answer 9

No.

Question 10

Do the New Interest-Bearing Loans satisfy the debt test in section 974-20 of the ITAA 1997?

Answer 10

Yes.

Question 11

Did Refinancing 2 give rise to a commercial debt forgiveness under section 245-35 of the ITAA 1997?

Answer 11

No.

Question 12

Did Refinancing 2 give rise to a deemed commercial debt forgiveness under section 245-37 of the ITAA 1997?

Answer 12

No.

Question 13

Did a balancing adjustment arise under Subdivision 230-G of the ITAA 1997 from the repayment of the Existing Interest-Bearing Loans?

Answer 13

Yes.

Question 14

Is the interest on the New Interest-Bearing Loans deductible under subsection 230-15(2) of the ITAA 1997?

Answer 14

Yes.

Question 15

Will the coupon distributions payable on the CNs be frankable distributions in accordance with section 202-40 of the ITAA 1997?

Answer 15

Yes.

Question 16

To the extent the coupon distributions are unfranked, will they be subject to withholding tax at a rate of 30% in accordance with subsection 128B(1) of the ITAA 1936?

Answer 16

Yes.

Question 17

Will the conversion of CNs into ordinary shares give rise to commercial debt forgiveness under sections 245-35 or 245-37 of the ITAA 1997?

Answer 17

No.

This ruling applies for the following periods:

31 December 20XX to 31 December 20XX

The scheme commenced on:

31 December XX

Relevant facts and circumstances

Company A, Company B and Company C, along with other subsidiaries, are part of a Multiple Entry Consolidated (MEC) Group (A Group) in Australia.

Company D (Foreign Shareholder) is an entity resident in a foreign country.

Company A, Company B and Company C are wholly owned by the Foreign Shareholder. The Foreign Shareholder does not carry on business in Australia other than its interests in Company A, Company B and Company C.

A Group was funded by a mix of related party and third party bank debt. The Foreign Shareholder has provided a combination of interest-bearing and interest-free loans (collectively the Existing Loans) to A Group to fund Australian operations.

Interest-Bearing Loans

The existing related party interest-bearing loans (Existing Interest-Bearing Loans), and third party loans, were primarily used to fund the acquisition and development of assets, and working capital.

The key terms of the Existing Interest-Bearing Loans were:

•                     The lender was the Foreign Shareholder and the borrower was a subsidiary of Company B or Company C.

•                     The interest rate applicable to the loans was XX% per annum.

•                     The termination date (the date on which the principal was required to be repaid) was the date XX years from the date of the loan agreement.

Interest-Free Loans

The existing interest-free loans (Existing Interest-Free Loans) were used to either refinance a portion of the existing interest-bearing loans, or fund expenditure of the group, reflecting the worsening position of the group resulting in its reduced ability to make interest payments on the loans.

The key terms of the Existing Interest-Free Loans were:

•                     The lender was the Foreign Shareholder and the borrower was a subsidiary of Company B or Company C.

•                     The interest rate applicable to the loans was nil.

•                     The termination date (the date on which the principal was required to be repaid) was the date XX years from the date of the loan agreement.

•                     The outstanding principal on the loans is repayable on demand at the lender's request.

Refinancing of the Existing Interest-Free Loans (Refinancing 1)

A Group refinanced its related party loans from the Foreign Shareholder to a more appropriate capital structure. This was influenced by factors including:

•                     The potential introduction of third party investors.

•                     The implementation of a new corporate tax regime in the foreign country.

•                     The recent amendments to the Australian thin cap legislation.

Company B and Company C issued Convertible Notes (CNs) to the Foreign Shareholder and used the proceeds to repay existing related party loans to the extent required to achieve an appropriate arm's length capital structure.

The steps to implement Refinancing 1 were as follows:

•                     Company B and Company C issued the CNs to the Foreign Shareholder.

•                     The Foreign Shareholder satisfied the subscription amount of the CNs by issuing non-interest-bearing on-demand Promissory Notes (PNs).

•                     The PNs were contributed by Company B and Company C to the relevant subsidiary entities by way of intercompany loans.

•                     The PNs were used by the relevant subsidiaries to repay the face value of the Existing Interest-Free Loans to the Foreign Shareholder.

•                     The PNs then automatically extinguished.

Refinancing the Existing Interest-Bearing Loans (Refinancing 2)

For A Group it was determined that the arm's length debt amount for the group should not exceed A$XX. The total interest-bearing debt (related party and third party) at XX December 20XX was A$XX.

A Group refinanced the Existing Interest-Bearing Loans with new interest-bearing loans (New Interest-Bearing Loans), which have similar terms to the Existing Interest-Bearing Loans, and CNs, to achieve the appropriate capital structure. The interest rate on the New Interest-Bearing Loans is based on the Australian Bank Bill Swap Reference Rate (administered by the Australian Securities Exchange) plus a margin.

The steps to implement Refinancing 2 were as follows:

•                     A subsidiary of Company B, Company E (Company E has the majority of external debt of the A Group), borrowed the New Interest-Bearing Loans from the Foreign Shareholder.

•                     Company B issued CNs to the Foreign Shareholder.

•                     The Foreign Shareholder satisfied the loan advance for the New Interest-Bearing Loans and subscription amount of the CNs by issuing further PNs.

•                     The PNs were contributed by Company B and Company E to the relevant subsidiary entities by way of intercompany loans.

•                     The PNs were used by the relevant subsidiaries to repay the face value of the Existing Interest-Bearing Loans and accrued but unpaid interest to the Foreign Shareholder.

•                     The PNs then automatically extinguished.

The interest rate on the New Interest-Bearing Loans was determined in accordance with Australian transfer pricing principles.

Convertible Notes

The key terms of the deed for the CNs are as follows:

•                     The issuers are Company B and Company C.

•                     The holder is the Foreign Shareholder.

•                     The issue price is $XX per note.

•                     Company B and Company C used the proceeds to repay debt facilities of A Group (and for any other purpose agreed with the Foreign Shareholder).

•                     Each CN is perpetual and unsecured.

•                     Each CN ranks behind all secured and unsecured creditors of Company B or Company C on winding up but rank equally with all other CNs on issue.

•                     Each CN will be redeemed in priority to any return of capital or payment made on ordinary shares in the event of Company B or Company C being wound up.

•                     Each CN bears a discretionary coupon that accrues each calendar year at XX% per annum. The coupon is non-cumulative, and payment is at the election of Company B or Company C (i.e. there is no obligation on Company B or Company C to pay the coupon) except where a dividend is declared. In this instance the coupon must be paid prior to payment of the dividend. Where a coupon is paid it is considered likely that the payment would be unfranked.

•                     Company B and Company C may elect to convert some or all the CNs to ordinary shares based on a prescribed formula. The Foreign Shareholder has no right to convert the CNs.

•                     Company B and Company C may elect to redeem some or all the CNs where any of the following redemption events occurs (see below) or following the fifth anniversary of issue. The Foreign Shareholder has no right to redeem the CNs.

•                     A redemption event means the occurrence of any of the following:

­        A regulatory event, being a change in tax or other regulatory arrangement that impacts how the CNs are treated.

­        A material capital raise through the divestment of investment assets.

­        A capital raising, being an issue of securities by the company to a further equity financing or funding arrangement.

•                     The CNs may be transferred by the Foreign Shareholder but only where the transfer does not give rise to any adverse outcomes for Company B, Company C and its shareholders, to a transferee that is not a competitor and has agreed to be bound by the terms of the CN deed.

Other

A Group and the Foreign Shareholder are subject to the Taxation of Financial Arrangements (TOFA) provisions as contained in Division 230 of the ITAA 1997 and have not made any tax timing elections.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 128AAA(1)(c)

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1936 subsection 128B(1)

Income Tax Assessment Act 1936 paragraph 128B(3)(ga)

Income Tax Assessment Act 1936 subsection 128B(4)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 202-40

Income Tax Assessment Act 1997 section 202-45

Income Tax Assessment Act 1997 paragraph 202-45(f)

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 Subdivision 230-B

Income Tax Assessment Act 1997 Subdivision 230-G

Income Tax Assessment Act 1997 subsection 230-15(2)

Income Tax Assessment Act 1997 section 230-40(2)

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

Income Tax Assessment Act 1997 section 230-50

Income Tax Assessment Act 1997 subsection 230-50(1)

Income Tax Assessment Act 1997 paragraph 230-435(1)(b)

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

Income Tax Assessment Act 1997 subsection 230-445(1)

Income Tax Assessment Act 1997 section 230-510

Income Tax Assessment Act 1997 subsection 230-510(1)

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 section 245-35

Income Tax Assessment Act 1997 paragraph 245-35(a)

Income Tax Assessment Act 1997 section 245-37

Income Tax Assessment Act 1997 Division 974

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

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 subparagraph 974-35(1)(a)(i)

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 subsection 974-60(1)

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

Income Tax Assessment Act 1997 section 974-75

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

Income Tax Assessment Act 1997 section 974-130

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

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

Income Tax Assessment Act 1997 section 974-155

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 subsection 995-1(1)

Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 paragraph 7(a)

Reasons for decision

Question 1

The Existing Interest-Free Loans satisfy the debt test in section 974-20 of the ITAA 1997.

Detailed reasoning

Subsection 974-15(1) of the ITAA 1997 notes that a scheme gives rise to a debt interest in an entity if, when it comes into existence, it satisfies the debt test in subsection 974-20(1) in relation to the entity.

A scheme gives rise to a debt interest under subsection 974-20(1) of the ITAA 1997 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)); ...

Scheme

The term 'scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, 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) of the ITAA 1997 to mean any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable by legal proceedings.

The Existing Interest-Free Loans satisfy the definition of a scheme.

Financing arrangement

Section 974-130 of the ITAA 1997 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 of the entity), or to fund another financing arrangement.

The Existing Interest-Free Loans were used by A Group to either refinance a portion of the Existing Interest-Bearing Loans or fund expenditure of the group.

The Existing Interest-Free Loans are a financing arrangement.

Financial benefit

Subsection 974-60(1) of the ITAA 1997 defines a financial benefit to include anything of economic value.

A Group received the loan amount when the Existing Interest-Free Loans were advanced, satisfying this requirement.

An 'Effectively Non-Contingent Obligation' (ENCO) to provide a future financial benefit

Subsection 974-135(1) of the ITAA 1997 provides that there is an ENCO 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.

Subsection 974-135(3) of the ITAA 1997 provides that 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 connected entity) other than the ability or willingness of the relevant entity (or connected entity) to meet the obligation.

At the time A Group received the financial benefit under the Existing Interest-Free Loans, it also had an ENCO to repay the Foreign Shareholder by the termination date. Accordingly, this requirement is satisfied.

Value of the financial benefit

The last element of the debt test requires that it is substantially more likely than not that the value of the financial benefit to be provided by the entity (or connected 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.

Under subsection 974-35(3) of the ITAA 1997 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. Broadly, where the performance period is within ten years then the value will be calculated in nominal terms per subparagraph 974-35(1)(a)(i); and where the performance period is more than ten years then the value will be calculated in present value terms per subparagraph 974-35(1)(a)(ii).

Under the terms of the Existing Interest-Free Loans, the termination date (the date on which the principal is required to be repaid by A Group to the Foreign Shareholder) is the date XX years from the date of the loan agreement. This means the value of the financial benefits provided by A Group are assessed in nominal terms.

The amount A Group has an obligation to repay the Foreign Shareholder is equal to the amount received under the Existing Interest-Free Loans which means this requirement is also satisfied.

As all of the requirements of section 974-20 are satisfied, the Existing Interest-Free Loans satisfy the debt test.

Question 2

The Existing Interest-Bearing Loans satisfy the debt test in section 974-20 of the ITAA 1997.

Detailed reasoning

In accordance with section 974-20 of the ITAA 1997 and based on the detailed reasoning in question 1:

•                     The Existing Interest-Bearing Loans satisfy the definition of a scheme (paragraph 974-20(1)(a) of the ITAA 1997).

•                     The Existing Interest-Bearing Loans were primarily used to fund the acquisition of assets and working capital and are therefore a financing arrangement (paragraph 974-20(1)(a) of the ITAA 1997).

•                     A Group received the loan amount when the Existing Interest-Bearing Loans were advanced, satisfying the financial benefit requirement (paragraph 974-20(1)(b) of the ITAA 1997).

•                     At the time A Group received the financial benefit under the Existing Interest-Bearing Loans, it also had an ENCO to repay the Foreign Shareholder by the termination date. Accordingly, this requirement is satisfied (paragraph 974-20(1)(c) of the ITAA 1997).

•                     Under the terms of the Existing Interest-Bearing Loans, the termination date (the date on which the principal is required to be repaid by A Group to the Foreign Shareholder) is the date XX years from the date of the loan agreement. This means the value of the financial benefits provided by A Group are assessed in nominal terms. A Group is also required to pay interest at a rate of XX% per annum. The amount A Group has an obligation to repay the Foreign Shareholder will therefore exceed the amount received under the Existing Interest-Bearing Loans which means this requirement is satisfied (paragraph 974-20(1)(d) of the ITAA 1997).

As all of the requirements of section 974-20 are satisfied, the Existing Interest-Bearing Loans satisfy the debt test.

Question 3

The CNs do not satisfy the debt test in section 974-20 of the ITAA 1997.

Detailed reasoning

Under the terms of the deed, the CNs are perpetual, and payment of the coupon is at the discretion of Company B or Company C (except where a dividend is declared).

This means at the time A Group received the financial benefit under the CN, it does not have an ENCO to provide the Foreign Shareholder any financial benefits under paragraph 974-20(1)(c) of the ITAA 1997.

The CNs therefore do not satisfy the debt test.

Question 4

The CNs satisfy the equity test in subsection 974-70(1) of the ITAA 1997.

Detailed reasoning

A scheme gives rise to an equity interest under subsection 974-70(1) of the ITAA 1997 if the scheme satisfies the equity test in section 974-75 and the interest is not classified as a debt interest under section 974-20.

A scheme satisfies the equity test if it gives rise to an interest of the kind listed in the table at subsection 974-75(1) of the ITAA 1997 which are:

1.             An interest in the company as a member or stockholder of the company (table item 1 of subsection 974-75(1)).

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 aspects of the economic performance of

(a)           the company ...

(c)           ... connected entity ...

The return may be a return of an amount invested in the interest (table item 2 of subsection 974-75(1)).

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

(b)           or connected entity ....

The return may be a return of an amount invested in the interest (table item 3 of subsection 974-75(1)).

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 connected entity), or

(b)           is an interest that will, or may, convert into an equity interest in the company or connected entity ... (table item 4 of subsection 974-75(1)).

Under the terms of the deed for the CNs, each CN bears a discretionary coupon with payment at the election of Company B or Company C. The exception is when either company, respectively, declares a dividend but this declaration itself is at the discretion of those companies.

Company B and Company C may also elect to convert some or all of the CNs to ordinary shares according to the deed. The Foreign Shareholder which holds the CNs has no right to convert the CNs.

Based on this the CNs meet the requirements of both item 3 and item 4(b) of the table in subsection 974-75(1) of the ITAA 1997.

The CNs therefore satisfy the equity test. As the CNs do not also meet the debt test per question 3, they will be treated as equity interests.

Question 5

The CNs are financial arrangements under section 230-50 of the ITAA 1997.

Detailed reasoning

Under subsection 230-50(1) of the ITAA 1997 an equity interest is taken to be a financial arrangement. As determined in question 4 the CNs satisfy the equity test in Division 974, and thus they will also be a financial arrangement subject to the TOFA provisions in Division 230.

Question 6

The CNs and New Interest-Bearing Loans are not considered 'related schemes' that are required to be aggregated under section 974-155 of the ITAA 1997.

Detailed reasoning

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.

Without limiting subsection 974-155(1) of the ITAA 1997, subsection 974-155(2) provides that 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 one refers to the other, or they both have a common party.

Having regard to the facts and circumstances, none of the criteria in subsection 974-155(2) of the ITAA 1997 are met. The CNs and New Interest-Bearing Loans will not give rise to related schemes for the purposes of section 974-155.

Question 7

Refinancing 1 did not give rise to a commercial debt forgiveness under section 245-35 of the ITAA 1997.

Detailed reasoning

Division 245 applies when a commercial debt (or part of a commercial debt) is forgiven. Under paragraph 245-35(a) of the ITAA 1997 a debt is forgiven if and 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.

The value of the Existing Interest-Free Loans refinanced in Refinancing 1 are repaid in full using the proceeds from the issuance of the CNs. Therefore, no commercial debt forgiveness arises under section 245-35 of the ITAA 1997.

Question 8

Refinancing 1 did not give rise to a deemed commercial debt forgiveness under section 245-37 of the ITAA 1997.

Detailed reasoning

Section 245-37 of the ITAA 1997 provides that where an entity subscribes for shares in a company to enable the company to make a payment in or towards discharge of a debt it owes to the entity, the debt is forgiven when, and to the extent that, the company applies any of the money subscribed in or towards payment of the debt.

Subsection 995-1(1) of the ITAA 1997 defines a share in a company as a share in the capital of the company, and includes stock. These terms are not further defined and so should take their ordinary meaning.

Notwithstanding that the CNs are equity interests under Division 974 of the ITAA 1997, they do not create a share or stock interest in Company B or Company C. Therefore, section 245-37 of the ITAA 1997 does not apply to Refinancing 1.

Question 9

A balancing adjustment did not arise under Subdivision 230-G of the ITAA 1997 from the repayment of the Existing Interest-Free Loans.

Detailed reasoning

A balancing adjustment under Subdivision 230-G of the ITAA 1997 applies when a taxpayer either transfers some or all of the rights and obligations under a financial arrangement to another person, or all of the taxpayer's rights or obligations under the financial arrangement otherwise cease.

Specifically, paragraph 230-435(1)(b) of the ITAA 1997 provides that a balancing adjustment is made under Subdivision 230-G if the financial arrangement ceases. As the Existing Interest-Free Loans will be repaid in full, no balancing adjustment will arise under the method statement in subsection 230-445(1).

In certain circumstances section 230-510 of the ITAA 1997 will substitute arm's length amounts in the balancing adjustment calculation where non-arm's length dealings have occurred. However, the Existing Interest-Free Loans will not require substitution as subsection 230-510(1) excludes debt interests or loans from this requirement.

Question 10

The New Interest-Bearing Loans satisfy the debt test in section 974-20 of the ITAA 1997.

Detailed reasoning

In accordance with section 974-20 of the ITAA 1997 and based on the detailed reasoning per question 1:

•                     The New Interest-Bearing Loans satisfy the definition of a scheme (paragraph 974-20(1)(a) of the ITAA 1997).

•                     The New Interest-Bearing Loans were used to refinance the Existing Interest-Bearing Loans (which were used primarily to fund the acquisition of assets and working capital) and are therefore a financing arrangement (paragraph 974-20(1)(a) of the ITAA 1997).

•                     A Group received the loan amount when the New Interest-Bearing Loans were advanced, satisfying the financial benefit requirement (paragraph 974-20(1)(b) of the ITAA 1997).

•                     At the time A Group received the financial benefit under the New Interest-Bearing Loans, it also has an ENCO to repay the Foreign Shareholder by the termination date. Accordingly, this requirement is satisfied (paragraph 974-20(1)(c) of the ITAA 1997).

•                     Under the terms of the New Interest-Bearing Loans, the termination date (the date on which the principal is required to be repaid by A Group to the Foreign Shareholder) is the date XX years from the date of the loan agreement. This means the value of the financial benefits provided by A Group are assessed in nominal terms. A Group also is required to pay interest at a defined rate. The amount A Group has an obligation to repay the Foreign Shareholder will therefore exceed the amount received under the New Interest-Bearing Loans which means this requirement is satisfied (paragraph 974-20(1)(d) of the ITAA 1997).

As all of the requirements of section 974-20 are satisfied, the New Interest-Bearing Loans satisfy the debt test.

Question 11

Refinancing 2 did not give rise to a commercial debt forgiveness under section 245-35 of the ITAA 1997.

Detailed reasoning

Division 245 applies when a commercial debt (or part of a commercial debt) is forgiven. Under paragraph 245-35(a) of the ITAA 1997 a debt is forgiven if and 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.

The value of the Existing Interest-Bearing Loans refinanced in Refinancing 2 are repaid in full using the proceeds from the New Interest-Bearing Loans and issuance of the CNs. Therefore, no commercial debt forgiveness arises under section 245-35 of the ITAA 1997.

Question 12

Refinancing 2 did not give rise to a deemed commercial debt forgiveness under section 245-37 of the ITAA 1997.

Detailed reasoning

Section 245-37 of the ITAA 1997 provides that where an entity subscribes for shares in a company to enable the company to make a payment in or towards discharge of a debt it owes to the entity, the debt is forgiven when, and to the extent that, the company applies any of the money subscribed in or towards payment of the debt.

Subsection 995-1(1) of the ITAA 1997 defines a share in a company as a share in the capital of the company, and includes stock. These terms are not further defined and so should take their ordinary meaning.

Notwithstanding that the CNs are equity interests under Division 974 of the ITAA 1997, they do not create a share or stock interest in Company B or Company C. As per question 10 the New Interest-Bearing Loans are a debt interest and do not create a share or stock interest in Company B or Company C.

Therefore, section 245-37 of the ITAA 1997 does not apply to Refinancing 2.

Question 13

A balancing adjustment did arise under Subdivision 230-G of the ITAA 1997 from the repayment of the Existing Interest-Bearing Loans.

Detailed reasoning

A balancing adjustment under Subdivision 230-G of the ITAA 1997 applies when a taxpayer either transfers some or all of the rights and obligations under a financial arrangement to another person, or all of the taxpayer's rights or obligations under the financial arrangement otherwise cease.

Specifically, paragraph 230-435(1)(b) of the ITAA 1997 provides that a balancing adjustment is made under Subdivision 230-G if the financial arrangement ceases. Where accrued interest on the Existing Interest-Bearing Loans is only paid to the Foreign Shareholder as part of the repayment of the loan in full, it should result in a balancing adjustment loss under the method statement in subsection 230-445(1).

In accordance with subsection 230-40(2) of the ITAA 1997, to the extent that the accrued interest is taken into account by the balancing adjustment under Subdivision 230-G, it cannot be taken into account under the accruals or realisation method set out in Subdivision 230-B.

Question 14

The interest on the New Interest-Bearing Loans is deductible under subsection 230-15(2) of the ITAA 1997.

Detailed reasoning

Subsection 230-15(2) of the ITAA 1997 provides that you can deduct a loss you make from a financial arrangement, but only to the extent that:

•                     You make it in gaining or producing your assessable income.

•                     You necessarily make it in carrying on a business for the purpose of gaining or producing your assessable income.

The Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (TOFA EM) states (at paragraph 3.71) that subsection 230-15(2) of the ITAA 1997 reflects the general deduction rule in section 8-1, with the exception that it generally does not deny deductions for a loss of a capital nature. In particular, the TOFA EM states (at paragraph 3.72) that subsection 230-15(2) reflects the nexus aspects, which means the case law in respect of the nexus aspects of section 8-1 is also relevant when determining whether losses made from a financial arrangement satisfy subsection 230-15(2).

Whether a loss has a sufficient nexus to gaining or producing of income or carrying on a business for that purpose is a question of fact and circumstances. Taxation Ruling TR 95/25 Income tax: deduction for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith (TR 95/25) provides the Commissioner's view on the implications flowing from the decision of the Full Federal Court on demonstrating that a loss comprising interest satisfies the requirements of section 8-1 for deductibility. TR 95/25 provides (at paragraph 3(a)) that the test is one of characterisation and the essential character of an expense is a question of fact to be determined by reference to all the circumstances.

In relation to refinancing loans, TR 95/25 provides (at paragraph 3(b)) that

The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower. However, regard must be had to all the circumstances, including the character of the taxpayer's undertaking or business, the objective purpose of the borrowing, and the nature of the transaction or series of transactions of which the borrowing of funds is an element. In some cases, the taxpayer's subjective purpose, intention or motive may be relevant in deciding the deductibility of interest.

The New Interest-Bearing Loans replace the Existing Interest-Bearing Loans which were originally used to fund the acquisition of assets and as working capital. In accordance with the refinancing principle, interest on the New Interest-Bearing Loans will be deductible under subsection 230-15(2) of the ITAA 1997, subject to satisfying the requirements of thin capitalisation and transfer pricing.

Question 15

The coupon distributions payable on the CNs will be frankable distributions in accordance with section 202-40 of the ITAA 1997.

Detailed reasoning

Section 202-40 of the ITAA 1997 provides that a non-share dividend is a frankable distribution to the extent it is not unfrankable under section 202-45.

The meaning of non-share dividend is given in subsection 974-120(1) of the ITAA 1997 as being all non-share distributions, while the meaning of non-share distribution is given in section 974-115 and requires the holding of a non-share equity interest. A non-share equity interest is defined in subsection 995-1(1) as an equity interest in the company that is not solely a share. The CNs meet this definition as they are an equity interest that is not a share.

Therefore, consideration must be given to what are unfrankable distributions which are listed in section 202-45 of the ITAA 1997. There are no specific circumstances listed which would cause the CNs to be an unfrankable non-share dividend, however paragraph 202-45(f) provides that a distribution will be unfrankable if section 215-15 applies.

Section 215-15 of the ITAA 1997 states that a non-share dividend will be unfrankable where a corporate tax entity pays a non-share dividend and immediately before the payment, the amount of the available frankable profits of the entity is nil, or less than nil.

Accordingly, to the extent that coupon distributions are sourced from available frankable profits (as worked out under section 215-20 of the ITAA 1997), they will be frankable distributions in accordance with section 202-40.

Question 16

To the extent the coupon distributions are unfranked, they will be subject to withholding tax at a rate of 30% in accordance with subsection 128B(1) of the ITAA 1936.

Detailed reasoning

Subsection 128B(1) of the ITAA 1936 provides that section 128B applies to dividend income paid by a resident company and derived by a non-resident (subject to certain exceptions which have no application here but noting the exclusion for franked dividends provided by paragraph 128B(3)(ga)). Under subsection 128B(4) the non-resident is liable to income tax (withholding tax) on this dividend at the rate prescribed by Parliament for such income.

Paragraph 128AAA(1)(c) of the ITAA 1936 states that section 128B applies to a non-share dividend in the same way as it applies to a dividend.

Therefore, to the extent the coupon distributions are unfranked, they will be subject to withholding tax at a rate of 30%. This is in accordance with paragraph 7(a) of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974, noting there is no reduction in the absence of a double tax agreement between Australia and the foreign country.

The withholding tax liability will be due when the dividend is paid, credited or distributed to the non-resident per the definition of 'paid' under subsection 6(1) of the ITAA 1936.

Question 17

The conversion of CNs into ordinary shares will not give rise to commercial debt forgiveness under sections 245-35 or 245-37 of the ITAA 1997.

Detailed reasoning

Section 245-10 provides that the commercial debt forgiveness provisions apply to a debt 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.

Therefore, there must be a debt in existence for the provisions to have application.

The CNs are perpetual, and only Company B and Company C have the right to elect to convert some or all of them to ordinary shares. The issue of perpetual notes was considered in ATO ID 2012/25 Income Tax: Commercial debt forgiveness: whether a perpetual note is a debt. There, the issuer of a perpetual note had no enforceable obligation to pay the note holder the face value of the note. As such, the perpetual note did not satisfy the definition in former subsection 245-15(1) of Schedule 2C to the ITAA 1936 of a debt as being 'an enforceable obligation imposed by law on a person to pay an amount to another person'.

In 2010, former Schedule 2C was transferred to the ITAA 1997 as part of the tax law rewrite. Paragraph 3.10 of the Explanatory Memorandum to the Tax Laws Amendment (Transfer of Provisions) Bill 2010 noted that as the ITAA 1997 already used the term 'debt' in its ordinary sense, it could not adopt the existing Schedule 2C definition. Paragraph 3.11 noted the ordinary meaning of debt requires an obligation, so it does not need to be expressly stated. The Macquarie Dictionary (Macquarie Dictionary Online, 2025) defines 'debt' as

that which is owed; that which one person is bound to pay to or perform for another; a liability or obligation to pay or render something; the condition of being under such an obligation ... .

As the CNs do not carry this obligation they do not constitute debts for the purposes of the commercial debt forgiveness provisions in Division 245 of the ITAA 1997, meaning sections 245-35 and 245-37 have no application.