Private ruling: Income tax treatment of unsecured notes
Published: September 2011
Ruling period: 1 July 2010 to 30 June 2020
Date scheme commenced: 1 July 2010

Ruling: Q1: Do the Unsecured Notes (Notes) constitute debt interests pursuant to Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Are the Notes and the loans provided to purchase Notes (Note Loans) separate arrangements for the purposes of Division 230 of the ITAA 1997? | A2: Yes. | Q3: Do the Notes constitute financial arrangements pursuant to Division 230 of the ITAA 1997? | A3: Yes. | Q4: If the Notes constitute financial arrangements pursuant to Division 230 of the ITAA 1997, are losses made on the Notes deductible pursuant to subsection 230-15(2) of the ITAA 1997? | A4: Yes. | Q5: If the Notes are classified as financial arrangements pursuant to Division 230 of the ITAA 1997, does subsection 230-15(5) of the ITAA 1997 apply to cap the deduction? | A5: No. | Q6: If the answer to Question 2 is yes, do the Note Loans constitute financial arrangements pursuant to Division 230 of the ITAA 1997? | A6: Yes. | Q7: If the Note Loans constitute financial arrangements pursuant to Division 230, are gains made on the Note Loans fully assessable to Entity A as head company of the tax consolidated group pursuant to subsection 230-15(1) of the ITAA 1997? | A7: Yes. | Q8: If the answer to Question 3 is no, are the interest payments on the Notes deductible pursuant to section 8-1 of the ITAA 1997? | A8: Not applicable. | Q9: If the answer to Questions 3 is no, does section 25-85 of the ITAA 1997 operate to cap the deduction for interest payments on the Notes? | A9: Not applicable.

Relevant facts and circumstances: Entity A commenced offering certain employees (or their nominees) the opportunity to invest in Unsecured Notes (Notes). To facilitate this, Entity A prepared a Prospectus and Note Deed. The Notes issued by Entity A are issued under the Prospectus and subject to the terms and conditions in the Note Deed. The relevant terms and conditions include: · Entity A selects which shop managers and other senior managers (or their nominees) are to be offered the Notes. Employees that accept the offer are issued with Notes and become Note Holders (Note Holders). · The Note Deed provides that Note Holders are entitled to an interest distribution calculated by reference to the management profits of the business unit (Profit Note) or improvements in such management profits of the business unit (Improvement Note). No level of interest return is promised or guaranteed. · Profit Notes are offered when a business unit has recorded a management profit result over the prior 12 months. Interest payments are calculated based on the management profit made by the business unit each month. · Improvement Notes are offered when a business has recorded a loss result over the prior 12 months. Interest payments are calculated by reference to any improvement in the results of the business unit over a specified monthly improvement figure. · Interest distributions are possible in situations where there is no management profit in relation to a business unit but there has been an improvement in a loss position from a previous year or a return to a profit position. It is important to observe that interest distributions are not out of the profits of Entity A, merely calculated by reference to profits of a business unit, or an improvement in a loss position. · The Note Deed provides that interest payments will be no less frequently than quarterly. In practice, interest is paid monthly in arrears and the percentage interest rate applicable is set out in the Prospectus and a sliding scale of rates rather than a fixed number may be provided. · The Note Deed provides that Note Holders are to pay the face value of the Note to Entity A within 31 days after the date of the Unsecured Note Agreement. The Note will be issued for face value as soon as is practicable after payment is received by the issuing of a certificate to the Note Holder by Entity A. · Note Holders must source appropriate funding to invest in a Note. Generally, funding will be sourced from personal cash or debt capital. · The Note Deed provides that upon redemption of a Note, the face value together with any interest due under the Note will be paid to the Note Holder. · The Note Deed provides that Notes will be redeemed at the earliest of the following: o Upon termination of the Manager's employment with Entity A; o Upon notice in writing from the Note Holder requesting redemption or repayment of the Note; o In relation to Notes issued after December 2007, upon notice in writing from Entity A advising that redemption or repayment of the Note will occur on a certain date; or o Upon the tenth anniversary of the date of issue of the Note. Entity A submits that the Note is entered into in order to: · Increase the profitability of the business unit that the Note Holder manages and hence the overall profitability of Entity A. · Provide Note Holders with an ability to share in the net profits of the store or business unit to which Notes relate in order to motivate staff and thereby increase the profitability of the business unit. · Raise additional working capital which can be utilised by Entity A, the choice of exactly how the funds should be utilised being a business decision made by Entity A. Entity B is a wholly owned subsidiary of Entity A. Entity A is the head company of a tax consolidated group. Entity B is a member of the tax consolidated group. Entity B provides loans to selected employees to enable them to purchase Notes in Entity A (Note Loan). Entity B is a separate legal entity responsible for the Note Loan and not involved in the issue of Notes by Entity A. The relevant terms and conditions in relation to the Note Loans include: · The Finance Offer for Note Loans provides that the purpose of a Note Loan is to purchase or refinance a Note issued by Entity A. The Note Loan is effectively secured by the relevant Note. · The Finance Offer for Note Loans provides that the interest per annum will be charged on the Note Loan at a variable commercial rate. The interest rate is the Reserve Bank Cash Rate plus an interest margin. Interest is paid monthly in arrears. The Note Loan is interest only until it concludes at which point the principal amount and any accrued interest is payable to Entity B. · The Finance Offer for Note Loans provides that the loans are for an initial period of 12 months commencing from the date funds are advanced. Subject to an annual review to the satisfaction of Entity B the Note Loan will automatically rollover for a subsequent 12 month term unless there is an event of default or, not less than 14 days prior to the rollover date, either party decides to terminate the Note Loan. A Note Loan may also be terminated if the Note falls due for redemption, is redeemed or if the borrower defaults and the Note Loan is terminated by Entity B. · The Finance Offer for Note Loans provides that Notes may be redeemed by delivering a redemption notice where the Note Holder has defaulted in payment of interest or other monies by the due date, where the Note Holder ceases to be a manager of a Entity A business, or where Entity B demands repayment of the Note Loan pursuant to the loan agreement and the Note Holder fails to comply with the prescribed obligations. It is anticipated that approximately 5 out of every 6 Notes will be funded through Note Loans provided by Entity B. Each Note and Note Loan is recorded separately in the financial reports of Entity A.


Reasons for decision: Detailed Reasoning - Detailed reasoning: Whether an interest is a debt interest or an equity interest is determined by applying the provisions and tests contained within Division 974 of the ITAA 1997. Subsection 974-15(1) of the ITAA 1997 provides that a scheme will give rise to a debt interest in an entity if, when it comes into existence, it satisfies the debt test in subsection 974-20(1) of the ITAA 1997 (debt test). Subsection 974-70(1) of the ITAA 1997 provides that a scheme will give rise to a equity interest in a company if, when it comes into existence, it satisfies the equity test in subsection 974-75(1) of the ITAA 1997 and is not characterised as, or form part of a larger interest that is characterised as a debt interest in the company or a connected entity of the company (equity test). In the event that an interest satisfies both the debt test and equity test the interest is to be treated as a debt interest due to the operation of paragraph 974-70(1)(b) of the ITAA 1997. As such, if an interest satisfies the debt test it is not necessary to consider the equity test. Existence of a scheme The debt test requires the existence of a 'scheme'. A 'scheme' is broadly defined in subsection 995-1(1) of the ITAA 1997 as being any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The issue of each Note by Entity A under the Prospectus and Note Deed satisfies the definition of a scheme under subsection 995-1(1) of the ITAA 1997. Each Note is therefore a scheme for the purposes subsection 974-15(1) of the ITAA 1997. Application of the debt test On being satisfied a scheme exists the next step in applying the debt test is to consider whether the scheme satisfies the requirements of paragraphs 974-20(1)(a)-(e) of the ITAA 1997. The paragraphs are not alternatives and as such the scheme must satisfy each paragraph. Financing arrangement Paragraph 974-20(1)(a) of the ITAA 1997 requires that the scheme be a 'financing arrangement' for the entity. Subsection 995-1(1) of the ITAA 1997 provides that a 'financing arrangement' has the meaning given by section 974-130 of the ITAA 1997. Section 974-130 of the ITAA 1997 provides that a scheme will be a financing arrangement if it satisfies any of the requirements in paragraphs 974-130(1)(a)-(c) of the ITAA 1997. The paragraphs are alternatives, in the event that one paragraph is satisfied it becomes unnecessary to consider whether the scheme satisfies those which remain. Paragraph 974-130(1)(a) of the ITAA 1997 provides that a scheme will be a financing arrangement if it raises finance for the entity. Subsection 974-130(2) of the ITAA 1997 provides examples of a number of schemes that are generally entered into or undertaken for the purposes of raising finance. These are bills of exchange, income securities or convertible interests that will convert into an equity interest. Subsection 974-130(3) of the ITAA 1997 provides examples of a number of schemes that are generally not entered into or undertaken for the purposes of raising finance. These are derivatives used solely for managing financial risk and contracts for personal services entered into in the ordinary course of business. The Explanatory Memorandum to the New Business Tax System (Debt and Equity) Bill 2001 provides at paragraph 2.7 that raising finance …generally entails a contribution to the capital of an entity, whether by way of money, property or services, in respect of which a return is paid by the entity, be it contingent (connoting equity) or non-contingent (connoting debt). It is important, however, to consider all the relevant circumstances and features of a particular arrangement to determine whether, in substance, it is appropriately characterised as a financing arrangement or not. In this regard, the intentions of the parties to the arrangement may be relevant, but are not determinative. The Prospectus provides that amounts generated from each Note issued will be used as working capital for Entity A. Entity A submits that each Note is entered into in order to: · Increase the profitability of the business unit that the Note Holder manages and hence the overall profitability of Entity A. · Provide Note Holders with an ability to share in the net profits of the store or business unit to which Notes relate in order to increase the store's or business unit's profitability. · Raise additional working capital which can be utilised by Entity A, the choice of exactly how the funds should be utilised being a business decision made by Entity A. As one of the purposes for issuing each Note is to raise finance the requirements of paragraph 974-130(1)(a) of the ITAA 1997 are met. Will the entity or a connected entity receive a financial benefit under the scheme? Paragraph 974-20(1)(b) of the ITAA 1997 requires that the entity or a connected entity receive, or will receive, a 'financial benefit' or benefits under the scheme. The term 'financial benefit' is defined in section 974-160 of the ITAA 1997. A 'financial benefit' means anything of economic value. Subsection 974-20(4) of the ITAA 1997 provides that a financial benefit received by an entity is only taken into account for the purposes of paragraph 974-20(1)(b) of the ITAA 1997 if the entity that provided it had an 'effectively non-contingent obligation' to do so. An 'effectively non-contingent obligation' is defined in section 974-135 of the ITAA 1997. Subsection 974-135(1) of the ITAA 1997 provides that an obligation is effectively non-contingent if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action. What constitutes a non-contingent obligation is elaborated upon further in subsections 974-135(3)-(7) of the ITAA 1997. The Note Deed and Prospectus provide that a Note Holder who acquires a Note is to pay the face value of the Note to Entity A within 31 days after the date of the Unsecured Note Agreement. If the required amount is not received then it will be deemed that no Note has been issued. Each Note is settled in cash which has economic value and is paid to the issuer of the Note, being Entity A. The obligation to pay that amount is effectively non-contingent as it does not depend on any event, condition or situation other than the willingness of the Note Holder. The requirements of paragraph 974-20(1)(b) of the ITAA 1997 are met. An effectively non-contingent obligation to provide a financial benefit Paragraph 974-20(1)(c) of the ITAA 1997 requires that the entity have an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when it receives: · If there is only one financial benefit, that financial benefit; or · If there is more than one financial benefit, the first financial benefit. As above, a financial benefit means anything of economic value and an obligation is effectively a non-contingent obligation if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action. The Note Deed provides that the scheme concludes on the occurrence of a number of specified circumstances and events which will cause redemption of the Note, specifically: · Termination of the Manager's employment with Entity A; · Notice in writing from the Note Holder requesting redemption or repayment; · In relation to Notes issued after December 2007, upon notice in writing from the issuer advising that redemption or repayment will occur on a certain date; or · The tenth anniversary of the date of issue of the Note. These requirements mean that, in effect, Entity A must redeem the Note for its face value at the latest 10 years after issue of the Note. That obligation to take action is not contingent on any event, condition or situation other than the willingness or ability of Entity A to meet the obligation. As Entity A has an effectively non-contingent obligation under each Note to return the face value to the Note Holders after the time when the face value was received, the requirements of paragraph 974-20(1)(c) of the ITAA 1997 are met. The value provided is at least equal to the value received Paragraph 974-20(1)(d) of the ITAA 1997 requires that it is substantially more likely than not that the value provided by the entity will be at least equal to the financial benefit it received. The value provided and value received is worked out by reference to subsections 974-20(2) and (3) of the ITAA 1997. As outlined above, Entity A has an effectively non-contingent obligation to repay the face value or original purchase price of each Note on redemption to the Note Holder. Section 974-35 of the ITAA 1997 contains valuation rules for financial benefits. Subparagraph 974-35(1)(a)(i) of the ITAA 1997 provides that the value of a financial benefit received or provided under a scheme is calculated in nominal terms if the performance period ends no later than 10 years after the interest arising from the scheme is issued. Subsection 974-35(3) of the ITAA 1997 provides that the performance period is essentially the period within which, under the terms on which the interest is issued, the effectively non-contingent obligations of the issuer to provide a financial benefit in relation to the interest have to be met. Subsection 974-35(2) of the ITAA 1997 requires an assumption that the interest arising from the scheme will continue to be held for the rest of its life when calculating the value of financial benefits received or provided. Since the performance period of the interest will end no later than 10 years after the issue of each Note, both the value received and the value provided is calculated in nominal terms. As outlined above, Entity A must repay at least the face value of each Note on redemption to the Note Holder. Since in nominal terms, the value provided (as discussed in subsection 974-20(2) of the ITAA 1997) will be at least equal to the value received, the requirements of paragraph 974-20(1)(d) of the ITAA 1997 are met. The value received and value provided are not both nil Paragraph 974-20(1)(e) of the ITAA 1997 requires that the value provided and the value received are not both nil. Each Note involves the issue, redemption and repayment of a Note. An amount is paid by the Note Holder to acquire a Note. On redemption the face value of the Note is repayable, along with any interest which may be due, to the Note Holder. Nothing suggests that the financial benefit to be received and provided would consist of a nil value. As the value provided and value received are not both nil, the requirements of paragraph 974-20(1)(e) of the ITAA 1997 are met. Conclusion Each Note satisfies the test for a debt interest in section 974-20 of the ITAA 1997. It is therefore unnecessary to consider whether each Note also satisfies the test for an equity interest in section 974-75 of the ITAA 1997 due to the operation of paragraph 974-70(1)(b) of the ITAA 1997. An interest cannot be characterised as an equity interest if the interest is already characterised as a debt interest under Subdivision 974-B of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Division 230 of the ITAA 1997 brings to account gains and losses on financial arrangements. In order to determine whether gains and losses arise under a financial arrangement, it is first necessary to identify the relevant 'arrangement'. An 'arrangement' is defined in subsection 995-1(1) of the ITAA 1997 as '…any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.' The scope of the arrangement for the purposes of Division 230 of the ITAA 1997 is determined by subsection 230-55(4) of the ITAA 1997. Generally, under section 230-55 of the ITAA 1997, a contract will define the boundaries of an arrangement, especially where the form of the contract is consistent with its substance. Paragraph 2.47 of the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (EM) provides that: 2.47 The various rights and obligations subsisting under a contract will typically constitute the relevant arrangement for the purposes of Division 230. That is, the contract is typically viewed on a 'stand-alone' basis. In this context, the contract is neither aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230. Since the rights and obligations under each Note and Note Loan arise under separate contracts, each will prima facie be viewed on a 'stand-alone' basis for the purposes of Division 230 of the ITAA 1997. However, section 230-55 of the ITAA 1997 is not limited by the form of a single contract in the identification of an arrangement. Specifically, under subsection 230-55(4) of the ITAA 1997 regard must be had to a range of factors in order to determine whether a number of rights and/or obligations arise under one or more arrangements. The way various rights and obligations are combined under subsection 230-55(4) is an objective enquiry, the purpose of which is to identify the correct 'unit of taxation' in the context of Division 230 of the ITAA 1997. Conclusion Having regard to each of the factors listed in subsection 230-55(4) of the ITAA 1997, each Note and Note Loan should be viewed on a 'stand-alone' basis for the purposes of Division 230 of the ITAA 1997. It is considered that the following matters support the conclusion that each Note and Note Loan is a separate arrangement for the purposes of Division 230: · Each Note and Note Loan arise in separate legal documents. · While each Note and Note Loan are related in form, in substance they are treated as separate bundles of rights and obligations and can be understood independently and without reference to the other. · Each Note and Note Loan is accounted for separately by Entity A. · While the terms and conditions of each Note Loan refer to the Note, the mere fact that one contract refers to another does not indicate that the rights and/or obligations under the contracts are to be combined. · The fact that each Note Loan is conditional upon credit approval by Entity B suggests this is not mere performance of a single wider arrangement. · It is not mandatory for a Note Holder to raise funds to purchase a Note through a Note Loan as a prospective Note Holder can source alternative personal finance to fund the purchase of a Note. · The decision to offer a Note to a particular employee is separate and distinct from the decision to make a Note Loan to that employee. | Detailed Reasoning - Detailed reasoning: An arrangement must meet the definition of a 'financial arrangement' before it will be subject to Division 230 of the ITAA 1997. Subdivision 230-A of the ITAA 1997 provides the test for determining whether an arrangement is a 'financial arrangement'. An arrangement will be a financial arrangement if it satisfies the definition under section 230-45 of the ITAA 1997 (dealing with cash settlable rights and obligations to financial benefits) or the definition under section 230-50 of the ITAA 1997 (dealing with equity interest and rights and obligations to equity interests). Subsection 230-45(1) of the ITAA 1997 provides: (1) You have a financial arrangement if you have, under an arrangement: (a) a cash settlable legal or equitable right to receive a financial benefit; or (b) a cash settlable legal or equitable obligation to provide a financial benefit; or (c) a combination of one or more such rights and/or one or more such obligations; unless: (d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and (e) for one or more of the rights and/or obligations covered by paragraph (d): (i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or (ii) the right or obligation is not cash settlable; and (f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c). The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangementParagraph 230-45(2)(a) of the ITAA 1997 provides an exhaustive list of when you have a right to receive, or an obligation to provide, a financial benefit that is 'cash settlable'. This list includes a situation when the financial benefit is money or a money equivalent. Under each Note, Entity A has rights to receive and obligations to provide things which are financial benefits within the meaning of section 974-160 of the ITAA 1997. Entity A has a right to receive a financial benefit, being payment by the Note Holder of the face value of the Note upon its issue. Entity A has obligations to provide financial benefits to Note Holders, which include: · Interest payments where relevant improvement or profit targets are met; and · On redemption, the return of the face value of the Note to the Note Holder. It is noted that, for the purposes of Division 230, contingent rights and obligations, such as the contingent obligation to make interest payments, are treated as rights and obligations (see section 230-85 of the ITAA 1997). Conclusion Entity A's rights and obligations under each Note all meet the definition of cash settlable as in each case the financial benefit involved is money. Entity A does not have any rights or obligations under each Note which are not cash settlable and also not insignificant in comparison to the cash settlable rights and obligations discussed. Each Note will satisfy the definition of a 'financial arrangement' under subsection 230-45(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: A loss made from a financial arrangement will be allowable as a deduction where it meets the requirements of subsection 230-15(2) of the ITAA 1997. Subsection 230-15(2) of the ITAA 1997 relevantly provides: (2) You can deduct a loss you make from a financial arrangement, but only to the extent that: (a) you make it in gaining or producing your assessable income; or (b) you necessarily make it in carrying on a business for the purpose of gaining or producing your assessable income. Note: This Division does not apply to losses that are subject to exceptions under Subdivision 230-H. Paragraph 3.71 of the EM provides that: 3.71 This rule reflects the current general deduction rule in section 8-1 of the ITAA 1997 with the exception that it generally does not deny deductions for a loss of a capital nature. This is consistent with an object of Division 230, which is to generally ignore distinctions between capital and revenue. As such, case law considering the operation of section 8-1 of the ITAA 1997 can provide assistance in interpreting the operation of section 230-15 of the ITAA 1997. This is confirmed in paragraph 3.72 of the EM. Like section 8-1 of the ITAA 1997, section 230-15 of the ITAA 1997 has two positive limbs. The first positive limb was considered by the High Court of Australia in Ronpibon Tin N.L. and Tongkah Compound N.L. v Federal Commissioner of Taxation (1949) 78 CLR 47 ( Ronpibon ). In Ronpibon it was determined that the first positive limb would be satisfied where the loss is incidental and relevant to the gaining or production of assessable income. The second positive limb was considered by the High Court of Australia in Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 ( Fletcher ). In Fletcher it was determined that the second positive limb would be satisfied where the loss is part of the cost of conducting a business so that it has the character of being an operating expense or an essential part of business operations which is directed toward the production of assessable income. Both limbs require a nexus between the loss and the gaining or producing of assessable income. Profit Sharing Notes The deductibility of interest payments under profit-sharing notes was considered by the High Court of Australia in Boulder Perseverance Limited v Commissioner of Taxation (Western Australia) (1937) 58 CLR 223 ( Boulder Perseverance ). While this case does not provide a bright line test for deductibility of distributions on profit-sharing notes, it does suggest that such distributions can, in some circumstances, be allowable as a deduction. Professor Ross Parsons in Income Taxation in Australia , LBC, 1985 considers this aspect of Boulder Perseverance at paragraph 6.304: The distinction between "a payment contingent upon the making of net profits and proportional to their amount", which may be deductible, and a "payment of part of the net profits under that description" may be thought verbal only, and the reference to the purpose of the statute, towards the end of the judgment, as not "confined to the taxation of profits that are available to shareholders and no one else" serves no more than to limit the decision in the case to the operation of the particular statute. One would have thought that, consistent with the approach taken in cases which rest on the purpose of the payment, the question of deductibility might have been resolved by asking whether the function of the payment was to service the borrowing or to effect a distribution of profits. A conclusion that it was the latter required a denial of the deduction. In the present case, the payment of interest is calculated by reference to the performance of relevant business units. It is not reliant on the profits of Entity A. The performance of the business units is used as a measure for determining the interest payments made to Note Holders. It follows that in the present circumstances the function of the interest payment was to service the borrowing by Entity A under each Note. In addition, it is noted that Entity A uses the funds raised under each Note as working capital which is used in generating business income and not to secure an enduring structural advantage as contemplated in St George Bank Ltd v Federal Commissioner of Taxation (2009) FCAFC 62. Specific Exceptions Division 230 of the ITAA 1997 does not apply to gains and losses from a financial arrangement to the extent that your rights and obligations under the arrangement are the subject of an exception under Subdivision 230-H of the ITAA 1997. In the present circumstances none of the exceptions in Subdivision 230-H of the ITAA 1997 apply. Conclusion The losses that Entity A makes under each Note are made in gaining or producing Entity A's assessable income. Accordingly those losses will be deductible under subsection 230-15(2) of the ITAA 1997 | Detailed Reasoning - Detailed reasoning: Subsection 230-15(5) of the ITAA 1997 seeks to limit losses which are deductible as a consequence of the operation of subsection 230-15(4) of the ITAA 1997. Subsection 230-15(4) of the ITAA 1997 provides: (4) If the financial arrangement is a debt interest, the loss is not prevented from being deductible for an income year under subsection (2) merely because of either or both of the following: (a) one or more of the financial benefits that are taken into account in working out the amount of the loss are contingent on the economic performance (whether past, current or future) of: (i) you or a part of your activities; or (ii) a connected entity of yours or a part of the activities of a connected entity of yours; (b) one or more of the financial benefits that are taken into account in working out the amount of the loss secure a permanent or enduring benefit for you or a connected entity of yours. In the present case, no loss arising from each Note is prevented from being deductible because of the circumstances described in paragraph 230-15(4)(a) or (b) of the ITAA 1997. A loss made by Entity A under each Note will be deductible under subsection 230-15(2) of the ITAA 1997. Conclusion As subsection 230-15(4) of the ITAA 1997 does not apply in these circumstances, subsection 230-15(5) of the ITAA 1997 will not operate to limit the losses Entity A makes under each Note which would be deductible under subsection 230-15(2) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Having established that each Note and Note Loan are separate arrangements for the purposes of Division 230 of the ITAA 1997, the question at issue is whether each Note Loan is a financial arrangement as defined in section 230-45 of the ITAA 1997. Under each Note Loan, Entity B will have a cash settlable obligation to provide a financial benefit, being the Note Loan principal. Entity B will also have a cash settlable right to receive a financial benefit, being repayment of the Note Loan principal, as well as cash settlable rights to receive periodic interest. Entity B has rights and obligations under each Note Loan which all meet the definition of cash settlable, as in each case the financial benefit involved is money. Entity B does not have any rights or obligations under each Note Loan which are not cash settlable and also not insignificant in comparison to the cash settlable rights and obligations discussed. Conclusion Each Note Loan will satisfy the definition of a 'financial arrangement' under subsection 230-45(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 230-15(1) of the ITAA 1997 provides: Your assessable income includes a gain you make from a financial arrangement. The concept of 'gain' is not defined in the ITAA 1997. However, Division 230 of the ITAA 1997 provides methods for determining the recognition of gains and losses from financial arrangements. In the present circumstances, Entity B is a member of Entity A's income tax consolidated group. Pursuant to the single entity rule in subsection 701-1(1) of the ITAA 1997, Entity B is taken to be part of Entity A for the purposes of working out the amount of Entity A's liability for income tax. Conclusion To the extent that there is a gain from each Note Loan it will be included in the assessable income of Entity A under subsection 230-15(1) of the ITAA 1997 as head company of the income tax consolidated group.

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