ATO ID 2002/1106: Convertible Notes
Date of decision: 26 March 2002
Year of income: Year ended 30 June 2001
Business line: Public Groups and International

Issue
Whether interest paid on Notes subsequent to an amendment to the Unsecured Note Trust Deed (Trust Deed) to allow Noteholders additional shares on conversion, is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes

Facts
The Company issued a prospectus prior to 1 July 2000 to raise funds from the issue of subordinated unsecured redeemable Notes. The Notes were issued subject to the terms and conditions contained in the Trust Deed. The purpose of the fund raising was to facilitate the restructuring of the Group's debt facility. Some key characteristics of the Notes are: After 1 July 2001 the Company made a return of capital to shareholders. The Company and Trustee offered Noteholders a new conversion period prior to the return of capital. The Trustee agreed to adjust the conversion terms in the Trust Deed after the capital return.

Reasons for decision
Detailed Reasoning - Sections 82R and 82SA of the Income Tax Assessment Act 1936 (ITAA 1936): The tests detailed in section 82SA have been passed, therefore section 82R of that Act will not be triggered and the interest will be deductible under section 8-1 of the ITAA 1997. ATO ID 2001/321 can be distinguished from the current circumstances because in that case the proposed amendment to the conversion formula would also have resulted in the failure of the minimum conversion price test. Since 1 July 2001, most convertible interests fall within the ambit of Division 974 of ITAA 1997., However Division 3A of ITAA 1936 continues to have application when dealing with Controlled Foreign Companies (CFCs). For interests created prior to 1 July 2001, a transition period of 3 years was allowed, if so elected, to follow Division 3A.

Legislative references: Income Tax Assessment Act 1936 Section 82R Section 82SA
Case references: FC of T v. Total Holdings (Aust) Pty Ltd (1979) 9 ATR 885 79 ATC 4279
Related public rulings and determinations: Taxation Ruling IT 2657
Related ATO interpretative decisions: ATO ID 2001/321 | ATO ID 2002/1110 | ATO ID 2003/983
Other references: Explanatory Memorandum relating to sections 82R and 82SA of the ITAA 1936 Explanatory Memorandum relating to Division 974 of the ITAA 1997
Subject references: Convertible notes Interest expenses Expenses of borrowing