Federal Register of Legislation - Australian Government

Primary content

A Bill for an Act to implement the New Business Tax System in relation to debt and equity interests, and for related purposes
For authoritative information on the progress of bills and on amendments proposed to them, please see the House of Representatives Votes and Proceedings, and the Journals of the Senate as available on the Parliament House website.
Introduced HR 28 Jun 2001

New Business Tax System (Debt And Equity) Bill 2001

1998-1999-2000-2001

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

HOUSE OF REPRESENTATIVES

NEW BUSINESS TAX SYSTEM (DEBT AND EQUITY) BILL 2001

EXPLANATORY MEMORANDUM

(Circulated by authority of the
Treasurer, the Hon Peter Costello, MP)

ISBN: 0642 460469

Table of contents

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

A Platform for Consultation

Review of Business Taxation: A Platform for Consultation

A Tax System Redesigned

Review of Business Taxation: A Tax System Redesigned

ADI

authorised deposit-taking institution

ANTS

Government's Tax Reform Document: Tax Reform: not a new tax, a new tax system

APRA

Australian Prudential Regulation Authority

ATO

Australian Taxation Office

CFC

controlled foreign company

CGT

capital gains tax

Commissioner

Commissioner of Taxation

CPS

converting preference share

FDA

foreign dividend account

FIF

foreign investment fund

FRN

floating rate notes

PAYG

pay as you go

SPV

special purpose vehicle

TAA 1953

Taxation Administration Act 1953


Back to Top

General outline and financial impact

Debt and equity rules This bill defines what constitutes equity in a company and what constitutes debt. This determines the tax treatment of a return on a financing interest issued by a company (i.e. whether it is frankable or may be deductible). The definition of debt also constitutes a key component of the new thin capitalisation regime since it is used to determine what deductions may be disallowed.

Date of effect: 1 July 2001. However, transitional rules allow the issuers of an interest issued before 21 February 2001 that changes character as a result of the new rules to elect to have them treated under the existing law until 1 July 2004.

Proposal announced: The Government released an exposure draft of the rules in the New Business Tax System (Thin Capitalisation and Other Measures) Bill 2001 on 21 February 2001. Treasurer's Press Release No. 38 of 22 May 2001 announced changes to the exposure draft legislation.

Financial impact: The revenue impact of this measure is unquantifiable, although it will protect the revenue base from erosion from deductible returns on certain future financial instruments that are equity in economic substance but debt in legal form. To the extent that the revenue base is not protected, there could be a potential significant loss to annual revenue.

Compliance cost impact: The rules will have a minor impact on those financing interests that do not change character. For those interests which change character there will be associated compliance costs in making the transition to the new law. However, these costs will be reduced by the transitional rules.

Chapter 1
Overview of the debt/equity rules

Outline of chapter 1.1 This chapter provides an overview of the debt/equity rules, which provide what constitutes equity in a company and what constitutes debt. Consequently, it explains how the debt/equity borderline is drawn for tax purposes.

1.2 The side of the debt/equity borderline that an interest in a company lies on is relevant for the purposes of determining the tax treatment of a return on the interest (i.e. whether it may be frankable or may be deductible). The definition of debt also constitutes a key component of the proposed thin capitalisation regime since it is used to determine what deductions may be disallowed.

1.3 Chapter 2 explains the operation of the debt/equity test. Chapter 3 sets out where the new debt and equity definitions are used in the income tax law. Chapter 4 explains the mechanics of the operation of the non-share capital account of a company and Chapter 5 contains the regulation impact statement.

Context of reform 1.4 The income tax law provides a tax treatment of returns to the shareholders of a company which differs from the tax treatment of returns to its creditors (debt holders).

1.5 Shareholders of a company receive dividends - which may be franked (i.e. they may carry imputation credits representing underlying company tax which may be used to reduce the shareholders' tax) but which are not deductible to the company making the dividend. By paying franked dividends a company can ensure that, for the most part, its profits are ultimately taxed at its shareholders' marginal tax rates. Creditors, on the other hand, receive returns which cannot be franked but which are usually deductible to the company.

1.6 This differential tax treatment is fundamental to the tax law. It recognises the fundamental difference between the equity holders of a company, who take on the risks associated with investing in the activities of the entity, and its creditors, who, as far as possible, avoid exposure to that risk. In recognising this fundamental difference, it is essential that the tax law draws the borderline separating the 2 (the debt/equity border) in such a way that the legal form of an interest cannot be used to result in a characterisation at odds with its economic substance.

1.7 A mischaracterisation of a debt interest as an equity interest can result in the inappropriate franking of debt-like returns (see Example 2.2), or companies circumventing the thin capitalisation measures. On the other hand, mischaracterising an equity interest as debt could allow inappropriate tax deductions for the issuer through so-called deductible equity (see Example 2.3). In other words, mischaracterisation could result in frankable returns being made to creditors of an entity and deductible returns to its equity holders. This would undermine the well-established distinction between the 2 types of returns and would expose the revenue to a significant risk of erosion.

1.8 Although the distinction between debt and equity is well established, the means for distinguishing between the 2 is not coherent or necessarily appropriate under the current law. A mischaracterisation of certain interests

Back to Top

can therefore occur. For example, the current thin capitalisation provisions rely on a concept of debt that is based more on legal form than economic substance. This concept lacks the ability to deal with innovative financial arrangements. Consequently, certain arrangements that constitute in-substance debt (including synthetic and embedded debt) may result in a different tax outcome for thin capitalisation purposes than more conventional, but economically equivalent, debt arrangements.

1.9 Under the new law, the test for distinguishing debt interests from equity interests focuses on a single organising principle - the effective obligation of an issuer to return to the investor an amount at least equal to the amount invested. This test seeks to minimise uncertainty and provide a more coherent, substance-based test which is less reliant on the legal form of a particular arrangement. It provides greater certainty, coherence and simplicity than is attainable under the current law.

Summary of new law 1.10 Part 3-5 of the ITAA 1997 provides that, for certain purposes of the income tax law (including the thin capitalisation provisions and the taxation of returns on interests in companies), `equity interests' in a company are those that are listed as such, unless they constitute `debt interests'. Those listed are:

* shares;

* interests providing returns contingent on economic performance, or at the discretion of the company; and

* interests that may or will convert into such interests or shares.

1.11 An interest in a company is a debt interest (i.e. satisfies the debt test) if, at the time of its issue, there is a scheme that is a financing arrangement under which the company has an effectively non-contingent obligation to pay an amount (or the total of several amounts) to the holder of the interest at least equal to its issue price. If the term of the interest is 10 years or less, the amount to be paid to the holder must equal or exceed the issue price in nominal value terms. If the term is greater than 10 years, the amount to be paid to the holder must equal or exceed the issue price in present value terms.

1.12 The holder of an equity interest in a company is an equity holder in the company. If an equity interest is not a share in legal form then it is called a `non-share equity interest'. Both shareholders and holders of non-share equity interests may be paid frankable dividends by the company.

1.13 For the purposes of determining the taxation treatment of returns (including for imputation purposes), equity interests in a company are, except in certain specified respects, treated in the same way for tax purposes irrespective of whether they are shares or non-share equity interests. To facilitate this, companies maintain a `non-share capital account' in relation to their issued non-share equity interests, which serves the same purpose as a share capital account in relation to shares.

1.14 The new law permits specified aspects of the new tests and definitions to be supplemented or modified in certain respects by regulation. This is to promote certainty and facilitate the categorisation of debt/equity hybrids (i.e. interests that have both debt and equity characteristics) as either debt or equity by providing guidance on how to give effect to certain aspects of the law. The regulations will not be used to alter the operation of the new law in a way inconsistent with, or not envisaged by, the objects of the provisions contained in this bill. Nor will they be used without regard to the legitimate expectations of taxpayers that any changes to the effect of the debt/equity tests should not unfairly prejudice transactions already entered into.

Comparison of key features of new law and current law

New law

Current law

There is an extended definition of equity based on economic substance (broadly speaking, interests that raise finance and provide returns contingent on the economic performance of a company constitute equity, subject to the debt test).

Equity is limited to shares in a company.

There is an extended definition of dividend to encompass both dividends on shares as well as most distributions on non-share equity interests (i.e. interests which fall within the extended definition of equity).

Dividends are limited to profit distributions on shares. Non-share equity interests cannot provide frankable dividends.

Non-share dividends paid on equity interests issued by certain permanent establishments (branches) of Australian ADIs are, subject to conditions, to be unfrankable.

There is no equivalent rule in the existing law.

Debt interests are identified by reference to a single organising principle - the effective obligation of the issuer of a debt interest to return an amount at least equal to the issue price. This provides greater certainty and coherence than the current law.

The identification of debt capital, or certain other types of debt, turns on the concept of interest payments, which lacks certainty and whose determination is influenced more by legal form than economic substance.

For thin capitalisation purposes, debt deductions include the cost of debt capital, which incorporates interest and amounts that function as interest. This provides greater clarity and coherence than the current law.

The focus of the current thin capitalisation provisions is on the concept of interest, whose determination may be influenced more by legal form than economic substance.


Back to Top

Application and transitional provisions 1.15 The debt/equity rules will apply from 1 July 2001 subject to certain transitional rules. Details of the application and transitional provisions are discussed in Chapter 2.

Chapter 2
Debt/equity test

Outline of chapter 2.1 This chapter explains the operation of the debt/equity test. The explanation of the new law is divided into 2 sections:

* the first section addresses the equity component of the test, including what constitutes a frankable distribution on equity interests that are not shares; and

* the second section explains what interests are debt interests.

Detailed explanation of new law Company equity 2.2 Division 974 of the ITAA 1997, which is inserted by this bill, provides the new rules governing what is an equity interest for tax purposes. The rules identify those interests in a company which, like ordinary shares, can support frankable (as opposed to deductible) returns. The new rules classify an interest in a company as equity or debt according to the economic substance of the rights and obligations of an arrangement rather than its mere legal form in a more comprehensive way than the current law. Relevant to the classification is the pricing, terms and conditions of the arrangement under which the interest is issued. This limits the ability of taxpayers to have returns on an interest artificially categorised as frankable or deductible to best suit the tax profiles of the issuer and the holder so as to create undesirable tax arbitrage.

2.3 To gain a comprehensive understanding of the new debt/equity rules it is necessary to understand why it matters whether an interest in a company is categorised as debt or equity. If taxpayers could choose the categorisation - by structuring the instrument's legal form and without regard to the substance or nature of the arrangement - it would be at the expense of the revenue, as Examples 2.1, 2.2 and 2.3 illustrate. The new rules attempt to tax interests according to their nature rather than facilitating the manipulation of tax treatments on the basis of the tax profiles of the parties to the transaction. Without this substantive approach, tax entities could issue instruments that are identical in nature but frankable or not to suit the circumstances of the parties, at the expense of the revenue.

Example 2.1: The different tax results of debt and equity

The practical effect of the difference in tax treatment between distributions made by a company to its equity holders and other returns paid by a company (e.g. interest paid to a creditor) can be illustrated by a consideration of the different tax results that arise when $100 of assessable income is derived by a company and then paid either as a frankable distribution or as interest on a loan. The company tax rate is assumed to be 30%.

If paid as a frankable distribution, the company pays $30 tax and pays a fully franked dividend of $70 (the after-tax amount); the $30 tax paid by the company may be imputed to the recipient of the dividend.

If paid as interest, the company could distribute the full $100 without paying tax (the $100 assessable income being offset by a $100 deduction); the recipient of the interest would then be liable to tax on the full amount.

If the recipient is a taxable resident, the $100 derived by the company is effectively taxed at the recipient's marginal tax rate in both cases (in the franked dividend case, the tax already paid by the company is imputed to the recipient).

However, if the recipient is a non-resident or a tax exempt unable to benefit from refundable imputation credits, the $100 is taxed at the company tax rate if it is distributed as a franked dividend. On the other hand, it is usually tax exempt if it is paid as interest to such recipients, and interest withholding tax may not be payable (because of an exemption granted under section 128F of the ITAA 1936, for example). Even if interest withholding tax is payable, it is subject to a lower rate of tax than equity.

Example 2.2: Artificial categorisation of debt as equity

A tax loss company (for whom an interest deduction is of no immediate value) with surplus franking credits, or a company with surplus franking credits seeking to lower its cost of capital or strengthen its shareholders' equity base or gearing ratios, might seek to issue an equity interest that is debt-like. The purpose of this would be to compensate the investor with franked (and therefore rebatable) payments, notwithstanding that the payments are in substance interest. This would minimise the wastage of franking credits in the company's franking account that would occur as a result of the company's normal dividend policy, where the wastage would otherwise reduce the revenue cost of the imputation system.


Back to Top

Example 2.3: Artificial categorisation of equity as debt

A company might seek to stream a limited supply of franking credits to taxpayers best able to use them by issuing franked dividend-paying shares to Australian residents and other financial instruments to non-residents which provide economically equivalent, but non-dividend and unfranked returns, that are deductible in the company's hands.

2.4 The new debt/equity rules are framed against this background of the different tax effects that can arise from the taxation of debt and equity.

What is an equity interest in a company? Only financing arrangements can be equity interests 2.5 The threshold question in determining whether a particular interest in a company (other than a share) is an equity interest is whether the relevant scheme giving rise to the interest is a financing arrangement. If it is not, the interest cannot be an equity interest; nor can it be a debt interest. Shares in a company do not have to satisfy this threshold question as they are inherently capital-raising instruments. [Schedule 1, item 34, subsection 974-75(2)]

What is a financing arrangement? 2.6 A financing arrangement is a scheme entered into or undertaken to raise finance for a company or a connected entity (or to fund another financing arrangement). (The use of the word `scheme' in this and other provisions explained in this chapter picks up the broad definition of that term in subsection 995(1) of the ITAA 1997 so that, for example, it encompasses unilateral arrangements: it is not of itself intended to imply that the relevant arrangement constitutes a tax avoidance scheme.) [Schedule 1, item 34, section 974-130]

2.7 The raising of finance generally entails a contribution to the capital of an entity, whether by way of money, property or services, in respect of which a return is paid by the entity, be it contingent (connoting equity) or non-contingent (connoting debt). It is important, however, to consider all the relevant circumstances and features of a particular arrangement to determine whether, in substance, it is appropriately characterised as a financing arrangement or not. In this regard, the intentions of the parties to the arrangement may be relevant, but are not determinative.

2.8 In the vast majority of cases it is readily apparent whether a particular arrangement constitutes the raising of finance. The issuing of a debt/equity hybrid instrument, whether in consideration for money (as would usually be the case), property or the provision of services, would, for example, constitute a financing arrangement. Conversely, a financing arrangement is not created from a contract for personal services entered into in the ordinary course of business where, in consideration for the provision of services, the employer provides a return in the form of salary commensurate with the value of the services provided. This is the case even if there is some delay between the provision of services and the payment of the salary, as occurs when, for example, an employer provides long service leave payments in recognition of services provided several years before. Another example of a scheme that is generally not entered into or undertaken to raise finance is a derivative that is used solely for managing financial risk. [Schedule 1, item 34, subsection 974-130(3)]

2.9 However, the example of an employment contract demonstrates how important it is to consider all the relevant circumstances and features of a particular arrangement to determine whether, in substance, it is appropriately characterised as a financing arrangement or not. This is because in certain, albeit unusual, circumstances an employment contract may constitute a financing arrangement, as Example 2.4 shows. The example illustrates an exception to the general rule that employment contracts do not constitute financing arrangements.

Example 2.4: An employment contract that is a financing arrangement

A company issues shares to all the members of a family except one, who is instead employed by the company for a salary contingent on profits of the company. The calculation of the salary is such that the employee receives a return equivalent to that of the other family members on their shares (increased to reflect the value of the services provided).

In these unusual circumstances the employment contract would constitute a financing arrangement because the employee is effectively funding the company by providing services instead of money. The employment contract is a substitute for shares in the company.

2.10 Some schemes are explicitly excluded from being financing arrangements. Two excluded schemes, which are relevant to the definition of equity, are schemes for the payment of royalties within the meaning of the ITAA 1936, and life insurance or general insurance contracts. [Schedule 1, item 34, subsection 974-130(4)]

2.11 Because a financing arrangement may be funded by another scheme, schemes that fund other schemes that are themselves financing arrangements will also be financing arrangements. An example is an arrangement between dual listed

Back to Top

companies under which profits are transferred between the 2 companies in certain situations to enable the transferee to pay a dividend on its shares. In this case the profit-sharing arrangement funds the financing arrangement constituted by the shares in the transferee company and is therefore a financing arrangement itself. [Schedule 1, item 34, paragraph 974-130(1)(b)]

2.12 The following discussion of equity interests in a company relates to schemes that constitute financing arrangements.

Debt interests are not equity interests 2.13 In determining whether an interest in a company is an equity interest it is important to note that interests that, at the time of their issue (or at certain other times involving a material change: see paragraphs 2.129 to 2.134), are debt interests (or are part of a larger interest that constitute debt interests) will not be equity interests. For example, a share in a company, which would ordinarily be an equity interest, is not an equity interest if it constitutes a debt interest at the time of its issue (debt interests are explained in paragraphs 2.124 to 2.209). [Schedule 1, item 34, paragraph 974-70(1)(b)]

2.14 In applying this carve-out debt test to a converting or convertible interest (see paragraphs 2.37 to 2.40) the interest into which it converts is taken to be a new interest. Therefore, for example, the fact that a convertible preference share may be a debt interest at the time of its issue does not prevent the shares into which it converts being equity interests if those shares themselves are not debt interests. [Schedule 1, item 34, section 974-100]

2.15 In addition, there is an exception to the carve-out in relation to non-arm's length arrangements (explained in paragraphs 2.61 to 2.66), and in relation to equity interests arising from certain schemes that fund returns through connected entities (see paragraphs 2.50 to 2.58).

2.16 Shares that satisfy the debt test (e.g. compulsorily redeemable preference shares) are still shares for the purposes of the income tax law and returns on them are still dividends. However, those dividends generally receive a different tax treatment from dividends on shares that do not satisfy the debt test. For example they are not frankable. To facilitate this different tax treatment, shares that satisfy the debt test are called `non-equity shares'. [Schedule 1, item 39, definition of `non-equity share' in subsection6(1)]

General test for determining whether a scheme gives rise to an equity interest 2.17 To better reflect the economic substance of particular transactions a holistic approach is adopted by the debt/equity tests. Under this approach it is necessary to look not at single transactions but at schemes, or a number of related schemes, comprising those transactions. If a particular scheme, or a number of related schemes, gives rise to an interest set out in the table in subsection 974-75(1) then that interest is an equity interest in a company, unless it, or a larger interest of which it is a part, satisfies the debt test. If the scheme or schemes do satisfy the debt test the interest will not be an equity interest even though it would have been if looked at in isolation rather than as part of the scheme or schemes. [Schedule 1, item 34, subsection 974-70(1)]

2.18 The holder of an equity interest in a company is an `equity holder' in the company [Schedule 2, item 8, definition of `equity holder' in subsection 995-1(1)]. If returns from the interest (not being a share) are payable to more than one entity, each entity is an equity holder in the company [Schedule 1, item 34, subsection 974-95(4)]. (The exception relating to shares prevents the new debt/equity rules affecting the existing law in relation to shares.)

2.19 A consequence of being an equity interest is that the whole of a distribution made in relation to the interest may be frankable. For simplicity reasons, there is no general bifurcation of a distribution on an equity interest into a frankable component and a non-frankable component even though the interest is a debt/equity hybrid. [Schedule 1, item 34, subsections 974-95(1) and (2)]

What is a scheme? 2.20 The term `scheme' sometimes has a tax avoidance connotation. However, as indicated in paragraph 2.6, it is used in the debt/equity tests in a broader sense that covers ordinary situations as well. It is used here in the sense of an arrangement, but one that also incorporates unilateral arrangements (see the definition of scheme in subsection 995-1(1) of the ITAA 1997).

2.21 In the context of the equity test, the relevant scheme will usually constitute just a single instrument - a share, for example. In more complicated cases the relevant scheme may constitute a particular instrument affected by some other arrangement - for example, a share combined with a guarantee as to payment of dividends. In the former case the share will constitute an equity interest unless it satisfies the debt test. In the latter case, the share will

Back to Top

constitute an equity interest unless the interest of which it is a part (i.e. including the guarantee) satisfies the debt test.

2.22 It is a question of fact depending on all the relevant circumstances whether a series of transactions are part of a single scheme or constitute more than one scheme. Merely because transactions are undertaken under one agreement does not necessarily mean that they are all part of the one scheme. For example, an employment contract that provides for the payment of salary and, in addition, the issue of shares in the company to the employee would not ordinarily constitute a single scheme for the purposes of the debt/equity tests. Rather it would usually be seen as constituting 2 separate schemes: one for the payment of salary and the other for the issue of shares. Similarly, without limiting the Commissioner's discretion or scope of regulations, a financing arrangement and a hedging transaction (e.g. a derivative) would also usually be seen as constituting 2 separate schemes. To enable specific circumstances to be taken into account, the Commissioner has a discretion to treat a particular scheme as constituting 2 or more separate schemes. Regulations may also be made to provide further guidance on when a scheme is treated as 2 or more separate schemes. [Schedule 1, item 34, subsections 974-150(2) and (3)]

The table in subsection 974-75(1) 2.23 The first item in the table in subsection 974-75(1) simply identifies the current class of equity interests in a company, namely the interests held by members and stockholders (i.e. shares and stock). Shareholders in a company are `members' for these purposes, as are guarantors of a company limited by guarantee. [Schedule 1, item 34, subsection 974-75(1), item 1 in the table]

2.24 The reference to stockholders in a company incorporates the concept of fractional interests in shares known as stock. Until 1 July 1998 Australian companies could issue stock, but are now prevented from doing so due to Corporations Law reforms. Thus the concept of stock is no longer relevant for companies incorporated under the Australian Corporations Law. However, the concept of stock as a fractional interest in shares may still be relevant for companies incorporated in other jurisdictions. Therefore that concept has been retained in the income tax law by the reference to stock in the definition of a share in subsection 995-1(1) of the ITAA 1997, and by the reference to stockholders in the table in subsection 974-75(1).

2.25 Items 2 to 4 in the table bring within the equity concept interests which, because of their legal form, cannot provide frankable returns under the current law, even though, in economic substance, they have significant equity features. Under the new law the legal form of an interest does not preclude the franking of its returns. An interest referred to in these items in the table may or may not represent a proprietary right or chose in action. [Schedule 1, item 34, subsection 974-75(3)]

2.26 Item 2 in the table treats as equity interests (subject to the debt test explained in paragraphs 2.124 to 2.209), interests that provide an effectively contingent (i.e. contingent in substance or effect, even if not in legal form) right to a return (whether fixed or variable), or an absolute right to a contingent return. In this context a return is both a return on an investment and a return of an investment. For example, dividends are returns on an equity interest, and the redemption proceeds of a share constitute the return of the investment: either may be contingent on economic performance, and both are `returns' for the purposes of this definition of an equity interest. [Schedule 1, item 34, subsection 974-75(1), item 2 in the table]

2.27 The relevant contingency is the economic performance of the company (or a part of the company's activities) that issued the interest, or that of a `connected entity' (defined in subsection 995-1(1) of the ITAA 1997 to mean an associate - defined by reference to section 318 of the ITAA 1936 - or a member of the same wholly-owned group) of the company. [Schedule 1, item 34, subsection 974-75(1), item 2 in the table]

Example 2.5: Contingent right

A company issues an interest which gives its holder the right to $100 in each year that a company within the same wholly-owned group makes a profit.

The interest satisfies item 2 in the table in subsection 974-75(1) because there is a right which is contingent on the economic performance of a connected entity of the company.

Example 2.6: Contingent return

A company issues an interest which gives its holder the right to 1% of the profits made by the company's steel-making business.

The interest satisfies item 2 in the table in subsection 974-75(1) because there is a right to a return which is contingent on the economic performance of part of the company's activities.

The scope of economic performance 2.28 Item 2 in the table requires a link between the return to the investor and

Back to Top

the economic performance of the issuer (i.e. the company in which the interest exists - see new subsection 974-95(5)) or a connected entity of the issuer. An interest whose returns are contingent on something other than the economic performance of the issuer or a connected entity is not brought within the item. For example, an option issued by a company over shares in an unconnected entity does not constitute an equity interest in the issuer even though the return to the investor is contingent.

2.29 The economic performance on which the returns are based may be past, present or future economic performance of the company. In addition, there is no requirement that the link between economic performance and the return be a direct one. It is sufficient that the return is, in substance, contingent on economic performance of the company, even if the link is an indirect one.

Example 2.7: Contingent on economic performance

A company issues an interest to a trust that has issued income securities to its beneficiaries. The income securities provide returns that are contingent on the profits of the company. The interest issued by the company to the trust provides returns based on the returns on the income securities.

The returns on the interest issued to the trust are contingent on the economic performance of the company because they are based on the returns on the income securities, which are contingent on profits (i.e. a manifestation of the company's economic performance). This is the case whether the returns are cumulative or non-cumulative; however, if the returns are cumulative, the interest is more likely to satisfy the debt test.

2.30 The right that a creditor has to a return may be said to be contingent on the debtor company being able to meet its debts when they fall due. That by itself will not be taken as meaning that the right is contingent on the economic performance of the company. [Schedule 1, item 34, paragraph 974-85(1)(a)]

2.31 To promote certainty, regulations may prescribe circumstances in which a right or return is taken to be contingent, or not contingent on economic performance means. [Schedule 1, item 34, subsection 974-85(2)]

Disregarded kinds of economic performance - de minimis contingencies and turnover-based payments 2.32 There can be circumstances where a right to a return or an amount of return is based on the turnover of the entity obliged to make the relevant payments. An example is a lease contract where part of the rentals are based on the lessee's turnover. Generally speaking, turnover-based returns will be excluded from being regarded as contingent on economic performance in the relevant sense. [Schedule 1, item 34, paragraph 974-85(1)(b)]

2.33 However, there may be types of contracts where turnover is a close proxy for an economic performance indicator other than turnover (e.g. profitability) of the payer. Regulations may be made to treat such contracts as equity interests. Regulations may also be made to clarify when a particular return is or is not contingent on economic performance. [Schedule 1, item 34, subsection 974-85(2)]

2.34 Where a right to a return or an amount of return on an interest is contingent on profitability or some other economic performance indicator (other than turnover) to a minor extent, regulations may be made to exclude such types of interests from being equity interests. [Schedule 1, item 34, subsection 974-85(2)]

Returns dependent on the exercise of a discretion 2.35 Item 3 in the table in subsection 974-75(1) covers interests that provide a return (whether on or of the investment) to the holder which is at the discretion of the issuer or a connected entity. An example of this would be an interest that provides a 10% return to the holder unless the directors of the issuing company determine otherwise. In this case the right to a return is contingent on the exercise of the issuer's discretion. [Schedule 1, item 34, subsection 974-75(1), item 3 in the table]

2.36 To promote certainty, regulations may specify when a particular return is at the discretion of a company or a connected entity. These regulations may, for example, explain in what circumstances a loan between connected entities (e.g. companies in the same wholly-owned group) will be treated as an equity interest because, having regard to all the surrounding circumstances, repayment is effectively at the discretion of the so-called lender. [Schedule 1, item 34, section 974-90]

Converting or convertible interests 2.37 Item 4 in the table in subsection 974-75(1) identifies interests whose equity character stems from the fact that their holder may become an equity holder in the future. These interests are convertible if the holder has a choice of whether or not to convert the interest, or converting if the conversion is automatic. Examples of such interests are convertible notes (i.e. interests which give their holder an option to convert - in a loose sense of that term - the interest into a share in the

Back to Top

issuer) and rights issued by a company to acquire shares in the company. [Schedule 1, item 34, subsection 974-75(1), item 4 in the table]

2.38 Of course, as with the other items in the table, if the relevant interest satisfies the debt test it will not be an equity interest in the company. Therefore, not all convertible note holders will be equity holders in the company - only those whose notes are insufficiently debt-like to fall within the definition of a debt interest explained in paragraphs 2.148 to 2.157. [Schedule 1, item 34, paragraph 974-70(1)(b)]

2.39 An interest is a converting or convertible interest if:

* the interest, or a component part of the interest, may (or must) be converted into an equity interest in the company or a connected entity (the reference to a component part addresses interests comprising a number or rights or interests, only one of which converts into an equity interest);

* the interest, or a component part of the interest, may (or must) be redeemed, repaid or satisfied by the:

- allotment or transfer of an equity interest in the company or a connected entity (whether to the holder of the interest or to some other person);

- acquisition of an equity interest in the company or a connected entity (whether by the holder of the interest or by some other person); or

- application in or towards paying-up (in whole or part) the balance unpaid on an equity interest issued or to be issued by the company or a connected entity (whether to the holder or to some other person); or

* the holder of the interest has, or is to have, any right or option to have allotted or transferred to a person an equity interest (or a right or option to acquire an equity interest) in the company or a connected entity, or otherwise to acquire such an interest.

[Schedule 1, item 34, section 974-165]

2.40 That these events are conversion events does not carry any implication as to whether the events are disposals or not for income tax and CGT purposes.

Example 2.8: Converting or convertible interests

A company issues a stapled instrument comprising an unpaid preference share and a perpetual note whose terms provide that, if the face value of the note is redeemed, a call is made on the unpaid amount of the preference share (i.e. there is an effective, but not an actual, conversion of the note into a preference share).

A variation on this type of instrument is where the redemption of the note triggers an obligation of the holder to acquire an equity interest in the issuer from a connected entity of the issuer.

In both these cases the interest is a converting or convertible interest that falls within item 4 in the table in subsection 974-75(1). Whether or not they constitute equity interests depends on whether they satisfy the debt test.

Interests that fund returns on equity interests 2.41 Sometimes it is possible for an effective equity interest in a company to arise even though the holder of the interest has no direct interest in the company. Instead there may be a series of related arrangements entered into by the company and connected entities culminating in the payment of a return to an investor in respect of an interest which provides the investor with an effective interest in the company.

2.42 A common scenario where this can arise is the issue of an equity interest through a SPV controlled by a holding company. Diagram 2.1 illustrates an example of this structure.

Diagram 2.1

2.43 In Diagram 2.1 there is a series of related arrangements under which the ultimate investors have obtained an effective, but not an actual, equity interest in the holding company. The investors hold units in a the SPV which provide returns contingent on the profits of the holding company and which may convert into ordinary shares of that company. The subscription price has been on-lent, at interest, by the SPV to the holding company through its subsidiaries. The holding company has funded the contingent returns paid by the SPV by way of the payment of interest through its subsidiaries. Assuming the SPV is a trust, the investors do not have a direct equity interest in any company. The structure relies not only on the interest on loans made by the subsidiaries being deductible, but also the returns paid by the SPV being deductible, perhaps under the terms of a foreign tax law, notwithstanding that the latter are profit-contingent. This is designed to ensure that the holding company's corporate group has received a net tax deduction for the funding of effective dividends to effective shareholders in the holding company.

2.44 The appropriate tax outcome for situations like this one where related arrangements comprise an effective equity interest is to treat the related arrangements which effectively fund the payment of the returns on the effective equity interest (i.e. the returns to the investors in the SPV in Diagram 2.1) as equity interests. Thus the loans by the subsidiary companies in Diagram 2.1 would be equity interests rather than debt interests because they are interests issued by related companies which are used to fund the payment on the deemed

Back to Top

equity interest. [Schedule 1, item 34, section 974-80]

2.45 The starting point in determining whether an equity interest arises in cases like these is to look at the holder(s) of all the related arrangements. The combined effect of related arrangements will result in the holder of an interest (in any entity) having an equity interest in a company if:

* the interest (even though it is issued by another entity) will or may convert into an equity interest in the company, or provides returns which are either contingent on the economic performance of the company or a connected entity, or at their discretion; or

* returns on the interest are effectively from the company because, although there is no direct payment to the holder by the company, the company provides a return to another entity which effectively on-pays that amount (directly, or through interposed related companies) to the entity that provides the return to the holder.

2.46 The consequence of this type of arrangement is that all the interests through which the ultimate returns are funded are taken to be equity interests (in the entity in which the interest is directly held). In these cases it does not matter that the payment(s) that fund the ultimate return to the holder of the interest that represents an effective equity interest in a company may not themselves be contingent on the economic performance of the paying company or be at its discretion. Thus, in Diagram 2.1, the on-payments actually constitute interest on a loan between the connected entities and are not contingent on economic performance at all. However, when combined with the interest held by the investors in the SPV, they ensure that the return to the investors are effectively from the holding company (on whose economic performance the returns are based), albeit indirectly through a number of entities and by way of interest payments on loans.

2.47 It is important to note that, in these cases, the only entity taken to have an equity interest in the company is the entity which holds a direct interest in the company and which funds the payment to the investor whose return represents an effective equity interest in the company. That investor, and any interposed entities, is not taken to be an equity holder in the company itself - just an equity holder in the entity in which the investor has a direct interest. If the interest is held in a connected entity that is not itself a company (e.g. a trust) then it will not be an equity interest (because only companies, or entities taxed as companies, can issue equity interests). However, because the payments to fund the ultimate return must (by definition) flow through that non-corporate entity, the entity itself will have an equity interest in the company or a related company.

2.48 Section 974-80 applies to treat an interest in a company as an equity interest only if that interest is not already an equity interest. Therefore if in Diagram 2.1 the loans between the connected entities were back-to-back equity interests mirroring the interest issued by the SPV, section 974-80 would have no effect. [Schedule 1, item 34, paragraph 974-80(1)(c)]

2.49 As a result, the debt test (see paragraphs 2.124 to 2.209).) 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. For example, if the interest in the SPV in Diagram 2.1 constituted a debt interest in the SPV because the SPV or a connected entity guaranteed repayment of the subscription price within 10 years, none of the loans between the connected entities would be an equity interest. [Schedule 1, item 34, subsection 974-80(2)]

Example 2.9: Application of section 974-80 to a stapled security

An Australian resident bank issues a fully-paid preference share to a trust that is controlled by its subsidiary. The subsidiary issues to the trust a deeply-subordinated perpetual note that pays a non-cumulative coupon whose payment is contingent on distributable profits of the bank. The trust then issues to investors a stapled security for $100 comprising a beneficial interest in the note and the preference share.

The holders of the security receive a non-cumulative coupon whose payment is contingent on distributable profits of the bank. While the note pays the coupon, the preference share pays no dividends.

The funds raised by the issue of the stapled securities are lent by the trust to the subsidiary and then on-lent by the subsidiary to the bank at a fixed market rate of interest under a term security.

The bank has issued an interest (the term security) to its subsidiary (a connected entity) which carries a right to a fixed return. The interest would not (but for section 974-80) be an equity interest in the bank. However, there is a scheme under which the return to the connected entity is to fund (indirectly through the trust) a return to the ultimate recipient of the return, who is the holder of the stapled security. The amount of the return to the holder of the stapled security is effectively contingent on the economic performance of the bank since it is a return on the beneficial interest in the note, whose returns are contingent on the economic performance of the bank.

Under subsection 974-80(2) the term security (representing the loan to the bank of the funds raised on the issue of the stapled security) constitutes an

Back to Top

equity interest in the bank. As an equity interest, the bank is liable to frank the term security coupons.

The subsidiary company has also issued an equity interest (the perpetual note) which is an equity interest under item 2 in the table in subsection 974-75(1).

Example 2.10: Application of section 974-80 to offshore trust units exchangeable into preference shares

An Australian resident bank issues trust preferred securities through a trust in Foreign Country 1 to investors in that Foreign Country. The securities are perpetual and exchangeable into the bank's preference shares. They provide non-cumulative returns contingent on profits of the bank.

The proceeds of the Foreign Country 1 issue are used by the trust to purchase redeemable debt securities issued by a special purpose subsidiary of the bank that is resident in Foreign Country 2. These securities pay an arm's length, fixed rate of interest to the Foreign Country 1 trust, which is used to fund the returns to the investors in the trust. The proceeds from the Foreign Country 2 issue are on-lent to the bank by the subsidiary in Foreign Country 2 on terms similar to the redeemable debt securities. Should a contingency occur such that the trust is not required to pay a return to its investors, the funds are made available to the bank.

Section 974-80 applies to this trust preferred issuance as follows. The Foreign Country 2 subsidiary has an interest in the bank (a connected entity) that carries a right to a fixed return from the
bank. That interest would not otherwise be an equity interest in the bank (because it would otherwise be a debt interest). However, there is a scheme or a series of schemes under which the return to the Foreign Country 2 subsidiary funds the return to the Foreign Country 1 investors, albeit indirectly through the trust.

Thus, the return to the Foreign Country 1 investors, which is ultimately funded by the interest payments by the bank to the Foreign Country 2 subsidiary, is effectively contingent upon the economic performance of the bank, in addition to them being convertible into equity interests of the bank (the preference shares). Therefore the interest held by the Foreign Country 2 subsidiary in the bank is an equity interest in the bank, returns on which are not deductible but may be frankable and, if not franked, subject to dividend withholding tax.

Integration of related schemes 2.50 Some interests in a company are made up of 2 or more related instruments. To provide a correct reflex of the economic substance of related instruments of this kind it is necessary to integrate them and treat them as a single interest for the purposes of the equity interest definition (and, in turn, for determining whether the terms of the interest satisfy the debt test).

2.51 Therefore, an integration test is required for determining whether an interest is an equity interest in a company. The test adopted by this bill draws on subsection 82L(2) of the ITAA 1936 (applicable to convertible notes). Under this test, 2 or more related schemes (whether or not they come into existence at the same time) to which a company is a party give rise to an equity interest in the company if they would have done so had they constituted a single scheme. [Schedule 1, item 34, subsection 974-70(2)]

2.52 This integration test applies where 2 or more schemes which, by reason of the relationship that they bear to each other or the connection that they have to one another, can be said to be related and operate together to have the effect or operation of an equity interest in a company. For the schemes to be integrated, the company must be a party to them, in the sense that it must enter into, cause another entity to enter into, participate in, or cause another entity to participate in, the schemes. This ensures that a company will not be taken to have issued an equity interest if it has not been involved in some way in its creation. Also, the combined effect of the schemes to produce an equity interest must be intended by the company rather than being produced by mere chance. [Schedule 1, item 34, subsection 974-70(2)]

2.53 Interests that are referred to as being stapled together (in the sense that they are not detachable from each other) would constitute related schemes for these purposes. In this context `stapled instruments' has its ordinary commercial meaning. [Schedule 1, item 34, paragraph 974-155(2)(a)]

2.54 In addition, the following examples of interests would be related even if they are detachable:

* interests that are commercially connected in the sense that it is unlikely that one would be entered into without the other;

* interests that are dependent for their effect or operation on the effect or operation of another interest; and

* interests that complement or supplement the effect or operation of each other.

[Schedule 1, item 34, subsection 974-155(2)]

2.55 Schemes can be integrated for these purposes even if one or more of them constitutes an equity interest in its own right (e.g. a stapled security

Back to Top

comprising an interest-bearing note and a preference share). In this regard the decision of Network Finance Pty Ltd v FCT (1976) 6 ATR 589 is overcome. (In the Network Finance case it was held that if an interest in itself is a convertible note, it cannot also be related to another interest to cause it and that other interest to be treated as a convertible note). [Schedule 1, item 34, subsection 974-70(2)]

2.56 However, if all the related schemes are equity interests themselves, they will not be integrated to form a separate, combined equity interest. [Schedule 1, item 34, subsection 974-70(3)]

2.57 If related schemes are combined to form a single integrated equity interest, returns in respect of the individual schemes are taken to be returns in respect of the integrated equity interest and not in relation to any other interest. For example, a stapled interest-bearing note and preference share that do not satisfy the debt test would be taken to be a single equity interest, and both the interest payments on the note and dividends on the share would be taken to be payments in respect of that interest and not payments in respect of the note or the share as separate instruments. [Schedule 1, item 34, section 974-105]

2.58 In addition, the debt test applies to the single interest arising from the integrated schemes rather than each component part. Therefore it is possible to have an interest arising from integrated schemes that include interests listed in the table in subsection 974-75(1) being treated as a debt interest. An example of such an interest is a preference share stapled to a note which constitute separate schemes and together satisfy the debt test. [Schedule 1, item 34, subsections 974-70(1) and (2)]

Commissioner's discretion not to integrate 2.59 To ensure the proposed debt/equity rules are not undermined by the issue of discrete instruments with a combined effect equivalent to an equity (or debt interest), it is necessary to have a broad integration rule of the kind explained in paragraphs 2.50 to 2.58.

2.60 However, it is possible that such a broad rule could operate inappropriately, having regard to the objects of the debt/equity test in general and the integration rule in particular. For example, schemes that are related schemes within the definition of that term which could technically be combined to produce a particular effect may, in economic substance, have a different effect. In these cases the Commissioner may determine that it would be inappropriate to integrate certain schemes. In this regard the Commissioner will be guided by the purpose of the scheme, as well as their effect. [Schedule 1, item 34, subsection 974-70(4)]

Non-arm's length arrangements 2.61 The debt test is applied to all interests that are identified in the table in subsection 974-75(1) - those that satisfy the test cannot be equity interests. However, interests that arise from a non-arm's length dealing cannot satisfy the debt test if they fall within one of the items in the table in subsection 974-75(1) and it is reasonable to suppose that they would have been equity interests if the relevant scheme had been conducted at arm's length. Therefore, if such arrangements are covered by an item in the table they will be equity interests and distributions on them may be frankable but will not be deductible. [Schedule 1, item 34, subsection 974-25(1)]

2.62 The reason for excluding non-arm's length arrangements of this kind is because otherwise they could nominally satisfy the debt test without representing genuine debt. Some examples include non-arm's length loans to a company within the same company group as the so-called lender, and artificial arrangements under which family members obtain an interest in a family company by paying an insignificant sum to the company, which guarantees repayment of the insignificant sum within 10 years. It would be inappropriate to allow such arrangements to be treated as debt.

2.63 Non-arm's length arrangements arise if the parties to the relevant scheme are not dealing with each other at arm's length. The term `dealing at arm's length' has an established meaning in Australia and internationally, for example in double tax agreements. Parties are dealing at arm's length where they have `acted severally and independently in forming their bargain' (see Granby v FCT 95 ATC 4240 at 4243). Lee J in that case said:

`. . . The expression "dealing with each other at arm's length" involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs.' (Granby v FCT 95 ATC 4240 at 4243)

2.64 Therefore a key aspect to the test is whether the parties to a transaction behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs.

2.65 The courts have held that the actual relationship of the parties is not determinative of the question of whether parties are dealing at arm's length.

Back to Top

Hill J in AW Furse No 5 Will Trust v FCT 91 ATC 4007 at 4014-1015 stated that "the fact that the parties are themselves not at arm's length does not mean that they may not, in respect of a particular dealing, deal with each other at arm's length". Determining whether an entity did not deal at arm's length in connection with an arrangement is a question of fact having regard to all of the circumstances.

2.66 The definition of arm's length in subsection 995-1(1) of the ITAA 1997 provides that in determining whether parties deal at arm's length it is necessary to consider any connection between the parties and any other relevant circumstances.

Non-share equity interests 2.67 Subject to the debt test, shares are equity interests (as they are under the current law). However, not all equity interests in a company are shares.

2.68 As a general rule, equity interests are treated alike for the purposes of determining the taxation treatment of returns (including imputation and withholding tax), whether or not they are shares in legal form. Therefore, the concepts of share and shareholder in relevant provisions of the income tax law have been expanded to encompass all types of equity interests and equity holders (see paragraphs 2.17 to 2.19). Where necessary, specific modifications have been made to particular provisions (e.g. to subsection 44(1) and sections 45A, 45B, 45C and 159GZZZP of the ITAA 1936). [Schedule 1, items 57 to 60, 88 and 89]

2.69 However, it is necessary to distinguish between equity interests that are in the form of a share and those that are not for the purposes of determining what is a distribution and what is a capital return on an equity interest. To enable this, this bill creates the concept of a `non-share equity interest', that is to say, an equity interest that is not solely in the form of a share (which is defined in subsection 995-1(1) of the ITAA 1997 to include stock). [Schedule 2, item 18, definition of' `non-share equity interest' in subsection 995-1(1)]

2.70 For an equity interest to be a non-share equity interest it is necessary for the whole interest, or a component part thereof, to be in a form other than a share. Therefore, if an equity interest in a company is made up of related interests and at least one of those interests is not a share (for instance, a preference share which is stapled to a note) the interest is a non-share equity interest. [Schedule 2, item 18, definition of `non-share equity interest' in subsection 995-1(1)]

2.71 Capital raised by a company from the issue of non-share equity interests is credited to a non-share capital account (see Chapter 4). [Schedule 1, item 33, section 164-10]

2.72 An example of how equivalent tax treatment applies for non-share equity interests and equity interests in the form of shares (that are not non-equity shares) is provided by the amendments to the imputation provisions in Part IIIAA of the ITAA 1936. Those provisions apply in relation to non-share equity interests in the same way as they apply to shares [Schedule 1, item 93, section 160AOA]. Thus references to shares in the imputation provisions can be read as including non-share equity interests.

2.73 For example, the definition of excluded shares in existing subsection 160APHBC(3) of the ITAA 1936 (which is used for the purposes of determining whether a company is effectively wholly-owned by a non-resident or tax-exempt entity) will, because of the amendments made by this bill, now apply to non-share equity interests as well. Given that non-share equity interests are unlikely to entail the risks and opportunities ordinarily attached to ordinary shares, the effect of the definition in that subsection would be to treat most non-share equity interests as excluded shares.

2.74 Another example of the effect of applying the imputation system to non-share equity interests in the same way as equity interests in the form of shares (that are not non-equity shares) is provided by the definition of preference shares in section 160APHD of the ITAA 1936 (which is relevant for the holding period rule). Applying that definition to non-share equity interests will result in many of them being preference shares for the purposes of the holding period rule because they will often be less risky than ordinary shares.

What is a frankable distribution on a non-share equity interest? 2.75 In essence, a payment to a non-share equity interest holder that corresponds to a dividend paid to a shareholder is treated in the same way as a dividend. This is effected by the definitions of non-share distribution and non-share dividend, which are based on the definition of a dividend in the ITAA 1936. [Schedule 1, item 34, sections 974-115 and 974-120]

2.76 The starting point is the definition of a non-share distribution. This is the distribution of money or property, or the crediting thereof, by the company to a non-share equity holder. In this context `distribution' has a very broad meaning that would encompass, for example, the repayment of a profit-participating loan. [Schedule 1, item 34,

Back to Top

section 974-115]

2.77 A non-share distribution will usually constitute a non-share dividend (which corresponds to a dividend on a share). However, this is qualified by a capital distribution exception corresponding to the exception (subject to certain anti-avoidance rules) for distributions to a shareholder which are debited to the share capital account. In the case of the holder of a non-share equity interest, the exception relates to distributions debited to the non-share capital account of the company, or, where company law permits it, to the (untainted) share capital account. (As a general rule, a share capital account is tainted if an amount other than share capital is credited to it.) [Schedule 1, item 34, subsections 974-120(1) and (2)]

2.78 These capital distributions are called `non-share capital returns' and are taxed as returns of capital rather than as dividends. [Schedule 1, item 34, section 974-125]

Anti-avoidance rules 2.79 To prevent the substitution of concessionally-taxed capital gains for taxable dividends, a company may only debit a distribution to its non-share capital account to the extent that the distribution is made as part of a process that results directly in a non-share equity interest ceasing to exist (e.g. by its redemption or cancellation), or to the extent that the distribution is in connection with a reduction in its market value
(e.g. by partly repaying a profit-participating loan) [Schedule 1, item 33, subsection 164-20(1)]. Also, the capital distribution made in relation to a particular non-share equity interest cannot exceed the capital contributed in relation to that particular interest [Schedule 1, item 33, subsection 164-20(2)].

2.80 Other anti-avoidance provisions relevant to ordinary shares (e.g. the capital streaming and dividend substitution rules contained in sections 45A and 45B of the ITAA 1936) are also applicable in relation to non-share equity interests because the broad definition of equity and its related concepts are extended to them [Schedule 1, item 56, section 43B of the ITAA 1936]. Where necessary, minor modifications have been made to those provisions to ensure they can apply in relation to non-share equity interests [Schedule 1, items 58 to 60].

General tax treatment of non-share dividends 2.81 If a non-share distribution is a non-share dividend it is generally included in the assessable income of the non-share equity holder. Unlike dividends paid on shares, non-share dividends might be paid even if the paying company has no profits. Therefore, the inclusion of such dividends in assessable income does not depend on them being sourced from profits (as it does for shares). This is reflected in the amended section 44, which also include a clarificatory note providing a non-exhaustive list of some of the provisions of the income tax law to which the section is subject. [Schedule 1, item 57, subsection 44(1) of the ITAA 1936]

2.82 If the recipients of non-share dividends are non-residents, the source of the dividends is relevant. In these cases, the recipient is assessable in respect of the non-share dividend only if it is derived from sources in Australia. For this purpose, it is relevant to consider that the underlying purpose of the debt/equity rules is, generally, to treat non-share dividends in a similar way to normal dividends. Although questions of source are governed by the facts of each particular case, the source rules applicable to dividends are the more appropriate ones to apply. In a typical case, the place of residence of the entity paying the non-share dividends will be the source from which the dividends are derived.

2.83 As is the case with dividends on shares which are equity interests, non-share dividends are not deductible. Instead, they are generally frankable in accordance with the rules governing frankability of dividends in the imputation system. Similarly, returns accrued but not paid in respect of a non-share equity interest are not deductible. [Schedule 1, item 4, section 26-26]

Franking of non-share dividends generally 2.84 Non-share dividends are generally frankable in the same circumstances that dividends on shares (share dividends) are frankable. However, some special rules apply.

Special franking rule for non-share dividends: non-share dividends are not frankable unless profits are available 2.85 Under the current law dividends on shares have to be paid out of realised profits to be frankable. Thus dividends debited to share capital or asset revaluation reserves are not frankable (see sections 46G to 46M of the ITAA 1936). Although non-share dividends debited to those sources will also be unfrankable, there is no general requirement that they be debited to realised profits to be frankable. This could give rise to opportunities to stream

Back to Top

franking credits in circumstances where there is no such opportunity under the current law because the relevant company has no profits. Of course the issue of a non-share equity interest under a scheme with a purpose to provide a franking benefit would be subject to the rule in section 177EA of the ITAA 1936 preventing franking credit trading. However, that provision is not self-executing and requires a Commissioner's determination to operate.

2.86 Therefore, to prevent the use of non-share dividends to stream franking credits, the ability to frank non-share dividends is capped by reference to `available frankable profits'. These are profits that are available to pay frankable dividends (therefore they exclude unrealised profits). If a company does not have any such profits then it will be unable to frank non-share dividends. [Schedule 1, item 98, subsection 160APAAAB(2) of the ITAA 1936]

2.87 The concept of available frankable profits takes into account the available profits of the company at the time it pays a non-share dividend, having regard to future claims on those profits by dividends on shares (`share dividends') which have yet to be paid, and also past claims on those profits by non-share dividends that have been franked on the basis of profits available at the time of their payment (though were not actually debited to those profits, thereby allowing them to be used to fund frankable share dividends). To avoid the complexities and compliance costs that could arise from the establishment of a notional account to record available frankable profits that have already been used to support the franking of a non-share dividend, a simple calculation method is used which focuses only on non-share dividends paid in the preceding 2 franking years (or under the same scheme). [Schedule 1, item 98, subsection 160APAAAB(10) of the ITAA 1936]

Example 2.11: Available frankable profits

On 1 January 2002 a company has $1 million realised profits. It pays a franked non-share dividend of $600,000 on that day, but the dividend is not debited to those profits. On 1 February 2002 the company announces another non-share dividend to be paid on that day (but not debited to the profits), and a $400,000 dividend to its ordinary shareholders to be paid in the following month. No profits were derived during January.

The company has no available frankable profits on 1 February. This is because $600,000 of the $1 million has already been accounted for in allowing the franking of the first non-share dividend, and the remaining $400,000 has to be set aside for the dividend to the company's ordinary shareholders.

Because there are no available frankable profits at the time it pays the second non-share dividend, the company is unable to frank it (subject to its ability to anticipate profits - see paragraph 2.89).

2.88 If a company has no available frankable profits when it pays a non-share dividend then the whole of that dividend is unfrankable. [Schedule 1, item 98, subsection 160APAAAB(2)]

2.89 If the available frankable profits of a company when it pays a non-share dividend is less than the amount of that dividend, then, in effect, the non-share dividend is partly frankable. The mechanism for achieving this is the same as that employed in section 46M of the ITAA 1936 in relation to dividends debited to share capital accounts or asset revaluation reserves. Thus the non-share dividend is notionally split into 2 non-share dividends: one frankable; the other not. To ensure this notional splitting of the dividend does not result in untoward consequences in relation to the required franking rules, the non-share dividend that is taken to be the unfrankable dividend is not a dividend to which those rules apply (nor is a dividend which is wholly unfrankable because there are no available frankable profits). [Schedule 1, item 98, subsections 160APAAAB(3) to (5)]

2.90 In certain situations the calculation of available frankable profits could disadvantage a company. These are where the company has committed itself to paying dividends on shares in the future and expects to derive available profits between the time it committed itself to their payment and the time of payment, and, but for the committed dividends, the company would have been able to frank a non-share dividend. In these cases the company can estimate future profits to the extent it expects them to arise, and provided the estimated profits do not permit the franking of the non-share dividend to an extent greater than would be the case if the committed share dividends did not exist. [Schedule 1, item 98, subsections 160APAAAB(6), (6A) and (7)]

2.91 To prevent a company over-estimating future profits, a franking debit arises if it over-estimates future profits. The debit arises at the earlier of the time the committed share dividends are paid and the end of the franking year following payment of the non-share dividend. [Schedule 1, item 98, subsection 160APAAAB(8)]

Special franking rule for non-share dividends: certain non-share dividends of ADIs are not frankable 2.92 New section 160APAAAA removes a competitive disadvantage that Australian ADIs would otherwise suffer from the introduction of the new debt/equity rules. [Schedule 1, item 98, section 160APAAAA]

2.93 Australian ADIs are subject to APRA regulations under which there are advantages for the ADI to raise Tier 1 capital through branch structures rather

Back to Top

than through foreign subsidiaries. At present, foreign branches and subsidiaries of Australian ADIs compete, broadly, on an equal footing with foreign independent entities which raise capital overseas by the issue of hybrid instruments. These instruments form part of the Tier 1 capital of the Australian ADI under APRA prudential standards. The new debt/equity rules will result in some hybrid instruments which are currently treated as debt interests for income tax purposes being recharacterised as non-share equity interests (eligible hybrids). A consequence is that an Australian ADI (i.e. the entity legally liable in the head office/branch structure) would need to frank the returns on these instruments (i.e. non-share dividends). This is an inherent additional cost of raising capital overseas which would not be incurred if the Australian ADI issued eligible hybrids through a foreign subsidiary and is a cost which may not be incurred by a foreign independent entity raising capital in the same way.

2.94 This measure prevents the disadvantage from arising by treating the returns on the eligible hybrids as unfrankable dividends of the ADI. Aligning the taxation treatment of foreign branches with that of foreign subsidiaries of the ADI and foreign independent entities in relation to the issue of eligible hybrids will assist Australian ADIs to grow their businesses conducted through foreign branches. Conditions for the application of the concession are explained in paragraphs 2.95 to 2.114.

Which non-share dividends qualify as unfrankable dividends under the ADI concession? 2.95 Even though eligible hybrids may be issued out of a foreign branch, the Australian ADI (or head office) is the entity legally liable for payment of the returns and subject to APRA regulations. Moreover, eligible hybrids issued by a foreign branch are assessed as to whether they can form part of the Tier 1 capital of the ADI. Accordingly, the concession applies in respect of non-share dividends paid by an ADI in respect of non-share equity interests issued by a foreign branch but which form part of the Tier 1 capital of the ADI. [Schedule 1, item 98, paragraph 160APAAAA(1)(b)]

Which entities qualify for the ADI concession? 2.96 Only ADIs which are Australian residents will qualify for the concession. Entities qualify as ADIs under the Banking Act 1959 and are subject to APRA regulations. [Schedule 1, item 98, paragraph 160APAAAA(1)(a)]

2.97 The concession is further confined to Australian ADIs which have branches in broad-exemption listed countries (BELCs). A BELC has the meaning given in Part X of the ITAA 1936 which deals with controlled foreign companies. BELCs include the major international capital centres through which Australian ADIs raise capital and represent countries with taxation systems comparable to those of Australia, that is, United States of America, United Kingdom, Canada, New Zealand, Japan, France and Germany. [Schedule 1, item 98, paragraph 160APAAAA(1)(c)]

2.98 A branch is a permanent establishment as defined in section 6 of the ITAA 1936. Broadly, it is a place at or through which an Australian ADI carries on business in a foreign country.

What hybrids are eligible for the ADI concession? 2.99 Eligible hybrids have 2 characteristics. First, they must be non-share equity interests under the new debt/equity rules. These are explained in paragraphs 2.67 to 2.74 and include innovative hybrid instruments which, in the absence of the debt/equity rules, would be debt instruments. [Schedule 1, item 98, paragraph 160APAAAA(1)(b)]

2.100 The other characteristic of an eligible hybrid is that the equity interests must form part of the Tier 1 capital of the Australian ADI under the APRA prudential standards. [Schedule 1, item 98, paragraph 160APAAAA(1)(b)]

Rules relating to the raising and application of funds raised in relation to the ADI concession 2.101 Paragraph 160APAAAA(1)(d) contains a test relating to the raising and application of funds raised from the issue of eligible hybrids (the funding test) [Schedule 1, item 98, paragraph 160APAAAA(1)(d)]. This test is linked, but is not exclusively related, to item 101 of Schedule 1 which deals with anti-streaming rules relating to this concession. Those rules are explained in paragraphs 2.117 to 2.119.

2.102 The funding test is primarily an integrity measure to prevent avoidance of franking debits if the eligible hybrids were issued in Australia. This would occur, for example, if the Australian ADI needs to raise capital for its Australian operations and thereby incur franking debits on the returns but instead raises the capital through its foreign branch and immediately, or sometime later, the funds are transferred to the Australian head office.

2.103 Consistent with the underlying intent of the measure, the test requires that the funds from the issue of eligible hybrids be raised and applied for

Back to Top

permitted purposes. Essentially, the test ensures that the funds are raised and used solely for the business of the foreign branch and not for the Australian operations of the group. Broadly, an indicator that the test is satisfied is if the amount of capital attributed to the foreign branch is equal to or greater than the value of eligible hybrids on issue by that branch. [Schedule 1, item 98, paragraph 160APAAAA(1)(d)]

2.104 Permitted purposes are contained in subsection 160APAAAA(2) and explained in paragraphs 2.105 to 2.113. [Schedule 1, item 98, subsection 160APAAAA(2)]

Inter-relationship of the business of foreign branch and the funding test in the ADI concession 2.105 What constitutes the business of the foreign branch is to be interpreted in the context of the normal operations of a banking business. Principal activities include the raising of funds; the making of loans; the acquisition of debt securities and the redemption of debt (or equity interests) on maturity or earlier in order to reduce the cost of capital. [Schedule 1, item 98, paragraph 160APAAAA(2)(a)]

2.106 The conduct of a banking business by a foreign branch includes transactions with subsidiaries or other branches of the Australian ADI or of connected entities as well as with third parties each of which may be located in Australia or overseas. If the funding test were to apply without restriction, funds raised by the issue of eligible hybrids could be lent or transferred to fund the Australian operations of the group. These loans or transfers could be made for the purpose of relieving the Australian entities from franking debit obligations if they had issued the eligible hybrids. To prevent this outcome, the funding test prescribes that the test is not satisfied if the foreign branch which raises funds by the issue of eligible hybrids transfers those funds, other than as a return of amounts (see paragraphs 2.110 to 2.113), to:

* its Australian head office [Schedule 1, item 98, subparagraph 160APAAAA(2)(a)(i)];

* any connected entity of the Australian ADI that is a resident of Australia [Schedule 1, item 98, subparagraph 160APAAAA(2)(a)(ii)]; and

* any Australian branch of the ADI or of a connected entity of the ADI [Schedule 1, item 98, subparagraph 160APAAAA(2)(a)(iii)].

2.107 A connected entity is one within the meaning of that term in subsection 995-1(1) of the ITAA 1997 and, in the context of this measure, includes:

* an Australian parent company of an Australian subsidiary with the foreign branch;

* an Australian subsidiary of the ADI or of another subsidiary of the ADI; or

* an Australian subsidiary of one or more of the above entities.

2.108 The exclusion applies equally if the funds are moved direct to the entities mentioned or whether they are moved through intermediaries to the Australian destinations. [Schedule 1, item 98, paragraph 160APAAAA(2)(a)]

2.109 The movement of funds may occur under different circumstances. Funds are usually moved as part of normal business operations but may equally be moved not in the ordinary course of business. For example, consider the closure of a foreign branch which is found to be unprofitable several years after the issue of eligible hybrids which are still current. The transfer of surplus funds to the Australian head office of an amount equal to or greater than the value of eligible hybrids on issue has the effect of providing capital which, if raised by the Australian ADI, would give rise to franking debits on the returns paid. Whether a transaction of this kind fails the funding test turns on a finding on the facts of the case that the purpose of the raising and application of funds from the issue of eligible hybrids was not solely for a permitted purpose.

Factors determining the purpose of the raising and application of funds 2.110 As a general rule, the purpose for which funds are raised and applied becomes evident from an examination of the facts of the particular case.

2.111 The purpose for which funds are raised is normally stated in the relevant prospectus. This may have been cleared by a regulatory authority. The stated purpose for the raising of funds is, accordingly, relevant in determining whether the funding test is satisfied. However, their probative value depends on the facts of the case. For instance, a clear statement of purpose for the raising and the application of funds (e.g. to finance a named project as part of the business of the branch) and a separate announcement of a commitment to the project requiring the capital to be raised carries greater weight than a statement which is unclear. For example, a general statement of purpose (e.g. to fund the business of the branch) and evidence that funds raised were immediately transferred to the ADI in Australia to be part of its working capital suggest that the raising and application of funds were for a purpose other than for use in the business of the foreign branch.


Back to Top

Application of funds towards the payment of debts incurred by the foreign branch
2.112 The scope of the exclusion in paragraph 160APAAAA(2)(a) is very broad and, without restriction, would deny the concession where there is any movement of funds to the prescribed entities (see paragraph 2.106) [Schedule 1, item 98, paragraph 160APAAAA(2)(a)]. This could impose an unfair restriction on the operations of the foreign branch in relation to the redemption of debts if they were treated differently from those of foreign subsidiaries of the Australian ADI. For instance, a subsidiary could redeem its debts to lower costs of capital but redemptions of debt of the foreign branch with, say, its Australian head office would fail the funding test and result in the Australian ADI incurring franking debits on returns of the eligible hybrids. This result would be inconsistent with the objective of the measure.

2.113 Accordingly, there is a carve-out from the exclusion for:

* a redemption by the foreign branch of a debt interest or a non-share equity interest held by a connected entity of the ADI that is a resident, if the debt interest or the non-share equity interest was issued before the relevant interest was issued by the foreign branch [Schedule 1, item 98, paragraph 160APAAAA(2)(b)]; and

* a return of what may be economically called loans or contributions of the Australian head office, or an Australian permanent establishment of the ADI or of a connected entity, to the working capital of the foreign branch, if the funds were contributed before the relevant interest was issued by the foreign branch [Schedule 1, item 98, paragraph 160APAAAA(2)(c)].

Repatriation of profits 2.114 The funding test is, in substance, a matter relating to the capital of the foreign branch and its use. This is distinguishable from the application of the gains made from the exploitation of that capital. Accordingly, a repatriation of profits from the foreign branch to the Australian head office is not within the scope of the funding test. However, a purported repatriation of profits, which cannot be substantiated by reference to the current or accumulated profits of the branch, may constitute, in the context of a head office and branch structure, a transfer of capital. A transaction of this nature is relevant to a determination of whether funds have been applied solely for permitted purposes.

Certain unfrankable dividends are excluded from dividend withholding tax 2.115 Subject to certain exceptions, section 128B of the ITAA 1936, imposes a final withholding tax on unfranked dividends paid by resident companies to non-resident shareholders. Other amendments being made under the debt/equity rules will make non-share dividends subject to dividend withholding tax to the extent that the dividends are unfranked.

2.116 Non-share dividends paid to non-residents by an ADI that is a resident of Australia in respect of non-share equity interests issued by a foreign branch are, subject to conditions, to be unfrankable [Schedule 1, item 98, section 160APAAAA]. These dividends could, accordingly, be subject to dividend withholding tax. However, a withholding tax on these dividends would increase the costs of borrowing for the ADI and be contrary to the objectives of new section 160APAAAA. This outcome is avoided by making non-share dividends which are unfrankable by virtue of new section 160APAAAA to be excluded from the obligation to deduct dividend withholding tax [Schedule 1, item 86, paragraph 128B(3)(aaa)].

Preventing the ADI concession being used to stream franking credits 2.117 There is a risk to the revenue that this ADI concession could be used by an eligible ADI to stream franking credits to certain equity holders. The most obvious type of streaming that could occur would be by issuing non-share equity interests through the ADI's branch to non-residents, while issuing similar equity interests to residents. Because the non-share equity interests issued through the branch would be unfrankable under the ADI concession, the effect of such conduct would be to stream franking credits from non-residents (who are unable to fully benefit from franking) to residents (who benefit most from franking). While this type of streaming is the most obvious type of streaming (to which the modified section 177EA could apply), it does not represent the only type of streaming activity that an ADI could undertake. [Schedule 1, item 105, paragraph 177EA(19)(da)]

2.118 Notwithstanding this potential for streaming, it is possible that the existing anti-streaming provision in section 160AQCBA of the ITAA 1936 could apply to an ADI merely because, under this concession, non-share dividends are not frankable. To ensure that the section is not automatically triggered merely because the non-share dividends are unfrankable, the Commissioner is prevented from making a streaming determination relying solely on that fact. [Schedule 1, item 101, subsection 160AQCBA(3A)]


Back to Top

2.119 However, if an ADI is streaming franking credits within the terms of section 160AQCBA in a way that is not exclusively due to the fact that non-share dividends through its branch are unfrankable, the section can still apply. Moreover, if the ADI has a non-incidental purpose of streaming franking credits, the Commissioner will be able to make a streaming determination under section 160AQCBA notwithstanding that the streaming arises because the non-share dividends issued through the branch are unfrankable. [Schedule 1, item 101, subsections 160AQCBA(3B) and (3C)]

Special franking rules for non-share dividends: non-share dividends paid by certain co-operatives not frankable

2.120 Non-share dividends paid by co-operative companies eligible for tax concessions under Division 9 of Part III of the ITAA 1936 are not frankable. [Schedule 1, item 95, paragraph (da) of the definition of `frankable dividend' in section 160APA]

Bonus issues 2.121 The tax consequences of a company issuing bonus interests to the holders of non-share equity interests correspond to those for the issue of bonus shares. This arises because of the interaction between the provision in the ITAA 1936 governing bonus share issues (section 6BA) and the extended definitions of shares and dividends incorporating non-share equity interests and non-share distributions that apply for the purposes of that section.

2.122 Because of subsection 6BA(5) of the ITAA 1936, if the holder of a non-share equity interest has a choice to be paid a non-share dividend or to be issued with equity interests (bonus interests) then the non-share dividend is taken to have been credited to the holder. In other cases, the cost base of the non-share equity interests is spread over the original interest and the bonus interests in accordance with subsection 6BA(3) of the ITAA 1936.

2.123 Subsection 6BA(6) of the ITAA 1936 is a provision applicable only to actual shareholders in a public company and has no application to non-share equity holders. [Schedule 1, item 50, subsection 6BA(7) of the ITAA 1936]

Debt interests Is there a financing arrangement? 2.124 As is the case with equity interests, the threshold question in determining whether a particular interest in an entity is a debt interest is whether the scheme giving rise to the relevant interest is a financing arrangement. If it is not, the interest cannot be a debt interest. [Schedule 1, item 34, paragraph 974-20(1)(a)]

2.125 The comments in paragraphs 2.6 to 2.9 in relation to equity interests apply equally to financing arrangements in relation to debt interests. In addition the following schemes relevant to debt interests are explicitly excluded from being financing arrangements:

* leases that are not qualifying arrangements for the purpose of Division 16D of Part III of the ITAA 1936 and also not a relevant agreement for the purposes of section 128AC of that Act [Schedule 1, item 34, subparagraphs 974-130(4)(a)(i) and (ii)];

* securities lending agreements under section 26BC of the ITAA 1936 [Schedule 1, item 34, paragraph 974-130(4)(b)];

* life insurance and general insurance contracts undertaken as part of the issuer's ordinary course of business [Schedule 1, item 34, paragraph 974-130(4)(c)]; and

* schemes for the payment of royalties within the meaning of the ITAA 1936 (other than qualifying arrangements for the purpose of Division 16D of Part III of the ITAA 1936 or relevant agreements for the purposes of section 128AC of that Act [Schedule 1, item 34, paragraph 974-130(4)(d)].

2.126 The following discussion of debt interests in a company relates to interests arising under schemes that constitute financing arrangements.

2.127 If an interest in a company, including an interest comprising integrated related schemes (see paragraphs 2.50 to 2.58), falls within the definition of a debt interest (i.e. it satisfies the debt test) at the time it comes into existence (or at certain other times involving a material change - see paragraphs 2.129 to 2.134), then it is not an equity interest. [Schedule 1, item 34, subsection 974-70(1)]

2.128 Therefore, whether a debt/equity hybrid interest in a company satisfies the debt test will determine whether returns provided to its holder are frankable or may be deductible. The definition of a debt interest is also relevant for thin capitalisation purposes (see paragraph 3.23). For these purposes the debt test is applied to an interest issued by any type of entity, not only companies (the new equity rules are limited to companies).

Material changes to existing schemes 2.129

Back to Top

The determination of the character of an interest as a debt interest or an equity interest at the time it comes into existence means that, without a special rule dealing with material changes, the economic substance of an interest could be radically changed without a change to its tax treatment.

2.130 To prevent this, an equity interest that does not satisfy the debt test at the time it comes into existence will nevertheless be treated as a debt interest if there is a material change to the scheme or schemes. A material change is one that has the effect of converting the equity interest into a debt interest. An equivalent rule applies in relation to debt interests that become equity interests. [Schedule 1, item 34, section 974-110]

2.131 The material change could come about because the scheme or schemes that gave rise to the debt or equity interest is changed. In this case, the new equity or debt interest comes into existence at the time of the change. [Schedule 1, item 34, subsection 974-110(1)]

2.132 A material change could also occur because a new related scheme is entered into. In this case the new equity or debt interest comes into existence when the new scheme is entered into. [Schedule 1, item 34, subsection 974-110(2)]

2.133 In applying these tests, it is necessary to take into account all changes or new schemes entered into before the material change occurred, even if they did not themselves amount to a material change because they did not change the character of the interest from debt to equity, or equity to debt. [Schedule 1, item 34, subsection 974-110(3)]

2.134 Certain consequences arise for the non-share capital account if a debt interest changes to an equity interest, or vice versa. These are discussed in paragraph 4.7.

Example 2.12: Changing from equity to debt

A company issues a preference share which, after 5 years, is effectively converted into a 5-year bond. The so-called conversion into a bond is a material change which results in the original preference share becoming a debt interest from the time the so-called conversion takes place.

Which returns on debt interests are deductible? 2.135 The deductibility of a return on a debt interest is determined according to the general deductibility provisions of the income tax law, principally section 8-1 of the ITAA 1997.

2.136 However, returns on interests (including debt/equity hybrids) that satisfy the debt test (e.g. an interest that would be equity interests but for the fact that they satisfy the debt test such as a mandatorily redeemable preference share) may not be able to satisfy section 8-1 because they may be contingent on economic performance or may secure a permanent or enduring benefit for the company. The effect of the contingency is to prevent the return being incurred in the gaining or producing of assessable income within the meaning of section 8-1 (because it represents the application of income derived, see Commissioner of Taxation v Boulder Perseverance (1937) 58 CLR 223; FC of T v The Midland Railway Company of Western Australia Ltd (1951) 85 CLR 306). The effect of the securing of the permanent or enduring benefit may make the return capital and therefore not deductible under section 8-1.

2.137 If, but for these 2 obstacles, a return on the debt interest (including, for example, dividends on shares that satisfy the debt test) would satisfy section 8-1 then the return should be deductible up to the limit explained in paragraph 2.139. This is because of the equivalence of such returns to interest payments on a loan. To effect this, the fact that the returns on such hybrids may be contingent on economic performance, or may secure a permanent or enduring benefit, is disregarded when applying section 8-1. (Return in this context means a return on an investment rather than a return of an investment.) [Schedule 1, item 3, section 25-85]

Example 2.13: Deductibility of returns on a cumulative perpetual note

A company issues an unsecured, subordinated perpetual note. The coupon exceeds the company's ordinary debt rate (i.e. the benchmark rate of return) by 1.5 percentage points (150 basis points) and payment is contingent on the company's profits of the previous year. Payments on the note can be deferred for up to 5 years where the profit contingency is not satisfied. Deferred payments accumulate and compound at a market interest rate and are payable at the end of 5 years irrespective of whether the contingency is satisfied or not (i.e. the company must make the payments even in circumstances where there are no available profits). The company cannot defer or waive the obligation to pay the coupons beyond 5 years.

The note is an interest of a kind referred to in item 2 of the table in subsection 153-10(1) as the returns are contingent on the company's economic performance. However, because the coupons are effectively non-contingent (see paragraphs 2.174 to 2.183), the note is a debt interest in the company under section 974-20: the company has an effectively non-contingent obligation to repay the note's subscription price through the perpetual coupons, given the obligation to pay the deferred coupons at the end of 5 years.


Back to Top

But for paragraph 25-85(1)(b), section 8-1 would deny a deduction for the coupons as the character of the advantage sought by the company in making the coupon payments is to secure a permanent and enduring benefit (i.e. they are of a capital nature). However, the effect of that paragraph is to disregard that fact in applying section 8-1. Assuming the other requirements of section 8-1 are satisfied, the coupons will be deductible to the company.

2.138 As a revenue safeguard it is necessary to prevent excessive deductible payments on debt/equity hybrids that satisfy the debt test. The risk to the revenue is that a company could distribute its profits as deductible payments in lieu of frankable dividends by making the distribution in respect of a hybrid that has been artificially characterised as debt. The artificiality of the characterisation would be indicated by a return on the interest considerably in excess of the interest payable on an equivalent interest without any equity component (i.e. straight debt).

2.139 Therefore the deduction for returns on debt/equity hybrids is capped by reference to the rate of return on an equivalent straight debt interest, increased by a margin to recognise the premium paid for the increased risk of non-payment because of the contingency. That rate of return is referred to as the `benchmark rate of return', and the margin is 150 basis points. The margin may be increased or decreased by regulation. [Schedule 1, item 3, subsections 25-85(3) and (4)]

2.140 To determine whether this cap applies it is necessary first to calculate the annually compounded internal rate of return on the debt interest. The annually compounded internal rate of return is the same as the effective annual rate, which is the interest rate expressed as if it were compounded each year.

2.141 If this rate exceeds the benchmark rate of return (which is also annually compounded - see paragraph 2.170) then the fact that the return is contingent on profits or secures a permanent or enduring benefit is not disregarded to the extent of the excess. As a result no deduction would be available under section 8-1 to that extent.

Example 2.14: Limit to deductibility of returns on debt/equity hybrids

Under a commercial, arm's length arrangement, a company issues a 10 year subordinated debenture with a face value of $1 million. The terms of issue do not allow the term of the debenture to be extended. The company is under an effectively non-contingent obligation to repay the $1 million to the debenture holder at maturity.

Coupons are payable to the debenture holder at an annual rate of 5% plus 5% of distributable profits. Distributable profits in the first year are $900,000. The company's ordinary debt rate (i.e. the benchmark rate of return) is 6% per annum.

The debenture is a debt interest in the company under section 960-202. But for section 25-85, section 8-1 would deny a deduction for the returns as they are paid out of after-tax profits at a point in time after the derivation of income. However, the effect of paragraph 25-85(2)(a) is to allow the returns to be an allowable deduction provided the other requirements of section 8-1 are satisfied.

However, subsection 25-85(3) limits how much of the $95,000 (5% of $900,000 and 5% of $1,000,000) return is deductible. The subsection denies a deduction to the extent to which the annually compounded internal rate of return exceeds the benchmark rate of return increased by 150 basis points (i.e. 7.5% in this case). The annually compounded internal rate of return is 9.5% (i.e. the annual internal rate of return assuming payments of $95,000 per annum) Therefore a deduction is denied for 2% of $1 million, namely $20,000. Thus only $75,000 of the $95,000 return is deductible.

What interests have a term in excess of 10 years? 2.142 If an interest to which the debt test applies has a term in excess of 10 years then a calculation of the present value of certain amounts is required. Thus, to apply the debt test to an interest it is first necessary to determine whether it has a term in excess of 10 years.

2.143 An interest has a term in excess of 10 years if its performance period exceeds 10 years. The performance period is the period within which the issuer of the interest (or, if relevant, the issuer's connected entity) has to meet its obligations in relation to the interest. [Schedule 1, item 34, subsection 974-35(3)]

2.144 An obligation under an interest has to be met within 10 years if there is an `effectively non-contingent obligation' (as explained in paragraphs 2.174 to 2.183) to terminate the interest within that period. This is the case even if the terms of the interest nominally allow it to remain extant for more than 10 years. [Schedule 1, item 34, subsection 974-35(4)]

2.145 A termination can occur in a number of ways, including by discharging an obligation or converting an interest into another interest. Sections 974-40 and 974-45 explain termination events. [Schedule 1, item 34, sections 974-40 and 974-45]


Back to Top

2.146 For example, a nominally perpetual instrument which may be redeemed by the issuer at any time will have a term of 10 years or less for the purposes of the debt test if the issuer is effectively obliged to redeem the interest within that time because the terms of issue require an economically unsustainable step-up in the return on the interest if the interest is not redeemed after 5 years.

2.147 It is necessary to have regard to all the circumstances when considering whether a step-up in the return on a particular interest is economically unsustainable, thereby rendering a termination of an interest effectively non-contingent. However, as a general rule, the level of permissible step-up provided by the APRA for Tier 1 capital instruments issued by APRA regulated institutions (e.g. Australian banks) would be economically sustainable. Step-ups in excess of that would usually, depending on the circumstances, be unsustainable for those institutions.

What is a debt interest? 2.148 The meaning of a debt interest is determined generally in accordance with the tests contained in Subdivision 974-B. To promote certainty and facilitate the categorisation of new types of financial instruments as debt or equity, the tests provided in the Subdivision may be modified or supplemented by the regulations. [Schedule 1, item 34, subsection 974-10(5)]

2.149 A scheme or a number of integrated related schemes gives rise to a debt interest if, when it comes into existence, it satisfies the debt test. [Schedule 1, item 34, subsections 974-15(1) and (2)]

2.150 The debt test provides that a debt interest arises under a scheme if:

* the scheme is a financing arrangement or is one that constitutes a share;

* an entity or associate receives or will receive a financial benefit(s) under the scheme;

* the entity or a connected entity has an effectively non-contingent obligation under the scheme to provide a financial benefit(s) in the future; and

* it is substantially more likely than not that the value of the financial benefit(s) to be provided will equal or exceed the value of the financial benefit(s) received (depending on the term of the scheme, the relevant values may be calculated in nominal value or present value terms).

[Schedule 1, item 34, subsection 974-20(1)]

2.151 The focus of the debt test on the effectively non-contingent obligations of the issuer (rather than on the ability of the investors to recover their investment) is consistent with accounting standards and the regulatory regime for Australian ADIs.

2.152 An exception to the debt test is made for cases where an entity receives a financial benefit other than money or other liquid assets and is obliged to, and does, provide a financial benefit in return (or the transaction is otherwise settled) within 100 days. For example, the supply of goods on terms allowing 100 days to pay will not give rise to a debt interest if payment is made on time. [Schedule 1, item 34, subsection 974-25(2)]

2.153 This exception may be supplemented or modified by regulations. The regulations may, for example, provide guidance on when a financial benefit is, or is not, a monetary or liquid asset. Generally speaking, a liquid or monetary asset is an asset that is cash or readily exchangeable into cash. Examples include most listed company shares, foreign currency and negotiable bills of exchange. [Schedule 1, item 34, subsection 974-25(3)]

2.154 Another exception relates to the non-arm's length arrangements explained in paragraphs 2.61 to 2.66. Notwithstanding that such arrangements may nominally satisfy the debt test, they will not constitute a debt interest if they otherwise fall within the definition of an equity interest and would have been equity interests if the relevant scheme had been undertaken on an arm's length basis. Of course, not all non-arm's length arrangements would otherwise be equity interests (those that would not will be debt if they satisfy the debt test). However, those which provide returns contingent on the economic performance of the issuer, or which are convertible into equity interests, would remain equity interests if they would have been had the arrangement been at arm's length. [Schedule 1, item 34, subsection 974-25(1)]

2.155 If a particular scheme constitutes a debt interest then the debt interest consists of the interest that carries the right corresponding to the relevant effectively non-contingent obligation. The interest is taken to have been issued when the issuer (i.e. the entity that has, or whose connected entity has, the effectively non-contingent obligation referred to in paragraph 2.172) first receives a financial benefit under the scheme. It remains on issue for as long as an obligation under the scheme remains outstanding. [Schedule 1, item 34, subsection 974-55(1)]

2.156 If a debt interest contains obligations by more than one entity it is necessary to determine which entity is the issuer of the interest. Subject to an over-riding discretion of the Commissioner to determine who is, in economic substance, the issuer of the interest, it is the entity with the greatest total

Back to Top

value of obligations that is taken to be the issuer. [Schedule 1, item 34, section 974-60]

Example 2.15: Determining the issuer of a debt interest

Two companies in a wholly-owned group enter into a scheme that is a scheme that is financing an arrangement under which the first company obtains $1 million and is obliged to repay it in 5 years, and the second company is obliged to pay interest of 8% per annum during that 5 year period.

As the scheme has a performance period of 5 years the obligation value of each entity is to be calculated in nominal terms.

As the first entity has an obligation both in legal form and in economic substance to repay $1 million it has an obligation value of $1 million. The second entity has an obligation both in legal form and in economic substance to pay interest of $400,000 (i.e. $80,000 × 5) during the performance period.

Unless the Commissioner determines otherwise, the first company is taken to be the issuer of the debt interest because its obligation value of $1 million is greater than the obligation value of $400,000 of the second company.

2.157 The constituent elements of the debt test are explained in paragraphs 2.158 to 2.206.

First element: there needs to be a scheme which is a financing arrangement 2.158 A scheme is a financing arrangement if it satisfies the definition of that term. See paragraphs 2.6 to 2.9.

2.159 A scheme is defined broadly in subsection 995-1(1) of the ITAA 1997 to include formal and informal agreements, arrangements and understandings that are not legally binding. A simple example of a scheme is the issue of a debt/equity hybrid instrument by a company (e.g. a redeemable preference share).

2.160 The concept of a scheme allows the linking of the receipt of a benefit and the obligation to make a payment in determining whether a debt interest exists. In certain cases the Commissioner may determine that a single scheme reflects, in economic substance, disparate schemes and may therefore exercise a discretion to disaggregate it. [Schedule 1, item 34, subsection 974-150(2)]

2.161 Related schemes may be integrated in an equivalent way to that described in relation to equity interests in paragraphs 2.50 to 2.60. Consistent with the integration test for equity interest, related schemes that individually constitute debt interests will not be integrated to form a single debt interest, and the Commissioner may determine not to integrate related schemes. [Schedule 1, item 34, subsections 974-15(2) to (4)]

2.162 If an interest that would be an equity interest by itself is one of a number of related schemes that together satisfy the debt test then it will not be an equity interest. For example, if a company issues an ordinary share and, under a related scheme, guarantees to repay the issue price after 5 years, the ordinary share will not be an equity interest if the related schemes of the share and the guarantee together constitute a debt interest.

Second element: there needs to be the receipt of a financial benefit under the scheme 2.163 For a scheme to be a debt interest there must first be the receipt, now or in the future, of a financial benefit by an entity (e.g. the issue price of a debt/equity hybrid interest). [Schedule 1, item 34, paragraph 974-20(1)(b)]

2.164 In the simplest case of a debt interest, this financial benefit would be a sum of money, which the entity is obliged to repay (with interest). However, financial benefit is defined broadly to mean anything of economic value, including property or services [Schedule 1, item 34, subsection 974-160(1)]. Moreover, the fact that the receipt of property or services may be accompanied by an obligation to repay it does not prevent it constituting a financial benefit. Instead, in this respect the receipt and the obligation will be separate financial benefits (i.e. they are to be looked at separately and not offset against each other in determining whether there is a financial benefit) [Schedule 1, item 34, subsection 974-160(2)]. A financial benefit may also comprise a reduction of a liability or deferral of a payment. For example, if a taxpayer owes money that is due and payable, non-payment of that money constitutes a financial benefit because of the time value of money. Example 2.17 shows how a debt interest may arise because of the non-payment of money due.

2.165 The initial receipt of a financial benefit under an arrangement may also involve the provision of a financial benefit at the same time. In determining the value of the financial benefit received the value of the benefit provided would be offset against the value of the benefit received. Financial benefits provided or received at the same time may be offset in determining their value for the purposes of applying the debt test (but not in determining whether a financial benefit arises).

Example 2.16: Exchange of financial benefits

A company obtains goods valued at $1,000 on credit and at the same time pays an instalment to the provider of the goods of $200. Under the terms of the credit arrangement the company is required to pay a final instalment of $900 in 2

Back to Top

years time. The value of the financial benefit received under the scheme is taken to be $800. As the company has an effectively non-contingent obligation to provide $900 in the future the scheme satisfies the debt test as the value of the financial benefits to be provided at least equals the value of the financial benefit received.

2.166 The financial benefit received does not have to be an immediate one, but could be a financial benefit to be received (in the sense of there being an effectively non-contingent obligation by an entity to provide it) in the future, and could comprise a number of financial benefits (e.g. the payment of the issue price of a debt/equity hybrid interest in instalments). In such cases, the value of all the benefits is taken into account in determining the total value of financial benefits received or to be received under the scheme. [Schedule 1, item 34, subsections 974-20(2), (4) and (5)]

Example 2.17: Benefit received over time

A company issues an instrument which it calls an instalment bond with an issue price of $100, payable in 2 instalments. The first instalment of $50 is to be paid on issue; the second $50 instalment is payable one year later.

The issue of the bonds constitutes a scheme under which the company has received financial benefits equal to $100.

Calculating the benefit in present value terms 2.167 The following discussion of calculating benefits in present value term is equally relevant to benefits to be received and benefits to be provided.

2.168 If the financial benefit is to be provided in the future then its present value needs to be calculated if the performance period of the relevant scheme exceeds 10 years (as explained in paragraphs 2.142 to 2.147). [Schedule 1, item 34, subparagraph 974-35(1)(a)(ii)]

2.169 Section 974-50 explains how to calculate the present value of a financial benefit. The calculation of the value of a financial benefit in present value terms is, subject to the regulations, based on the assumptions that the interest is held until maturity and all payments are paid at the earliest time that the issuer becomes liable to pay them. Thus, for example, if a company is liable to provide a return on a particular day then it is taken to be paid on that day for the purpose of calculating its present value even if, under the terms of the relevant instrument, payment may be deferred. Of course, it is a question of fact as to when a company is actually liable to pay an amount: in this regard the nominal date for when a liability arises would not be conclusive if the circumstances indicate that the liability actually arises at a different time. [Schedule 1, item 34, subsections 974-35(2) and 974-50(3)]

2.170 The formula for calculating the present value of a financial benefit provides for the nominal value of the financial benefit to be discounted using the adjusted benchmark rate of return. This is defined as 75% of the benchmark rate of return which, in turn, is defined as the internal rate of return on an investment if the investment were `ordinary debt' of the issuer or an equivalent entity, compounded annually and otherwise comparable with the interest under consideration. Ordinary debt entails no contingent payments. [Schedule 1, item 34, subsection 974-50(4), sections 974-140 and 974-145]

2.171 See Examples 2.21 and 2.22 for a practical application of the present value formula and paragraph 2.192 for an explanation of the 75% figure. Regulations may prescribe an alternative way of calculating the value of financial benefits. [Schedule 1, item 34, subsections 974-50(5) and (6)]

Benefits of connected entities 2.172 Because a benefit received by a connected entity of an entity can be equivalent to a benefit received by the entity itself, the receipt of a financial benefit element of the debt test is satisfied if the financial benefit is received by the entity or by a connected entity of the entity.

Regulations 2.173 The regulations may provide how to calculate the value of financial benefits received, and also what the financial benefit is and when it arises. [Schedule 1, item 34, subsections 974-50(6) and 974-160(3)]

Third element: there needs to be an effectively non-contingent obligation to provide a financial benefit in the future 2.174 Debt in a formal sense involves obligations which are non-contingent in legal form (e.g. a legal obligation to pay interest and to return principal). However, if the debt test were to focus solely on obligations which are non-contingent in legal form, schemes that are equivalent in economic substance might give rise to different tax outcomes. This would encourage tax arbitrage and open up tax avoidance opportunities.

2.175 The debt test therefore uses the concept of an effectively

Back to Top

non-contingent obligation as opposed to a legally (or formally) non-contingent obligation. Thus a scheme under which an entity has a right but not a legal obligation to provide a financial benefit could nevertheless be debt if, having regard to the pricing, terms and conditions of the scheme, the entity is in substance or effect inevitably bound, to exercise that right. This would occur where not to exercise the right would result in the entity having to sustain a greater loss (in present value terms) from the scheme than if it exercised the right. A simple example of this would be where the issuer of a financing instrument has a right to redeem it after a certain period but is compelled to provide accelerating returns on the instrument if it does not exercise that right: the accelerating returns would make it uneconomic for the issuer not to redeem the instrument so that it is under an effectively non-contingent obligation to do so.

2.176 The concept of an effectively non-contingent obligation is, however, not intended to displace regard to legal rights and obligations. This is particularly so where those rights and obligations are consistent with arm's length transactions of commercial substance and reflect the clear intention of the parties.

The meaning of effectively non-contingent 2.177 There is an effectively non-contingent obligation to provide a financial benefit for these purposes if, having regard to the practical or economic consequences of not providing the benefit, there is in substance or effect an obligation to provide that benefit. [Schedule 1, item 34, subsection 974-135(1)]

2.178 Determining whether or not this is the case in a particular set of circumstances, is to be guided by the rationale for having an effectively non-contingent concept rather than simply a formal non-contingent test (i.e. where any form of contingency, whether artificial or not, would be sufficient to prevent the obligation being non-contingent). In this regard, reliance solely on a formal non-contingent test would enable taxpayers to easily impose artificial contingencies in order to prevent an interest being debt. In addition, consistent with the principle inherent in the debt test of focusing on economic substance rather than legal form, where a contingency is so remote as to be effectively inoperative (immaterially remote) it is as if the contingency did not exist and it should be disregarded.

2.179 In some circumstances it will be clear that a particular contingency is immaterially remote for these purposes. These will be cases where there is only a theoretical rather than a real possibility of the contingency occurring. In other cases it will be necessary to be guided by the purpose underlying a particular contingency: if the evidence indicates that a contingency is an artificial one used to disguise the inherent non-contingent substance of an obligation then it will be effectively non-contingent for the purposes of the debt test. This approach ensures debt cannot be disguised by inserting an immaterial contingency. [Schedule 1, item 34, subsection 974-135(6)]

2.180 In summary, therefore, the effectively non-contingent test identifies formal contingencies attached to a right that are:

* manifestly so remote as not to be real because they have only a theoretical rather than a real possibility of occurring; or

* artificial contingencies disguising the inherent non-contingent character of a particular right which are imposed to avoid the interest being classified as debt.

2.181 Conversely, the effectively non-contingent test also identifies formally non-contingent obligations that, having regard to the circumstances of the scheme, are such that there is no non-contingent obligation as a matter of substance or effect. This may be the case, for example, where related parties enter into formally binding obligations which, because of matters such as the relationship between the parties, are in substance or effect not obligations at all because failure to perform the so-called obligation will have no practical consequences. This can be contrasted with ordinary cases involving formally non-contingent obligations, where failure to perform an obligation would expose the non-performer to legal or economic sanctions.

2.182 Regulations may be made to supplement, and provide guidance as to, the meaning of effectively non-contingent obligations. Among other things, this will enable certainty to be provided for particular types of arrangements - specifying whether they do, or do not, constitute debt. Factors relevant to the making of such regulations may include:

* the individual circumstances of the parties to the arrangement, including their purpose or purposes in relation to the arrangement;

* whether the contingencies and non-contingent obligations are artificial or immaterially remote;

* financial analysis;

* the type of arrangement, including the nature of the rights, obligations, assets and liabilities in respect of the arrangement; and

* the level of return provided.

[Schedule 1, item 34, subsection 974-135(8)]

2.183 The regulations will enable, for example, clarification of the circumstances in which so-called interest-free debt does not give rise to an

Back to Top

effectively non-contingent obligation for the purposes of determining what constitutes a debt interest.

A benefit to be provided in the future 2.184 In one sense, an obligation to provide a benefit in the future to someone represents a present benefit to that person (because the person is assured of getting a benefit later on). However, that is not the sense in which the provision of a benefit in the future is to be read for the purposes of the debt test. For those purposes a present obligation to provide future benefits is disregarded, and the focus is on those future benefits. [Schedule 1, item 34, subsection 974-30(3)]

2.185 The financial benefit to be provided in the future may be provided to any entity. There may be one or more benefits. If there is more than one benefit then the sum of those benefits is taken into account. [Schedule 1, item 34, subsections 974-20(3) and (5)]

2.186 Usually it will be provided to the entity from whom a financial benefit was received. However, it could also be provided to a connected entity of that entity, or even an unrelated third party. A benefit can be provided to an entity by applying it on the entity's behalf. [Schedule 1, item 34, subsection 974-30(2)]

2.187 The financial benefit may be money, other property, services, or anything else of economic value. [Schedule 1, item 34, section 974-160]

2.188 However, the provision of equity interests in the issuer or a connected entity does not count. Nor does the provision of an amount of money that is to be applied in respect of the issue of such equity interests. [Schedule 1, item 34, subsection 974-30(1)]

Example 2.18: Converting preference shares

A company issues CPS which convert at the end of their term into a number of ordinary shares whose total value is at least equal to the issue price of the CPS. The terms of issue are such that the holder of the CPS has a real likelihood of making a gain from the conversion because the value of an ordinary share on conversion may exceed the CPS price.

The CPS are not debt. Although the value to be returned to the investor at least equals the investment amount, that value is returned in the form of equity interests (ordinary shares), which are disregarded. The outcome would be different if the CPS converted, in a loose sense of that term, into shares of an unconnected company: in that case other property is being provided which at least equals the investment amount, so the debt test would be satisfied.

Example 2.19: Convertible note with `two-step conversion'

A company issues a `convertible note' on terms that define the word `convert' as the repayment of the face value of the note to the holder and the subsequent application of those proceeds towards the subscription of shares in the company. Under the terms of the instrument, this conversion is mandatory.

The repayment of the face value in these circumstances does not result in an effectively non-contingent obligation to provide a financial benefit of that amount. This is because paragraph 974-30(1)(b) provides that there is no such obligation where the benefit to be provided is an amount that is to be applied in respect of the issue of an equity interest in the company.

2.189 The regulations may provide what a financial benefit is and when it arises for these purposes. [Schedule 1, item 34, subsection 974-160(3)]

2.190 The requirement that the financial benefit be provided in the future means that transactions where a financial benefit is received contemporaneously with the provision of a financial benefit will not constitute a debt interest. For example, a simple conversion of currency whereby Australian dollars are exchanged for foreign currency will not constitute debt because the obligation to pay Australian dollars is contemporaneous with the receipt of the financial benefit (the foreign currency).

2.191 As with the value of financial benefits received, the value of financial benefits to be provided in the future is to be determined in:

* nominal value terms if the performance period is 10 years or less; or

* present value terms if the performance period is greater than 10 years.

[Schedule 1, item 34, paragraph 974-35(1)(a)]

2.192 As explained in paragraphs 2.168 and 2.169 a future benefit which is subject to the present value test is taken to be equivalent to a benefit which is received today and reinvested at a compounding rate of return equal to 75% of the ordinary debt rate of the relevant company. The 75% reflects the fact that the equity component of a debt/equity hybrid interest will, in a sense, be paid for by a lower guaranteed (i.e. effectively non-contingent) return than that on a straight-debt interest (i.e. an interest without any equity component). If this were not the case the investor would be getting the equity component of the hybrid without paying for it. Therefore, if the full ordinary debt rate was used, the present value of effectively non-contingent future benefits paid on debt/equity hybrids could be expected always to be less than the amount paid for them, preventing all hybrids to which the present value test applies satisfying the debt test. Using only 75% of that rate ensures a small equity component of a debt/equity hybrid will not preclude the hybrid

Back to Top

from satisfying the debt test.

2.193 Sometimes it is necessary to calculate the present value of an indefinite number of returns because the instrument is perpetual. For example, a note may provide for a specified annual return to be paid perpetually. In cases like these where the value or amount of the financial benefit received is the same for each year, as the term `n' in the formula in subsection 974-50(4) approaches infinity the total value of the returns on a present value basis can be approximated as:

amount or value of financial benefit in nominal terms

adjusted benchmark rate of return

Example 2.20: Benefits to be provided calculated in nominal value terms

Assume in Example 2.17 that the instalment bonds are issued on terms requiring the payment of annual interest of 5% and compulsory redemption after 5 years for their issue price.

At the time of issue of the bond, the company has an effectively non-contingent obligation (because in form and substance there is an actual legal obligation) to provide a financial benefit in the future, namely the interest payments and the redemption proceeds. The value of the financial benefit to be provided is therefore the nominal value of the sum of the 5% annual returns and the issue price.

Example 2.21: Benefits to be provided calculated in present value terms

A company issues convertible notes for $9 each on 1 July 2001. The notes provide a coupon of 7% paid once a year (on 1 July). Each of the notes may be converted into 2 ordinary shares on 30 June 2016. Assume that the benchmark rate of return of the company is 8%.

On the assumption that the convertible note will be held until maturity, there will be 15 coupon payments of $0.63 ($9 × 7%)
and a return of the principal of $9 at maturity. The value of the financial benefit provided will be the sum of the present value of these benefits discounted using an adjusted benchmark rate of return of 6% (8% × 75%) and 15 interest periods.

Using present value calculation methods, the value of financial benefits to be provided is calculated as follows:

$0.63 / (1.06)^1 + $0.63 / (1.06)^2 . . . + $9.63 / (1.06)^15

= $9.87

Therefore, because the present value of the financial benefits to be provided in the future exceeds the issue price of the notes, the notes constitute debt interests.

Example 2.22: Calculating present value for perpetual instruments

A company issues undated notes for $9 each on 1 July 2001. The notes provide a coupon of 7% paid once a year. Assume that the benchmark rate of return of the company is 6%.

The value of the financial benefit provided will be the sum of the present value of these financial benefits discounted using an adjusted benchmark rate of return of 4.5% (6% × 75%).

The present value of the value of financial benefits to be provided is approximated as follows:

$0.63 ÷ 0.045

= $14.00

Therefore, because the present value of the financial benefits to be provided in the future exceeds the issue price of the notes, the notes constitute debt interests.

2.194 When calculating the total value of financial benefits received, it is necessary to assume that the scheme will continue to be held for the rest of its life. Thus the fact that the issuer may have an option to terminate the scheme early does not prevent the consideration of financial benefits to be provided after that optional termination time. [Schedule 1, item 34, subsection 974-35(2)]

2.195 However, if a party to the scheme has a right or option to terminate it (including by discharging an obligation early or by converting it into another interest) and the relevant circumstances of the scheme indicate that there is an effectively non-contingent obligation to exercise that right or option at a particular time, the life of the interest is taken to end at that time. An example of this is where the issuer has a right to redeem an interest after 5 years, or to leave the interest on issue and pay a commercially unsustainable return on it. In this case the issuer has an effectively non-contingent obligation to redeem it after 5 years, and that is when the life of the interest will be taken to end. [Schedule 1, item 34, section 974-40]


Back to Top

Fourth element: it must be substantially more likely than not that the financial benefit to be provided will at least equal the value of the financial benefit received
2.196 For the debt test to be satisfied, the financial benefit to be provided under the scheme must at least equal the financial benefit received or to be received. [Schedule 1, item 34, paragraph 974-20(1)(d)]

Expected value 2.197 The debt test does not generally require an assessment of expected value. Thus, where there is no effectively non-contingent obligation to provide a financial benefit, the fact that it might be reasonable to expect a financial benefit of a certain amount would be provided is not relevant. For this reason, returns which, for commercial reasons, are contingent on the availability of profits of an entity would generally not be counted in determining whether the debt test is satisfied, even if the possibility of not having profits is slight.

2.198 In some circumstances, however, the value of a financial benefit to be provided in the future, although non-contingent, will be uncertain. Because it is non-contingent it is necessary to count it in determining whether the debt test is satisfied, and this presents a problem if its value is uncertain.

2.199 If the value of that benefit depends on a variable in general commercial use whose future value it is not possible to predict with sufficient certainty (e.g. a floating interest rate), the current value of that variable is used to calculate the future benefit. For example, a non-contingent return in 5 years based on the 90-day bank bill rate existing at that time will be calculated on the basis of the prevailing rate at the time of the relevant interest's issue. [Schedule 1, item 34, subsection 974-35(5)]

2.200 In other cases, it is necessary to make an assessment of whether it is substantially more likely than not that the financial benefit to be provided will at least equal the financial benefit received. However, subject to the Commissioner's power to make a determination, only financial benefits provided under an effectively non-contingent obligation need to be considered for these purposes: contingent benefits are not subject to this test even if they are likely to be made. [Schedule 1, item 34, paragraph 974-20(1)(d)]

2.201 Regulations may be made prescribing what substantially more likely than not means in this context. Subject to those regulations it means that the likelihood of the financial benefit to be provided being at least equal to the amount invested has to be not merely more likely than not, it has to be substantially more likely than not. This does not, however, mean that it has to be highly likely that the financial benefit to be provided at least equals the amount invested. [Schedule 1, item 34, subsection 974-20(6)]

Example 2.23: Indexation

A company issues an inflation-indexed bond that provides an effectively non-contingent return equal to the issue price indexed to inflation.

Technically, inflation can be negative (i.e. deflation is possible). Therefore, it would be theoretically possible for the bond to provide a return less than its issue price (in which case it would not be debt). However, deflation is a very rare occurrence in an economy like Australia's and, for practical purposes, the possibility of it occurring can be ignored. Therefore, because it is substantially more likely than not that the return on the bond will at least equal its issue price, it is debt.

Expressing financial benefits in foreign currency 2.202 If the financial benefit received is expressed in a foreign currency and the financial benefit to be provided is expressed in the same terms, then the debt test can be applied using the foreign currency to ascertain whether the financial benefits are equal or not. [Schedule 1, item 34, subsection 974-35(6)]

Example 2.24: Debt expressed in foreign currency or other units of measure

An Australian company borrows $US1 million to be repaid (in US dollars) over 5 years. This constitutes debt notwithstanding that changes in the US dollar exchange rate may mean that, in Australian dollar terms, the company pays back less than the amount borrowed. (The outcome would be the same if the loan were expressed in, for example, ounces of gold.)

Commissioner's power to determine that a scheme gives rise to a debt interest 2.203 Because the debt test is generally not based on expected value, it is susceptible to the creation of artificial schemes designed to convert what would otherwise be debt into an arrangement that, technically, does not satisfy the general debt test. Such an arrangement would entail:

* an effectively non-contingent obligation to provide a financial benefit constituting a substantial part of the financial benefit received; and

* contingent, but likely, financial benefits that, when combined with the effectively non-contingent payments, are expected to equal or exceed the financial benefit received.


Back to Top

2.204 To prevent avoidance arrangements of this kind the Commissioner may, having regard to specified factors, treat certain schemes as debt, but only if:

* the financial benefit provided pursuant to an effectively non-contingent obligation under the scheme constitutes a substantial part of the financial benefit received under the scheme;

* it is substantially more likely than not that other financial benefits will be provided under the scheme; and

* the sum of those other benefits and the financial benefits provided under the effectively non-contingent obligation is substantially more likely than not to equal or exceed the amount received.

[Schedule 1, item 34, subsection 974-65(1)]

2.205 In making this determination, the Commissioner must have regard to the following factors:

* the value of the financial benefit to be provided under the effectively non-contingent obligation relative to the financial benefit received;

* the degree of likelihood of the other financial benefits being made; and

* the individual circumstances of the parties to the scheme, including the purpose or purposes for entering into it.

[Schedule 1, item 34, subsection 974-65(2)]

2.206 As the exercise of the Commissioner's discretion will directly affect an entity's assessment, a person who is dissatisfied with the Commissioner's decision may object against it under Part IVC of the TAA 1953.

Example 2.25: Exercise of Commissioner's discretion

A profitable Australian company with retained earnings issues a redeemable security to its parent. Under the terms of issue of the security, the Australian company is obliged to redeem it for 99% of its issue price in 5 years' time, and must pay annual returns of 10%, subject to profits being available.

Because the financial benefit to be provided under the effectively non-contingent obligation does not quite equal the amount received by the Australian company (i.e. the issue price of the security), the security does not satisfy the terms of the general debt test. However, having regard to the artificiality of the scheme, its purpose, and the likelihood of annual returns being paid sufficient to make up the shortfall, the Commissioner could make a determination that the security be treated as debt.

Examples of applying the debt test to debt/equity hybrids 2.207 Examples 2.26 to 2.28 show how the debt test combines with the definition of equity interests to determine whether a particular debt/equity hybrid is to be accorded debt or equity tax treatment.

Example 2.26: Perpetual convertible notes

A company issues perpetual convertible notes on 1 July 2001 for $9 each. The notes have coupons of 7% which are paid annually on 1 July. The obligation to pay the coupons is not subject to any contingency and cannot be deferred or waived in any circumstance. The company may, at its option, redeem the notes, or convert them into ordinary shares, at any time after 1 July 2007. The company's benchmark rate of return is 8% per annum.

Because the notes are convertible, they will represent an equity interest unless the debt test is satisfied (the scheme is a commercial arrangement at arm's length).

Under the relevant scheme, the company has received a financial benefit - the issue price of $9. Making the required assumption that the notes are held for the rest of their lives, the company has an effectively non-contingent obligation to pay 7% annually in perpetuity to the note holder. The value of this benefit to be provided is calculated in present value terms as the performance period is more than 10 years (it is assumed that, while there is an option to redeem, there is no effective non-contingent obligation to do so).

The total present value of the financial benefit to be provided by the company in relation to each note is calculated as follows:

* the coupon amount per coupon period is $0.63 ($9 × 7%);

* the adjusted benchmark rate of return per period is 6% per annum compounded annually (8% × 75%), or 0.06; and

* therefore, the value of the financial benefit to be provided by the company is $10.50 ($0.63 ÷ 0.06, which is an approximation of the present value formula in subsection 974-50(4) for a perpetuity).

Since the value of the financial benefit to be provided ($10.50) exceeds the value of the financial benefit received ($9), the convertible note is a debt interest. Therefore, the returns to the note holder will not be frankable and will be deductible if they satisfy the general deduction provisions of the income tax law.

Example 2.27: Converting preference shares

On 1 July 2001, a company issues CPS with a term of 15 years for $100 each. The shares pay annual dividends of 7.5%.

Conversion is mandatory after 15 years, but the company has the option to buy back the shares on 1 July 2006.

The company's benchmark rate of return is 8% per annum.


Back to Top

Because the holders of the CPS are shareholders in the company, they constitute equity interests unless the debt test is satisfied (the scheme is a commercial arrangement at arm's length).

Under the relevant scheme, the company has received a financial benefit - the issue price of $100. However, the company does not have an effectively non-contingent obligation under a scheme to provide a future financial benefit because the payment of a dividend is contingent on profits, and the issue of ordinary shares is specifically excluded as being the provision of a financial benefit. (It is assumed that there is nothing to suggest that the company would be effectively obliged to buy back the CPS before conversion - if that were the case then the buy back price would be an effectively non-contingent return.)

Because there are no effectively non-contingent returns which are to be taken into account, the CPS do not satisfy the debt test and therefore constitute equity interests. As a result, the coupon payments will, subject to the rules governing frankability of dividends, be frankable but not deductible.

Example 2.28: Income securities

A company issues income securities on 1 July 2001 with an issue price and face value of $100.

Each income security can be redeemed (at the issuer's, but not the holder's, option) after 1 July 2006 at face value plus accrued interest. The coupon will float at a margin of 250 basis points above the 90-day Bank Bill rate. Coupon payments are conditional on the company having sufficient profits to support those payments.

The income securities are stapled securities comprising a fully paid $100 perpetual note and an unpaid preference share that cannot be traded separately. Under certain prescribed circumstances, the note will be cancelled and the $100 issue price used to pay up the preference share. The preference share thereupon commences to pay a dividend on the same terms as the note.

Because the income securities provide a return contingent on economic performance of the issuer (profitability), they will represent an equity interest unless the debt test is satisfied (the scheme is a commercial arrangement at arm's length).

Under the relevant scheme, the company has received a financial benefit - the issue price of $100. However, the company does not have an effectively non-contingent obligation under a scheme to provide a future financial benefit because the coupon payments are contingent on profits, and there is no effectively non-contingent obligation to repay the principal. Subsection 974-135(7) provides that an obligation will not be effectively non-contingent merely because the failure to satisfy the obligation will result in detrimental practical or commercial consequences.

Because there are no effectively non-contingent returns, the income securities do not satisfy the debt test and therefore constitute equity interests. As a result the coupon payments will, subject to the rules governing frankability of dividends, be frankable but not deductible.

Some examples of non-hybrid debt interests 2.208 Examples 2.29 to 2.36 provide a selection of non-hybrid interests that constitute debt. It is not intended to be exhaustive. Whether the type of interest described in each example is debt or not is determined by reference to its terms and substance rather than how it is described. Interests in these examples are debt for the purposes of the thin capitalisation regime.

Example 2.29: Non-payment of money due

A company has an obligation under a lease to pay interest on overdue rent. The company fails to make a rental payment on time.

In this case there is a scheme (the lease agreement) that is a financing arrangement under which the company has received a financial benefit (the use of funds represented by the overdue rental payment) and has an effectively non-contingent obligation to provide a financial benefit in the future to the lessor (i.e. to pay the overdue rent with interest). Because interest is charged, the benefit to be provided by the company to the lessor exceeds the benefit it received from the non-payment of the rent. Therefore, a debt interest has been created.

Example 2.30: Embedded debt

A company acquires an item of plant with a market value of $1 million for $1.05 million to be paid over 6 months.

Although there is no explicit debt component in this transaction, there is an embedded debt reflected in the premium paid for the asset. Because there is an effectively non-contingent obligation to pay the $1.05 million (which exceeds the $1 million benefit received), the debt test is satisfied. (Note that, if payment was made within 100 days, the arrangement would be specifically excluded from being debt.)

Example 2.31: Project finance

Project finance typically involves the provision of finance on a limited recourse basis to a mining venture. Although the terms of the particular arrangement will determine whether the arrangement gives rise to a debt interest, the project finance arrangements described in this example are indicative of debt interests.

Under a production payment arrangement, a financier buys a right to future

Back to Top

sales proceeds of minerals from a specified mine. The financier is entitled to sales proceeds sufficient to cover its investment plus accrued interest; when the arrangement is entered into, the value of the mine's proven mineral reserves substantially exceed this amount. The financier's rights are limited to the mining venture's assets. At the same time, parties to the mining venture or associated parties guarantee minimum production levels.

Under a production-backed loan, a financier lends a gold mining venture a specified amount of gold, sells the gold on behalf of the venture and gives the proceeds to the venture. The venture is required to repay the amount of gold plus interest, which is denominated in gold. The venture has proven gold reserves that substantially exceed the amount it owes plus interest. The financier's rights are limited to the mining venture's assets. At the same time, parties to the mining venture or associated parties guarantee minimum production levels. Using gold as a unit of account for the purpose of determining whether an arrangement gives rise to a debt interest, the value of the financial benefit to be provided by the venture at least equals the value of the financial benefit it received.

Further clarification of the treatment of such arrangements can be provided by regulations under subsection 974-135(8) of the ITAA 1997 concerning what constitutes an effectively non-contingent obligation.

Example 2.32: Securitisation

As part of a securitisation of a pool of debt interests, a SPV of an Australian ADI, typically a trust, issues a number of foreign currency denominated long term FRNs to non-resident investors. The SPV generally has an option to redeem the securities after a specific date or earlier for a specified contractual condition.

The total of the issue prices of all the FRN is the present value of the expected future cash flows from the pool of debt interests, net of administration (including payments for provision of credit enhancement) and set-up costs. Investors are entitled to a return of the issue price of each security plus interest thereon. The investors' rights are limited to the pool of debt interests. However, the investors have the benefit of a credit enhancement arrangement that insures against the risk of default in respect of the pool of debt interests.

Each security issued by the entity would give rise to a debt interest. The absence of the credit enhancement arrangement would not necessarily lead to a different result. It could be expected that often it would not do so. However, there may be a need for a greater level of enquiry of the particular circumstances (e.g. the nature of the assets underlying the debt interests; the terms, conditions and pricing of the arrangements; and other relevant factors) to determine whether it is substantially more likely than not (as explained in paragraphs 2.196 to 2.201) that the value of the pool or the redemption price will at least equal the issue price of the securities.

Regulations can be made under subsection 974-135(8) of the ITAA 1997 to provide further clarification of what constitutes an effectively non-contingent obligation for the purpose of securitisation arrangements.

Example 2.33: Sale and repurchase agreement

An entity sells to an investor for $9.5 million now, a right to receive $10 million worth of widgets in one year. The entity enters into a separate agreement to buy back that right in one year for $10 million.

The combined effect of the 2 related schemes is that the entity receives $9.5 million now and has an effectively non-contingent obligation to pay $10 million in one year. The schemes are taken to give rise to a debt interest because they are related schemes (see subsection 974-15(2) of the ITAA 1997.

Example 2.34: Bailment floor plan

A bailment floor plan has the following features:

* A finance company buys cars from a car manufacturer/distributor that a car dealer orders. The cars are delivered to the dealer. Call the price the `manufacturer's price'.

* The dealer comes under an obligation to pay the finance company the manufacturer's price at the end of the bailment period.

* During the bailment period, which is the time from when the dealer takes possession of the car until it is sold, the dealer pays the finance company an amount which reflects the manufacturer's price, prevailing interest rates and the bailment period. In essence, the payment(s) functions as interest on a loan. (The dealer may also reimburse the finance company for any insurance cover that the finance companies take out over the cars.) The interest rate would normally encompass a margin for the finance company that reflects credit risk and the finance company's expenses.

In this situation, the finance company finances the purchase of the car by the dealer, and the arrangement is a financing arrangement for the purpose of section 974-130.

By allowing the dealer to take possession of the car, which it can deal with but which the finance company has financed, the finance company provides the dealer with a financial benefit equal in value to the manufacturer's price. As a result, the dealer has an effectively non-contingent obligation to pay the finance company an amount that will be at least equal to the amount that it received when the arrangement was entered into. Hence, a bailment floor plan with these features is a debt interest.


Back to Top

Example 2.35: Hire purchase transaction

Under a hire purchase transaction, a financier owns an item of property which it hires out to a customer. The customer pays hire fees and has an option to purchase the property, which it essentially exercises by paying the agreed fees. That is, the transaction is structured on the basis that all hire payments are to be made, whereupon title to the property passes to the customer.

The fees are calculated to pay the financier the cost of the property plus a return on the financier's investment. By entering into the hire purchase transaction, the customer essentially raises the finance necessary to acquire the property. The arrangement is a financing arrangement.

As a result of entering into the hire purchase transaction, the customer receives a financial benefit equal to the value of the funds required to acquire the item of property. This is because the contemplation of the transaction is that the property will pass to the customer, the funds for the purchase of which the financier, rather than the customer, has provided.

Under the arrangement, the customer has an effectively non-contingent obligation to pay hire fees that will at least equal the value of the property. Accordingly, a hire purchase contract of this nature is a debt interest.

Example 2.36: Repurchase agreements

Two different types of repurchase agreements (repos) can be distinguished: `cash repos' and `securities repos'.

Cash repos involve a finance provider buying securities from a finance obtainer and, as part of a packaged arrangement, agreeing to sell them back at a price greater than the purchase price. The difference between the buy and sell price is the product of the funds provided under the initial purchase contract, the time between that contract and the sale back contract and prevailing interest rates.

Cash repos enable the finance obtainer to raise finance (with securities used as collateral). They are financing arrangements that give rise to a debt interest, as the finance obtainer comes under an effectively non-contingent obligation to provide an amount at least equal to what it obtained.

Cash repos and arrangements that are economically equivalent include those referred to as `reciprocal purchase agreements' and `sell-buyback arrangements'.

Securities repos (also referred to as `securities loan arrangements') involve an owner (the `securities lender') of securities transferring title to another party (the `securities borrower'). In consideration of that, the securities borrower agrees to transfer either those or equivalent securities to the securities lender at a future date. Further, the borrower agrees to pay a fee that is based on the value of the securities and the time that the borrower has the securities, but not on interest rates. Although the `securities borrower' in substance borrows securities, generally it cannot be said to have raised finance, even if the arrangement does not fall within section 26BC of the ITAA 1936. If it does fall within that provision, paragraph 974-130(4)(b) specifically excludes it from being treated as a financing arrangement.

Some examples of interests that are not debt 2.209 Examples 2.37 to 2.39 provide a (non-exhaustive) selection of schemes that do not constitute debt. Again, the conclusion as to whether or not each one is debt depends on the terms and substance of the scheme rather than how it is described.

Example 2.37: Statutory obligations

A company derives taxable income and incurs a liability to pay income tax. Although the company has an effectively non-contingent obligation to provide a financial benefit (i.e. to pay an amount of money), there is no relevant scheme under which the company has received a financial benefit and thereby incurred the obligation. Therefore, there is no debt interest.

Example 2.38: Trade finance

A company buys supplies on terms allowing payment within 6 weeks. It pays for the supplies on time.

This arrangement is not debt because it is covered by the exception in subsection 974-25(2) of the ITAA 1997.

Example 2.39: Options

A company writes an at the money call option over an asset it holds which gives the purchaser of the option the right, but not the obligation, to acquire the asset in 3 months for a fixed price (which, because the option is at the money, is the same as the current market value of the asset). After the end of the 3 month period, the option holder exercises the right to purchase the asset.

This arrangement is not debt. At the time the arrangement was entered into, the company did not have an effectively non-contingent obligation to provide a financial benefit (i.e. deliver the asset). Rather, it had a contingent obligation because it only had to deliver the asset if the option holder exercised the option.

Application and transitional provisions 2.210 Subject to the concession explained in paragraph 2.211 the changes explained in

Back to Top

this chapter apply from 1 July 2001, irrespective of when the relevant interest was issued. For example, the frankability and deductibility of payments on a hybrid instrument issued before 1 July 2001 will be subject to the current law until that date, from when it will be subject to the rules explained in this chapter. [Schedule 1, subitem 118(2)]

2.211 However, a company that, before the release of the exposure draft of this bill (on 21 February 2001), has issued a debt or equity interest may lodge a written election with the Commissioner for the current law to continue to operate in relation to that interest until 1 July 2004. The election must be lodged within 28 days after the day on which the Act containing the amendments receives Royal Assent or within such further time as the Commissioner allows. The Commissioner may only allow further time where the Commissioner is satisfied that the issuer did not have sufficient opportunity to make the election. [Schedule 1, subitems 118(10) and (11)]

2.212 If an election is made, the amendments described in this explanatory memorandum are to be disregarded when applying the law to such interests. This optional transitional rule provides for continuity in private sector decision-making and allows issuers sufficient time to redeem issued instruments in an orderly manner. [Schedule 1, subitem 118(6)]

2.213 The election needs to be in writing and is irrevocable. It must provide the specified information.

2.214 To avoid streaming, an election must cover all interests issued by the company which are substantially identical. [Schedule 1, subitem 118(10)]

Chapter 3
Other applications of the debt/equity test

Outline of chapter 3.1 This chapter describes the other places in the income tax law where the new debt and equity definitions are used.

Detailed explanation of new law Where are the new debt and equity definitions used in the income tax law? 3.2 The new definition of a debt interest is intended to be used in the proposed new thin capitalisation regime (see paragraph 3.23). However, this bill does not purport generally to extend the new definition elsewhere in the income tax law.

3.3 The new definition of equity interests and related concepts of equity holders and non-share dividends are generally used in all the provisions of the income tax law dealing with the taxation of returns on financing instruments, including the imputation provisions. However, because non-share equity interests are rarely relevant in determining ownership of companies, the new definition and its related concepts are not used in provisions relating to the ownership of companies, including:

* provisions governing the transfer and use of losses;

* grouping concessions (e.g. the provision of the intercorporate dividend for unfranked dividends paid within a company group);

* the definition of public and private companies;

* the CFC and FIF provisions; and

* sections 23AJ, 23AI and 23AK of the ITAA 1936.

3.4 An exception is made in relation to co-operative companies that are eligible for tax concessions under Division 9 of Part III of the ITAA 1936. These companies are not required to frank non-share dividends, and will not lose their concessional tax treatment merely by issuing non-share equity interests. [Schedule 1, item 94, paragraph (ga) of the definition of `frankable dividend' in section 160APA]

3.5 Tables 3.1 and 3.2 summarise the provisions of the income tax law where the new definition of equity interest and its related concepts apply. Provisions dealing with international taxation to which the new debt/equity rules apply are discussed immediately after the tables.

Table 3.1: Provisions of the ITAA 1936 to which the new definition of equity interest and its related concepts apply

Provisions in the ITAA 1936 (and bill reference)

What the provisions are about

Comments

Subsection 6(1) (paragraph (b) of the definition of income from personal exertion)

[Schedule 1, item 38]

Excludes certain types of income from the definition of income from personal exertion.

The definition will exclude non-share dividends in the same way it excludes dividends.

Subsection 6(1) (definition of paid)

[Schedule 1, item 45]

Amounts credited or distributed in relation to dividends.

The definition will apply to non-share dividends in the same way it applies to dividends.

Section 6AB

[Schedule 1, item 47, subsection 6AB(5B)]

Identifies both the foreign income and foreign tax to which Australia's foreign tax credit system applies.

The section will apply to non-share dividends in the way it applies to dividends.

Section 6AC

[Schedule 1, item 48, subsection 6AC(7)]

Facilitates the operation of Australia's foreign tax credit system via a gross-up mechanism.

The section will apply to non-share dividends in the same way as it applies to dividends.

Section 6B

[Schedule 1, item 49, subsection 6B(4)]

Where a person indirectly receives dividend income, that person is taken to have received income attributable to a dividend.

The section will apply to non-share equity interests, equity holders and non-share dividends in the same way it applies to shares, shareholders and dividends.

Section 6BA

[Schedule 1, item 50, subsection 6BA(7)]

Contains rules for the tax treatment of bonus shares.

The section will apply to non-share equity interests, equity holders and non-share dividends in the same way it applies to shares, shareholders and dividends.

Subparagraph 23(jb)(ii)

[Schedule 1, item 51, subparagraph 23(jb)(ii)]

Generally, exempts from income tax dividend income paid by resident companies to foreign superannuation funds.

The exemption applies to non-share dividends in the same way it applies to dividends.

Subparagraph 26(e)(iii)

[Schedule 1, item 52, subparagraph 26(e)(iii)]

Deemed dividends received in respect of a taxpayer's employment are not assessable income.

The exemption applies to non-share dividends in the same way it applies to dividends.

Section 26A

[Schedule 1, item 53, subsection 26A(2)]

Assessable income will include the repayment of tax paid abroad in respect of dividends.

The section applies to non-share dividends in the same way it applies to dividends.

Subsection 27A(1), subparagraph (a)(v) of the definition of eligible termination payment

[Schedule 1, item 54, subsection 27A(1)]

A deemed dividend payment to a taxpayer is excluded as an eligible termination payment.

The section applies to exclude non-share dividends as an eligible termination payment in the same way it applies to dividends.

Subsection 27A(5)

[Schedule 1, item 55, subsection 27A(5)]

Dividends to a dependent not an eligible termination payment.

The section will apply to non-share equity dividends in the same way it applies to dividends.

Subdivision D of Division 2 of Part III (except section 47A)

[Schedule 1, item 56, section 43B]

Provides for liability to taxation in respect of dividends paid by companies.

The Subdivision applies to include a liability to taxation for non-share dividends paid by a company in the same way it applies to dividends.

Section 50

[Schedule 1, item 65, subsection 50(2)]

Where assessable income is derived from more than one class of income, the section applies to allowable deductions.

The section applies to non-share dividends in the same way it applies to dividends.

Section 52A

[Schedule 1, item 66, subsection 52A(9)]

Anti-avoidance provision applying to `prescribed property' and schemes that take advantage of deductibility.

The section applies to non-share equity interests in the same way it applies to shares.

Division 7 of Part III

[Schedule 1, item 79, section 102V]

Deemed dividends of private companies.

Generally, the provisions apply to non-share dividends in the same way they apply to dividends. The exception is section 103A (which deals with the definition of a private company).

Division 7A of Part III

[Schedule 1, items 80 and 81, section 109BA]

Deemed dividends of private companies.

The Division applies to non-share equity interests in private companies in the same way it applies to shares.

Division 16K, Part III

[Schedule 1, item 87, section 159GZZZIA]

Provides for the tax consequences of share buybacks.

The Division applies to non-share equity interests in the same way it applies to shares.

Part IIIAA

[Schedule 1, item 93, section 160AOA]

Imputation of company tax to shareholders by way of franking credits.

Generally the imputation provisions apply to non-share equity interests, equity holders and non-share dividends in the same way as they apply to shares, shareholders and dividends.

Section 177E

[Schedule 1, item 103, subsection 177E(2A)]

Dividend stripping schemes.

The section applies to non-share dividends in the same way it applies to dividends.

Section 177EA

[Schedule 1, item 104, subsection 177EA(11A)]

Franking credit trading schemes involving the issue of a share and a non-incidental purpose of providing franking benefits.

The section applies to schemes involving non-share equity interests in the same way it applies to shares.

Section 202D

[Schedule 1, item 106, subsection 202D(1A)]

Lists the Part VA investments for which a quotation of tax file number is required. This includes shares in a company.

The section applies to non-share equity interests and equity holders in the same way it applies to shares and shareholders.

Division 3B of Part VI

[Schedule 1, item 107, section 221YHZAA]

Deals with the collection of tax in respect of certain payments.

The Division applies to non-share equity interests in the same way it applies to shares.

Division 4 of Part VI

[Schedule 1, item 108, section 221YJA]

Deals with the collection of withholding tax.

The Division applies to non-share dividends in the same way it applies to dividends.

Section 273

[Schedule 1, item 110, subsection 273(9)]

Excludes certain classes of income (special income) from concessional treatment in respect of superannuation.

The section applies to non-share equity interests, equity holders, and non-share dividends in the same way it applies to shares, shareholders and dividends.

Section 245-25 in Schedule 2C

[Schedule 1, item 114, subsection 245-25(4) in Schedule 2C]

Determines what constitutes a commercial debt.

The section applies so that a non-equity share issued by a company to the shareholder may be a commercial debt.

Section 272-50 in Schedule 2F

[Schedule 1, item 116, subsection 272-50(3) in Schedule 2F]

Outlines what is a company distribution to a shareholder under the trust loss measures.

The section applies so that a non-share capital return made by a company to a shareholder is considered a distribution.

Table
Back to Top

3.2: Provisions of the TAA 1953 to which the new definition of equity interest and its related concepts apply

Provisions in the TAA 1953 (and bill reference)

What the provisions are about

Comments

Division 12 of Schedule 1

[Schedule 1, item 117, section 12-20]

Relates to payments from which amounts must be withheld.

The Division applies so that non-share dividends are treated in the same manner for PAYG purposes as dividends.

Also applies in relation to regulations relevant to Division 12 (Divisions 3 and 4 of Part 5 of the Tax Administration Regulations 1976).

Application of debt/equity concepts to provisions relating to international taxation How do the debt/equity rules apply to the withholding taxes? 3.6 The debt/equity concepts apply to Division 11A of Part III of the ITAA 1936. This Division imposes a withholding tax on Australian sourced dividends, interest and royalties paid to non-residents. However, sections 128AE, 128F, 128J and 128K of the ITAA 1936 are specifically excluded from the application of the debt/equity concepts because relevant references in these sections relate to levels of ownership rather than the taxation treatment of a payment from the payer's and recipient's points of view. [Schedule 1, item 82, section 128AAA]

3.7 For the purpose of determining the boundary between interest and dividend withholding tax, interest (as defined in subsection 128A(1AB) of the ITAA 1936) includes an amount that is a dividend paid in respect of a non-equity share (see paragraph 2.16 for an explanation of what is a non-equity share as defined in subsection 6(1)) [Schedule 1, item 84, paragraph 128A(1AB)(d)]. For consistency, the definition of dividend does not include a dividend paid in respect of a non-equity share. [Schedule 1, item 83, paragraph 128A(1)(b)]. This ensures that interest withholding tax applies to these dividends, rather than dividend withholding tax.

3.8 A non-share dividend (generally a distribution or crediting of an amount in respect of a non-share equity interest) is now potentially subject to dividend withholding tax [Schedule 1, item 82, paragraph 128AAA(1)(c)]. Previously, such amounts may have been subject to interest (or less commonly, royalty) withholding tax. To the extent to which an amount is a return on an equity interest, neither interest nor royalty withholding tax will apply. [Schedule 1, item 84, subsection 128A(1AB); item 85, subsection 128B(2D)]

What is the effect of the debt/equity rules on the foreign dividend account system? 3.9 Division 11A, which applies to a non-share dividend in the same way as it applies to a dividend, also provides the rules for the operation of FDA [Schedule 1, item 82, paragraph 128AAA(1)(c)]. The practical effect of the debt/equity rules on the FDA system is in relation to the payment of dividends to non-residents out of the FDA. A return on an equity interest may be a dividend or a non-share dividend within the meaning of subsection 6(1) of the ITAA 1936 and this applies for FDA purposes where a resident company makes an FDA declaration in relation to a dividend or non-share dividend paid.

3.10 With regard to the receipt of a qualifying foreign source dividend by a resident company, although the expanded meaning of dividend applies, it is either the receipt of a non-portfolio dividend (within the meaning of section 317 of the ITAA 1936) or a dividend from a related company (within the meaning of subsection 51AE(16) of the ITAA 1936) that may result in a credit to the FDA. As the expanded meaning of dividend does not apply to a non-portfolio dividend, in practice the types of non-share dividends received

Back to Top

by a resident company that may qualify for a FDA credit will only be non-share dividends paid to a resident company by a related company where a FDA debit arises for the paying company.

How do the debt/equity rules apply to the foreign tax credit system? 3.11 Division 18 of Part III of the ITAA 1936 provides a credit for foreign tax paid in respect of foreign income that is included in the assessable income of an Australian resident. The debt/equity rules apply to sections 160AE, 160AEA, 160AF, 160AFAA and 160AFD of the Division. The application of the debt/equity concepts is not extended to the remaining sections of the Division because relevant references in these sections relate to levels of ownership rather than the taxation treatment of a payment from the payer's and recipient's points of view. [Schedule 1, item 90, section 160ADB]

3.12 Currently, where an Australian company receives a non-portfolio dividend from a related foreign company it is allowed a foreign tax credit for foreign underlying tax paid on profits by the foreign company. A basic premise of this treatment is that the foreign tax is paid on the pool of profits from which the dividends are drawn and as a result the Australian company is paying tax on both. Therefore, this treatment ensures relief from double tax on non-portfolio dividends.

3.13 However, the credit will not be extended to non-share dividends. Typically non-share dividends have the legal form of interest payments and are deducted in calculating profits. An equity interest that distributes a non-share dividend does not necessarily carry the requisite voting rights for the companies to be related. This treatment is consistent with the exemption of certain non-portfolio dividends paid to a resident company, under section 23AJ of the ITAA 1936. The application of the debt/equity rules does not extend to the exemption provided in section 23AJ because whether a dividend qualifies for the section 23AJ exemption ultimately depends on whether the recipient and paying companies are related.

3.14 In ascertaining the `baskets' of foreign income, the debt/equity rules will determine the boundary between `interest' and `dividend'. The treatment of a non-share dividend will be the same as a dividend [Schedule 1, item 47, subsection 6AB(5B); item 48, subsection 6AC(7); item 90, paragraph 160ADB(1)(c); item 92, paragraph 160AE(4)(b)]. Interest will not include a return on an equity interest (which also impacts on the quarantining rules for foreign losses where interest income is a separate class of foreign income) [Schedule 1, item 91, paragraph 160AE(3)(da)].

What effect will the debt/equity rules have on the accruals regime? 3.15 The accruals measures have been carved out from the application of the debt/equity rules as the proposed foreign source income review will address the implications of this and other measures. The review was foreshadowed in A Tax System Redesigned and on 22 March 2001, Treasurer's Press Release No. 16 reiterated the Government's support.

3.16 Consistent with the intention of the carve out, this bill makes amendments which have the effect of ensuring that the accruals measures continue to operate as if the debt/equity rules were not implemented. This is achieved by ensuring that the debt/equity concepts contained in Division 974 do not apply for the purposes of:

* calculating the net income of a non-resident trust estate for the purposes of attribution where the trust is covered by Division 6 of the ITAA 1936 or the transferor trust provisions; and

* calculating the attributable income of an eligible CFC in Part X of the ITAA 1936, or in determining the foreign investment fund income by the calculation method in Part XI of the ITAA 1936.

3.17 However, Division 974 does not contain all the amendments giving effect to the debt/equity rules. Therefore, it is necessary to carve out the operation of provisions which are dependent on expressions implemented in Division 974 when applying the accruals measures. [Schedule 1, item 71, subsection 96C(5A); item 72, subsection 102AAW(2); item 111, section 389A; item 113, section 557A]

3.18 For example, one of the basic assumptions in the calculation of the attributable income of a CFC is that the CFC is treated as though it is a resident. Therefore, the operation of provisions such as subsection 44(1) of the ITAA 1936 is imported to calculate attributable income. Currently subsection 44(1) refers to dividends within the meaning of subsection 6(1), however, the debt/equity rules will amend subsection 44(1) to include non-share dividends in the assessable income of a resident shareholder. The intention of the carve out is that the operation of the amended provision be ignored to the extent that it depends on the debt/equity rules.

3.19 Another example of ensuring that the accruals measures continue to operate as if the debt/equity rules were not implemented is the retention of Division 3A of Part III of the ITAA 1936. However, Division 3A will be limited to providing a definition of convertible note and to the calculation of attributable income of a CFC for the purposes of Part X of the ITAA 1936.

Back to Top

[Schedule 1, item 67, section 82LA; item 112, section 398A]

3.20 This treatment for the accruals regime is also consistent with the exemption of certain amounts paid out of previously attributed CFC income (section 23AI of the ITAA 1936) and previously attributed FIF income (section 23AK of the ITAA 1936). The application of the debt/equity rules does not extend to these exemptions as they rely on terms defined as part of the CFC and FIF regimes, respectively.

Application of the new debt/equity rules to public trading trusts and corporate unit trusts 3.21 Certain unit trusts are taxed in an equivalent way to companies. These are public trading trusts and corporate unit trusts identified in Divisions 6B and 6C of Part III of the ITAA 1936.

3.22 The new debt/equity rules apply in relation to these trusts in an equivalent way to how they apply to companies. [Schedule 1, item 74, paragraph 102L(2)(c); items 75 and 77, paragraph 102T(2)(c); items 78 and 102, Division 7A of Part IIIA Subdivision CA]

Application of the new debt/equity rules to the proposed thin capitalisation regime? 3.23 The debt/equity rules apply in determining the extent to which deductions may be disallowed under the proposed thin capitalisation regime. Under the proposed regime it is necessary to determine the debt capital of an entity and the debt deductions in relation to that capital. An arrangement will constitute debt capital of an entity if it satisfies the debt test and it is on issue. The proposed thin capitalisation regime is discussed in the explanatory memorandum to the New Business Tax System (Thin Capitalisation) Bill 2001.

Consequential amendments 3.24 There are a number of consequential amendments arising from the new debt and equity rules. These are explained in paragraphs 3.25 to 3.45.

Amendments to provisions relating to the intercorporate dividend rebate 3.25 Under the current law, dividend on shares that are equivalent to interest on a loan do not provide an entitlement to the intercorporate dividend rebate under section 46D of the ITAA 1936. This is because such dividends are more appropriately characterised as returns on debt then as returns on equity. For the same reason dividends on shares which satisfy the debt test (non-equity shares) are not eligible for the intercoproate dividend rebate, whether received directly or indirectly through a trust or partnership. [Schedule 1, item 61, subsection 45Z(1A); item 62, subsection 46(1); item 63, subsection 46A(1)]

3.26 Similarly, no intercorporate dividend rebate is available for dividend-equivalent payments (unit trust dividends) by corporate unit trusts or public trading trusts taxed like companies if such payments are made in respect of units in the trust that satisfy the debt test. [Schedule 1, item 74, paragraph 102L(2)(c); item 77, paragraph 102T(2)(c)]

Amendments to the imputation provisions 3.27 Minor consequential amendments are made to the imputation provisions in Part IIIAA of the ITAA 1936 to ensure that non-share dividends are generally frankable and that dividends on shares satisfying the debt test (`non-equity shares') are not. The consequential amendments also clarify that non-equity shares will constitute finance shares for the purposes of Part IIIAA and that dividends on them will not be frankable. [Schedule 1, items 94, 96, 99 and 100]

Amendments to the capital gains provisions 3.28 Certain provisions relating to capital gains and losses will be amended as a consequence of the new debt/equity rules. These relate to:

* cost base rules for convertible notes and certain rights; and

* exclusions from CGT events D1 (about creating contractual or other rights) and H2 (about receipts for an event relating to a CGT asset).

3.29 Amendments to be included in a later bill will include those to other CGT provisions, if any, that are identified as being necessary as a consequence of the new debt/equity rules.

Exclusions from CGT events D1 and H2 3.30 Presently, borrowings and the issue or allotment of shares are expressly excluded from CGT events D1 and H2 where they might otherwise result in the proceeds being, inappropriately, subject to CGT. Similarly, the grant of an option to acquire shares or debentures is excluded from these CGT events.

3.31 To prevent the inappropriate application of CGT, the creation of non-share equity interests, and the granting of options to acquire such interests, are to

Back to Top

be brought within the scope of these exclusions. This will be achieved by referring to the broader concept of equity interests rather than shares in the relevant provisions. [Schedule 1, items 7 to 10]

3.32 Shares that are acquired other than as a result of a CGT event (i.e. because the holder subscribed to the issue of the shares) are acquired at the earlier of when the shares are issued or allotted, or when a contract to do so is entered into.

3.33 The same rule will apply to the acquisition of non-share equity interests. This will be achieved by referring to the broader concept of equity interests rather than shares in the relevant provisions. [Schedule 1, item 11, section 109-10, item 2 in the table]

3.34 These amendments to the CGT event and acquisition provisions will apply to equity interests issued or allotted on or after 1 July 2001, and to options to acquire such interests granted on or after that date. [Schedule 1, subitem 118(3)]

Convertible notes and certain rights 3.35 The definition of convertible note in section 82L of the ITAA 1936 is being replaced, except for the purposes of calculating the attributable income of a CFC, by the concept of convertible interest. Therefore, the CGT rules that provide cost base calculations for shares acquired as a result of converting a convertible note or exercise of an option need to be consistent with the new terminology. [Schedule 1, items 5, 6 and 12 to 17; Schedule 2, item 5, definition of `convertible interest' in subsection 995-1(1)]

3.36 In addition, certain options that fall within the current section 82L definition of convertible note may not be a convertible interest according to the new concept. For example, a company that issues an option, that is within the section 82L meaning, allowing the holder to have shares issued to them on its exercise may not be the company who issues shares to the option holder. That is, another company may actually issue those shares to the taxpayer. If that other company is unrelated to the company that issued the option then the option will fall outside the definition of a convertible interest. As a result the exercise of certain options may now fall within Subdivision 130-B (dealing with shares etc acquired on exercise of an option) and no longer in Subdivision 130-C (dealing with shares and etc acquired on conversion of a convertible interest). Therefore, consequential amendments are made to both Subdivisions 130-B and 130-C of Part 3-1 of the ITAA 1997.

3.37 The consequential amendments will replace the existing cost base and reduced cost base calculations with a standard calculation. The following comments on the amendments to those Subdivisions apply equally to both the cost base and reduced cost base of an asset acquired on exercise of an option or conversion of an interest. [Schedule 1, items 18 to 32]

3.38 For options or convertible interests that fall within Subdivisions 130-B and 130-C, the first element of the cost base (acquisition cost) of the shares acquired on exercise of the option or conversion of the interest will be equal to the cost base of the option or convertible interest. This acquisition cost will be increased with amounts that have reduced a capital gain the taxpayer has made from either the exercise or conversion. This is so even though the capital gain is disregarded under those Subdivisions. This is achieved by providing a direct link to section 118-20 of the ITAA 1997. This section avoids double taxation, as a capital gain made from a CGT event is reduced under this section to take account of any other provisions that include an amount in assessable or exempt income.

3.39 Subdivisions 130-B and 130-C do not require a capital gain to be realised on exercise of a right or conversion of a convertible interest, deferring the realisation of a capital gain to the final disposal of the share. Because of this, section 118-20 is unable to reach back to the right or convertible interest before it was converted into a share. This is because section 118-20, in working out the capital gain to be realised on sale of the share, only takes account of any other provision that includes an amount in assessable or exempt income because of the CGT event happening to the share, and not because of the right or convertible interest. Therefore, specific links are needed within those Subdivisions to section 118-20 to take into account amounts included in assessable income or exempt income because of a CGT event happening to the right or convertible interest. This avoids double taxation on that final disposal of the share.

Example 3.1: Cost base of a share acquired on conversion of a convertible interest.

A taxpayer in year 1 acquires on issue a convertible interest for $84, which has a face value of $100. The interest is acquired on 1 July 2000. The interest is a qualifying security subject to Division 16E of the ITAA 1936.

The convertible interest has a term of 5 years. In each of those years the taxpayer will receive $5 interest income.

As the taxpayer acquired the interest at a $16 discount ($100 face value for a purchase price of $84), subsection 159GQ(2) of the ITAA 1936 would include $1.98 in year 1 and $3.09 in year 2 in the taxpayer's assessable income as an accrued gain.


Back to Top

At the beginning of year 3, the taxpayer converts the interest into a share with a market value of $110.

Section 159GS of the ITAA 1936 will include in the taxpayer's assessable income a net profit on the interest of $19.93. This is calculated as $110 less $84 (cost) and $1.98 and $3.09 accrued gain already included in the taxpayer's assessable income under subsection 159GQ(2).

The amendments to Subdivisions 130-B and 130-C will avoid double taxation occurring on the eventual sale of the share by working out the first element of the cost base of the share as a sum of the cost base of the convertible interest at the time of conversion and any amount that has reduced a capital gain made on the convertible interest.

The conversion of the interest leads to the taxpayer making a capital gain (even though the capital gain is disregarded). Subsection 118-20(1) of the ITAA 1997 reduces that capital gain by the section 159GS amount being the $19.93 net profit.

Subsection 118-20(1A) of the ITAA 1997 will also reduce the capital gain by the subsection 159GQ(2) amounts being the $6.07 accrued annual gain.

As a result, the first element of the cost base of the share would be $110. This being the sum of the $84 purchase price of the convertible interest (assuming this is the cost base of the interest at the time of conversion) plus the $19.93 net profit and $6.07 of accrued annual gain.

The $5 interest the taxpayer received annually on the convertible interest does not form part of the cost base of the share. This is because section 118-20 does not reduce the capital gain by those amounts.

If the taxpayer then sells the share for $120, the taxpayer will have a capital gain of $10, being the difference between the cost base (assuming it is still $110) and the capital proceeds of $120. This is the correct outcome.

In the absence of a link to section 118-20 of the ITAA 1997 in Subdivisions 130-B and 130-C of that Act, the taxpayer would have a first element of the cost base of only $84, being the purchase price of the convertible interest assuming the taxpayer did not pay anything for conversion. If the taxpayer sells the share for $120, the taxpayer would have a capital gain of $36.

The taxpayer would be assessed twice on an amount of $26 due to $19.93 of the $36 capital gain already having been included in their assessable income under section 159GS of the ITAA 1997 and another $6.07 of accrued gain under subsection 159GQ(2).

Amounts deducted 3.40 By referencing the first element of the cost base of the share to the cost base of the right or convertible interest at the time of its exercise or conversion, an amount in respect of the cost base that is deductible to the taxpayer would reduce that cost base before it is incorporated into the first element of the cost base of the share. Division 110 of the ITAA 1997 determines which amounts do not form part of a cost base or reduce that cost base. [Schedule 1, items 21 and 27]

Application provisions for capital gains amendments 3.41 There is an application provision for rights issued to a taxpayer because they own a convertible note that was acquired before 20 September 1985. The application provision provides consistent treatment for such a right that is exercised under Subdivision 130-B as that for a right issued to a taxpayer because the taxpayer owned a convertible interest that was acquired before 20 September 1985. [Schedule 1, subitem 118(5)]

3.42 The amendments to Subdivision 130-B and 130-C will apply to the exercise of a right or conversion of a convertible interest after 30 June 2001. [Schedule 1, subitem 118(4)]

Miscellaneous consequential amendments 3.43 The new debt/equity rules supersede the debt dividend provision in section 46D of the ITAA 1936. Section 46D is therefore repealed. [Schedule 1, item 64]

3.44 This provision continues to operate, however, in relation to interests for which an election described in paragraph 2.211 is made. [Schedule 1, subitem 118(6)]

3.45 The convertible note provisions in Division 3A of Part III of the ITAA 1936 do not apply to returns paid on or after 1 July 2001 unless an election is made for the current law to continue to apply in relation to particular interests (see paragraph 2.211). However, the provisions continue to have a residual operation for the purposes of calculating an eligible CFC's attributable income for the purposes of Part X of the ITAA 1936 and for providing a definition of convertible note. [Schedule 1, items 67 to 69, section 82LA and subsection 82L(1)]

Chapter 4
Mechanics of the non-share capital account

Outline of chapter

Back to Top

4.1 This chapter explains the operation of the non-share capital account which records contributions to the company in relation to non-share equity interests that are issued by the company and also records returns made by the company in relation to those contributions.

Detailed explanation of new law The non-share capital account 4.2 As mentioned in paragraph 2.71, capital raised from the issue of non-share equity interests is recorded in the company's non-share capital account. This allows non-share distributions to be characterised as a non-share dividend or a non-share capital return. [Schedule 1, item 33, section 164-5]

4.3 The non-share capital account is credited with consideration received by the company for the issue of non-share equity interests. Ordinarily the consideration received will be money. However, it may also be property or services, in which case the amount credited to the non-share capital account will be its market value at the time it is provided. [Schedule 1, item 33, section 164-15]

4.4 The crediting occurs at the time the amount is received. Thus, if a partly paid non-share equity interest is issued, the non-share capital account is credited by the amount paid at the time of issue and then, if a call for the unpaid amount is subsequently made, it is credited with the amount called and received at that subsequent time.

4.5 To prevent the same amount being credited to both a non-share capital account and a share capital account, a credit to the former is reduced to the extent of a credit to the latter. For example, if a company credits its share capital account with an amount when it issues a stapled security comprising a share and a note, the non-share capital account will not be credited with the same amount. [Schedule 1, item 33, subsection 164-15(1)]

4.6 The non-share capital account is also credited with capital raised from the issue of non-share equity interests before the commencement of these measures (i.e. 1 July 2001), provided they are still in existence at that date. Some issuers may elect that the new measures not apply to certain non-share equity interests until 1 July 2004 (see paragraphs 2.210 to 2.214). These interests have to be in existence on 1 July 2004 if they are to cause a credit to the non-share capital account. [Schedule 1, item 33, subsection 164-15(2) and subitem 118(9)]

4.7 Credits also can arise if a debt interest becomes an equity interest because of a material change (see paragraphs 2.129 to 2.134). Conversely, a debit arises if an equity interest becomes a debt interest because of a material change. [Schedule 1, item 33, subsections 164-15(2) and 164-20(3)]

4.8 If a company makes a distribution as consideration for the surrender, redemption or cancellation of a non-share equity interest, it may debit its non-share capital account to the extent of the surrender, cancellation or redemption. The company may also debit its non-share capital account to the extent to which a distribution is made in connection with a reduction in the market value of a non-share equity interest and the distribution is equal in amount to that reduction. This will ordinarily result in the distribution being treated as capital in the non-share equity holder's hands (see paragraphs 2.75 to 2.78). The total debits to the non-share capital account in respect of a particular equity interest cannot exceed the total credits made in respect of that interest. [Schedule 1, item 33, subsections 164-20(1) and (2)]

4.9 Because the non-share capital account is a construct of the tax law and the only credits that may be made to it are legislatively defined, the rules applying to share capital accounts in relation to their so-called tainting (i.e. the crediting to a share capital account of amounts other than share capital) are not required. [Schedule 1, item 33, subsection 164-10(4)]

Chapter 5
Regulation impact statement

Policy objective The objectives of the New Business Tax System 5.1 The measures in this bill are part of the Government's broad ranging reforms which will give Australia a New Business Tax System. The reforms are based on the recommendations of the Review of Business Taxation, instituted by the Government to consider reform of Australia's business tax system.

5.2 The Government instituted the Review of Business Taxation to consult on its plan to comprehensively reform the business income tax system, as outlined in ANTS. The Review of Business Taxation's recommendations were designed to achieve a simpler, stable and durable business tax system.


Back to Top

5.3 The New Business Tax System is designed to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings, as well as providing a sustainable revenue base so the Government can continue to deliver services to the community.

5.4 The New Business Tax System also seeks to provide a basis for more robust investment decisions. This is achieved by:

* using consistent and clearly articulated principles;

* improving simplicity and transparency;

* reducing the cost of compliance through principled tax laws that are easier to understand and comply with; and

* providing fairer and more equitable outcomes.

5.5 This bill is part of the legislative program implementing the New Business Tax System. Other bills have been introduced and passed already and are summarised in Table 5.1.

Table 5.1: Earlier business tax legislation

Legislation

Status

New Business Tax System (Integrity and Other Measures) Act 1999

Received Royal Assent on 10 December 1999.

New Business Tax System (Capital Allowances) Act 1999

Received Royal Assent on 10 December 1999.

New Business Tax System (Income Tax Rates) Act (No. 1) 1999

Received Royal Assent on 10 December 1999.

New Business Tax System (Former Subsidiary Tax Imposition) Act 1999

Received Royal Assent on 10 December 1999.

New Business Tax System (Capital Gains Tax) Act 1999

Received Royal Assent on 10 December 1999.

New Business Tax System (Income Tax Rates) Act (No. 2) 1999

Received Royal Assent on 10 December 1999.

New Business Tax System (Venture Capital Deficit Tax) Bill 1999

Received Royal Assent on 22 June 2000.

New Business Tax System (Miscellaneous) Bill 1999

Received Royal Assent on 30 June 2000.

New Business Tax System (Miscellaneous) Bill (No. 2) 2000

Received Royal Assent on 30 June 2000.

New Business Tax System (Integrity Measures) Bill 2000

Received Royal Assent on 30 June 2000.

New Business Tax System (Alienation of Personal Services Income) Bill 2000

Received Royal Assent on 30 June 2000.

New Business Tax System (Alienated Personal Services Income) Tax Imposition Bill (No. 1) 2000

Received Royal Assent on 30 June 2000.

New Business Tax System (Alienated Personal Services Income) Tax Imposition Bill (No. 2) 2000

Received Royal Assent on 30 June 2000.

New Business Tax System (Simplified Tax System) Bill 2000

Introduced into the Parliament on 7 December 2000.

New Business Tax System (Capital Allowances) Bill 2001

Introduced into the Parliament on 24 May 2001.

New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001

Introduced into the Parliament on 24 May 2001.


Back to Top

The objectives of measures in this bill 5.6 The New Business Tax System will contribute to the fairness and equity of the tax system. It will also enhance Australia's competitiveness through lower company and capital gains tax rates, and reduced compliance costs.

5.7 More particularly, the debt/equity rules contained in this bill provide a new approach for determining whether a financing arrangement is debt or equity for certain tax purposes. This new approach seeks to minimise uncertainty and provide a more coherent, substance-based test which is less reliant on the legal form of a particular arrangement than is the case under the current law. The debt/equity rules also enable the removal of a number of rules under the current law.

5.8 By paying greater regard to the economic substance of a transaction than the current legal form-based approach, the new approach prevents arrangements that mischaracterise an in-substance equity interest as debt. This type of mischaracterisation could allow inappropriate tax deductions for the issuer through `deductible equity' (i.e. in-substance equity providing returns which are tax deductible as if they were interest payments rather than frankable in the same way as dividends), and an undermining of the imputation system by allowing returns that are equivalent in economic substance to have different imputation tax consequences. Allowing returns which are equivalent in economic substance to have different imputation tax consequences could facilitate the streaming of franking credits.

5.9 Another objective of paying greater regard to the economic substance of a transaction is to prevent the use of the legal form of arrangements to mischaracterise a debt interest as an equity interest, resulting in the inappropriate franking of debt-like returns, or companies circumventing the proposed new thin capitalisation measures.

Implementation options 5.10 The majority of the measures in this bill arise directly from recommendations of the Review of Business Taxation. Those recommendations were the subject of extensive consultation. The implementation options for these measures can be found in Chapter 7 of A Platform for Consultation (pages 200-202) and recommendations 12.10 and 12.11 of A Tax System Redesigned (pages 442-448).

5.11 The transitional rules to allow issuers of financial instruments to elect to have the current law apply to existing interests until 1 July 2004 provides an appropriate balance between, on the one hand, ensuring that the measures have consistent application to all issuers relatively quickly and, on the other hand, allowing for continuity in private sector decision-making and providing issuers sufficient time to redeem instruments in an orderly manner.

Assessment of impacts 5.12 The potential compliance, administrative and economic impacts of the measures in this bill have been carefully considered, both by the Government, the Review of Business Taxation and the business sector. The Review of Business Taxation focused on the economy as a whole in assessing the impacts of its recommendations and concluded that there would be net gains to business, government and the community generally from business tax reform. Submissions received during consultation did not indicate significant concerns about compliance issues.

Impact group identification 5.13 Financial institutions, as the predominant issuers of hybrid instruments, will need to familiarise themselves with the impact that debt/equity re-characterisation may have on their operations.

5.14 As issuers of hybrid instruments, life insurers and general insurers will be impacted although to a lesser degree than financial institutions. As investors, these companies are substantial users of these instruments.

5.15 Large/medium business, to the extent that they issue these instruments, will need to understand the re-characterisation issues.

5.16 Superannuation funds, large/medium business, small business, and individuals will be impacted to the extent that they invest in hybrids. The re-characterisation issues will have minimal impact on these entities.

5.17 Non-resident investors in debt/equity hybrid instruments will be impacted to the extent that the character of the returns on those instruments changes. The impact will be on the relevant withholding tax rate, which will be zero if the return is franked, and up to 30% if unfranked. The compliance impact for these investors is minimal.

5.18 Investors in hybrid instruments will also need to familiarise themselves with the new rules. However, issuers will generally advise investors of the tax treatment of the instruments and under the current law are required to notify recipients of the extent to which dividends are franked.

5.19 It is not possible to reliably estimate the number of instruments or issuers that will be affected by the changes. However, the number of issuers

Back to Top

who issue complex debt/equity hybrid instruments is relatively small.

Analysis of costs/benefits Compliance costs 5.20 As is standard with new measures, entities affected by them will need to incur a small cost in either familiarising themselves with the new law or having advisers familiarise themselves with the new law. However, the new debt test, relying as it does on a single organising principle, is more coherent, comprehensive and certain than the current law and therefore a small reduction in compliance costs could be expected for issuers on an on-going basis. Most issuers of hybrids have a sophisticated understanding of the tax law and have ready access to high level tax advice so that they would quickly and easily understand the changes to the law.

5.21 The majority of debt/equity hybrid issuers are large companies, including financial institutions, life insurers and general insurers. The new rules will predominantly impact upon their operations to the extent instruments they have issued change character from debt to equity or equity to debt. However, the taxation treatment of most debt/equity hybrids will remain unchanged under the new rules, resulting in no compliance cost either to the issuer or investor.

5.22 In addition the new law will allow issuers of interests issued before release of the exposure draft bill to elect to have the current law apply to them until 1 July 2004. This will require issuers to examine their position and determine whether or not to make an election. In making an election the issuer is required to provide to the Commissioner in writing details of the interest that is on issue. The required information should be readily available to the issuer and will involve minimal compliance costs to collate and provide it to the Commissioner.

5.23 It is anticipated that most issuers will make this election, hence few instruments will change character on 1 July 2001. This transitional election facilitates continuity in private sector decision making and allows issuers sufficient time to redeem instruments in an orderly manner. Companies that elect to have this 3 year grandfathering arrangement apply will have no compliance issues associated with the new rules.

5.24 However, the tax treatment of some interests will change under the new law, either because they are currently not frankable and may be deductible under the current law but will become frankable and non-deductible under the new law, or because they are currently frankable under the current law but may become deductible and non-frankable. The compliance implications of this change in tax treatment depend on the tax profiles of the issuers and holders, and whether the arrangements remain in place under the new law. However, any change from current compliance costs is unlikely to be significant and is a consequence of the overall tax system which differentiates debt from equity.

5.25 A change in the tax treatment of a return may cause some affected companies to incur minor costs in notifying investors of the change in the treatment of the return. These costs may involve preparing the information (for example, in conjunction with normal provision of payment details) and providing it to investors by way of correspondence or newspaper advertisements.

5.26 A change in the tax treatment of a return on an interest from being frankable to being deductible is unlikely to have any material impact on compliance costs. This is because issuers would simply claim a deduction in relation to the return instead of providing a dividend statement to the recipient indicating the extent to which it is franked. The recipient would then just include the return as assessable income without having to consider any franking consequences.

5.27 In the reverse case where a return ceases to be deductible but becomes frankable under the new law there is expected to be a minimal impact on compliance costs. Both issuers and investors would need to address the franking consequences of the return. However, companies already have systems in place to deal with the franking of dividends and those systems could equally be applied to the franking of other distributions. Investors in receipt of franked returns would treat them in exactly the same way as franked dividends and would be unlikely to incur additional compliance costs in doing so.

5.28 In the case of both possibilities, issuers of interests that change character as a result of the reforms have the option of refinancing so that they remain on their preferred side of the debt/equity borderline. That is, while the new measures do not require refinancing, some issuers may make a commercial decision to refinance to obtain a desired tax result. There will be a cost (which is difficult to estimate) to issuers associated with this refinancing; the cost will depend on a number of factors including the size, complexity, extent of underwriting and currency of the issue.

5.29 It is also very difficult to estimate the extent to which refinancing will occur as a result of the new measures. First, in the transitional period up to 1 July 2004 some affected issuers that elect to have the current law apply, may refinance or otherwise terminate their hybrids for reasons unrelated to the tax changes. Second, the measures facilitate a change of debt/equity treatment by a change to the terms of an interest so that it falls on the preferred side of the debt/equity borderline; this would obviate the need for a refinancing.

5.30 In addition, the systemic changes to the debt/equity borderline will

Back to Top

result in less reliance on specific anti-avoidance rules, with consequent compliance and administrative savings for both taxpayers and the ATO. In general, for issuers of straightforward debt and equity instruments, the compliance impacts of the new measures will be relatively minor.

Administration costs 5.31 The administrative impact on the ATO will be minimised as it is anticipated that most issuers of hybrid instruments will elect to maintain their current taxation treatment. The education needs of companies will be low, as most of these taxpayers are large sophisticated companies with ready access to taxation advice.

5.32 Issuers will, from a commercial standpoint, be required to tell their holders of changes to the character of returns. With regard to instruments that are equity instruments for tax law purposes the issuer will be required to notify the holder of any franking implications. However, the ATO will also have a responsibility to ensure that taxpayers are informed of changes affecting them. This could potentially impact across all business lines. However, the ATO response could be limited to checking that issuers are informing their holders. Since most companies will elect to have their current taxation treatment maintained, the administrative cost to the ATO of checking on the few issuers that are impacted by the new rules will be minimised.

Government revenue 5.33 The revenue impact of this measure is unquantifiable, although it will protect the revenue base from erosion from deductible returns on certain future financial instruments that are equity in economic substance but debt in legal form. To the extent that the revenue base is not protected, there could be a potential significant loss to annual revenue. The measures improve the integrity of the tax system and help to provide a sustainable revenue base by reducing the opportunity for tax arbitrage by taxing interests by reference to their economic substance rather than their legal form.

5.34 The taxation treatment of most current debt/equity hybrids will remain unchanged. However, the tax treatment of some interests will change, either because they are currently not frankable and may be deductible under the current law but will become frankable and non-deductible under the new law, or because they are currently frankable under the current law but may become deductible instead under the new law. The revenue implications of this change in tax treatment depend on the tax profiles of the issuers and holders, whether the issuers elect to apply the transitional arrangements provided by the measure, and whether the arrangements remain in place under the new law.

Economic benefits 5.35 The New Business Tax System will provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings. The economic benefits of these measures are explained in more detail in the publications of the Review of Business Taxation, particularly A Platform for Consultation and A Tax System Redesigned.

5.36 The measures in this bill will contribute to these broader economic goals by reducing uncertainty, improving the integrity of the tax system and helping to provide a sustainable revenue base. The debt/equity rules facilitate the effective pricing of financial arrangements through more coherent taxation laws improving the operation of the capital markets.

Other issues - consultation 5.37 The consultation process began with the release of ANTS in August 1998. The Government established the Review of Business Taxation in that month. Since then, the Review of Business Taxation has published 4 documents about business tax reform: in particular A Platform for Consultation and A Tax System Redesigned in which it canvassed options, discussed issues and sought public input.

5.38 Throughout that period, the Review of Business Taxation held numerous public seminars and focus group meetings with key stakeholders in the tax system. It received and analysed 376 submissions from the public about reform options. Further details are contained in paragraphs 11 to 16 of the Overview of A Tax System Redesigned.

5.39 In analysing options, the published documents frequently referred to, and were guided by, views expressed during the consultation process.

5.40 The measures in this bill have also been subject to extensive consultation since the Review of Business Taxation reported to Government. For example, the measures have been the subject of ongoing discussions with focus groups comprising representatives of large corporations in the main, including the banking industry and their advisers, and representatives of professional taxation bodies. In addition the measures were included with the proposed thin capitalisation rules in an exposure draft bill, on which there has been extensive consultation following submissions made by interested parties.


Back to Top

Conclusion and recommended option 5.41 The measures contained in this bill are expected to provide a net benefit to society as the economic benefits of certainty, integrity and sustainable revenue will exceed the costs. The measures should be adopted to support a more structurally sound business tax system as it applies to issuers of financial instruments. They are an integral part of the New Business Tax System.

Index

Schedule 1: Debt and equity interests

Bill reference

Paragraph number

Item 3, section 25-85

2.137

Item 3, subsections 25-85(3) and (4)

2.139

Item 4, section 26-26

2.83

Items 5 and 6

3.35

Items 7 to 10

3.31

Item 11, section 109-10, item 2 in the table

3.33

Items 12 to 17

3.35

Items 18 to 32

3.37

Items 21 and 27

3.40

Item 33, section 164-5

4.2

Item 33, section 164-10

2.71

Item 33, subsection 164-10(4)

4.9

Item 33, section 164-15

4.3

Item 33, subsection 164-15(1)

4.5

Item 33, subsection 164-15(2)

4.6

Item 33, subsections 164-15(2) and 164-20(3)

4.7

Item 33, subsections 164-20(1) and (2)

2.79, 4.8

Item 34, subsection 974-10(5)

2.148

Item 34, subsections 974-15(1) and (2)

2.149

Item 34, subsections 974-15(2) to (4)

2.161

Item 34, subsection 974-20(1)

2.150

Item 34, paragraph 974-20(1)(a)

2.124

Item 34, paragraph 974-20(1)(b)

2.163

Item 34, paragraph 974-20(1)(d)

2.196, 2.200

Item 34, subsections 974-20(2), (4) and (5)

2.166, 2.185

Item 34, subsection 974-20(3)

2.185

Item 34, subsection 974-20(6)

2.201

Item 34, subsection 974-25(1)

2.61, 2.154

Item 34, subsection 974-25(2)

2.152

Item 34, subsection 974-25(3)

2.153

Item 34, subsection 974-30(1)

2.188

Item 34, subsection 974-30(2)

2.186

Item 34, subsection 974-30(3)

2.184

Item 34, paragraph 974-35(1)(a)

2.191

Item 34, subparagraph 974-35(1)(a)(ii)

2.168

Item 34, subsection 974-35(2)

2.194

Item 34, subsection 974-35(2)

2.169

Item 34, subsection 974-35(3)

2.143

Item 34, subsection 974-35(4)

2.144

Item 34, subsection 974-35(5)

2.199

Item 34, subsection 974-35(6)

2.202

Item 34, section 974-40

2.145, 2.195

Item 34, section 974-45

2.145

Item 34, subsection 974-50(3)

2.169

Item 34, subsection 974-50(4)

2.170

Item 34, subsections 974-50(5) and (6)

2.171

Item 34, subsection 974-50(6)

2.173

Item 34, subsection 974-55(1)

2.155

Item 34, section 974-60

2.156

Item 34, subsection 974-65(1)

2.204

Item 34, subsection 974-65(2)

2.205

Item 34, subsection 974-70(1)

2.17, 2.58, 2.127

Item 34, paragraph 974-70(1)(b)

2.13, 2.38

Item 34, subsection 974-70(2)

2.51, 2.52, 2.55, 2.58

Item 34, subsection 974-70(3)

2.56

Item 34, subsection 974-70(4)

2.60

Item 34, subsection 974-75(1), item 1 in the table

2.23

Item 34, subsection 974-75(1), item 2 in the table

2.26, 2.27

Item 34, subsection 974-75(1), item 3 in the table

2.35

Item 34, subsection 974-75(1), item 4 in the table

2.37

Item 34, subsection 974-75(2)

2.5

Item 34, subsection 974-75(3)

2.25

Item 34, section 974-80

2.44

Item 34, paragraph 974-80(1)(c)

2.48

Item 34, subsection 974-80(2)

2.49

Item 34, paragraph 974-85(1)(a)

2.30

Item 34, paragraph 974-85(1)(b)

2.32

Item 34, subsection 974-85(2)

2.31, 2.33, 2.34

Item 34, section 974-90

2.36

Item 34, subsections 974-95(1) and (2)

2.19

Item 34, subsection 974-95(4)

2.18

Item 34, section 974-100

2.14

Item 34, section 974-105

2.57

Item 34, section 974-110

2.130

Item 34, subsection 974-110(1)

2.131

Item 34, subsection 974-110(2)

2.132

Item 34, subsection 974-110(3)

2.133

Item 34, section 974-115

2.75, 2.76

Item 34, section 974-120

2.75

Item 34, subsections 974-120(1) and (2)

2.77

Item 34, section 974-125

2.78

Item 34, section 974-130

2.6

Item 34, paragraph 974-130(1)(b)

2.11

Item 34, subsection 974-130(3)

2.8

Item 34, subsection 974-130(4)

2.10

Item 34, subparagraphs 974-130(4)(a)(i) and (ii)

2.125

Item 34, paragraph 974-130(4)(b)

2.125

Item 34, paragraph 974-130(4)(c)

2.125

Item 34, paragraph 974-130(4)(d)

2.125

Item 34, subsection 974-135(1)

2.177

Item 34, subsection 974-135(6)

2.179

Item 34, subsection 974-135(8)

2.182

Item 34, section 974-140

2.170

Item 34, section 974-145

2.170

Item 34, subsection 974-150(2)

2.22, 2.160

Item 34, subsection 974-150(3)

2.22

Item 34, subsection 974-155(2)

2.54

Item 34, paragraph 974-155(2)(a)

2.53

Item 34, section 974-160

2.187

Item 34, subsections 974-160(1) and (2)

2.164

Item 34, subsection 974-160(3)

2.173, 2.189

Item 34, section 974-165

2.39

Item 38

Table 3.1

Item 39, definition of `non-equity share' in subsection 6(1)

2.16

Item 45

Table 3.1

Item 47, subsection 6AB(5B)

3.14

Item 47, subsection 6AB(5B)

Table 3.1

Item 48, subsection 6AC(7)

3.14, Table 3.1

Item 49, subsection 6B(4)

Table 3.1

Item 50, subsection 6BA(7) of the ITAA 1936

2.123, Table 3.1

Item 51, subparagraph 23(jb)(ii)

Table 3.1

Item 52, subparagraph 26(e)(iii)

Table 3.1

Item 53, subsection 26A(2)

Table 3.1

Item 54, subsection 27A(1)

Table 3.1

Item 55, subsection 27A(5)

Table 3.1

Item 56, section 43B of the ITAA 1936

2.80, Table 3.1

Item 57, subsection 44(1) of the ITAA 1936

2.81

Items 57 to 60, 88 and 89

2.68

Items 58 to 60

2.80

Item 61, subsection 45Z(1A), item 62, subsection 46(1) and item 63, subsection 46A(1)

3.25

Item 64

3.43

Item 65, subsection 50(2)

Table 3.1

Item 66, subsection 52A(9)

Table 3.1

Item 67, section 82LA

3.19

Items 67 to 69, section 82LA and subsection 82L(1)

3.45

Item 71, subsection 96C(5A); item 72, subsection 102AAW(2)

3.17

Item 74, paragraph 102L(2)(c)

3.22, 3.26

Item 75

3.22

Item 77, paragraph 102T(2)(c)

3.22, 3.26

Item 78

3.22

Item 79, section 102V

Table 3.1

Items 80 and 81, section 109BA

Table 3.1

Item 82, section 128AAA

3.6

Item 82, paragraph 128AAA(1)(c)

3.8, 3.9

Item 83, paragraph 128A(1)(b)

3.7

Item 84, paragraph 128A(1AB)(d)

3.7

Item 84, subsection 128A(1AB); item 85, subsection 128B(2D)

3.8

Item 86, paragraph 128B(3)(aaa)

2.116

Item 87, section 159GZZZIA

Table 3.1

Item 90, section 160ADB

3.11

Item 90, paragraph 160ADB(1)(c)

3.14

Item 91, paragraph 160AE(3)(da)

3.14

Item 92, paragraph 160AE(4)(b)

3.14

Item 93, section 160AOA

2.72, Table 3.1

Item 94, paragraph (ga) of the definition of `frankable dividend' in section 160APA

3.4, 3.27

Item 95, paragraph (da) of the definition of `frankable dividend' in section 160APA

2.120

Items 96, 99 and 100

3.27

Item 98, section 160APAAAA

2.92

Item 98, section 160APAAAA

2.116

Item 98, paragraph 160APAAAA(1)(a)

2.96

Item 98, paragraph 160APAAAA(1)(b)

2.95, 2.99, 2.100

Item 98, paragraph 160APAAAA(1)(c)

2.97

Item 98, paragraph 160APAAAA(1)(d)

2.101, 2.103

Item 98, subsection 160APAAAA(2)

2.104

Item 98, paragraph 160APAAAA(2)(a)

2.105, 2.108, 2.112

Item 98, subparagraph 160APAAAA(2)(a)(i)

2.106

Item 98, subparagraph 160APAAAA(2)(a)(ii)

2.106

Item 98, subparagraph 160APAAAA(2)(a)(iii)

2.106

Item 98, paragraph 160APAAAA(2)(b)

2.113

Item 98, paragraph 160APAAAA(2)(c)

2.113

Item 98, subsection 160APAAAB(2) of the ITAA 1936

2.86, 2.88

Item 98, subsections 160APAAAB(3) to (5)

2.89

Item 98, subsections 160APAAAB(6), (6A) and (7)

2.90

Item 98, subsection 160APAAAB(8)

2.91

Item 98, subsection 160APAAAB(10) of the ITAA 1936

2.87

Item 101, subsection 160AQCBA(3A)

2.118

Item 101, subsections 160AQCBA(3B) and (3C)

2.119

Item 102, Division 7A of Part IIIA Subdivision CA

3.22

Item 103, subsection 177E(2A)

Table 3.1

Item 104, subsection 177EA(11A)

Table 3.1

Item 105, paragraph 177EA(19)(da)

2.117

Item 106, subsection 202D(1A)

Table 3.1

Item 107, section 221YHZAA

Table 3.1

Item 108, section 221YJA

Table 3.1

Item 110, subsection 273(9)

Table 3.1

Item 111, section 389A

3.17

Item 112, section 398A

3.19

Item 113, section 557A

3.17

Item 114, subsection 245-25(4) in Schedule 2C

Table 3.1

Item 116, subsection 272-50(3) in Schedule 2F

Table 3.1

Item 117, section 12-20

Table 3.2

Subitem 118(2)

2.210

Subitem 118(3)

3.34

Subitem 118(4)

3.42

Subitem 118(5)

3.41

Subitem 118(6)

3.44. 2.212

Subitem 118(9)

4.6

Subitem 118(10)

2.211, 2.214

Subitems 118(11)

2.211


Back to Top

Schedule 2: Dictionary amendments
Bill reference

Paragraph number

Item 5, definition of `convertible interest' in subsection 995-1(1)

3.35

Item 8, definition of `equity holder' in subsection 995-(1)1

2.18

Item 18, definition of `non-share equity interest' in subsection 995-1(1)

2.69, 2.70