ATO ID 2005/20: Deferred interest under a Loan Note
Date of decision: 23 December 2004
Year of income: 31 December 2003
Business line: Public Groups and International

Issue
Will a loan note have an 'eligible return' for the purposes of subsection 159GP(3) of the Income Tax Assessment Act 1936 (ITAA 1936) if the issuer can, from time to time, elect that interest on the loan note will accrue but not be payable for a period of more than one year?

Decision
Yes. A loan note will have an 'eligible return' where the issuer can elect that interest on the note will accrue but not be payable for more than one year.

Facts
A company issued Loan Notes to raise unsecured finance. Interest on the Loan Notes accrues at a fixed interest rate per annum. In each year, the issuer can elect that interest accruing during that year will not be paid on an annual basis but will be 'capitalised', at interest, and payable on redemption. The term of the Loan Notes is likely to be in excess of 12 months. The Loan Notes must be redeemed no later than 10 years after the date of issue.

Reasons for decision
Summary: Division 16E of the ITAA 1936 imposes a statutory accruals regime on certain payments in relation to a 'security' that is a 'qualifying security'. The Loan Notes are a 'security' for the purposes of Division 16E because they are a loan, and thus meet paragraph (c) of the definition of 'security' in section 159GP(1) of the ITAA 1936. The term 'qualifying security' is also defined in subsection 159GP(1) of the ITAA 1936. One of the elements of that definition is that the security under consideration must have an 'eligible return'. A security will have an 'eligible return' for the purposes of Division 16E of the ITAA 1936 if, at the time the security is issued it is reasonably likely, by reason that the security was issued at a discount, bears deferred interest or is capital indexed or for any other reason, having regard to the terms of the security, that the sum of all payments, other than periodic interest payments, under the security will exceed the issue price of the security (subsection 159GP(3) of the ITAA 1936). The critical issue in this matter is whether interest payable under the terms of issue is 'periodic interest'. If amounts of interest payable are not all periodic interest, there will be an eligible return because it would necessarily follow on the facts that the sum of all payments, other than periodic interest payments, under the security would exceed the issue price of the security. Interest is 'periodic interest' for the purposes of Division 16E if the period between the commencement of the period in respect of which the interest is expressed to be payable, and the time at which the interest is payable, is less than or equal to one year (subsection 159GP(6) of the ITAA 1936). Amounts of interest payable under the Loan Note are not 'periodic interest' for the purposes of Division 16E. At the time of issue, it is apparent that the issuer can elect at certain times to defer the payment of interest so that in any year in which that election is made, the period between the commencement of the period in respect of which that interest is expressed to be payable, and the time at which the interest is payable, would be greater than one year. Accordingly, at the time of issue it cannot be said in relation to all amounts of interest payable under the Loan Notes, that the period between the commencement of the period in respect of which Interest is expressed to be payable, and the time at which the interest is payable, is less than or equal to one year. Therefore, there are amounts of interest that will be payable under the terms of the Loan Notes that are not periodic interest, and the Loan Notes have an 'eligible return' for the purposes of Division 16E of the ITAA 1936.

Legislative references: Income Tax Assessment Act 1936 subsection 159GP(1) subsection 159GP(3) subsection 159GP(6)
Subject references: Deferred interest securities