Private ruling: Financing Arrangement
Date of advice: 24 April 2020
Published: June 2020
Ruling period: Years ended 30 June 2020 to 2025
Date scheme commenced: 1 July 2019

Ruling: Q1: Will the Loans owing to the Trusts be deemed equity interests under section 820-930 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will any assessable gain arise to the Trusts under Division 230 of the ITAA 1997when the Loans owing to the Trusts are repaid in part or full? | A2: No | Q3: Will a capital gain arise to the Trusts under section 104-25 of the ITAA 1997 when the Loans owing to the Trusts are repaid in part or full? | A3: No | Q4: Will an assessable gain arise to the Trusts under section 26BB of the Income Tax Assessment Act 1936 when the Loans owing to the Trusts are repaid in part or full? | A4: No

Relevant facts and circumstances: The Trusts ( Trust X and Trust Z ) are both part of a larger group of entities ( the Group ). The Group currently comprises significant property assets and various other investments and commercial interests. The settlor of both Trusts is AA. The specified beneficiary of Trust X is BB and the specified beneficiary of Trust Z is CC. Various other persons and entities relating to BB, in the case of Trust X, and CC, in the case of Trust Z, are also discretionary objects in each case. Both Trusts are residents of Australia for income tax purposes, in that both trusts have their place of central management and control based in Australia. Accordingly, a Tax File Number has been applied for and obtained for both Trusts and tax returns are expected to be lodged annually. At the time of preparing the Private ruling application, both Trusts have trust funds equal to their initial settled sum of $xx each. The Trusts are both discretionary trusts and have been established as the ultimate holding vehicles for structures that will hold investments predominantly based overseas. It is proposed that both Trusts be provided significant funding to invest in overseas based assets. It is proposed that this funding will involve amounts up to $xx for each Trust to be provided by way of gifts from AA, as explained below. AA currently has significant loans owing to AA from another Australian resident Group discretionary trust, being Trust F. The vast bulk of these loan amounts were provided by AA to Trust F and loaned by AA and to Trust F. Under the terms of the Loan Agreement between AA and Trust F in respect of $xx (denominated in AUD) loaned to Trust F, the loan from AA to Trust F is repayable at-call and is to not bear interest unless otherwise agreed between the parties. There has been no agreement to vary the interest-free nature of this loan. Whilst Trust F was established a number of years ago, it remained dormant until the recently when it commenced commercial activities as the treasury vehicle. Trust F has significant liquid funds being cash and term deposits well in excess of the loan owing to AA and in excess of total liabilities. On the basis that the loan owing to AA from Trust F is repayable on demand and Trust F has ample liquid funds to discharge this loan, there is no evidence to suggest that the loan owing to AA by Trust F would have a market value other than its face value. For the purposes of this private ruling request, it can therefore be assumed that the loan would have a market value equivalent to its face value. It is proposed that AA will provide funding to the Trusts via gift in the form of an assignment of a portion (up to $xx in total) of AA's existing loan entitlements owing to AA from Trust F. This funding will be assigned in equal shares to Trust X and Trust Z. The portion of the loans proposed to be assigned by way of gift by AA to the Trusts will collectively be referred to as the ' Loans '. It is proposed that each gift/assignment will be documented by deed entered into by AA and the relevant Trust. A template of the draft Deed of Assignment has been provided. Subsequent to these assignments, both Trusts will be owed an at-call interest-free loan from Trust F, which they acquired by gift (that is, for no consideration). As funds are progressively required for investment purposes, the Trusts would each draw down the Loan assigned to them. It is expected that these drawdowns and investment of funds would take place over approximately 2 - 5 years, as suitable investments are progressively identified. The proposed funding of the Trusts in this way (using an assignment of the Trust F Loans, rather than the gifting of cash) has been determined as the preferred mechanism, as a result of the following: (a) a preference to only introduce cash into the Trusts once appropriate investments have been identified, so that cash is provided progressively over a period of years and invested immediately (rather than having large cash balances held in the Trusts pending identification of suitable investments). The following documents provided with the Application for private ruling form part of the facts: · Trust Deeds for Trust X and Trust Z · Loan Agreement between AA and Trust F · Trust deed of Trust F, · Template of the draft Deed of Assignment Assumptions 1. The Loans have a market value equal to their face value. 2. The terms of the Loans will remain the same after their assignment to the Trusts. That is, there will be no variation to these terms and they will remain repayable at-call, AUD denominated and non-interest bearing. 3. Over time, the Loans would be repaid in full to the Trusts; that is, the full face value of the Loans would be repaid. 4. On the basis that the Trusts are each expected to be subject to Division 230 as a consequence of the aggregated turnover threshold in section 230-455 being exceeded: · The Trusts are each subject to the 'TOFA' provisions of Division 230 and will not make any TOFA elections under Subdivisions 230-C, 230-D, 230-E or 230-F that will impact on gains or losses made on the Loans. Accordingly, it is only the accruals and realisation methods in Subdivision 230-B that are relevant to determining any Division 230 gain or loss that might arise to the Trusts on the Loans.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 26BB | Subsection 26BB(1) | Subsection 26BB(2) | Subsection 26BB(3) | Division 16E | Subsection 159GP(1) | Subsection 159GP(3) | Section 318 | Income Tax Assessment Act 1997 Section 102-20 | Section 104-25 | Subsection 104-25(1) | Subsection 104-25(3) | Section 104-60 | Subsection 104-60(5) | Section 108-5 | Division 110 | Subsection 110-25(2) | Subsection 110-45(3) | Subsection 110-55(2) | Subsection 112-20(1) | Paragraph 112-20(1)(a) | Subsection 112-20(2) | Section 116-20 | Subsection 116-20(1) | Subsection 116-30(2) | Section 188-5 | Division 230 | Subsection 230-15(1) | Subsection 230-40(1) | Subsection 230-40(4) | Subsection 230-45(1) | Subsection 230-45(2) | Section 230-50 | Subsection 230-50(1) | Subsection 230-50(2) | Subdivision 230-B | Subdivision 230-C | Subdivision 230-D | Subdivision 230-E | Subdivision 230-F | Subdivision 230-G | Subsection 230-100 | Subsection 230-440(1) | Section 820-930 | Subsection 820-930(1) | Subsection 820-930(2) | Subsection 820-930(3) | Subsection 820-930(4) | Subdivision 960-S | Division 974 | Subsection 974-10(1) | Subsection 974-20(1) | Paragraph 974-20(1)(a) | Paragraph 974-20(1)(b) | Paragraph 974-20(1)(c) | Paragraph 974-20(1)(d) | Paragraph 974-20(1)(e) | Section 974-35 | Subsection 974-70(1) | Subsection 974-130(1) | Subsection 974-130(4) | Section 974-135 | Subsection 995-1(1)

Reasons for decision: Summary: The Loans owing to the Trusts will be equity interests under section 820-930. | Detailed Reasoning - Detailed reasoning: Division 974 provides a test for whether an interest is a debt interest or an equity interest for tax purposes. Subsection 974-10(1) states: An object of this Division is to establish a test for determining for particular tax purposes whether a *scheme, or the combined operation of a number of schemes: (a) gives rise to a *debt interest; or (b) gives rise to an *equity interest. Subsection 995-1(1) includes relevant definitions: debt interest in an entity has the meaning given by Subdivision 974-B equity interest in an entity has the meaning given by: (a) in the case of a company - Subdivision 974-C; and (b) in the case of a trust or partnership - section 820-930. scheme means: (a) any * arrangement; or (b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. As specified in the definition of 'equity interest' in section 995-1, where the entity is a trust, subsection 820-930(1) states that an equity interest in a trust has the meaning given by the provisions in Division 974, with modification as specified in Items 1 to 8 of the table in subsection 820-930(1). Item 3 of the table in subsection 820-930(1) states the equity test for a trust will be as specified in subsections 820-930(2) to (4): | Detailed Reasoning - 820-930(2): A *scheme satisfies the equity test in this subsection in relation to an entity that is a trust or partnership if the scheme gives rise to an interest set out in the following table: | Detailed Reasoning - Interest: 3 An interest that carries a right to a variable or fixed return from the entity if either the right itself, or the amount of the return, is at the discretion of: (a) the entity; or (b) an *associate of the entity The return may be a return of an amount invested in the interest This subsection has effect subject to subsection (3) (requirement for financing arrangement). | Detailed Reasoning - 820-930(3): A *scheme that would otherwise give rise to an *equity interest in an entity that is a trust or partnership because of an item in the table in subsection (2) (other than item 1) does not give rise to an equity interest in the entity unless the scheme is a *financing arrangement (see section 974-130 as applied by this section) for the trust or partnership. | Detailed Reasoning - 820-930(4): The interest referred to in item 2, 3 or 4 in the table in subsection (2) may take the form of a proprietary right, a chose in action or any other form. Subsection 820-930(2) refers to 'an associate of the entity'. 'Associate' is defined in section 995-1 to have the meaning in section 318 of the Income Tax Assessment Act 1936 (ITAA 1936). An associate of a trustee can include any entity that benefits under the trust. An entity is taken to benefit under a trust where it actually benefits or is merely capable of benefiting, whether by the exercise of a power of appointment or in some other way. The benefit may either be direct, or indirect through any interposed companies, partnerships or trusts. The scheme must be a 'financing arrangement'. Subsection 974-130(1) states: A *scheme is a financing arrangement for an entity if it is entered into or undertaken: (a) to raise finance for the entity (or a *connected entity of the entity); or (b) to fund another scheme, or a part of another scheme, that is a *financing arrangement under paragraph (a); or (c) to fund a return, or a part of a return, payable under or provided by or under another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a). An interest that could be characterised as both a debt interest and an equity interest will be treated as a debt interest (subsection 974-70(1)). An interest will be a debt interest if it satisfies the debt test. Subsection 974-20(1) states: A *scheme satisfies the debt test in this subsection in relation to an entity if: (a) the scheme is a *financing arrangement for the entity; and (b) the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and (c) the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when: (i) the financial benefit referred to in paragraph (b) is received if there is only one; or (ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and (d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and (e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil. Section 974-35 sets out the manner in which the value of a financial benefit to be provided or received under the scheme is to be calculated for the purposes of under subsections 974-20(2) and (3). Paragraph 974-35(1)(a) provides that the value of a financial benefit to be provided or received is to be calculated in nominal terms, if the performance period ends no later than 10 years after the interest arising from the scheme is issued or, in present value terms if the performance period must, or may, end more than 10 years after the interest arising from the scheme is issued. A 'financial benefit' is defined in section 974-160 as anything of economic value. It includes property and services. Generally, the financial benefit received will be the issue price specified in the terms of the financing arrangement. It is the amount paid to acquire the financial interest. The financial benefit to be provided could be a single amount or involve a number of instalments over time. An 'effectively non-contingent obligation' has the meaning given by section 974-135. Subsection 974-135(1) provides that whether an 'effectively non-contingent obligation' exists is determined having regard to the terms, conditions and pricing of the financing arrangement. The obligation must be non-contingent in substance as opposed to being non-contingent only in form. Application to the Loans To determine whether the Loans will be equity interests it is relevant to consider: | Detailed Reasoning - Whether the scheme is a financing arrangement: AA currently has loans owing from Trust F. The vast bulk of these loans were provided by AA to Trust F in the year ended 30 June 20xx. Under the terms of the Loan Agreement, the loan is repayable at-call and is to be interest free unless otherwise mutually agreed between the parties. There has been no agreement to vary the interest-free nature of this loan. Trust F commenced commercial activities as the treasury vehicle for the Group. The arrangement between Trust F and AA was a scheme entered into to provide and raise finance for Trust F. The loans were therefore financing arrangements, being the provision of loan capital in return for the issue of a debt interest. The Trusts have been established as the ultimate holding vehicles for structures that will hold investments predominantly based overseas. It is proposed that both Trusts will be provided funding to invest in overseas assets. AA will provide funding to the Trusts by way of gift in the form of an assignment of a portion of the existing loan entitlements owing to AA from Trust F. This funding will be assigned in equal shares to the Trusts. Each assignment will be documented by deed entered into by AA and the relevant Trust. The terms of the Loans will remain as set out in the Loan Agreement between AA and Trust F after their assignment to the Trusts. That is, there will be no variation to the terms and the loans will remain repayable at-call, AUD denominated and not interest bearing. The Loans will be financing arrangements and will be the continued provision of finance to Trust F after the assignment. | Detailed Reasoning - Whether the scheme satisfies the equity test: A scheme which gives rise to any of the interests specified in the table in subsection 820-930(2) satisfies the equity test in relation to a trust. Item 3 of the table in subsection 820-930(2) specifies 'an interest that carries a right to a variable or fixed return from the entity if either the right itself, or the amount of the return, is at the discretion of the entity, or an associate of the entity. The return may be a return of an amount invested in the interest.' A financing arrangement that is a loan to a trust will therefore be regarded as an equity interest under section 820-930 where repayments under the financing arrangement are made at the discretion of an 'associate' of the trust that was financed by the arrangement. The Loans will be financing arrangements. The Loans will be repayable at-call at the discretion of the lender, the Trusts. Therefore, provided the Trusts are an associate of Trust F (i.e. the entity) then item 3 of the equity test in the table in subsection 820-930(2) will be satisfied. The Trust Deed of Trust F specifies the meaning of 'General Beneficiaries' in clause 1.1 and specifically names as General Beneficiaries various individuals, including BB and CC. In addition, the General Beneficiaries also include the trustees of any eligible trust. 'Eligible trust' is defined in clause 1.1 to mean any trust under which any beneficiary 'has any interest (whether presently in existence or formed thereafter)'. The term 'interest' is defined in clause 1.1 to include 'any interest contingent interest possibility expectancy or spes of whatever nature and whether liable or not to be defeated or diminished by the exercise of any power or by reason of any other matter or circumstance'. The Trusts would each be an 'eligible trust' if any of the beneficiaries of Trust F have an 'interest' (as defined in the Trust Deed of Trust F) in the Trusts. As stated previously, BB and CC are beneficiaries of Trust F, and each has an interest in a trust. BB is the specified beneficiary of Trust X and CC is the specified beneficiary of Trust Z. The Trusts are therefore 'eligible trusts'. As provided in clause 1.1 of the Trust Deed of Trust F, the General Beneficiaries of Trust F include the trustees of an eligible trust. Therefore, the Trusts are associates of Trust F, as defined in section 318 of the ITAA 1936 and are 'an associate of the entity' (i.e. of Trust F) for the purposes of Item 3 in the table in subsection 820-930(2). The Loan assigned to each Trust will be repayable at-call at the discretion of each Trust and each Trust is an associate of Trust F. Therefore the Loans are an equity interest in Trust F, being a scheme which gives rise to the interest specified in item 3 of the table in subsection 820-930(2). | Detailed Reasoning - Whether the interest is a debt interest: In this case, the debt test in subsection 974-20(1) is not satisfied because paragraph 974-20(1)(d) is not satisfied. The following requirements are satisfied: Paragraph 974-20(1)(d) is not satisfied because paragraph 974-20(1)(d) requires that it is substantially more likely than not that the value of the benefits provided at least equals the value of the benefits received. The Loans are repayable at-call and have no fixed term. Therefore the performance period may end more than 10 years after the loans were created. As stated in paragraph 974-35(1)(a), the value of a financial benefit to be provided or received is to be calculated in present value terms if the performance period may end more than 10 years after the interest arising from the scheme is issued. The value of the financial benefit to be provided will therefore be determined having regard to the present value of future benefits to be provided by Trust F under the loan. No interest is payable in respect of the Loans, therefore the present value of the financial benefits to be provided by Trust F as the borrower will be less than the value of the financial benefit received by Trust F, which is the nominal or face value of the loan. | Detailed Reasoning - Conclusion: The Loans will satisfy the conditions for an equity interest under section 820-930 and do not satisfy the debt test in section 974-20. Therefore, the Loans will be an equity interest. | Summary: An assessable gain will not arise to the Trusts under Division 230 when the Loans owing to the Trusts are repaid in part or full. | Detailed Reasoning - Detailed reasoning: Subsection 230-15(1) states that an entity's assessable income includes a gain made from a financial arrangement. Subsections 230-45(1), 230-50(1) and 230-50(2) provide tests which specify when an entity has a financial arrangement. Pursuant to subsection 230-45(1), an entity has a financial arrangement if it has a cash settlable right to receive or obligation to provide a financial benefit, or a combination of such rights and/or obligations, unless, broadly, the entity has no insignificant other rights to receive or obligations to provide something which is not a financial benefit, or the other rights or obligations are not cash settlable. Subsection 230-45(2) specifies the circumstances in which a right to receive or obligation to provide a financial benefit are cash settlable. A financial benefit will be 'cash settlable' if: · the financial benefit is money or a money equivalent; or · the financial benefit is non-monetary but the relevant right or obligation is, in substance or effect, expected to be dealt with in a manner which involves a monetary benefit or equivalent. Section 230-50 provides two further tests which specify when there will be a financial arrangement. As is most relevant, subsection 230-50(1) states you also have a financial arrangement if you have an equity interest. The equity interest constitutes the financial arrangement. Therefore, an equity interest, as defined in section 820-930 for an entity that is a trust, constitutes the financial arrangement. A financial arrangement may satisfy both subsections 230-45(1) and 230-50(1). In such a case Taxation Determination TD 2011/12 Income tax: where an equity interest is a financial arrangement which satisfies both subsections 230-45(1) and 230-50(1) of the Income Tax Assessment Act 1997, which provision applies? (TD 2011/12) states: 10. An equity interest that is cash settlable will satisfy subsection 230-50(1) and may also satisfy subsection 230-45(1). In these circumstances, subsection 230-50(1) applies in preference to subsection 230-45(1). Division 230 provides a number of methods for the taxation of financial arrangements. Subsection 230-40(1) specifies the methods which may be used for taking into account the gain or loss from a financial arrangement: | Detailed Reasoning - 230-40(1): The methods that can be applied to take account of a gain or loss you make from a *financial arrangement are: (a) the accruals and realisation methods provided for in Subdivision 230-B; or (b) the fair value method provided for in Subdivision 230-C; or (c) the foreign exchange retranslation method provided for in Subdivision 230-D; or (d) the hedging financial arrangement method provided for in Subdivision 230-E; or (e) the method of relying on your financial reports provided for in Subdivision 230-F; or (f) a balancing adjustment provided for in Subdivision 230-G. The methods referred to in paragraphs (b) to (e) only apply if you make an election under the relevant Subdivision and you must meet certain requirements before you can make such an election. As stated in the note in subsection 230-40(1), the methods in Subdivisions 230-C, 230-D, 230-E and 230-F only apply if an election is made and the relevant requirements for that election are met. Subdivision 230-B, as provided for in paragraph 230-40(1)(a), applies the accruals and realisation methods to determine the amount and timing of gains and losses from a financial arrangement. Subsection 230-100 states when to apply the accruals method and when to apply the realisation method, however subsection 230-40(4) specifies when the accruals and realisation methods will not apply and relevantly states: | Detailed Reasoning - 230-40(4): Subdivision 230-B (accruals and realisation method) does not apply to a gain or loss you make from a *financial arrangement: ... (e) if the arrangement is a financial arrangement under section 230-50 (equity interests etc.). Therefore, the accruals and realisation methods will not apply where the arrangement is an equity interest that is a financial arrangement under subsection 230-50(1). Subdivision 230-G, as included at paragraph 230-40(1)(f), provides for a 'balancing adjustment' to take account of a gain or loss you make from a financial arrangement where the financial arrangement ceases. However, subsection 230-440(1) provides exceptions and relevantly, in relation to equity interests, states: | Detailed Reasoning - 230-440(1): A balancing adjustment is not made under this Subdivision in relation to a *financial arrangement at a time if: (a) the arrangement is a financial arrangement under section 230-50 (equity interests etc); and (b) neither Subdivision 230-C nor Subdivision 230-F apply to the arrangement immediately before that time. Application to the Loans The Loans are cash settlable legal rights and therefore will be financial arrangements for the purposes subsection 230-45(1). In addition, the Loans will also be a financial arrangement for the purposes subsection 230-50(1). As discussed in Question 1, the Loans will satisfy the conditions for and will be an equity interest pursuant to section 820-930. Subsection 230-50(1) specifically states that an equity interest constitutes the financial arrangement therefore the Loans will also be a financial arrangement for the purposes subsection 230-50(1). In these circumstances, as explained in TD 2011/12, subsection 230-50(1) applies in preference to subsection 230-45(1). Subsection 230-40(1) specifies the methods applicable under Division 230 for taking into account the gain or loss from a financial arrangement. In relation to these methods: · The Trusts will not make any elections under Subdivisions 230-C, 230-D, 230-E or 230-F that will impact on gains or losses made on the Loans. Therefore the methods referred to in paragraphs 230-40(1)(b) to (e) are not applicable. · Subdivisions 230-B, as provided for in paragraphs 230-40(1)(a), will not apply because the Loans will be an equity interest that is a financial arrangement under subsection 230-50(1) which is specifically excluded from Subdivision 230-B by subsection 230-40(4). · Subdivision 230-G, as provided for in paragraphs 230-40(1)(a), will not apply because the Loans will be an equity interest that is a financial arrangement under subsection 230-50(1) and Subdivisions 230-C and 230-F will not apply to the arrangement. · Subsection 230-440(1) will therefore specifically exclude Subdivision 230-G from applying to the loans. The partial or full repayment by Trust F of the Loans held by the Trusts will therefore not give rise to any assessable gain under Division 230. | Summary: A capital gain under section 104-25 will not arise to the Trusts when CGT event C2 happens to the Loans. | Detailed Reasoning - Detailed reasoning: Section 102-20 states you make a capital gain or capital loss if a CGT event happens to a CGT asset you own. A 'CGT asset' is defined in section 108-5 and includes any kind of property or a legal or equitable right that is not property. Note 1 in section 188-5 specifically states that 'debts owed to you' are CGT assets. Subsection 104-25(1) states CGT event C2 happens if your ownership of an intangibleCGT asset ends because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited. An intangible asset is one that lacks a physical presence, for example a debt, a lease, a patent, a copyright or contractual right. Whether a capital gain or capital loss is made from CGT event C2 happening to a debt owing to the vendor, will depend on the calculation of the cost base of that debt and the capital proceeds from the CGT event. Subsection 104-25(3) provides: You make a capital gain if the *capital proceeds from the ending are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's *reduced cost base. The general rules about capital proceeds are contained in section 116-20. Subsection 116-20(1) states: The capital proceeds from a *CGT event are the total of: (a) the money you have received, or are entitled to receive, in respect of the event happening; and ( b) the *market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). In some situations there are modifications to the general rules about capital proceeds. Subsection 116-30(2) modifies the general rules, replacing the capital proceeds with the market value of the CGT asset in the specified circumstances. Subsection 116-30(2) states: The *capital proceeds from a *CGT event are replaced with the *market value of the *CGT asset that is the subject of the event if: (a) some or all of those proceeds cannot be valued; or (b) those capital proceeds are more or less than the market value of the asset and: (i) you and the entity that *acquired the asset from you did not deal with each other at *arm's length in connection with the event; or (ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings). (The market value is worked out as at the time of the event.) 'Market value' is defined in subsection 995-1(1) as having a meaning affected by Subdivision 960-S which contains special rules for working out the market value of assets and non-cash benefits. This means that in determining the market value of an item that is not an asset or a non-cash benefit the ordinary meaning of market value applies. The term 'arm's length' is defined in subsection 995-1(1): ...in determining whether parties deal at arm's length , consider any connection between them and any other relevant circumstance. In ACI Operations Pty Ltd v. Berri Ltd (2005) 15 VR 312 ( ACI Operations Pty Ltd ), Dodds-Streeton J said (at [223]) that the authorities establish: ... an arm's length relationship is that of strangers, or parties who are unaffected by existing mutual duties, liabilities, obligations, cross-ownership of assets, or identity of interests which present a capacity in either party to influence or control the other, or an inducement to serve that common interest, which might operate to modify the terms on which strangers would deal. The underlying principles of the case law discussing whether parties have dealt at arm's length have been summarised by McKerracher J in Healey v. FC of T [2012] FCA 269 [at 95]. Whether parties dealt at arm's length is a question of fact and involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. At issue is whether the parties have acted separately and independently, where neither party exercises influence or control over the other in connection with the transaction. Parties are not at arm's length where the parties are related or associated in some way so that while each party may enter a transaction with some self-interest in mind, it may also take into consideration the interests of the other party in making the agreement. Examples of such relationships are transactions between family members and related corporations. The general rules about cost base and reduced cost base are contained in Division 110. The cost base and reduced cost base of a CGT asset consists of five elements. Subsection 110-25(2) states: The first element is the total of: (a) the money you paid, or are required to pay, in respect of *acquiring it; and (b) the *market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition). In some situations there are modifications to the general rules about cost base and reduced cost base. The market value substitution rule in subsection 112-20(1) modifies the general rule by replacing the first element of the cost base with its market value (at the time of acquisition). Subsection 112-20(1) states: The first element of your *cost base and *reduced cost base of a *CGT asset you *acquire from another entity is its *market value (at the time of acquisition) if: (a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from: (i) *CGT event D1 happening; or (ii) another entity doing something that did not constitute a CGT event happening; or (b) some or all of the expenditure you incurred to acquire it cannot be valued; or (c) you did not deal at *arm's length with the other entity in connection with the acquisition. Subsection 112-20(2) provides an exception to the market substitution rule stating: Despite paragraph (1)(c), if: (a) you did not deal at *arm's length with the other entity; and (b) your *acquisition of the *CGT asset resulted from another entity doing something that did not constitute a CGT event happening; the *market value is substituted only if what you paid to acquire the CGT asset was more than its market value (at the time of acquisition). In the context of a CGT asset that is a loan subsection 110-45(3) relevantly provides that any recoupments of expenditure on the asset, which includes repayments of the loan, will reduce the cost base (and therefore the reduced cost base, see subsection 110-55(2)) by the amount of the recoupment, except so far as the amount has been included in your assessable income. Thus a repayment of a loan will reduce the cost base of the loan, unless the repayment amount is included in assessable income. Application to the Loans The Trusts will acquire the Loans from AA. The Loans will be a CGT asset (as defined in section 108-5) of the Trusts. Upon repayment of the Loans, CGT event C2 will happen because ownership of an intangible CGT asset by the Trusts, in this case a debt, ends by way of discharge or satisfaction. The Trusts will only make a capital gain under section 104-25 if the capital proceeds from CGT event C2 happening to the Loans are more than the cost base of the Loans. As provided for in subsection 116-20(1), the capital proceeds from CGT event C2 happening to the Loans will be the applicable repayment proceeds, being the money received in respect of the event happening. The market value substitution rule in subsection 116-30(2) will not apply in respect of the capital proceeds received by the Trusts from CGT event C2 happening to the Loans. Paragraph 116-30(2)(a) is not satisfied because the proceeds received in respect of CGT event C2 happening to the Loans can be valued. Further paragraph 116-30(2)(b) is not satisfied because the proceeds are not more than or less than the market value of the CGT asset. The Loans have a market value equal to their face value and the applicable repayment proceeds will be equal to their face value. In relation to the cost base of the Loans, the general rule in subsection 110-25(2) provides that the first element of the cost base is the money paid in respect of acquiring the CGT asset. This general rule is however modified by subsection 112-20(1) so that the first element of the cost base is replaced by the market value of the CGT asset at the time of acquisition. In this case the market value modification in subsection 112-20(1) is satisfied because both paragraphs 112-20(1)(a) and (c) are satisfied. Paragraph 112-20(1)(a) will be satisfied because the Trusts will not incur expenditure in relation to the acquisition of the Loans. The Loans will be gifted to the Trusts by AA. Further, in relation to paragraph 112-20(1)(a), the acquisition will not result from CGT event D1 happening (subparagraph 112-20(1)(a)(i)), or from another entity doing something that did not constitute a CGT event happening (subparagraph 112-20(1)(a)(ii)). Section 104-60 provides that CGT event E2 happens if you transfer a CGT asset to an existing trust. However subsection 104-60(5) provides an exception which applies if the transferor is the sole beneficiary of the trust and is absolutely entitled to the transferred asset as against the trustee, and the trust is not a unit trust. In this case, AA is not the sole beneficiary of the Trusts and the Trusts are not unit trusts, therefore CGT event E2 will happen when AA gifts the Loans to the Trusts by way of assignment (ATO ID 2003/559 Income Tax Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 ). The requirements of paragraph 112-20(1)(c) will also be satisfied. The gift of the Loans to the Trusts by AA is not considered to be an arm's length dealing because any dealing that does not involve real bargaining between independent parties is generally regarded as a non-arm's length dealing. In this case, the dealing is non-arm's length because the Loans which are assets with considerable value will be acquired by the Trusts from AA for no consideration. The exception to paragraph 112-20(1)(c) in subsection 112-20(2) will not apply because the requirements in that exception are not satisfied. Given that the market value substitution rule in subsection 112-20(1) will apply, the first element of the cost base of the Loans will be their market value at the time of their acquisition. The cost base of the Loans acquired by the Trusts will therefore be equal in amount to their face value less any repayments of the loans (to a maximum of the face value of the loans). A capital gain under section 104-25 arises if the capital proceeds from CGT event C2 happening are more than the cost base of the Loans. A capital gain will not arise to the Trusts under section 104-25 as the Loans are repaid, in part or full, because the capital proceeds will not exceed the cost base (i.e. the face value less any repayments) of the loans. | Summary: An assessable gain will not arise to the Trusts under section 26BB when the Loans owing to the Trusts are repaid in part or full. | Detailed Reasoning - Detailed reasoning: Subsection 26BB(2) provides that the amount of any gain on the disposal or redemption of a traditional security shall be included in the assessable income in the year that the disposal or redemption takes place. 'Traditional security' is defined in section 26BB(1) as a 'security' that: · is or was acquired after 10 May 1989 · does not have an 'eligible return', or where it does have an eligible return, it must not exceed the prescribed level, and · is not trading stock of the taxpayer. The definition of traditional security incorporates a number of terms that are defined as having the same meaning as in Division 16E. Subsection 159GP(1) provides the following definitions: security means: (a) stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security; (b) a deposit with a bank or other financial institution; (c) a secured or unsecured loan; or (d) any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured. redemption , in relation to a security, means the discharging of all liability to pay any amount or amounts under the security representing a return of the issue price of the security. A security has an 'eligible return' if the total of all payments (apart from periodic interest) payable under the security is reasonably likely to exceed its issue price (subsection 159GP(3)). Subsection 26BB(3) provides for the disposal or redemption of traditional securities where the parties are not dealing with each other at arm's length. Subsection 26BB(3) states: Where the Commissioner, having regard to any connection between the parties to the transaction by which the taxpayer disposed of the traditional security or by which it was redeemed, or by which the taxpayer acquired the traditional security, is satisfied that the parties were not dealing with each other at arm ' s length in relation to the transaction, then, for the purposes of determining under subsection (2) the amount of any gain on the disposal or redemption, the consideration for the transaction shall be taken to be: (a) the amount that might reasonably be expected for the transaction if the parties were independent parties dealing at arm's length with each other; or (b) where, for any reason it is not possible or practicable for the Commissioner to ascertain that amount - such amount as the Commissioner determines. Application to the Loans The Loans will be a 'traditional security' as defined in subsection 26BB(1). The Loans: · are 'securities' as defined in subsection 159GP(1) · will be issued after 10 May 1989 · do not have an eligible return as defined in subsection 159GP(3), and · are not trading stock of the Trusts. As provided for in subsection 26BB(2), where a traditional security is disposed or redeemed, any gain on the disposal or redemption is included in assessable income. The repayments of the Loans are expected to discharge all liability to pay an amount equal to the repayment, being a return of the loaned amount (i.e. the issue price of the security), therefore the repayments are redemptions of traditional securities for the purposes of section 26BB. Subsection 26BB(2) will include the gain on any redemption as assessable income in the year of income in which the redemption takes place. Therefore, as each repayment of the Loans takes place, the Trusts would include in its assessable income any gain made on the redemption. Whether any gain will arise to the Trusts on each redemption (i.e. repayment) requires consideration of the cost of the Loans for the purposes of the traditional security rules in section 26BB. In particular, it requires consideration of whether as provided for in subsection 26BB(3) the parties are not dealing with each other at arm's length. Any dealing that does not involve real bargaining between independent parties is generally regarded as a non-arm's length dealing. The gift of the Loans to the Trusts by AA is not considered to be an arm's length dealing because the parties are not independent and the Loans which are assets with considerable value will be acquired by the Trusts from AA for no consideration. Given that the gift of the Loans to the Trusts is not an arm's length dealing, subsection 26BB(3) states that the consideration for the acquisition of the Loans is taken to be the amount that might reasonably be expected if the parties were dealing at arm's length with each other. If the parties were dealing with each other at arm's length it is considered that the market value of the Loans (at the time of their acquisition) would be the amount that might reasonably be expected to be paid to acquire the loans. The Loans have a market value equal to their face value therefore the Trusts are deemed by subsection 26BB(3) to have paid consideration for the Loans equivalent to their face value. A gain will not arise to the Trusts and an amount will not be included in assessable income as provided for in subsection 26BB(2) because as the Loans are repaid or redeemed, the repayment or redemption amount, will not exceed the consideration (i.e. the face value/market value) deemed to have been paid by each of the Trusts for the Loans.

Reasons for decision: All legislative references in Questions 1, 2 and 3 are references to the Income Tax Assessment Act 1997 unless otherwise stated | All legislative references in Question 4 are references to the Income Tax Assessment Act 1936 unless otherwise stated | Whether the scheme satisfies the equity test, and | Whether the interest is a debt interest because it satisfies the debt test. | paragraph 974-20(1)(a) - The scheme is a financing arrangement for the Trust F, as defined in section 974-130. | paragraph 974-20(1)(b) - Trust F receives financial benefit(s) under the scheme as defined in section 974-160. | paragraph 974-20(1)(c) - There is an effectively non-contingent obligation under the scheme to provide a financial benefit when the financial benefit is received. | paragraph 974-20(1)(e) - The value provided and the value received both are not nil.