ATO ID 2004/611: Debt/Equity: application of Division 974 to material changes made to a loan agreement
Date of decision: 21 June 2004
Year of income: Year ended 30 June 2004
Business line: Finance and Investment Centre of Expertise

Issue
Will any material changes or alterations made to a loan agreement with the terms described in the facts below form a new scheme for the purposes of classifying the loan as a debt or equity interest in accordance with Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The effect of a material change to the loan agreement will mean that a new scheme has been entered into for the purposes of the application of Division 974 of the ITAA 1997.

Facts
A Company maintains accounts with a number of related entities that deposit funds into separate sub accounts. The Company refers to these lenders as its 'Depositors'. The Company has entered into written Cash Management Account agreements with each of the Depositors. These agreements have common terms, but in particular: The loan is classified as a debt interest under Division 974 of the ITAA 1997.

Reasons for decision
Summary: Section 974-110 of the ITAA 1997 contains rules which ensure that the general requirement under Division 974 of the ITAA 1997 that the debt and equity tests are applied to schemes at the time the scheme comes into existence does not prevent Division 974 applying where the scheme has changed in a material way. In particular subsection 974-110(1) of ITAA 1997 provides that if: The effect of section 974-110 of the ITAA 1997 is to put an imperative on the issuer to retest the instrument under Division 974 of the ITAA 1997 every time there is a change to an existing scheme to ensure it is not a material change that changes its classification under Division 974 from debt to equity or vice versa. The section can apply to an interest a number of times so that, for example, an interest that is debt when issued may change to equity because of one subsequent change and then back to debt because of a later change. This has the result that if at the end of the initial term the parties agree to extend the term of the loan, it will be necessary for the issuer to test the new arrangement to determine whether it is a debt or equity interest in accordance with Division 974 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 974-110
Subject references: Debt equity borderline Debt interest