Private ruling: Debt equity rules - application of division 974
Date of advice: 29 May 2025
Published: 4 August 2025
Ruling period: 1 January 20XX - 31 December 20YY
Date scheme commenced: 30 April 20XX

Ruling: Q1: Does the intragroup loan agreement between Sub Co and Parent Co give rise to an equity interest for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: Group structure Sub Co is a wholly owned direct subsidiary of Parent Co and an indirect subsidiary of Intermediary Co. Sub Co, Parent Co and Intermediary Co are part of a wider group (the Group), which is ultimately controlled by Head Co. Sub Co's GST turnover (as defined in subsection 995-1(1) of the ITAA 1997) at all relevant times during the ruling period has exceeded $20 million. Group activities The Group operates in multiple regions. The Group is overseen by the board of directors of Head Co (Board), and its daily operations are managed by a central Group Executive Management team (Executive). The Board functions principally in a supervisory capacity for the Group entities, with limited matters reserved for their approval and limited board meetings being held. Group funding arrangements The Group is financed by multiple bank loan facilities. The Group does not have a formal or written funding policy. Group entities are funded, and funds are moved between Group entities in a commercially rational matter that is not considered to require policy documentation or Board oversight. Group policy dictates that internal funding should, where possible, be accessed in priority to external funding. Executive approval is not required with respect to internal financing between Group entities. Funding of Sub Co The Group previously provided informal funding to Sub Co without written agreement. As part of this informal funding, Intermediary Co previously made advances in several tranches on behalf of Parent Co to Sub Co, totalling $X (in addition to interest charged). The Loan Agreement Sub Co (as Borrower) subsequently entered into a written intragroup loan agreement with Parent Co (as Lender) and Intermediary Co (as Intermediary) (the Loan Agreement). The Loan Agreement entered into was not of sufficient materiality to fall within the scope of responsibility of the Group Board and would not generally be the subject of formal documentation by management. The primary rationale for entering into the Loan Agreement was to formalise the intragroup funding received informally by Sub Co from Intermediary Co. In the absence of a subscription for shares in Sub Co with respect to that informal funding, the Group considered that the only way of documenting the existing funding arrangements was by way of a loan. The Group also considered that in respect of Group entities that might have accounting losses, it would be easier to repatriate funds by way of payments of interest or repayment of principal than it would be to pay dividends on shares (in the unlikely event, contrary to expectations of the Group, that the Sub Co was able to repatriate funds). Under the Loan Agreement, an existing debt owed by Parent Co to Sub Co was offset by Parent Co discharging Sub Co's debt to Intermediary Co, with the net amount of $X treated as an initial 'Advance' (Initial Advance) made by Parent Co to Sub Co subject to the terms of the Loan Agreement. Table 1: The Loan Agreement relevantly has the following features: Feature Description Term and repayments Unsecured and with no fixed term. Principal and interest payable within 90 days of a payment demand by the Lender. Loan amount Following the Initial Advance, Parent Co advanced $Y to Sub Co in several tranches (together with the Initial Advance referred to as the 'Advances'). There have been no further advances made to Sub Co under the Loan Agreement. Interest Interest accrues day to day at the 'Annual Interest Rate' on the outstanding aggregate principal amount of all Advances. The 'Annual Interest Rate' is the rate determined from time to time by Parent Co, based on the interest rate payable on Parent Co's borrowings adjusted for administration costs. The Variation Agreement varied the Annual Interest Rate, to the three-month BBSY plus 3.50%. Purpose Each Advance is to be used by the Borrower to invest in its development and to fund its ongoing working capital requirements. Intermediary The Borrower's existing debt to Intermediary Co is satisfied and substituted for a repayment obligation owed to Parent Co. Intermediary Co may make advances on behalf of Parent Co to the Borrower. At the time of entry into the Loan Agreement, the Group did not expect: • Sub Co to make any repayments of principal or payments of interest to Parent Co under the Loan Agreement, or • Parent Co to ever make a call on/demand for the debts arising under the Loan Agreement unless: ­ another Group entity needed those funds, ­ Sub Co had the funds available to make such repayment, and ­ Sub Co was not planning to invest funds in a future project. Since entering into the Loan Agreement, all funding provided to Sub Co has been in the form of subscriptions for share capital by Parent Co. Administration of the Loan Agreement In general, advances under the Loan Agreement have been made according to the following process: • when Sub Co is forecast to receive cash, this is confirmed with Sub Co's Head of Finance by the Group Financial Controller. If the funds are still required, the Group Financial Controller approves the transfer and their team processes the payment via the Group's online banking tools. • the principal amount advanced is then booked as an intercompany receivable (asset) in Parent Co's relevant intercompany account in the same month that the money is sent, and as an intercompany payable (liability) in Sub Cos relevant intercompany account. • the total intercompany balance is rolled forward and reconciled each month and, on a quarterly basis, intercompany interest is calculated and applied to that balance manually by the Group Financial Controller's team. That liability to pay interest is recorded as an expense in Sub Co's accounts (account XX), with a corresponding liability recorded in Sub Co's accounts in the intercompany account between Parent Co and Sub Co (account YY). Notwithstanding that the Loan Agreement specifies that interest is to be calculated and charged on a simple basis only, in practice the interest expenses in account XX and the corresponding intercompany liabilities in account YY are calculated by reference to both the principal amounts advanced under the Loan Agreement and any accrued but unpaid interest (i.e. on a compounding basis). Parent Co has not made any demand for, or otherwise invoiced, the principal amounts corresponding to the Advances made under the Loan Agreement at any time. Parent Co has issued invoices for interest on a quarterly basis as part of the quarterly recording of interest in the accounts. The inclusion of a due date on the invoices is simply a function of the template documents used and does not constitute a demand for payment. Parent Co has not otherwise made a demand for payment of the interest. Sub Co has never made any payments of interest arising under the Loan Agreement (nor been expected, or requested, to do so by Parent Co). At no time after entry into the Loan Agreement has the Group contemplated that Parent Co would demand repayment of the principal, or payment of interest amounts, or that Sub Co would make a repayment of the principal, or a payment of interest amounts invoiced. Loan Capitalisation The Group is in the process of capitalisation or elimination of intercompany loans. It is also the Group's intention that the advances under the Loan Agreement will be capitalised in due course.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 974 | Income Tax Assessment Act 1997 subdivision 974 -B | Income Tax Assessment Act 1997 subdivision 974 -C | Income Tax Assessment Act 1997 subsection 974-15(1) | Income Tax Assessment Act 1997 subsection 974-20(1) | Income Tax Assessment Act 1997 paragraph 974-20(1)(b) | Income Tax Assessment Act 1997 paragraph 974-20(1)(e) | Income Tax Assessment Act 1997 paragraph 974-20(4)(a) | Income Tax Assessment Act 1997 subsection 974-70(1) | Income Tax Assessment Act 1997 paragraph 974-70(1)(b) | Income Tax Assessment Act 1997 subsection 974-75(1) | Income Tax Assessment Act 1997 subsection 974-75(2) | Income Tax Assessment Act 1997 subsection 974-75(4) | Income Tax Assessment Act 1997 subsection 974-130(1) | Income Tax Assessment Act 1997 subsections 974-135(1) | Income Tax Assessment Act 1997 subsections 974-135(2) | Income Tax Assessment Act 1997 subsections 974-135(3) | Income Tax Assessment Act 1997 subsection 974-150(1) | Income Tax Assessment Act 1997 subsection 974-160(1) | Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision: Detailed Reasoning - Debt and equity interests: Division 974 contains rules that characterise schemes that are financing arrangements as a debt interest, an equity interest or neither a debt nor equity interest. Subsection 995-1(1) includes relevant definitions: debt interest in an entity has the meaning given by Subdivision 974-B equity interest in an entity has the meaning given by: • in the case of a company - Subdivision 974-C; and • in the case of a trust or partnership - section 820-930. Where an interest could be characterised as both a debt and equity interest, paragraph 974-70(1)(b) stipulates that the interest will be treated as a debt interest. | Detailed Reasoning - The debt test: Subsection 974-15(1) of the ITAA 1997 provides that a scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) of the ITAA 1997 in relation to the entity. Subsection 974-20(1) provides that a scheme satisfies the debt test if: (a) the scheme is a financing arrangement for the entity; and (b) the entity or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; and (c) the entity has, or both the entity and a connected entity of the entity have, an effectively non-contingent obligation (ENCO) under the scheme to provide a financial benefit or benefits to one or more entities after the time when: (i) the financial benefit referred to in paragraph (b) is received if there is only one; or (ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and (d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and (e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are both not nil. The essential elements required to satisfy the debt test are considered below. | Detailed Reasoning - Is there a scheme?: A scheme is defined for the purpose of Division 974 in subsection 974-150(1) and has the meaning given in section 995-1 of the ITAA 1997. A scheme is defined broadly in subsection 995-1(1) as 'any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct whether unilateral or otherwise'. On this basis, the arrangement being the Loan Agreement between the Sub Co and Parent Co is a 'scheme' in accordance with the definition in subsection 995-1(1) of the ITAA 1997. Therefore, this requirement is satisfied. | Detailed Reasoning - Is the scheme a financing arrangement for the entity?: Subsection 974-130(1) of the ITAA 1997 states: A scheme is a financing arrangement for an entity if it is entered into or undertaken: (a) to raise finance for the entity (or a connected entity of the entity); or (b) to fund another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a); or (c) to fund a return, or a part of a return, payable under or provided by or under another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a). In accordance with the terms of the Loan Agreement, the arrangement was entered into for the purpose of funding Sub Co's development and to fund its ongoing working capital requirements. Given the Loan Agreement was a scheme undertaken to raise finance for Sub Co, it is a financing arrangement in accordance with section 974-130 and therefore this requirement is satisfied. | Detailed Reasoning - Did the entity receive a financial benefit under the scheme?: The second element is satisfied if the entity or a connected entity receives, or will receive, a financial benefit or benefits under the scheme. In accordance with subsection 974-160(1), a financial benefit is anything of 'economic value' and includes property and services and anything that the regulations provide is a financial benefit. Sub Co has received at least two 'financial benefits' in respect of the Loan Agreement for the purposes of paragraph 974-20(1)(b): (a) upon entry into the Loan Agreement, Sub Co's existing debt to Intermediary Co was satisfied and substituted for a repayment obligation owed to Parent Co, and (b) upon entering into the Loan Agreement, Intermediary Co has advanced a total of $Y to Sub Co in various tranches. Therefore, paragraph 974-20(1)(b) is satisfied. | Detailed Reasoning - Is there an ENCO under the scheme to provide financial benefit(s)?: The third element of the debt test requires that the entity has an ENCO under the scheme to provide a financial benefit or benefits to one or more entities. An ENCO is defined in section 995-1 to have the meaning given by section 974-135 of the ITAA 1997. Section 974-135 has comprehensive rules for determining whether an obligation is effectively non-contingent. The term ENCO is defined in subsections 974-135(1) and (3). Subsection 974-135(1) states: 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 (see subsections (3), (4) and (6)) to take that action. Subsection 974-135(3) states: An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a connected entity of that entity), other than the ability or willingness of that entity or connected entity to meet the obligation. | Detailed Reasoning - Application to the Loan Agreement: The relevant financial obligations that fall for consideration under section 974-135 of the ITAA 1997 in relation to the Loan Agreement are Sub Co's obligations to: • repay the principal amounts advanced under the Loan Agreement, and • pay interest on the principal amounts. Under the formal terms of the Loan Agreement, Sub Co must repay the principal sum of any advances plus accrued interest and all other amounts outstanding under the Loan Agreement to Parent Co (or Intermediary Co at Parent Co's direction) within 90 days of a repayment demand by Parent Co. However, where related parties enter a transaction that imposes on one party an obligation to the other that is formally non-contingent, there is a question as to whether section 974-135 treats the obligation as not being effectively non-contingent. The Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 which introduced Division 974 (Explanatory Memorandum) takes the view that such obligations may be found not to be 'effectively non-contingent obligations' where failure to perform the obligation will have no practical consequence, i.e. the non-performer would not be exposed to any legal or economic sanctions (para 2.181). The Supplementary Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 (Supplementary Explanatory Memorandum) inserted the following sentences at the end of paragraph 2.181 of the Explanatory Memorandum: This is not, however, intended to indicate that an interest-free loan between associated parties necessarily gives rise to a contingent obligation. Thus, the effectively non-contingent obligation test is not intended to disturb what was decided in Total Holdings (Aust) Pty Ltd v Federal Commissioner of Taxation (1979) 9 ATR 885. As a general statement, the taxpayer 's intention and the context of the arrangement are relevant in construing whether an effectively non-contingent obligation is present. In this regard, the ' substance ' approach adopted in judicial decisions such as Ure v Federal Commissioner of Taxation (1981) 11 ATR 484 is more consonant with the intent of the debt (and equity) test than that adopted in decisions such as Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978) 8 ATR 879. On the facts presented, the Loan Agreement, in substance and effect, is subject to several contingencies: • Sub Co's repayment obligations with respect to both principal amounts and interest are contingent on Parent Co's demand, • the rate of interest is specified to be as determined from time to time by Parent Co (although based on the interest rate payable on Parent Co's borrowings adjusted for administration costs), • at the time of entry into the Loan Agreement, and at all subsequent times to present, the parties to the Loan Agreement did not expect Sub Co to make any repayments to Parent Co, or Parent Co to make a demand for repayment of the principal or demand payment of any interest amounts, and • the parties did not expect there would ever be a call on the debts arising under the Loan Agreement unless: ­ another Group entity needed those funds, ­ Sub Co had the funds available to make such repayment, and ­ Sub Co was not planning to invest funds in a future project. Furthermore, Parent Co has never made a demand for payment of principal or interest under the Loan Agreement, nor has Sub Co at any time paid any principal or interest amounts. Rather, the Loan Agreement forms part of the Group's broader funding arrangements, under which funding is effectively permanent in nature and there is no genuine expectation that these amounts will or must be repaid. This is supported by the fact that no repayments for principal or interest have ever been forecasted, required or demanded, nor has any money ever been paid to satisfy the interest or principal repayments under formal loan arrangements. Therefore, having regard to the pricing, terms and conditions of the scheme (both in form and substance), Sub Co does not have an ENCO under the Loan Agreement to provide financial benefits (in the form of principal or interest repayments) to Parent Co (or any other entity) for the purposes of paragraph 974-20(1)(c). Therefore, this requirement of the debt test is not satisfied. | Detailed Reasoning - Is it substantially more likely than not that the benefit provided will at least equal the benefit received?: In considering whether this test is satisfied, a financial benefit to be provided under the scheme by the entity or a connected entity is taken into account only if it is one that the entity or a connected entity has an ENCO to provide (paragraph 974-20((4)(a)). Given the above conclusion that Sub Co does not have an ENCO to provide any financial benefits under the Loan Agreement, this requirement is not satisfied. | Detailed Reasoning - The value provided and the value received are not both nil.: Paragraph 974-20(1)(e) requires that the value of the amounts provided and received are both greater than nil. The value provided and the value received by the Sub Co are not both nil. Therefore, this requirement is satisfied. | Detailed Reasoning - Conclusion: The Loan Agreement does not give rise to a debt interest under subsection 974-15(1) given the third and fourth elements of the debt test in subsection 974-20(1) are not satisfied. | Detailed Reasoning - The equity test: Subsection 974-70(1) of the ITAA 1997 provides that a scheme satisfies the equity test in relation to a company if it gives rise to an interest set out in the following table: Table 2 The equity test | Detailed Reasoning - Interest: 1 An interest in the company as a member or stockholder of the company. 2 An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is in substance or effect * contingent on aspects of the economic performance (whether past, current or future) of: (a) the company; or (b) a part of the company's activities; or (c) a * connected entity of the company or a part of the activities of a connected entity of the company. The return may be a return of an amount invested in the interest. 3 An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is at the discretion of: (a) the company; or (b) a * connected entity of the company. The return may be a return of an amount invested in the interest. 4 An interest issued by the company that: (a) gives its holder (or a * connected entity of the holder) a right to be issued with an * equity interest in the company or a * connected entity of the company; or (b) is an * interest that will, or may, convert into an equity interest in the company or a connected entity of the company. Subsection 974-75(2) furthermore requires that for a scheme to give rise to an equity interest in a company under an item in the table in subsection 974-75(1) (other than item 1), it must be a 'financing arrangement' for the company. It has been established above that the Loan Agreement is a financing arrangement under subsection 974-130(1). Therefore, advances made under the Loan Agreement will be equity interests if they give rise to an item in the table above. | Detailed Reasoning - Application to the Loan Agreement: Under the formal terms of the Loan Agreement, Sub Co must pay the principal sum of any advances plus accrued interest and all other amounts outstanding under the Loan Agreement to Parent Co (or Intermediary Co at Parent Co's direction) within 90 days of a repayment demand by Parent Co. Given the Loan Agreement does not have a fixed term, the formal terms of the Loan Agreement give rise to an at call loan between connected entities. In applying this to the table in subsection 974-70(1), Item 1 is not satisfied given Parent Co is not a member or stockholder of the Sub Co. Item 2 is not satisfied as the terms of the Loan Agreement are not, in substance or effect, contingent on any aspects of the economic performance of Sub Co. Item 4 is not satisfied as the Loan Agreement does not involve rights to be issued with an equity interest or interests that will or may convert into an equity interest. | Detailed Reasoning - Subsection 974-70(1) - Item 3: Item 3 provides that a financing arrangement that is a formal loan to a company will give rise to an equity interest where the right to a return from the company, or the amount of the return, is at the discretion of the company or a connected entity of that company. A 'connected entity' of an entity is defined in subsection 995-1(1) of the ITAA 1997 as an associate of the entity or another member of the same wholly owned group if the entity is a company and is a member of such a group. Sub Co is therefore a connected entity of Parent Co as both companies are members of the same wholly owned group. Given the Loan Agreement gives effect to an at call loan between the connected entities, the payment of both interest and principal under the Loan Agreement are at the discretion of Parent Co, a connected entity of Sub Co. This is supported by the fact that there was no expectation or obligation for Sub Co to make payments to Parent Co nor any expectation that Parent Co would make a demand for payment under the Loan Agreement. Therefore, Item 3 is satisfied such that the Loan Agreement will constitute an equity interest under subsection 974-70(1) of the ITAA 1997 provided no exceptions apply. | Detailed Reasoning - Exception for related party at-call loans: Subsection 974-75(6) of the ITAA 1997 provides that a scheme is taken to give rise to a debt interest in the company (rather than an equity interest), if: • the scheme takes the form of a loan to the company by a connected entity, • the loan does not have a fixed term, • the loan is repayable on demand immediately on the making of the demand or at the end of a reasonable particular period or, if the connected entity is an individual, on death, and • the company's GST turnover is less than $20m. The Supplementary Explanatory Memorandum at paragraph 1.20 states that: An 'at call' loan is a loan repayable on demand by the lender. Under the proposed debt/equity rules, an 'at call' loan would normally be classified as an equity interest where the return of either the principal or interest is at the discretion of an associate. While the loan could also satisfy the debt test, and therefore qualify as a debt interest as a result of the debt/equity tie-breaker test, this would be unlikely to be the case where the term is greater than 10 years and, as is common in such arrangements between associated parties, interest is nil, very low or is as determined by the parties from time to time. Whilst the Loan Agreement does not have a fixed term in the present case, Sub Co's relevant annual turnover at all relevant times has exceeded $20 million, such that the related party at call exception under subsection 974-75(6) is not enlivened. | Detailed Reasoning - Conclusion: Given Item 3 of the table in subsection 974-75(1) of the ITAA 1997 is satisfied and the exceptions for related party at call loans do not apply, the equity test is satisfied. Therefore, the Loan Agreement between Sub Co and Parent Co gives rise to an equity interest for the purposes of Division 974 of the ITAA 1997.