ATO ID 2007/52: Redeemable Preference Shares: accumulated dividends forming part of redemption amount
Date of decision: 5 March 2007
Year of income: Year ended 30 June 2004 Year ended 30 June 2005 Year ended 30 June 2006 Year ended 30 June 2007 Year ended 30 June 2008
Business line: Public Groups and International

Issue
For the purposes of subsection 974-135(5) of the Income Tax Assessment Act 1997 (ITAA 1997), does the 'redemption amount' in respect of a redeemable preference share include any accumulated but unpaid dividends that the company has an effectively non-contingent obligation to pay on redemption?

Decision
Yes. For the purposes of subsection 974-135(5) of the ITAA 1997, the 'redemption amount' in respect of a redeemable preference share does include accumulated but unpaid dividends that the company has an effectively non-contingent obligation to pay on redemption.

Facts
X Company Pty Ltd enters into a financing arrangement whereby it issues a redeemable preference share (RPS) to investors. Under the terms of issue, X Company Pty Ltd is under an effectively non-contingent obligation to redeem the RPS for its 'redemption amount' after twelve years. The RPS gives the shareholder a right to an annual fixed dividend entitlement on 30 June of each year over the life of the share provided X Company Pty Ltd has sufficient profits at that time to pay the dividend. Any dividends that are not declared and paid in full will accumulate and become due and payable on redemption, forming part of the 'redemption amount'. The shares are all fully paid up.

Reasons for decision
Summary: Subsection 974-135(5) of the ITAA 1997 provides that an obligation to redeem a preference share is not contingent merely because there is a legislative requirement for the redemption amount to be met out of profits or a fresh issue of equity interests. Further, regulation 974-135C of the Income Tax Regulations 1997 provides that an obligation to redeem or buy back a preference share in relation to a company is not a contingent obligation merely because a requirement exists, under a law, to the effect that the redemption or buy back must not prejudice the company's ability to pay its creditors or must not cause the company's remaining assets to become insufficient to pay any of the company's debts. These provisions have the effect of disregarding a contingency which would otherwise exist. Under the terms of issue, dividends on the RPS accumulate and the amount of any unpaid dividend entitlement is to be included in the 'redemption amount' payable by X Company Pty Ltd upon redemption of the RPS. On a plain reading of the provision, there is no basis for restricting 'redemption amount' in subsection 974-135(5) of the ITAA 1997 to only the issue price component of the redemption amount if it is defined to also include any accumulated but unpaid dividends (so that the holder is entitled to a fixed dividend regardless of whether that dividend is declared). Nor is there anything in the extrinsic materials relating to the provision that suggests a different outcome was intended. In such a case, subsection 974-135(5) of the ITAA 1997 will apply to the whole of the redemption amount (including the accumulated dividends which the issuer has an effectively non-contingent obligation to pay on redemption).

Legislative references: Income Tax Assessment Act 1997 subsection 974-135(5)
Related ATO interpretative decisions: ATO ID 2003/527
Subject references: Debt equity borderline Debt test Equity test Redeemable preference shares Effectively non-contingent obligation