ATO ID 2003/1041: Debt/Equity: whether short term trade finance gives rise to debt interest exception 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 that is a debt interest under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997), be excepted from being a debt interest under section 974-25 of the ITAA 1997?

Decision
No. The short term trade finance facility will not be excepted from being a debt interest under section 974-25 of the ITAA 1997 because it does not satisfy the requirements set out in that section.

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. Under the short-term trade finance facility, the funds cannot be used for any other purpose except for international trade transactions. The trade finance facility between the taxpayer and the financier limits the term of the borrowing to no more than 180 days. Typically borrowed funds under the facility are repaid within 100 days.

Reasons for decision
Summary: To determine whether a scheme falls within the debt interest exception as set out in subsection 974-25(1) of the ITAA 1997 it is necessary to determine that: In the present case the scheme (as defined in subsection 995-1(1) of the ITAA 1997) is the short-term trade finance facility. Whilst the trade finance borrowings under the short-term trade finance facility might be paid within 100 days, the scheme fails the first condition that a substantial part of the financial benefit provided is not a liquid or monetary asset (subparagraph 974-25(1)(a)(i) of the ITAA 1997). The letter of credit available under the trade finance facility would constitute a monetary or liquid asset because the letter of credit is equivalent to money or money's worth. The financial benefit the taxpayer receives is the money or credit provided by the financier to the supplier on the taxpayer's behalf and is taken to have been provided to the taxpayer (subsection 974-30(2) of the ITAA 1997). Therefore, the scheme comprising of the short term borrowings will not satisfy the exception to the debt test.

Legislative references: Income Tax Assessment Act 1997 section 974-15 section 974-20 section 974-25 section 974-30 section 974-160 subsection 995-1(1)
Related ATO interpretative decisions: ATO ID 2003/1040 | ATO ID 2003/1042
Subject references: Debt test Short term schemes Debt equity borderline