ATO ID 2006/125: Term subordinated notes issue: deferred interest and the existence of an effectively non-contingent obligation
Date of decision: 20 April 2006
Year of income: 30 September 2006
Business line: Public Groups and International

Issue
For the purposes of paragraph 974-20(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997), is an issuer of a term subordinated note under an 'effectively non-contingent obligation' to provide financial benefits as payments of interest every fifth year where the issuer may, in its absolute discretion, elect to defer the payment of amounts of interest that become due quarterly until the end of each 5 year period?

Decision
Yes. For the purposes of paragraph 974-20(1)(c) of the ITAA 1997 the issuer will have an effectively non-contingent obligation to provide a financial benefit as a payment of interest every fifth year.

Facts
The arrangement involves a company issuing a term subordinated note for a term of 15 years. Interest is due on a quarterly basis at the Bank Bill Swap Rate (BBSW) plus a margin. Interest becomes due on each quarterly Interest Payment Date. However, at each Interest Payment Date other than at the end of years 5, 10 and 15 the issuer may elect, in its absolute discretion, to defer the payment of interest. All amounts of interest due must be paid no later than the end of years 5, 10 and 15 respectively. The principal sum must be repaid at the end of year 15. Deferred interest will compound from each Interest Payment Date until the date of payment at the standard interest rate (that is, at the Bank Bill Swap Rate plus the margin).

Reasons for decision
Summary: One of the key elements of the debt test in subsection 974-20(1) of the ITAA 1997 is that the issuer must have an 'effectively non-contingent obligation' to provide a financial benefit or benefits (paragraph 974-20(1)(c) of the ITAA 1997). A financial benefit is defined under section 974-160 of the ITAA 1997 to include anything of economic value. Accordingly, each payment of interest will constitute the provision of a financial benefit. Subsection 974-135(1) of the ITAA 1997 states that there is an 'effectively non-contingent obligation' to take an action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action. In determining whether the issuer has an effectively non-contingent obligation it is necessary to have regard to the issuer's obligation to pay interest. As noted above, the payment of amounts of interest that fall due within each 5 year period can be deferred at the issuer's discretion until no later than the end of that 5 year period. Payment of the amounts of interest that fall due within a 5 year period cannot be deferred by the issuer beyond the end of each 5 year period. Having regard to the pricing, terms and conditions of the scheme, the issuer has in substance or effect a non-contingent obligation to provide financial benefits as interest payments at the end of years 5, 10 and 15 for the purposes of paragraph 974-20(1)(c) of the ITAA 1997 of the debt test under subsection 974-20(1). Whether the instrument gives rise to a debt interest under subsection 974-15(1) of the ITAA 1997 will depend upon whether the remaining elements of subsection 974-20(1) of the ITAA 1997 are satisfied.

Legislative references: Income Tax Assessment Act 1997 section 974-15 subsection 974-15(1) section 974-20 subsection 974-20(1) section 974-135 subsection 974-135(1) section 974-160
Subject references: Debt equity borderline Debt interest Effectively non-contingent obligation