Private ruling: Financing and Servicing Agreement
Date of advice: 8 September 2016
Published: November 2016
Ruling period: Year ended 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020
Date scheme commenced: 18 December 2015

Ruling: Q1: Is the Financing and Servicing Agreement (FSA) a scheme which gives rise to a 'debt interest' under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: If the FSA is a scheme which gives rise to a 'debt interest' under Division 974 of the ITAA 1997, will the Profit Amount payable by the Trust under the FSA be deductible to the Trust? | A2: Yes

Relevant facts and circumstances: The Trust: • is an Australian unit trust; • is an unregistered managed investment scheme, with an option to become a registered MIS in the future; • adheres to specific compliant financing principles; and • has been created for the purpose of acquiring a property (the Property). Financing of the Property The Trust's acquisition of the Property is to be funded by a combination of equity and debt. The debt component will include on-shore debt financing. The relevant board of the Trust requires that any finance advanced to the Trust for the purposes of funding the acquisition of the Property be done so in a form which is compliant, meaning it must adhere to a specific countries financing principles which prohibit the payment of interest (as technically defined under the relevant principles) on debt. Accordingly, the debt financing of the Property, used to part fund the Trust's acquisition of the Property, has been structured to be compliant and involves the Trust's participation in a FSA. The FSA The Investor agrees to appoint the Trust (as the Investment Manager) to invest the amount funded by debt (the 'debt amount') in the purchase of the Property and to manage the Property on behalf of the Investor in accordance with the Investment Plan and the terms of the FSA. The Investment Plan provides, inter alia, that: • the Trust undertakes to invest the debt amount in accordance with this Plan in order to generate an anticipated profit, which shall be sufficient to pay the Profit Amount to the Investor periodically; and • the Trust must manage the Property as a commercial office building; keep proper records in relation to the Property; and pay the Profit Amount to the Investor. Subject to the availability of funds, the Investor will promptly pay the debt amount to the Trust. In consideration of the Investor providing the debt amount and entering into the FSA, the Trust must pay to the Investor: • an amount equivalent to the debt amount (the 'repayment amount'), as well as any other unpaid Secured Moneys, in full by or on the Termination Date (being 36 months after the date on which the debt amount is provided to the Trust); and • the Profit Amount on each relevant date. In respect of each relevant period, the order of priority for the distribution of the Investment Income (defined in the FSA to broadly include rental income and other profits earned in connection with the Property) received by the Trust for that period shall, in the first instance, be 100% to the Investor until and to the extent the Investor has received an amount equal to the Profit Amount. The Trust acknowledges that a failure to pay the Profit Amount when due shall constitute an Event of Default under the FSA. Assumptions 1. Division 230 of the ITAA 1997 applies to gains or losses from the financial arrangements of the Trust. 2. The FSA (and associated financing arrangements) is entered into or carried out by the Trust in gaining or producing assessable income of the Trust, being rental income from the Property. 3. All dealings between and/or amongst any of the Trust and the other parties to involved will be at arm's length. 4. The Trust will not hold, or invest in, any assets other than the Property during the term of the FSA.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 Division 230 | Income Tax Assessment Act 1997 subsection 230-15(2) | Income Tax Assessment Act 1997 subsection 230-20(4) | Income Tax Assessment Act 1997 Subdivision 230-H | Income Tax Assessment Act 1997 Division 820 | Income Tax Assessment Act 1997 Division 974 | Income Tax Assessment Act 1997 subsection 974-5(1) | 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)(a) | Income Tax Assessment Act 1997 paragraph 974-20(1)(b) | Income Tax Assessment Act 1997 paragraph 974-20(1)(c) | Income Tax Assessment Act 1997 paragraph 974-20(1)(d) | Income Tax Assessment Act 1997 paragraph 974-20(1)(e) | 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 section 974-160

Reasons for decision: Summary: The FSA is a scheme which gives rise to a debt interest under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997) 1 . | Detailed Reasoning - Detailed reasoning: The provisions of Division 974 determine whether, for certain income tax purposes, an interest is a 'debt interest' or an 'equity interest' for tax purposes. These provisions do not impose tax, but rather categorise whether an interest is debt or equity based on "economic substance rather than mere legal form" (subsection 974-5(1)). 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 (subsection 974-15(1)). Subsection 974-20(1) provides that a scheme satisfies the debt test 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 classification of a scheme as giving rise to a debt interest is done from the perspective of the issuer of the interest, in this instance the Trust. Addressing each component of subsection 974-20(1) separately: • the FSA (a 'scheme' for the purposes of the Income Tax Assessment Act ) will be entered into by the Trust to raise finance used to fund (partly) its acquisition of the Property, and therefore will be a 'financing arrangement' for the Trust pursuant to section 974-130, thereby satisfying paragraph 974-20(1)(a); • the debt amount to be received by the Trust under the FSA from the Investor will constitute a 'financial benefit' pursuant to section 974-160, thereby satisfying paragraph 974-20(1)(b); • subsequent to its receipt of the debt amount from the Investor, the Trust will have an 'effectively non-contingent obligation', as per section 974-135, to provide a financial benefit under the FSA in the form of the repayment amount and the Profit Amounts, thereby satisfying paragraph 974-20(1)(c); • it is substantially more likely than not that: - the value of the repayment amount to be provided by the Trust to the Investor under the FSA (in nominal terms pursuant to section 974-35) will at least equal the value of the debt amount received by the Trust from the Investor under the FSA; and - the aggregate value of all the effectively non-contingent financial benefits (in nominal terms) to be provided by the Trust to the Investor under the FSA (including the Profit Amounts) will, to the extent of the Profit Amounts paid, exceed the value of the debt amount received by the Trust from the Investor under the FSA, thereby satisfying paragraph 974-20(1)(d); and • neither the value of the financial benefit received by the Trust, nor the value of the financial benefits provided by the Trust under the FSA will be nil, thereby satisfying paragraph 974-20(1)(e)). As each of the requirements of the debt test in subsection 974-20(1) will, when the FSA comes into existence, be satisfied, the FSA gives rise to a debt interest in the Trust. | Summary: The Profit Amount payable by the Trust under the FSA will be deductible. | Detailed Reasoning - Detailed reasoning: The classification of an interest as a debt interest under Division 974 has certain taxation consequences. In particular, returns paid on a debt interest may be deductible, but not frankable. A return on a debt interest will be deductible under section 8-1 if it meets the general deduction criteria, i.e. it is incurred in gaining or producing the issuer's assessable income, or is necessarily incurred in carrying on a business for the purpose of gaining or producing the issuer's assessable income, provided that the expenditure is not of a capital, private or domestic nature. Where the debt interest is also a financial arrangement for the purposes of Division 230, and that Division applies to the issuer's gains and losses from financial arrangements, losses on that debt interest are (subject to specific exceptions under Subdivision 230-H) allowable as a deduction under subsection 230-15(2) to the extent that they are made in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Subsection 230-15(2) therefore reflects the general deduction rule in section 8-1 with the exception that it generally doesn't deny deductions for a loss of a capital nature. The Profit Amount payable by the Trust under the FSA in consideration of money advanced to the Trust under the FSA (i.e. the debt amount) is, in substance, considered analogous to interest payable on money borrowed. Therefore, like interest, the essential character of the Profit Amount is a question of fact to be determined by reference to the objective circumstances of the use to which the advanced funds are put by the Trust. Under the terms of the FSA, the Trust will be advanced the debt amount from the Investor to part fund the Trust's acquisition of the Property. As the Profit Amount payable is in respect of the debt amount to be used to acquire the Property, being an asset that is expected to produce assessable income in the form of rental income, the Profit Amount will be incidental and relevant in carrying on a business for the purpose of gaining or producing the Trust's assessable income. Therefore, the Profit Amount will: • be incurred by the Trust in carrying on a business for the purpose of gaining or producing the Trust's assessable income, and deductible under section 8-1; and/or • in the event the FSA is a financial arrangement for the purposes of Division 230, be incurred by the Trust in carrying on a business for the purpose of gaining or producing the Trust's assessable income, and give rise to a deductible loss under subsection 230-15(2). A loss that is allowable as a deduction to an entity for an income year under Division 230 is not to be (to any extent) allowable as a deduction to that entity under any provisions of the ITAA outside Division 230 (including section 8-1) for the same or any other income year (subsection 230-20(4)). 1 All legislative references in this document are to the ITAA 1997.