Taxation Determination
TD 2015/3
Income tax: is the reference to 'the interest' as it appears in the phrase at the end of subsection 974-80(2) of the Income Tax Assessment Act 1997 a reference to the interest held by the 'ultimate recipient'?
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Please note that the PDF version is the authorised version of this ruling.There is no Compendium for this document as no comments were received on the draft Determination.
Preamble
This publication provides you with the following level of protection:
This publication (excluding appendixes) is a public ruling for the purposes of the Taxation Administration Act 1953. A public ruling is an expression of the Commissioner's opinion about the way in which a relevant provision applies, or would apply, to entities generally or to a class of entities in relation to a particular scheme or a class of schemes. If you rely on this ruling, the Commissioner must apply the law to you in the way set out in the ruling (unless the Commissioner is satisfied that the ruling is incorrect and disadvantages you, in which case the law may be applied to you in a way that is more favourable for you - provided the Commissioner is not prevented from doing so by a time limit imposed by the law). You will be protected from having to pay any underpaid tax, penalty or interest in respect of the matters covered by this ruling if it turns out that it does not correctly state how the relevant provision applies to you. |
Ruling
1. Yes. 'The interest' referred to in the phrase at the end of subsection 974-80(2)[1] is the interest held by the 'ultimate recipient' and not the interest held by the 'connected entity'.
Date of effect
2. This Determination applies to years of income commencing both before and after its date of issue. However, this Determination will not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of this Determination (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10).
Commissioner of Taxation
18 March 2015
Appendix 1 - Explanation
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This Appendix is provided as information to help you understand how the Commissioner's view has been reached. It does not form part of the binding public ruling.
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Explanation
3. Division 974 contains rules for classifying an interest as debt or equity for certain tax purposes. Section 974-80 is an integrity provision within Division 974. It deals with financing arrangements that grant an investor (the ultimate recipient) an interest which is effectively (in substance but not in form), an equity interest in a company. The provision applies when the equity-like returns that are paid to the ultimate recipient are funded from otherwise tax deductible payments made by the company or connected entities of the company.[2] That is, where interposed debt interests are used to create 'de facto' equity interests, the provision reclassifies the interposed debt interests as equity interests. This causes the returns paid in respect of those same interests to be non-deductible.[3]
4. Subsection 974-80(1) sets out the situations in which the provision will apply to characterise an interest as an equity interest. Relevantly, there must be an interest which is otherwise not an equity interest held by a connected entity of a company.
5. The interest will be characterised under subsection 974-80(2) provided that one of the requirements in subsection 974-80(2) is satisfied. Subsection 974-80(2) is intended to test whether the interest held by the ultimate recipient should be taken to be effectively an equity interest in the company (or a connected entity of the company).
6. Subsection 974-80(2) ends with the phrase:
and if the interest does not form part of a larger interest that is characterised as a *debt interest in the entity in which it is held, or a *connected entity, under Subdivision 974-B.
[Emphasis added]
7. It is not readily apparent on reading subsection 974-80(2) whether 'the interest' referred to in the phrase is the interest held by the ultimate recipient or the debt interest held by the connected entity.
8. On a literal reading of subsection 974-80(2), 'the interest' referred to may be thought to be the interest held by the connected entity. However, a literal reading is inconsistent with the purpose of the provision and does not consider the phrase in the context of the provision as a whole. When regard is had to the context and purpose of the section, it is clear that 'the interest' is a reference to the interest held by the ultimate recipient.
9. Section 974-80 was not intended to apply if the interest held by the ultimate recipient is a debt interest: see paragraph 2.49 of the Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 where it is stated that:
the debt test... does not apply individually to each of the interests identified in section 974-80 which fund the return to the ultimate recipient. Instead, the test applies in relation to the interest held by the ultimate recipient - if that satisfies the debt test then the funding interests will not be equity interests.
10. The inclusion of the phrase at the end of subsection 974-80(2) was clearly aimed at putting beyond doubt that section 974-80 would not apply where the ultimate recipient holds an equity interest, provided the interest is part of a larger debt interest under subsection 974-15(2).
11. The Commissioner's preferred construction is supported by the last sentence in subsection 974-80(2). It provides that:
The return may be a return of an amount invested in the interest.
12. The 'return' referred to in the last sentence is the return on the interest held by the ultimate recipient as identified throughout subsection 974-80(2). It would be a nonsensical outcome if the two relevant references to 'the interest' in the subsection, appearing as they do with one immediately following the other, were intended to be references to different interests.
13. Accordingly, the Commissioner is of the view that the reference to 'the interest', as it appears in the phrase, is a reference to the interest held by the ultimate recipient.
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Footnotes
All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.
See paragraphs 2.41 to 2.49 of the Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001. See also paragraphs 1.27 to 1.29 of the Supplementary Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001.
Section 26-26 provides that a company cannot deduct:
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- a non-share distribution, or a return that has accrued on a non-share equity interest; or
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- a dividend paid on an equity interest in the company as a general deduction under the Act.
Previously issued as TD 2014/D19
References
ATO references:
NO 1-63S4NV3
Related Rulings/Determinations:
TR 2006/10
Subject References:
debt test
equity test
Legislative References:
ITAA 1997
ITAA 1997 26-26
ITAA 1997 Div 974
ITAA 1997 Subdiv 974-B
ITAA 1997 974-15(2)
ITAA 1997 974-80
ITAA 1997 974-80(1)
ITAA 1997 974-80(2)
TAA 1953
Other References:
Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001
Supplementary Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001