ATO ID 2010/53: Imputation: benchmark rule and non-share equity interests
Date of decision: 11 December 2009
Year of income: Year ended 30 June 2010
Business line: Private Groups and High Wealth Individuals

Issue
Whether a non-share equity interest for the purposes of Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997) is treated as a membership interest for the purposes of Division 203 of the ITAA 1997.

Decision
Yes.

Facts
Sub Co is a subsidiary member of an Australian tax consolidated group whose head company is Head Co. Sub Co has issued a financing instrument, being a non-share equity interest, to an entity (X Co) that is not a member of the consolidated group. Any distribution by Sub Co to X Co constitutes a frankable distribution to which subsection 709-85(2) of the ITAA 1997 applies. The instrument is not a share or stock in legal form and its holder is not entitled to be registered as a member of Sub Co.

Reasons for decision
Summary: Subdivision 709-A (including section 709-85) of the ITAA 1997 concerns how the franking accounts operate in relation to a tax consolidated group. Subsection 709-85(2) of the ITAA 1997 applies so that the imputation system in Part 3-6 of the ITAA 1997 (Divisions 200-220) operates as if a non-share distribution that is a frankable distribution made by a subsidiary member of a tax consolidated group to an entity that is not a member of the consolidated group were a frankable distribution made by the head company of the consolidated group to a member of the head company. That means the imputation and franking consequences flowing from the operation of the imputation rules will apply in respect of the distributions made by the subsidiary: refer paragraph 10.22 of the Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No.1) 2002. A corporate tax entity (including a company) must frank all frankable distributions made within a particular franking period to the same extent. This is known as the benchmark rule: refer sections 203-5 and 203-25 of the ITAA 1997. It follows that any distributions on the instrument will be subject to the benchmark rule unless all of the criteria in subsection 203-20(1) of the ITAA 1997 are met by Head Co. Subsection 203-20(1) of the ITAA 1997 provides that: The *benchmark rule does not apply to a company in a *franking period if either: (a) the company satisfies each of the following criteria: (i) at all times during the franking period, the company is a *listed public company; (ii) the company cannot make a *distribution on one *membership interest during the franking period without making a distribution under the same resolution on all other membership interests; (iii) the company cannot *frank a distribution made on one membership interest during the franking period without franking distributions made on all other membership interests under the same resolution with a *franking credit worked out using the same *franking percentage; or A question arises, in determining whether the conditions in subparagraphs 203-20(1)(a)(ii) and (iii) of the ITAA 1997 are met, as to whether a non-share equity interest in a company, is treated as a 'membership interest' in that company for the purposes of section 203-20 of the ITAA 1997. The term 'membership interest' in an entity is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 960-135 of the ITAA 1997. Section 960-135 of the ITAA 1997 provides that if you are a member of an entity, (a) each interest, or set of interests, in the entity; or (b) each right, or set of rights, in relation to the entity, by virtue of which you are a member of the entity, is a membership interest of yours in the entity. The term 'member' in relation to an entity is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 960-130 of the ITAA 1997. Item 1 of the table in section 960-130 of the ITAA 1997 provides that a member of a company is a member or stockholder of the company. On the facts of this case, X Co, the holder of the instrument that gives rise to the non-share equity interest in Sub Co, is not a member of Sub Co pursuant to section 960-130 of the ITAA 1997. As such, the non-share equity interest does not constitute a membership interest in Sub Co. However, it is considered that the non-share equity interest held by X Co is treated as a membership interest in Head Co for the purposes of Part 3-6 of the ITAA 1997 by virtue of subsection 709-85(2) of the ITAA 1997. It is further considered that this interpretation is consistent with the provision in Subdivision 215-A of the ITAA 1997, which governs the application of the imputation system in Part 3-6 of the ITAA 1997 (including Divisions 203 and 215) to non-share equity interests. Specifically, section 215-1 of Subdivision 215-A of the ITAA 1997 provides that the imputation system applies to a non-share equity interest in the same way as it applies to a membership interest, and to an equity holder in an entity who is not a member of the entity in the same way as it applies to a member of the entity. Section 215-1 was inserted into the ITAA 1997 by Act No. 48 of 2002. The provision was intended as a rewrite of former section 160AOA of the Income Tax Assessment Act 1936 (ITAA 1936), which was introduced as part of the New Business Tax System (Debt and Equity) Act 2001 to provide that the imputation provisions apply to non-share equity interests in the same way as they apply to shares (that are not 'non-equity shares') in order to give consistent treatment to all kinds of equity interests. Thus references to shares in the imputation provisions can be read as including non-share equity interests: refer paragraph 2.72 of the Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001. Furthermore, the non-share equity interest in Sub Co is treated as a non-share equity interest in Head Co for the purposes of Subdivision 974-C of the ITAA 1997: refer to the single entity rule in section 701-1 of the ITAA 1997 and Taxation Ruling TR 2004/11. The debt/equity rules in Division 974 of the ITAA 1997 determine whether the return on an interest in an entity may be frankable or deductible. The definition of equity interests and related concepts of equity holders and non-share dividends are generally used in all the provisions of the income tax law dealing with the taxation of returns on financing instruments, including the imputation provisions although an interest that is an equity interest under Division 974 of the ITAA 1997 may not necessarily be a membership interest for consolidation purposes. Refer paragraph 3.3 of the Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001; and paragraph 3.70 of the Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No.1) 2002. Having regard to the foregoing, it is considered that non-share equity interests in a company are subject to the benchmark rule in section 203-25 of the ITAA 1997 and are relevant in determining whether the conditions in subparagraphs 203-20(1)(a)(ii) and (iii) of the ITAA 1997 are met. Accordingly, the non-share equity interest held by X Co is treated as a membership interest in Head Co for the purposes of Division 203 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 203-5 section 203-20 subsection 203-20(1) section 203-25 section 215-1 Subdivision 215-A Part 3-6 section 701-1 section 709-85 subsection 709-85(1) subsection 709-85(2) Subdivision 709-A section 960-130 section 960-135 section 974-75 subsection 974-75(1) subsection 974-75(2) Subdivision 974-C Division 974 subsection 995-1(1)
Related public rulings and determinations: Taxation Ruling TR 2004/11
Other references: ATO Practice Statement Law Administration PS LA 2001/8 Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002 Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002
Subject references: Consolidation Consolidation - franking Debt equity borderline Distributions Equity test Head company Imputation system Member of an entity Membership interest in an entity Non-equity share Non-share equity interest Shares Single entity rule