ATO ID 2003/973: Debt deduction: interest paid on convertible notes
Date of decision: 9 October 2003
Year of income: Year ending 30 June 2004
Business line: Public Groups and International

Issue
Are periodic payments made by the company on convertible notes a debt deduction within the meaning of subsection 820-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The payments made by the company constitute a debt deduction as they are a cost incurred that satisfies:

Facts
An Australian resident company has raised capital by issuing unsecured notes (notes). The notes were issued on the following terms: The issue of the notes gives rise to a debt interest under Division 974 of the ITAA 1997. The capital raised by the notes is applied by the company in the refinancing of funds employed in the company's business.

Reasons for decision
Summary: A debt deduction is defined by subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 820-40 of the ITAA 1997. Under section 820-40 of the ITAA 1997 a debt deduction of an entity for an income year includes a cost incurred that is: and which would be, apart from the operation of Division 820 of the ITAA 1997, deductible for the year of income. There is not a general definition of 'interest' in the ITAA 1997. In considering its ordinary meaning, interest was described by Rowlatt J in Bennett v. Ogston (HM Inspector of Taxes) (1930) 15 TC 374 at 379 as being 'payment by time for the use of money'. The payments made by the company are compensation for the delay in repayment of the consideration for the acquisition of the preference shares and as such are considered to be interest payments. Apart from Division 820 of the ITAA 1997 (about Thin Capitalisation) the payment of interest on funds employed in the business of the company, or in the refinancing of such funds, would be deductible under section 8-1 of the ITAA 1997. For these reasons, the periodic payments made by the company on convertible notes are a debt deduction within the meaning of subsection 820-40(1) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 820-40 subsection 820-40(1) subparagraph 820-40(1)(a)(i) paragraph 820-40(1)(b) subsection 995-1(1) section 8-1
Case references: Bennett v. Ogston (HM Inspector of Taxes) (1930) 15 TC 374
Related public rulings and determinations: Taxation Ruling TR 95/25
Subject references: Debt interest Debt equity borderline