On 10 October 2016, the Minister for Revenue and Financial Services, the Hon Kelly O’Dwyer MP released Exposure Draft legislation and explanatory material to provide greater certainty in relation to integrity rules regarding the taxation of debt and equity.
Australia’s tax rules classify financing arrangements as debt (with deductible interest) or equity according to their economic substance. They also contain integrity rules designed to prevent taxpayers from artificially splitting a single scheme into multiple schemes to achieve favourable tax outcomes.
These integrity rules have been seen to be uncertain and have created significant practical difficulties for taxpayers. The exposure draft legislation gives effect to the Board of Taxation’s recommendations on how to address the uncertainty and compliance costs that result from the current rules, while still preserving the integrity of the debt equity tax rules. The Board also recommended that examples of the operation of the new integrity rules should be set out in a legislative instrument.
The draft legislation provides greater certainty in relation to the integrity rules by implementing the Board of Taxation’s recommendations to ensure that multiple schemes are treated as a single scheme only when this accurately reflects the economic and commercial substance of the schemes. The Board’s recommendations were developed following extensive consultations with industry.
Consistent with the Board of Taxation’s recommendations, examples of how the rules would work in practice are also set out in a draft legislative instrument supporting the Exposure Draft legislation.
The final legislation will apply prospectively from a day to be fixed by proclamation or six months after Royal Assent, whichever is later.
The Exposure Draft legislation and Explanatory Memorandum are available on the Treasury website. Submissions will close on 21 November 2016.
[Asst Treasurer – media release] [Treasury website – consultation] [Draft Legislation] [Draft Explanatory Memorandum] [LTN 195, 10/10/16]
Extract from Draft Legislation
Schedule #—Debt and equity scheme integrity rules
Part 1—Main amendments
Income Tax Assessment Act 1997
- Section 974-155
Repeal the section, substitute:
974-155 Aggregate schemes
(1) For the purposes of this Division, treat 2 or more *schemes as a single aggregate scheme if:
(a) the pricing, terms and conditions of one or more of the schemes:
(i) are dependent on or linked to; or
(ii) operate to change the economic consequences of;
the pricing, terms and conditions of one or more of the other schemes; and
(b) if the schemes were a single aggregate scheme, this would change whether this Division treats an interest as a debt interest or an equity interest’ and
(c) having regard to the following, it would be concluded that the schemes were designed to operate together to produce the schemes’ combined economic effect:
(i) the nature and extent of any involvement by the parties to one of the schemes in any of the other schemes;
(ii) the way the schemes are entered into or carried out at arm’s length;
(iii) any dealing, between any of the parties to any of the
(iv) the relationships between any of the parties to any of the schemes;
(v) normal commercial understandings and practices;
(vi) any other relevant matters.
(2) Subsection (1) does not apply to 2 or more schemes if:
(a) the dependence, link or operation referred to in paragraph (1)(a) happens merely because of one or more of the following:
(i) the use of a return on or of an interest arising from one of the schemes to fund a return on or of an interest arising from another of the schemes, if this is not part of the terms and conditions of any of the schemes;
(ii) the holders of 2 or more kinds of interests agreeing to staple the interests so that each kind of interest may only be disposed of or cancelled with the other kinds of interests;
(iii) the arranging for an obligation to pay a return on a debt interest arising from one of the schemes to be subordinate to an obligation to pay a return on a debt interest arising from another of the schemes, if neither obligation is contingent on the performance of the other;
(iv) the subjecting of an interest arising from one of the schemes, or assets of the entity that issued the interest, to a security interest (within the meaning of the Corporations Act 2001) in order to secure a return on an interest arising from another of the schemes; or
(b) the Commissioner determines that it would be unreasonable for subsection (1) to apply to the schemes.
Note 1: The Commissioner must have regard to the objects of this Division (see subsection 974-10(5)).
Note 2: Applications, review and other matters relating to these determinations are set out in section 974-112.
(3) The Minister may, by legislative instrument, declare examples to illustrate the operation of subsection (1) and paragraph (2)(a). Such an example may extend or narrow the operation of that subsection and paragraph.
Note: None of the examples will be exhaustive (see section 15AD of the Acts Interpretation Act 1901).
(4) Subsection (1) does not apply for the purposes of this section or section 974-10 (about the objects of this Division).
Extract from Explanatory Memorandum
Chapter 2—Non-stapling examples
Part 2—Shareholder loan: no aggregation
Division 1—Main example
6 Object
This example focuses on the operation of the interdependence test
7 Explanation of facts
(1) A diagram explaining the facts for this example is as follows:
[DIAGRAM: Investor purchases shares and loans money to a subsidiary, receiving dividends and interest in return, respectively]
(2) An investor pays $100,000 to acquire all of the ordinary shares in a company.
(3) At the same time, the investor and the company enter into a loan agreement under which:
(a) the investor lends $150,000 to the company; and
(b) this principal of $150,000 is repayable at the end of 5 years; and
(c) financial benefits in the form of loan interest are payable by the company to the investor each 6 months during the 5-year loan period at a rate of 5% per annum.
(4) The amount of the loan principal is proportionate to the subscription value of the ordinary shares. However, the loan agreement does not expressly refer to the ordinary shares or to their value.
(5) Dividends on the ordinary shares are payable at the discretion of the company’s directors, subject to the requirements of the Corporations Act 2001. The pricing, terms and conditions under which the ordinary shares were issued to the investor do not expressly refer to the loan.
8 Assumptions—separate schemes exist if the aggregation rule is disregarded
(1) Assume that, under Division 974 of the Act:
(a) the issuing of the ordinary shares is a scheme (the share scheme) that gives rise to equity interests in the company; and
(b) the loan agreement is a separate scheme (the loan scheme) that gives rise to a debt interest in the company.
(2) Disregard the aggregation rule for the purposes of these assumptions.
9 Applying the interdependence test to the schemes
(1) The interdependence test is not satisfied in relation to the share scheme and the loan scheme because the pricing, terms and conditions of either scheme:
(a) are not dependent on, or linked to; and
(b) do not operate to change the economic consequences of; the pricing, terms and conditions of the other scheme.
(2) This is because:
(a) the company must perform its obligations under the loan agreement regardless of the pricing, terms and conditions attached to the issuing of the shares; and
(b) nothing about the shares affects:
(i) the amount of the financial benefits payable under the loan; or
(ii) how rights under the loan can be exercised; or
(iii) anything else about the loan scheme.
10 Applying the design test to the schemes
As the interdependence test is not satisfied, it is not necessary to consider whether the design test is satisfied in relation to the 2 schemes.
11 Conclusion
As the interdependence test is not satisfied, the aggregation rule does not apply to treat the share scheme and the loan scheme as a single aggregate scheme.