ATO ID 2002/1112: Convertible Notes - Non-Share Capital Account, Division 164, Income Tax Assessment Act 1997
Date of decision: 18 March 2002
Year of income: Other/Substituted Accounting Period 2004
Business line: Public Groups and International

Issue
If a non-share equity interest arises as a result of a material amendment to the terms of a convertible note will the issuer company have a non-share capital account pursuant to Division 164 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. A company will be treated under Division 164 of the ITAA 1997 as having a non-share capital account if a non-share equity interest is issued on or after 1 July 2001.

Facts
A company issued convertible notes that give rise to a debt interest for the purposes of Division 974 of the ITAA 1997. The issuer company proposes to materially alter the terms of the convertible notes by a scheme of arrangement. As a consequence of the amended terms, the convertible notes will be recharacterised as non-share equity interests for the purposes of Division 974 of the ITAA 1997 from the time that the proposed scheme comes into existence.

Reasons for decision
Summary: Division 164 of the ITAA 1997 was introduced by the New Business Tax System (Debt and Equity) Act 2001 . The object of Division 164 of the ITAA 1997, as set out in subsection 164-5 of the ITAA 1997, is to allow for the recording of contributions to the company in respect of non-share equity interests. The Division allows for distributions made to be characterised as either non-share dividends or as returns of non-share capital. Under Division 974 of the ITAA 1997, a non-share equity interest is defined in subsection 995-1(1) of the ITAA 1997 as an equity interest in a company that is not solely a share. Where a company materially amends the terms of an interest on or after 1 July 2001 and that interest is characterised as a non-share equity interest, it will be treated as having a notional account called a non-share capital account pursuant to subsection 164-10 of Division 164 of the ITAA 1997. That account will, in accordance with subsection 164-15(2) of the ITAA 1997, be credited by an amount equal to the market value of the consideration received by the taxpayer at the time the company issued the interest (at the date the convertible note was first issued) adjusted for any amount recorded in the company's share capital account in respect of that interest and any amount returned to the holder of the interest before its change from debt to equity.

Legislative references: Income Tax Assessment Act 1997 division 164 section 164-5 section 164-10 subsection 164-15(2) division 974 item 4 of subsection 974-75(1)
Other references: Explanatory Memorandum: New Business Tax System (Debt and Equity) Act 2001
Subject references: Convertible notes Debt equity borderline