Private ruling: The inclusion in the assessable income of Head Company (Company A)
Published: June 2012
Ruling period: The year ending 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Will Company A's assessable income include the amount of interest received by Company B from the Commissioner pursuant to the T(IOEP) A, under subsection 6-10(1) of the ITAA 1997 and section 15-35 of the ITAA 1997? | A1: Yes | Q2: Will Company A be entitled to claim deductions under section 8-1 of the ITAA 1997 in respect to the interest, or amounts in the nature of interest incurred by Company A? | A2: Yes

Relevant facts and circumstances: Company A is the head company of a tax consolidated group for the purposes of Part 3-90 of the ITAA 1997. Company B is a subsidiary member of the Company A tax consolidated group. Company C is the head company of the tax consolidated group of which Company B was formerly a member. In 2003, Company C divested the division of which Company B was a part. As part of the divestment Company C and Company B entered into certain obligations (The Deed). One of the clauses of the Deed stipulated that Company C would make any payments of tax to the Commissioner in relation to the assessments raised in respect of the Tax Dispute (refer below) and any money received by Company B from the Commissioner in relation to the Tax Dispute would be repaid to Company C. Company B became a subsidiary member of the Company A tax consolidated group in 2005. Company A, as head company of the tax consolidated group of which Company B is a subsidiary member, has not made an election pursuant to item 103(2) or item 104(2) in Schedule 1 of Part 3 of the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (TOFA Act) to have the taxation of financial arrangements rules apply from 1 July 2009 or to its financial arrangements that were on foot as at 1 July 2010. Tax Dispute Before 2009, Company B received assessment notices from the Commissioner. The assessments received by Company B included primary tax, penalties and interest. In year X Company C sent a letter to Company B reaffirming obligations set out in the Deed and also set out some points of clarification regarding the terms of the Deed and requested that Company B sign a copy of the letter to acknowledge its agreement to the new arrangements. In particular, Company C and Company B agreed that: · Company C would make the payment required in relation to the Company B assessments directly to the Commissioner on behalf of Company B; and · any amount subsequently received by Company B from the Commissioner in relation to the Company B assessments would be payable to Company C immediately in accordance with the Deed. In year X Company C made a payment to the Commissioner, on behalf of Company B. The above amount was credited to Company B's running balance account. In 2011, as a result of the resolution of the Tax Dispute, the Commissioner refunded to Company B the amount that had been paid to the Commissioner by Company C on behalf of Company B. The resolution of the Tax Dispute also resulted in an amount of interest payable by the Commissioner to Company B in respect of the amount paid by Company C to the Commissioner on behalf of Company B (refer to subsection 9(1) of the T(IOEP) A). The amount of interest in relation to the Company B assessments (lnterest Amount) was paid by the Commissioner directly to Company B at a later date. Pursuant to the Deed and the arrangements subsequently agreed between Company C and Company B, Company B is required to repay the amount that was paid by Company C to the Commissioner on its behalf. The debt owing by Company B to Company C as a result of Company C having made the payment in respect of the Company B assessments was repaid by Company B to Company C. The Deed also requires Company B to pay an amount of interest to Company C that is determined by reference to the lnterest Amount received by Company B. It is the amount referable to the Interest Amount incurred by Company A as head company of the tax consolidated group to satisfy the obligations of Company B, to pay Company C which is the subject of this Ruling.

Relevant legislative provisions: Income Tax Assessment Act 1997 Part 3-90 | Income Tax Assessment Act 1997 Section 6-10 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 10-5 | Income Tax Assessment Act 1997 Section 15-35 | Income Tax Assessment Act 1997 Section 701-1 | Taxation (Interest on Overpayments and Early Payments) Act 1983 | Taxation (Interest on Overpayments and Early Payments) Act 1983 Section 3 | Taxation (Interest on Overpayments and Early Payments) Act 1983 Section 9 | Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 Sub-item 103(2) of Schedule 1 | Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 Sub-item 104(2) of Schedule 1

Reasons for decision: Detailed Reasoning - Assessable income: Section 6-10 of the ITAA 1997 provides: (1) Your assessable income also includes some amounts that are not * ordinary income. (2) Amounts that are not * ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income . Section 10-5 of the ITAA 1997 follows to provide a table of provisions that include assessable income amounts that are not ordinary income. Relevantly, the table includes a reference to section 15-35 of the ITAA 1997 relating to interest on overpaid tax. Section 15-35 of the ITAA 1997 provides: Your assessable income includes interest payable to you under the Taxation (Interest on Overpayments and Early Payments) Act 1983 (T(IOEP)A). The interest becomes assessable when it is paid to you or applied to discharge a liability you have to the Commonwealth. | Detailed Reasoning - Interest on overpayments: Entitlement to interest on certain overpayments of tax debts is set out under the T(IOEP)A. Section 9 of the T(IOEP)A provides that where, as a result of a decision to which this Act applies, the whole or part of the amount paid is deemed overpaid by the person and is refunded to the person, interest is payable by the Commissioner on amounts of tax that are overpaid. According to paragraph 3(1)(c) of the T(IOEP)A, the definition of a "decision to which this Act applies" includes a decision of the court in relation to an objection, or a decision of the Tribunal in relation to an objection. or According to paragraph 3(1)(ca), of the T(IOEP)A the definition of a "decision to which this Act applies" includes a decision of the Commissioner to amend an assessment made in relation to a taxpayer reducing the liability of the taxpayer to tax. Relevantly, subsection 9(4) of the T(IOEP)A provides that, where the Commissioner applies an amount that has been paid by a person, against the liability of another person to pay an amount of relevant tax, the other person shall, for the purposes of the T(IOEP)A, be deemed to have paid to the Commissioner the amount of relevant tax. Accordingly, as Company C paid the relevant amounts of the Company B assessments to the Commissioner and the Commissioner applied Company C's payments against the liabilities of Company B under the Company B assessments, Company B will be deemed for the purposes of the T(IOEP) Act to have paid to the Commissioner the amounts applied. lt follows that the lnterest Amount was payable by the Commissioner to Company B pursuant to subsection 9(1) of the T(IOEP) A. To be assessable under subsection 6-10(1) of the ITAA 1997, the interest payable under the T(IOEP) A needs to be paid to Company B. According to the facts, Company B was paid directly from the Commissioner in 2011. | Detailed Reasoning - Single-entity rule: Under section 701-1 of the ITAA 1997, a subsidiary member of a consolidated group for any period is taken, for the purposes of calculating income tax liability, to be part of the head company of the group, rather than separate entities for that period. Accordingly, the assessable income of Company B will be included as assessable income for Company A as the head company of the tax consolidated group of which Company B is a subsidiary member. | Detailed Reasoning - Conclusion: In conclusion, the amount paid to Company B is interest payable under the T(IOEP) Act, and is considered assessable income for the purposes of subsection 6-10(1) and section 15-35 of the ITAA 1997. Pursuant to the single-entity rule, Company A as head company of the tax consolidated group of which Company B is a subsidiary member will include the Interest | Detailed Reasoning - Amounts received as assessable income.: Issue 2 Question 1 Summary Detailed reasoning | Detailed Reasoning - General deductions: Section 8-1 of the ITAA 1997 states: (1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income. (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your * exempt income or your * non- assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. (3) A loss or outgoing that you can deduct under this section is called a general deduction . Subsections 8-1(1) and 8-1(2) of the ITAA 1997 are also known as the positive and negative limb of the general deduction rule respectively. | Detailed Reasoning - Positive limb - losses or outgoings incurred: To qualify for deduction under section 8-1 a loss or outgoing must have been incurred. Paragraph 8-1(1)(b) of the ITAA 1997 entitles a taxpayer, where they are carrying on a business, to deduct an amount for a loss or outgoing if it is necessarily incurred for the purpose of gaining or producing assessable income. The Deed and arrangements set out in Company C's letter to Company B, stipulate that Company B had an obligation to pay any amount received from the Commissioner in relation to the Tax Dispute to Company C. It is considered that Company A incurred losses or outgoings at the time when Company B paid the Interest Amounts to Company C. Therefore for the purpose of the positive limb, it is considered that Company A incurred a loss or outgoing for the purposes of subsection 8-1(1) of the ITAA 1997 when the amount of interest referable to the lnterest Amount was paid to Company C. | Detailed Reasoning - Incidental and relevant character: lt is necessary to consider the character of the amount required to be paid by Company B to Company C pursuant to the Deed. Macquarie Finance Limited v. Commissioner of Taxation (2005) 2005 ATC 4840 at 52 sets out several general principles regarding the deductibility of interest expense: 1. Interest will ordinarily be an allowable deduction under s 8-1 if incurred in the course of an income producing activity or business. 2. Interest is ordinarily a recurrent or periodic payment securing ``the use of borrower money during the term of the loan''. There may nevertheless be circumstances in which interest will be seen as unrelated to the raising or maintenance of the borrowing and thus, perhaps, on capital account. 3. The question of deductibility is not determined by reference to the label which the parties attach to the outgoing. 4. There must be a borrowing before what is paid can be regarded as interest. That presupposes that the lender is entitled to a return of the money lent. 5. The necessary conditions for deductibility are to be found within the terms of s 8-1. It is not necessary to the deductibility of a perpetual debenture that the transaction be characterised as a loan or a borrowing and the amount paid to debenture holders as "interest". 6. An outgoing, to be deductible, must be ``incidental and relevant'' to the gaining or production of assessable income or the business the purpose of which is the gaining or production of assessable income. There must be a sufficient connection between the outgoing on the one hand and the gaining or producing of assessable income or the business as the case may be. | Detailed Reasoning - A Borrowing: Following the principles set out above, there must be a borrowing or loan before the outgoings from Company B can be considered to be an interest expense. What constitutes a loan is provided in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd (Radilo ), (1997) 72 FCR 300; 97 ATC 4151; where in their joint judgment Sackville and Lehane JJ said: 'A loan involves an obligation on the borrower to repay the sum borrowed. The matter is put this way by Dr Pannam: A loan of money may be defined, in general terms, as a simple contract whereby one person ('the lender') pays or agrees to pay a sum of money in consideration of a promise by another person ('the borrower') to repay the money upon demand or at a fixed date. The promise of repayment may or may not be coupled with a promise to pay interest on the money so paid. The essence of the transaction is the promise of repayment. ...' In the Deed and the letter from Company C to Company B, Company C agreed to make the part payment to the Commissioner in respect of the Company B assessment on behalf of Company B. It was also agreed that any subsequent amount received by Company B from the Commissioner in relation to the Tax Dispute must immediately be paid to Company C in accordance with the Deed. Based on the above, there is an obligation for Company B to repay the amounts that Company C paid on its behalf to the Commissioner. Accordingly the agreement between the parties can be defined as a borrowing. | Detailed Reasoning - Interest: There are numerous cases which consider the meaning of 'interest'. In Firth v. Commissioner of Taxation (Cth) 2001 ATC 4619, Hely J considered interest as, 'a return or consideration or compensation for the use or retention by one person of another's money...' Also in Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 the High Court stated (at CLR 218): '...interest is regarded as flowing from the principal sum…. and to be compensation to the lender for being kept out of the use and enjoyment of the principal sum: ….' As Company B entered into an agreement to pay any amounts received from the Commissioner to Company C, it follows that the additional amount above the repayment of the original part payment to the Commissioner in relation to the Company B assessments paid by Company C pursuant to the Deed can be considered as compensation to Company C for the use of the money and therefore constitutes interest or an amount in the nature of interest. As the amount is the same amount as the interest on overpayment it confirms the nature of this payment as a payment of interest. | Detailed Reasoning - Incurred in carrying on a business: Having determined that the relevant amount paid by Company B to Company C has the character of interest, it is next necessary to consider whether that interest is incidental and relevant to the gaining or producing of Company A's assessable income or the carrying on of Company A's business for that purpose. ATO Interpretive Decision ATO ID 2001/79 (ATO ID 2001/79) provides that interest is deductible under section 8-1 of the ITAA 1997 to the extent that the borrowed funds are used for the purposes of producing assessable income. ATO ID 2001/79 references the 'use test', established in FC of T v Munro (1926) 38 CLR 153 as the basic test for the deductibility of interest, focusing on the use of the borrowed funds as the main criteria. Interest incurred is deductible to the extent that the funds are used in the course of producing assessable income. A deduction can be claimed for interest on a loan to pay a business's income tax. Taxation Ruling IT 2582 (IT 2582) provides: Where a taxpayer carries on a business for the purpose of gaining or producing assessable income and, in connection with the carrying on of that business, borrows money to pay income tax (whether to preserve the assets of the business, maximise the return on them, retain sufficient money to fund the business or otherwise) then it is considered that the interest incurred on those borrowings is a normal incident of conducting that business. That is, such an expense is an expense incurred in carrying on that business... The amounts Company B borrowed from Company C when Company C paid the part payment to the Commissioner in respect of the Company B assessments was a borrowing to permit Company B to make the payment in respect of the Company B assessments. Accordingly, following the single-entity rule under section 701-1 of the ITAA 1997, Company A, as head company of the tax consolidated group of which Company B is a subsidiary member, is considered to have borrowed amounts to pay income tax. Following this, the interest expense incurred by Company A is considered to be an expense incurred in carrying on its business and satisfies the positive limb in subsection 8-1(1) of the ITAA 1997. | Detailed Reasoning - Negative Limb: Under the negative limb of subsection 8-1(2) of the ITAA 1997, Company A is unable to deduct from its assessable income losses or outgoings to the extent that they are of a capital, private or domestic nature, incurred in relation to gaining or producing exempt or non-assessable non-exempt income, or prevented by a provision from deduction. | Detailed Reasoning - Capital Expenditure: A fundamental issue is whether interest can be characterised as a loss or outgoing of capital or of a capital nature. The differentiation between revenue and capital is assisted by a considerable amount of case law. The leading Australian test which distinguishes between revenue and capital outgoings was formulated by Dixon J (as he then was) in Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 ( Sun Newspapers ). In the course of his judgment, Dixon J reviewed both the 'once and for all' and 'enduring benefit' tests of the United Kingdom and then developed his own criteria for distinguishing between revenue and capital expenditure by focusing on the purpose of the expenditure in the context of the taxpayer's business (at 359-360): The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and [on the other hand] the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss… As general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue…For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose… In applying this test, Dixon J pointed to three relevant factors, although none is in itself decisive at 363: There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. a) Character of advantage sought In regards to the first matter raised in Sun Newspapers , in Steele v DFC of T (1999) 99 ATC 4242 ,(Steele) the Full High Court considers: As was explained in Australian National Hotels Ltd v FC of T , interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of borrowed money during the term of the loan. According to the criteria noted by Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T it is therefore ordinarily a revenue item. This is not to deny the possibility that there may be particular circumstances where it is proper to regard the purpose of interest payments as something other than the raising or maintenance of the borrowing and thus, potentially, of a capital nature. However, in the usual case,... where interest is a recurrent payment to secure the use for a limited term of loan funds, then it is proper to regard the interest as a revenue item, and its character is not altered by reason of the fact that the borrowed funds are used to purchase a capital asset.'' The payment of interest by Company B to Company C secures the use of the borrowing that arose when Company C paid the part payment of tax to the Commissioner on behalf of Company B.. Therefore based on the above comments in Steele, the interest does not secure any enduring advantage to Company A and the first matter raised in Sun Newspapers points towards the expenditure being revenue in nature and not capital. b) The manner in which the advantage is to be used In relation to the second matter raised in Sun Newspapers, in Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634 Dixon J added the following comments to his criteria in Sun Newspapers at 648: The contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it. What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. In Sun Newspapers, Dixon J indicated that recurrence may play a part in relation to this factor. His Honour provided the following view in relation to the concept of 'recurrence' at 362: But the idea of recurrence and the idea of endurance or continuance over a duration of time both depend on degree and comparison…but "the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once for all" (per Rowlatt J., Ounsworth v. Vickers Ltd. (2)). By this I understand that the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely…Recurrence is not a test, it is no more than a consideration the weight of which depends upon the nature of the expenditure. In Firth v. Commissioner of Taxation (Cth) (2001) 2001 ATC 4615, Hely J considers the form of the interest payment impacting on the revenue or capital character of the expense: Although recurrence is a relevant consideration, it would not alter the situation if the parties chose to have interest paid in a lump sum. The payment of a lump sum interest amount by Company B to Company C does not alter the nature of the expenditure i.e. interest and no weight should be given to the absence of recurrence. c) The means adopted to obtain it The last factor looks at the means adopted to obtain the advantage. By this, a distinction is drawn between the provision of a periodical reward or outlay to cover the use or enjoyment of the advantage for periods commensurate with the payment, and the making of a final provision or payment so as to secure future use or enjoyment (Dixon J in Sun Newspapers at 363). The interest incurred by Company A is not made as to secure future use or enjoyment, but rather the use of the borrowing to pay the part payment of tax to the Commissioner. Therefore this factor lends weight to the expenditure being of a revenue nature. For the reasons stated above, the payment of the Interest Amount to Company C pursuant to the Deed is not capital or capital in nature and paragraph 8-1(2)(a) of the ITAA 1997 does not prevent deductibility of the amount to Company A | Detailed Reasoning - Private and Domestic Nature, Exempt Income, Other Provisions: Based on the above reasons the interest expenditure is not considered a loss or outgoing of a private or domestic nature or incurred for the purpose of obtaining exempt or non assessable income. | Detailed Reasoning - Conclusion: For the reasons stated above, the payment by Company B of the Interest Amount to Company C pursuant to the Deed is an outgoing of a revenue and not of a capital nature, and is therefore deductible to Company A under section 8-1 of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Subject: The inclusion in the assessable income of Head Company (Company A): subsection 6-10(1) of the Income Tax Assessment Act 1997 (lTAA 1997) and section 15-35 of the lTAA 1997 of amounts of interest received by, Company B, a subsidiary member of the Company A tax consolidated group, from the Commissioner of Taxation (Commissioner) pursuant to the Taxation (Interest on Overpayments and Early Payments)Act 1983 | (T(IOEP) A) and the deductibility under section 8-1 of the ITAA 1997 to Company A of certain amounts paid by Company B, to the Head Company (Company C) of the tax consolidated group of which Company B was formerly a subsidiary member.