ATO ID 2014/25: Taxation of financial arrangements: is a deposit a guarantee or indemnity subject to section 230-460
Date of decision: 12 May 2014
Business line: Private Groups and High Wealth Individuals

Issue
Is a term deposit provided as security for a performance bond a right or obligation under a guarantee or indemnity subject to the exception in subsection 230-460(8) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. The term deposit is not a guarantee or indemnity in terms of subsection 230-460(8) of ITAA 1997.

Facts
The taxpayer was required by the relevant state government to lodge a satisfactory bond before approval to commence mining operations could be given. The bond must be in the form of a guarantee or indemnity issued by an approved third party financial institution. The bond is a contract between the state government and the third party financial institution acceptable to the Minister. The bond provides the state government with security should the taxpayer fail to meet agreed upon environmental obligations. In the event of taxpayer default, the agreed sum will be forfeited by the financial institution to the state government. The financial institution requires a term deposit from the taxpayer to secure the bond. The taxpayer has a right to receive interest from the term deposit until the term deposit has been returned or forfeited. The bond and term deposit are separate contracts and each has its own legal rights and obligations. They are separate financial arrangements under subsection 230-55(4) of the ITAA 1997. The taxpayer is subject to Division 230 on a mandatory basis as the taxpayer has an aggregated turnover in excess of $100 million.

Reasons for decision
Summary: All legislative references are to the ITAA 1997 unless otherwise indicated. Division 230 deals with the tax treatment of gains and losses from financial arrangements. Section 230-15 broadly provides that gains and losses from 'financial arrangements' are assessable / deductible from assessable income. Subsection 230-460(1) provides that Division 230 does not apply to gains and losses from a financial arrangement for any income year to the extent that the rights and/or obligations under the arrangement are the subject of an exception under section 230-460. Subsection 230-460(8) provides an exception for a 'right or obligation under a guarantee or indemnity' (subject to certain exceptions). The Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (Cth) notes at paragraph 2.168: What is meant by a 'guarantee' or an 'indemnity' takes on its ordinary meaning to include a promise to answer for the debt or default of another, or to make good a loss suffered through a third party. Generally: '... A guarantee is essentially a promise to answer for the debt, default or miscarriage of another and it does not include as such the case of a person incurring an additional liability in respect of a sum of money for which he is already liable.' [1] Bank of New South Wales v. Permanent Trustee Co of New South Wales Ltd (1943) 68 CLR 1 (Bank of NSW case) , concerns a person who, being under a liability as guarantor, gave a mortgage to secure the payment of money under the guarantee. At issue was whether the obligation fell within a debt moratorium. In the course of his reasons for decision, Latham CJ stated, at 11, that: 'A person cannot guarantee the payment of money by himself. He may undertake an additional obligation to pay money which he is already bound to pay, but that added obligation cannot be described as a guarantee.' In this case the financial institution has promised the state government it will answer for default of the taxpayer to meet agreed upon environmental obligations. Upon default, the financial institution will pay the Minister an agreed sum. The arrangement between financial institution and the state government has created rights and obligations under a guarantee or indemnity. The arrangement between the financial institution and taxpayer whereby the taxpayer provides a term deposit to secure the bond provides security for the guarantee created by the financial institution. The deposit is held by the financial institution to secure the guarantee or indemnity against the performance of the taxpayer's obligations under the contract. If the taxpayer fails to perform the obligations the deposit is at risk of forfeiture. It is returned to the taxpayer upon performance of obligations. In terms of Bank of NSW, the deposit is not a 'guarantee' but is rather 'an additional obligation to pay money...' Therefore as the deposit is not a guarantee or indemnity it would be subject to taxation of financial arrangements rules as it meets the definition of a financial arrangement pursuant to section 230-45.

Legislative references: Income Tax Assessment Act 1997 Division 230 section 230-15 section 230-45 subsection 230-55(4) section 230-460 subsection 230-460(1) subsection 230-460(8)
Case references: Bank of New South Wales v Permanent Trustee Co of New South Wales Ltd (1943) 68 CLR 1 (1943) 17 ALJ 186 [1943] HCA 27
Related public rulings and determinations: TR 2012/4 | TR 96/23
Other references: Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008
Subject references: Financial institution deposits Guarantees Indemnity Taxation of financial arrangements