Private ruling: Taxation of Financial Arrangements: deductibility of underwriting fees
Date of advice: 18 May 2016
Published: July 2016
Ruling period: 2015 Income Year
Date scheme commenced: 2015 Income Year

Ruling: Q1: Is each draw down under the syndicated facility agreement a separate financial arrangement pursuant to subsection 230-55(4) and section 230-45 of the Income Tax Assessment Act 1997 ? | A1: No | Q2: Will the underwriting fees be a financial benefit the Borrower is taken to have had an obligation to provide under the financial arrangement, pursuant to subsection 230-60(1) of the Income Tax Assessment Act 1997 ? | A2: Yes | Q3: Will the underwriting fees be treated as expenditure incurred for borrowing money under section 25-25 of the Income Tax Assessment Act 1997 ? | A3: Unnecessary to rule given answer to Question 2 | Q4: Will the underwriting fees be deductible in the relevant Income Year when it was incurred under section 8-1 of the Income Tax Assessment Act 1997 ? | A4: Unnecessary to rule given answer to Question 2

Relevant facts and circumstances: The Borrower is an Australian resident company which is the head company of an income tax consolidated group. The Borrower entered into the syndicated facility agreement (Facility Agreement) to establish a syndicated loan facility of a predetermined credit limit (the Facility). The Arranger arranged the Facility and the Facility was underwritten by the Underwriter. The total Facility was fully funded and fully drawn down on the same day in a single draw down. On the same day, the Borrower paid underwriting fees pursuant to a separate document which specified the amount payable and when the amounts became due and payable (the Fee Document). The term of the Facility was X years from the date of the Facility Agreement. Successful indication of the Facility was completed a couple of months after the Facility was fully drawn down. During the syndication period, the Underwriter's commitment was novated to Financiers in accordance with the Assignment & Novation clause of the Facility Agreement. The Borrower used the net proceeds of the drawdowns for the purpose specified in the Purpose clause of the Facility Agreement. Relevant terms of the Facility and Underwriting Fees Due execution of the finance documents and payment of relevant fees are conditions precedent to the Facility. A Financier must make funds available to the Borrower in accordance with the terms of the Facility Agreement. The Funding Requirements clause of the Facility Agreement sets out the requirements for making a draw down under the Facility, which includes provision of a valid notice. The Funding Requirements clause limits the number of drawdowns outstanding at any time and the amount of each draw down is limited to total of the undrawn funds. The Interest clause requires that interest is calculated and payable on each drawdown under the Facility. The Facility Agreement allows for the consolidation and division of drawdowns in certain specified circumstances. The Early Repayment clause allows the Borrower to prepay a drawdown upon giving relevant notice. Nothing in the Facility Agreement requires that the Borrower must make any drawdowns under the Facility. All amounts outstanding under the Facility must be repaid by the termination date. The Default clause specifies that all outstanding amounts become due and payable immediately upon occurrence of an event of default. Neither the Arranger or Underwriter is responsible or has any obligations to any other party under the finance documents The Borrower cannot assign or novate any of its rights under the Facility without the consent of all Financiers. The key terms of the underwriting fees are contained in the Fee Document. The Fee Document specifies the amounts payable and date the amounts become due and payable. The Fee Document does not constitute or give rise to any obligation of the Arranger or Underwriter to arrange or underwrite any financing and such obligation arises only under and in accordance with the Facility Agreement and other finance documents. The terms of the Fee Document shall survive and continue after the finance documents are signed and after any termination or cancellation of any finance document. The Taxation of Financial Arrangements provisions in Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the Borrower. The Borrower has not made any elections under Division 230. The drawdown is not an 'equity interest' for the purposes of subsection 230-50(1) of the ITAA 1997. The underwriting fees are a cost incurred by the Borrower in carrying on a business for the purpose of gaining or producing assessable income. The underwriting fees are not a loss or outgoing of a private or domestic nature or incurred in relation to gaining or producing non-assessable non-exempt income. Assumption The underwriting fees is capitalised and amortised over the life of the facility for accounting purposes.

Relevant legislative provisions: Income Tax Assessment Act 1997, Division 230. | Income Tax Assessment Act 1997, Subdivision 230-A | Income Tax Assessment Act 1997, section 230-10 | Income Tax Assessment Act 1997, subsection 230-20(4) | Income Tax Assessment Act 1997, section 230-45 | Income Tax Assessment Act 1997, Subsection 230-55(4) | Income Tax Assessment Act 1997, subsection 230-60(1) | Income Tax Assessment Act 1997, section 230-85 | Income Tax Assessment Act 1997, subsection 974-160(1) | Income Tax Assessment Act 1997, subsection 995-1(1)

Reasons for decision: Summary: Division 230 deals with the tax treatment of gains and losses from financial arrangements. The Division provides for the recognition of gains and losses, as appropriate, over the life of a financial arrangement. Subsection 230-55(4) identifies whether a number of rights and/or obligations are themselves an 'arrangement' or are '2 or more separate arrangements' for the purposes of Division 230. Whether a number of rights and/or obligations are themselves an arrangement or are 2 or more separate arrangements is a question of fact and degree that is determined having regard to the matters in subsection 230-55(4): (a) the nature of the rights and/or obligations; (b) their terms and conditions (including those relating to any payment or other consideration for them); (c) the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved); (d) whether they can be dealt with separately or must be dealt with together; (e) normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole); (f) the objects of this Division. In applying subsection 230-55(4), regard must be had to all of the matters referred to in paragraphs (a) to (f) both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other. Taxation Ruling 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 (TR 2012/4) provides the Commissioner's view on the matters in subsection 230-55(4). Each of the factors referred to in paragraphs 230-55(4)(a) to (f) are considered in turn below. | Detailed Reasoning - Paragraph 230-55(4)(a) - nature of the rights and obligations: The Borrower entered into a syndicated loan facility under which it had the following rights and obligations: • right to drawdowns in accordance with the terms of the Facility • contingent right to receive drawdowns, subject to the provision of a valid notice • contingent obligation to repay principal amount for a drawdown, and • contingent obligation to pay interest on the outstanding amount of the principal amount for a drawdown Rights and obligations subject to a contingency are treated as rights and obligations for the purposes of Division 230 (section 230-85). TR 2012/4 provides that paragraph 230-55(4)(a) requires assessment of what is the nature or substance of the rights and/or obligations, both separately and in combination. This requires consideration of whether the rights and/or obligations are intrinsically linked, or, in substance, form part of a larger thing. Whether a number of rights and/or obligations constitute one or more arrangements is a question of fact. Relevantly, the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 ("the TOFA EM") stated: 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 (for contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230. On the facts, the rights and obligations of the Borrower arise from the same contract. Without the Facility, the Borrower would not have the Facility made available by the Financiers to draw down when required. The fact that rights and obligations arise from the same contract tends to suggest that there is one arrangement. However, the fact that the rights and obligations arise out of the same contract is not determinative. The way the rights and obligations are combined, and whether the drawdowns give rise to separate arrangements in their own right or form part of one arrangement under the Facility also requires consideration of the other factors in subsection 230-55(4). | Detailed Reasoning - Paragraph 230-55(4)(b) - their terms and conditions (including those relating to any payment or other consideration for them): Paragraph 16 of TR 2012/4 states that the consideration required by paragraph 230-55(4)(b) includes a consideration of the terms and conditions in which the rights and/or obligations are expressed. As part of doing so, it is necessary to consider terms and conditions relating to payment and/or consideration. Where one amount is calculated and paid as consideration for a number of rights, it will tend to suggest aggregation of such rights. Where the consideration is calculated and paid separately for different rights, it will tend to suggest such rights are separate. Paragraph 230-55(4)(b) requires an assessment of the legal expression of the arrangement. In combination with paragraph 230-55(4)(a), this requires a comparison of the substance of the rights and/or obligations with their legal form. Paragraph 163 of TR 2012/4 provides: For example, where, in a facility agreement, or an overdraft account, interest is paid on the total current outstanding balance, this will tend to suggest aggregation. Conversely, where, in a facility agreement, each drawdown is priced separately, having a different interest rate and term, this will tend to suggest separate treatment. Under the Facility, there are terms that point towards the rights and obligations in respect of the drawdowns as forming separate arrangement to the rights and obligations in respect of the Facility. However, there are also terms which suggest that the drawdowns and Facility together form a single arrangement. Consideration of the terms and conditions of the Facility seems balanced and does not point to there being a single arrangement or separate arrangements. Paragraph 230-55(4)(c) - the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of the entities involved) Paragraph 230-55(4)(c) requires the consideration of the context surrounding the life cycle of the rights and/or obligations from creation to what is proposed as exercise or performance. The word 'circumstances surrounding' should be understood as qualifying both 'their creation' and 'their proposed exercise or performance'. This is an objective assessment of the purposes of the entities involved. In such assessment, evidence of the subjective purpose of such entities may be relevant, though not determinative (paragraphs 17 and 18 of TR 2012/4). The circumstances surrounding the life cycle of the rights and obligations in respect of the Facility and the rights and obligations in respect of the drawdowns are as follows. The terms of the Facility are structured in a manner that gives the Borrower the right to make drawdowns as and when required, provided the funds are used for one of the purposes set out in the Purpose clause of the Facility Agreement. While the Borrower's use of the drawdowns is restricted, there is no certainty that any funds would be drawn down, the timing as to when drawdowns be made is unknown and there is no obligation on the Borrower to draw down on the Facility and use funds for each and every purpose listed in the Facility Agreement. The circumstances surrounding the creation of the rights and obligations in respect of each drawdown and their proposed exercise or performance under the Purpose clause tends to indicate that the rights and obligations in respect of each drawdown are separate arrangements to the rights and obligations in respect of the Facility itself. | Detailed Reasoning - Paragraph 230-55(4)(d) - whether they can be dealt with separately or must be dealt with together: Paragraph 19 of TR 2012/4 states that paragraph 230-55(4)(d) requires the consideration of whether the rights and/or obligations can be dealt with separately or must be dealt with together in accordance with the term and conditions of the arrangement. Where the rights and/or obligations must be dealt with together, it will tend to suggest aggregation. The enquiry under this paragraph is as to legal, rather than commercial, constraint. Under the terms of the Facility Agreement, the Borrower cannot assign its rights and obligations without the prior consent of all Financiers. The restriction to assign its rights and obligations under the Facility indicate that the rights and obligations relating to the drawdowns must be dealt with together as a single arrangement. Paragraph 230-55(4)(e) - normal commercial understandings and practices (including whether they are regarded commercially as separate things or as a group or series that forms a whole) Paragraph 20 of TR 2012/4 states that paragraph 230-55(4)(e) requires the consideration of normal commercial understandings and practices in relation to rights and/or obligations (including whether they are regarded commercially as separate things or as a group or series that forms a whole). Where normal commercial understandings and practices are to regard a number of rights and/or obligations as one aggregated whole, it will tend to suggest aggregation. Where normal commercial understandings and practices are to regard a number of rights and/or obligations as separate things, it will tend to suggest that they are separate. The circumstances in Example 7 and Example 9 of TR 2012/4 can be distinguished from the facts of this case. On the facts, the rights and obligations in relation to the drawdowns cannot operate independently of the Facility Agreement. | Detailed Reasoning - Paragraph 230-55(4)(f) - the objects of this Division: Paragraph 21 of TR 2012/4 states that paragraph 230-55(4)(f) requires the consideration of the objects of Division 230 as set out in section 230-10. Very broadly, the objects of Division 230 are: • to minimise tax distortions on commercial decision-making by, for gains and losses from financial arrangements, aligning tax recognition of such gains and losses with the reality of what gains and losses occur and when they occur; • to align tax and commercial recognition of gains and losses from financial arrangements by ensuring the time of recognition of those gains and losses is reasonable, and by generally recognising such gains and losses on revenue account; and • to appropriately take account of, and minimise, compliance costs. In the circumstances, consideration of the objects of Division 230 does not assist in determining whether there should be a single arrangement or multiple arrangements. Conclusion Having regard to the factors in subsection 230-55(4), it is reasonable to conclude that each drawdown forms part of a single arrangement, the Facility arrangement. On balance, factors pointing towards a single arrangement outweigh those that suggest separate arrangements. | Detailed Reasoning - Whether the Facility is a Financial Arrangement: For Division 230 to apply, an arrangement must meet the definition of a 'financial arrangement'. Subdivision 230-A provides the test for determining whether an arrangement is a financial arrangement. The term 'arrangement' is very broadly defined in subsection 995-1(1) to mean any arrangement, agreement, understanding, promise or undertaking. Broadly, an arrangement will be a financial arrangement if it satisfies the 'primary definition' of a financial arrangement under section 230-45 (cash settlable rights and obligations to financial benefits) or the 'secondary definition' under section 230-50 (equity interests and rights and obligations to equity interests). Subsection 230-45(1) provides that you have a financial arrangement if you have, under an arrangement: (a) cash settable legal or equitable right to receive a financial benefit; or (b) a cash settable 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 settable; 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 arrangement. The Facility Agreement will be a 'financial arrangement' for Division 230 purposes, if the conditions in subsection 230-45(1) are satisfied. To be a financial arrangement, the Facility Agreement must give rise to a cash settlable legal or equitable right to receive a financial benefit or a cash settlable legal or equitable obligation to provide a financial benefit. A 'financial benefit' is defined in subsection 974-160(1) to mean anything of economic value including property and services. Paragraph 230-45(2)(a) provides that a right to receive or an obligation to provide a financial benefit is cash settlable if, and only if the benefit is money or a money equivalent. The contingent rights and obligations that arise under the Facility Agreement meet the conditions under subsection 230-45(1) because the Borrower has a combination of cash settlable legal or equitable rights to receive or obligations to provide financial benefits under the Facility (paragraph 230-45(1)(c)). Those rights and obligations are monetary amounts. On the facts, the exceptions under paragraphs 230-45 (d),(e) and (f) do not apply. Therefore, the Facility arrangement constitutes a financial arrangement for the purposes of section 230-45 to which Division 230 will apply. Conclusion Each drawdown under the Facility is not a separate financial arrangement pursuant to section 230-45 and subsection 230-55(4). Rather, the relevant arrangement for Division 230 purposes is the Facility including each drawdown made under the Facility. | Detailed Reasoning - Question 2: Relevantly, subsection 230-60(1) states: You are taken, for the purposes of this Division, to have (or to have had) an obligation to provide a financial benefit under a financial arrangement if: (a) you have (or had) an obligation to provide the financial benefit in relation to the arrangement; and (b) the financial benefit would not otherwise be treated as one that you have (or had) an obligation to provide under the arrangement; and (c) the financial benefit plays an integral role in determining: (i) whether you make a gain or loss from the arrangement; or (ii) the amount of such a gain or loss. Paragraph (a) applies even if the entity to which you provide the financial benefit is not a party to the arrangement. Note: This means that the financial benefits you provide to acquire the financial arrangement (whether to the issuer, a previous holder or a third party) are taken to be financial benefits you provide under the arrangement. The financial benefit you provide may include, for example, fees paid or the forgoing of rights to receive a financial benefit. Each of the three (3) conditions is considered in turn below. | Detailed Reasoning - Paragraph 230-60(1)(a) you have (or had) an obligation to provide the financial benefit in relation to the arrangement: A 'financial benefit' is defined widely at section 974-160 to mean anything of economic value and includes property and services. The Underwriting Fees are financial benefits within the meaning in section 974-160. On the facts, the Borrower had an obligation to provide the financial benefit under the Fee Document and the condition in paragraph 230-60(1)(a) is satisfied. Paragraph 230-60(1)(b) the financial benefit would not otherwise be treated as one that you have (or had) an obligation to provide under the arrangement The issue is whether the obligation to provide the underwriting fees arises under the Facility arrangement. This requires an assessment of the factors in subsection 230-55(4) to determine whether the obligation to provide underwriting fees forms part of the Facility arrangement or is a separate arrangement from the Facility. Paragraph 230-55(4)(a) considers the nature of the rights and obligations, which considers the substance of the rights and/or obligations, both separately and in combination. On the facts, the underwriting fees does not form part of the Facility arrangement because: • the Underwriting Fees are due and payable on a different date to the termination date of the Facility • the conditions precedent to the Facility requires payment of the underwriting fees • the keys terms and conditions of the underwriting fees is set out in a separate document to the Facility Agreement. The nature of the obligation to provide underwriting fees (paragraph 230-55(4)(a)) and its terms and conditions (subsection 230-55(4)(b)) point towards the obligation as separate from the Facility arrangement. On the facts, the circumstances surrounding the creation of the obligation to provide underwriting fees and their proposed exercise or performance also point towards the obligation as forming part of a separate arrangement to the Facility. The purpose of the underwriting fees was in regards to the establishment of the Facility, whereas the purpose of the Facility was to provide the Borrower with the right to draw down on the Facility. Accordingly, the criterion in paragraph 230-55(4)(c) supports a conclusion that the obligation to provide underwriting fees arises under a separate arrangement. Paragraph 230-55(4)(d) considers whether the obligation to provide underwriting fees and the rights and obligations under the Facility can be dealt with separately or must be dealt with together. The Assignment & Novation clause does not prevent the Arranger or Underwriter from assigning their rights and obligations. Accordingly, this factor points towards the obligation to provide underwriting fees as being a separate arrangement. The factor in paragraph 230-55(4)(e) looks at the normal commercial understandings and practices in relation to, in this case, the obligation to provide underwriting fees. Commercially, fees and costs incurred in relation to the establishment of a syndicated loan facility would normally be understood as separate from the syndicated loan facility itself. Accordingly, this factor points towards the obligation to provide underwriting fees as separate from the Facility itself. Finally, treating the obligation to provide underwriting fees as a separate arrangement to the Facility would be consistent with the objects of Division 230. As such, the factor in paragraph 230-55(4)(f) point towards a separate arrangement. Accordingly, the obligation to provide the underwriting fees is a financial benefit that would not otherwise be treated as one that the Borrower had an obligation to provide under the Facility arrangement. As such, the condition in paragraph 230-60(1)(b) is satisfied. Paragraph 230-60(1)(c) the financial benefit plays an integral role in determining whether you make a gain or loss from the arrangement or the amount of such a gain or loss In terms of paragraph 230-60(1)(c), the issue is whether the underwriting fees plays an integral role in determining whether a gain or loss is made from the financial arrangement. The TOFA EM states at paragraphs 3.36 to 3.37: 3.36 For this purpose, a financial benefit received or provided will be integral to determining whether the taxpayer will make a relevant gain or loss from the financial arrangement if it is an essential part of determining that gain or loss or the amount of such a gain or loss. What is considered essential or integral will be determined by the nature or purpose of the financial benefit that is taken to be provided or received under the financial arrangement. The quantum of the particular financial benefit in this respect is not determinative as to whether it is considered 'integral'. For example an application fee paid on a home loan provided by a bank may be 'integral' to determining whether the bank makes a gain or loss from the home loan even though it would be a much smaller amount than the interest income that is to be received by the bank from the borrower. 3.37 Such integral financial benefits may include the costs incurred to acquire the financial arrangement (including, for example, any application or processing charges, in addition to the specific consideration for the relevant rights and obligations under the arrangement) and amounts received on transfer or cessation of all or part of the financial arrangement. On the facts, the underwriting fees were incurred to establish the Facility. Payment of the underwriting fees was a necessary precondition to the Facility becoming available to the Borrower. The underwriting fees are closely related to the successful syndication of the Facility as it relates to arranging Financiers and ensuring the Facility is available to the Borrower to draw down funds. Accordingly, the underwriting fees are integral to determining the gains or losses from the financial arrangement and the condition in paragraph 230-60(1)(c) is satisfied. | Detailed Reasoning - Conclusion: As all of the conditions in subsection 230-60(1) are met, the obligation to provide underwriting fees is taken to be an obligation to provide a financial benefit under the Facility for the purposes of Division 230. | Detailed Reasoning - Question 3: Due to the operation of subsection 230-20(4), the underwriting fees are not deductible under section 25-25. | Detailed Reasoning - Question 4: Due to the operation of subsection 230-20(4), the underwriting fees are not deductible under section 8-1.

Reasons for decision: All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.