ATO ID 2003/261: Qualifying Security: loan agreement - repayment of principal based on sale value of trees at time of harvest
Date of decision: 9 April 2003
Year of income: Year ended 30 June 2000 Year ended 30 June 2001 Year ended 30 June 2002 Year ended 30 June 2003 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 Year ended 30 June 2009
Business line: Private Groups and High Wealth Individuals

Issue
Is a loan agreement, where the repayment of the principal and any potential return on the principal is based on the sale value of trees at the time of harvest, a qualifying security under subsection 159GP(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Decision
No. The loan is not a qualifying security under subsection 159GP(1) of the ITAA 1936 as the eligible return on the security cannot be determined at the time the loan was issued.

Facts
The taxpayer entered into an agreement with a Government Authority for that authority to plant and maintain a tree plantation on third party land. Under the agreement, all costs associated with the plantation are to be borne by the taxpayer and all income resulting from the harvest belongs to the taxpayer. The taxpayer then entered into an agreement with an unrelated party who would fund the plantation expenses and be entitled to receive all the income resulting from the harvest. Under another agreement the taxpayer provided a loan to that party to meet 50% of the plantation expenses. In return, the taxpayer receives 60% of the harvest revenue which is applied to reduce the loan and any excess is deemed, under the agreement, to be interest on the loan.

Reasons for decision
Summary: Subsection 159GP(1) of the ITAA 1936 requires, among other things, that a security must have an eligible return for it to be a qualifying security. Under subsection 159GP(3) of the ITAA 1936, a security has an eligible return where, at the time of issue, it is reasonably likely that the sum of the payments (other than periodic interest payments) to an investor under the security will exceed the issue price of the security. In effect, the eligible return is the amount of the excess. As the return on the loan is subject to the profitability of the harvest at a future date it cannot be determined at the time the loan is issued that it is reasonably likely there will be an eligible return. Accordingly, the loan is not a qualifying security for the purposes of Division 16E of Part III of the ITAA 1936.

Legislative references: Income Tax Assessment Act 1936 subsection 159GP(1) subsection 159GP(3)
Related public rulings and determinations: Taxation Ruling TR 96/3 | Taxation Determination TD 94/95
Subject references: Deferred interest securities Variable return securities