ATO ID 2003/1040: Debt/Equity: whether short term trade finance gives rise to debt interest under Division 974
Date of decision: 20 October 2003
Year of income: Year ended 31 December 2002
Business line: Finance and Investment Centre of Expertise

Issue
Will trade finance borrowings under a short-term trade finance facility give rise to a debt interest in the taxpayer entity as defined in Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The trade finance borrowings under a short-term trade finance facility will give rise to a debt interest in the taxpayer entity under Division 974 of the ITAA 1997.

Facts
The taxpayer's main business activity consists of importing and exporting commodities. The taxpayer buys and on-sells these commodities. Commonly, there is a timing mismatch between the time of purchase and sale. The contracts for the acquisition and sale of commodities are financed by a short-term trade finance facility. The short-term trade finance facility allows the taxpayer to direct the financier to issue a letter of credit in favour of the supplier and to then pay the supplier once the financier is satisfied that the commodities are available and ready for delivery. In return for issuing the letter of credit, the taxpayer undertakes to pay the financier, an amount equal to the sum advanced by the financier to the supplier, including interest and reimbursement of expenses incurred by the financier. The trade finance facility between the taxpayer and the financier limits the term of the borrowing to no more than 180 days.

Reasons for decision
Summary: Division 974 of the ITAA 1997 sets out the tests that determine whether an interest is characterised as debt or equity. Subsection 974-15(1) of the ITAA 1997 provides that a 'scheme' gives rise to a 'debt interest' if all the requirements of the debt test, as set out in subsection 974-20(1) of the ITAA 1997, are met. These requirements are: Under subsection 974-150(1) of the ITAA 1997, the term 'scheme' has the meaning given in subsection 995-1(1) of the ITAA 1997. Under subsection 995-1(1) of the ITAA 1997, the term scheme is defined to mean 'any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise'. In the present case, the trade finance borrowings the taxpayer acquires under the trade finance facility would be a scheme pursuant to that definition. The trade finance borrowings are classified as a debt interest as those borrowings satisfy all the requirements of the debt test. That is:

Legislative references: Income Tax Assessment Act 1997 section 974-15 section 974-20 section 974-30 section 974-35 section 974-130 section 974-135 section 974-150 section 974-160 subsection 995-1(1)
Related ATO interpretative decisions: ATO ID 2003/1041 | ATO ID 2003/1042
Subject references: Debt equity borderline Debt test Financing arrangement Short term schemes