Private ruling: Reorganisation
Date of advice: 29 June 2018
Published: September 2018
Ruling period: Year ended 31 December 2016
Date scheme commenced: Year ended 31 December 2016

Ruling: Q1: Are the promissory notes issued by AusCo debt interests as defined in Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the interest on the promissory notes be deductible to HeadCo under subsection 230-15(2) of the ITAA 1997? | A2: Not applicable. | Q3: Did a gain or loss arise from a balancing adjustment under section 230-435 of the ITAA 1997 for the assignment of the promissory notes? | A3: Not applicable. | Q4: If yes to question 2, will HeadCo get a transfer pricing benefit for the purposes of Subdivision 815-B of the ITAA 1997 in respect of the promissory notes? | A4: Not applicable. | Q5: If yes to question 2, is all or part of the debt deductions incurred by HeadCo in respect of the promissory notes disallowed under Division 820 of the ITAA 1997? | A5: Not applicable. | Q6: If yes to question 2, will the Commissioner make a determination under paragraph 177F(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) to cancel a tax benefit of a kind referred to in paragraph 177C(1)(b) of the ITAA 1936 obtained, or that would but for paragraph 177F(1)(b) of the ITAA 1936 be obtained, by HeadCo as a result of issuing the promissory notes? | A6: Not applicable.

Relevant facts and circumstances: HeadCo is the head company of a consolidated group. HeadCo undertook a reorganisation. The reorganisation had a number of transactions and these included the following: ● AustCo, a subsidiary member of HeadCo, acquired all of the issued shares in ABC Co from ForeignCo. AustCo issued promissory notes to satisfy its obligations to pay for the ABC Co shares, and ● ForeignCo assigned the promissory notes and it received a consideration for the assignment. AustCo did not make a loss from the promissory notes by reference to, or by reason of, the interest on the promissory notes for the duration the promissory notes subsist.

Relevant legislative provisions: Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 subsection 177C(1) | Income Tax Assessment Act 1936 section 177F | Income Tax Assessment Act 1936 subsection 177F(1) | Income Tax Assessment Act 1997 subsection 230-15(2) | Income Tax Assessment Act 1997 subsection 230-435(1) | Income Tax Assessment Act 1997 Subdivision 815-B | Income Tax Assessment Act 1997 Division 820 | Income Tax Assessment Act 1997 Division 974 | Income Tax Assessment Act 1997 subsection 974-15(1) | Income Tax Assessment Act 1997 sub section 974-20(1) | Income Tax Assessment Act 1997 section 974-35 | Income Tax Assessment Act 1997 section 974-130 | Income Tax Assessment Act 1997 section 974-135 | Income Tax Assessment Act 1997 subsection 974-160(1) | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: As all the requirements of the debt test are satisfied, the promissory notes issued by AusCo are debt interests pursuant to section 974-20. | Detailed Reasoning - Detailed reasoning: Division 974 provides the rules that determine the classification of an interest as either debt or equity for income tax purposes. In particular, it determines the income tax treatment of distributions or returns made in respect of the relevant interest. Subsection 974-15(1) 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) in relation to the entity. The test for a debt interest is contained in subsection 974-20(1). That subsection states: A scheme satisfies the debt test in this subsection in relation to an entity 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 the entity and a connected entity of the entity each has, an effectively non-contingent obligation 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 not both nil. The scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company.) These requirements of the debt test in relation to the promissory notes, applied at the time the promissory notes are issued and come into existence, are discussed below. (a) Is there a scheme that is a financing arrangement for the entity? Subsection 995-1(1) defines 'scheme' to mean any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. Thus, the issue of each promissory note by AusCo during the period you asked us to rule on, will fall within this definition of a scheme. Each scheme is being entered into or undertaken by AusCo to raise finance to fund the acquisition of the ABC Co shares and therefore, each scheme is a financing arrangement for the entity [paragraph 974-130(1)(a)]. (b) Does the entity or a connected entity of the entity, receive, or will receive, a financial benefit or benefits under the scheme? Subsection 974-160(1) provides in part that: (1) in this Act: financial benefit : (a) means anything of economic value...; In accordance with the terms of the ABC Co share sale agreement, AusCo acquired the ABC Co shares from ForeignCo by issuing the promissory notes to satisfy its obligation to pay the ABC Co sale shares purchase price. The financial accommodation provided to AusCo by the issue of the promissory notes represents a financial benefit as defined in subsection 974-160(1). (c) Does the entity or a connected entity of the entity have an effectively non-contingent obligation to provide a financial benefit or benefits to one or more entities after the time when the financial benefit is received? 'Effectively non-contingent obligation' is defined in section 974-135. 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) then provides: "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." Considering these legislative requirements, AusCo will have an effectively non-contingent obligation to provide a financial benefit, as AusCo has an effectively non-contingent obligation under the terms, pricing and conditions of the promissory notes to repay the principal and accrued interest on maturity or upon written demand by ForeignCo. (d) Is it substantially more likely than not that the financial benefit provided will at least equal the financial benefit received? Section 974-35 sets out the manner in which the value of a financial benefit to be provided or received under the scheme is to be calculated. Paragraph 974-35(1)(a) provides that the value of a financial benefit to be provided or received is to be calculated in nominal terms, if the performance period ends no later than 10 years after the interest arising from the scheme is issued or, in present value terms if the performance period must, or may, end more than 10 years after the interest arising from the scheme is issued. As the performance period of the promissory notes is not longer than 10 years, nominal values will be used to value any effectively non-contingent obligations. Valuing the effectively non-contingent obligations in nominal terms has the result that it is substantially more likely than not that the value of the financial benefits provided by AusCo on maturity will at least be equal to the value of the financial benefits received under the promissory notes. (e) The value provided and the value received are not both nil The value provided and the value received will not both be nil. | Detailed Reasoning - Related schemes: Since each promissory note individually satisfies the debt test, it is not necessary to consider whether the promissory notes are related schemes (as defined in section 974-155) that together give rise to a debt interest (subsection 974-20(3)). The applicant has not identified any other scheme related to the promissory notes. | Detailed Reasoning - Other exceptions or modifications: None of the exceptions to the debt test in section 974-25 apply to the promissory notes. No scheme or series of schemes have been identified designed to operate so that the return on the promissory notes is to be used to fund (directly or indirectly) a return to another person in circumstances to which subsection 974-80(2) applies. | Detailed Reasoning - Conclusion: As all the requirements of the debt test are satisfied (and no exception or modification applies), each promissory note issued by AusCo is a debt interest pursuant to section 974-20. | Detailed Reasoning - Question 2: Will the interest on the promissory notes be deductible to HeadCo under subsection 230-15(2) of the ITAA 1997? Subsection 230-15(2) provides the general test for deductibility of a loss under Division 230. The deduction will be available to the extent the loss is made in gaining or producing the relevant taxpayer's assessable income or is necessarily made in carrying on a business for that purpose. Because AusCo did not make a loss from the promissory notes by reference to, or by reason of, the interest on the promissory notes for the duration the promissory notes subsist, the deductibility to HeadCo of the interest on the promissory notes issued by AusCo does not have to be considered. | Detailed Reasoning - Question 3: Did a gain or loss arise from a balancing adjustment under section 230-435 of the ITAA 1997 for the assignment of the promissory notes? Subsection 230-435(1) provides as follows: (1) A balancing adjustment is made under this Subdivision if: (a) you transfer to another entity all of your rights and/or obligations under a *financial arrangement; or (b) all of your rights and/or obligations under a financial arrangement otherwise cease; or (c) you transfer to another entity: (i) a proportionate share of all of your rights and/or obligations under a financial arrangement; or (ii) a right or obligation that you have under a financial arrangement to a specifically identified *financial benefit; or (iii) a proportionate share of a right or obligation that you have under a financial arrangement to a specifically identified financial benefit; or (d) an * arrangement that is a *Division 230 financial arrangement ceases to be a financial arrangement. Each assignment did not involve a change in the debtor company and did not involve AusCo doing anything that would trigger the making of a balancing adjustment under subsection 230-435(1). Accordingly, the operation of section 230-435 from HeadCo’s perspective does not have to be considered. | Detailed Reasoning - Question 4: If yes to question 2, will HeadCo get a transfer pricing benefit for the purposes of Subdivision 815-B of the ITAA 1997 in respect of the promissory notes? The object of Subdivision 815-B is to ensure that the amount that is brought to tax in Australia in respect of cross-border commercial and financial relations and conditions between separate legal entities reflects the arm's length contribution (that is, the economic functions performed, assets used and risks assumed) by the Australian operations and the conditions that might be expected to operate between independent entities dealing at arm's length. Because the answer to question 2 is ‘not applicable’, this question does not have to be considered. | Detailed Reasoning - Question 5: If yes to question 2, is all or part of the debt deductions incurred by HeadCo in respect of the promissory notes disallowed under Division 820 of the ITAA 1997? The object of Division 820 is to ensure that certain entities do not reduce their tax liabilities by using an excessive amount of debt capital to finance their Australian operations. Because the answer to question 2 is ‘not applicable’, this question does not have to be considered. | Detailed Reasoning - Question 6: If yes to question 2, will the Commissioner make a determination under paragraph 177F(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) to cancel a tax benefit of a kind referred to in paragraph 177C(1)(b) of the ITAA 1936 obtained, or that would but for paragraph 177F(1)(b) of the ITAA 1936 be obtained, by HeadCo as a result of issuing the promissory notes? Part IVA of the ITAA 1936 (Part IVA) is a general anti-avoidance provision. Under subsection 177F(1) of the ITAA 1936, the Commissioner may make a determination to cancel a tax benefit that has been obtained, or would but for section 177F of the ITAA 1936 be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. Part IVA cannot apply unless a taxpayer has obtained, or would, but for section 177F of the ITAA 1936 obtain, a tax benefit in connection with a scheme. Paragraph 177C(1)(b) of the ITAA 1936 relevantly includes as a kind of tax benefit, a deduction being allowable to the taxpayer in relation to a year of income. For schemes entered into or commenced to be carried out on or after 16 November 2012, a tax benefit must be determined with reference to section 177CB of the ITAA 1936. Because the answer to question 2 is ‘not applicable’, this question does not have to be considered.

Reasons for decision: All legislative references are to the ITAA 1997 unless indicated otherwise.