Question 19
This question seeks to help us assess the risk that an interest has been mischaracterised as either:
- a debt interest and inappropriate tax deductions have been claimed
- an equity interest and inappropriate franked distributions have been made.
The information reported at this question may also help us in doing both of the following:
- identifying arrangements with international related parties where the use of hybrid instruments may indicate a tax risk
- assessing any risk regarding your thin capitalisation position.
The dollar amounts or values asked for in this question are all based on your accounting records.
The terms debt interest and equity interest are defined in Division 974 of the ITAA 1997.
To complete this question:
- identify all debt and equity interests you had on issue or which you held during the income year that were on issue to or issued by international related parties and where the characterisation between debt and equity is different under Division 974 of the ITAA 1997 from your treatment for accounting purposes
- identify which of those financing arrangements would be classified as debt interests and which would be classified as equity interests under Division 974 of the ITAA 1997
- identify which of those financing arrangements under which you received finance from a related party and those under which you provided finance to a related party
- calculate the average quarterly balance of each relevant financing arrangement (by adding the relevant financing arrangement amount at the end of each quarter and dividing by four)
- add up the total of the average quarterly balances of each financial arrangement under which you
- received finance from a related party that is characterised as a debt interest under Division 974 of the ITAA 1997
- provided finance to a related party that is characterised as a debt interest under Division 974 of the ITAA 1997
- received finance from a related party that is characterised as an equity interest under Division 974 of the ITAA 1997
- provided finance to a related party that is characterised as an equity interest under Division 974 of the ITAA 1997.
If you had financing arrangements to which this question applies, answer Yes at A item 19 and complete the required fields.
At B item 19, write the average quarterly balance of debt interests issued (finance received).
At C item 19, write the average quarterly balance of debt interests held (finance provided.
At D item 19, write the average quarterly balance of equity interests issued (finance received).
At E item 19, write the average quarterly balance of equity interests held (finance provided.
For help working out the tax characterisation of an interest as debt or equity (debt and equity tests), see:
- Division 974 of the ITAA 1997
- Debt and equity tests
- Debt and equity tests: guide to 'at call' loans.
Example
Bob & Co analyses the financial arrangements they had during the income year that were entered into with international related parties where the debt and equity treatment under Division 974 of the ITAA 1997 is different from the debt and equity treatment for accounting purposes.
Bob & Co financial arrangementsFinancial arrangements |
Tax treatment |
Received or provided |
Quarter 1 |
Quarter 2 |
Quarter 3 |
Quarter 4 |
|---|---|---|---|---|---|---|
Redeemable preference shares |
Equity |
Received |
35,000,000 |
27,000,000 |
42,000,000 |
23,000,000 |
Convertible notes |
Debt |
Received |
16,800,000 |
16,800,000 |
16,800,000 |
16,800,000 |
Perpetual notes |
Debt |
Provided |
31,000,000 |
28,500,000 |
25,000,000 |
22,500,000 |
Stapled security |
Equity |
Received |
27,500,000 |
32,500,000 |
32,500,000 |
0 |
Bob & Co then collates the following information for those financial arrangements where the debt equity characterisation under Division 974 of the ITAA 1997 is different from their treatment for accounting purposes.
Financial arrangements where the debt equity characterisation under Div 974 is different from their treatment for accounting purposes.
Financial arrangements |
Average quarterly balances Div 974 treats as debt – Received |
Average quarterly balances Div 974 treats as debt – Provided |
Average quarterly balances Div 974 treats as equity – Received |
Average quarterly balances Div 974 treats as equity – Provided |
|---|---|---|---|---|
Redeemable preference shares |
na |
na |
31,750,000 |
na |
Convertible notes |
16,800,000 |
na |
na |
na |
Perpetual notes |
na |
26,750,000 |
na |
na |
Stapled security |
na |
na |
23,125,000 |
na |
Total |
16,800,000 |
26,750,000 |
54,875,000 |
0 |
With this information Bob & Co complete question 19 as follows:
Question 19a Do you have any arrangements involving hybrid instruments, which are treated as debt for tax purposes in one country but are treated as equity for tax purposes in another country?
The aim of this question is to identify whether the taxpayer has any arrangements involving hybrid financial instruments for tax purposes. A hybrid financial instrument is a financial instrument which gives rise to a mismatch in tax outcomes under the laws of the payer and payee jurisdiction and the mismatch is attributable to the terms of the instrument.
For example, a mismatch in tax outcome may arise where a financial instrument under an arrangement is taxed as debt under the laws of the payer jurisdiction, but taxed as equity under the laws of the payee jurisdiction.
This question includes any of your income or expenses affected by the hybrid financial instruments for tax purposes.
The dollar amounts or values asked for in this question are all based on your tax records.
If you have any arrangements involving hybrid financial instruments, answer Yes at A item 19a.
If you answer Yes, you must specify the amount of your income affected by the hybrid financial instruments tax mismatch at B item 19a, and the amount of your expense affected by the hybrid financial instruments tax mismatch at C item 19a.
Example
ABC Co is an Australian resident company which has issued 10,000,000 mandatory redeemable preference shares (MRPS) at face value to a foreign related company, Group Treasury Co. The MRPS are mandatorily redeemable at face value after 8 years, and pay a fixed annual dividend rate of 10%.
ABC Co paid a distribution of $1,000,000 on the MRPS in the year of assessment, and claims a deduction for the distribution because the distribution qualifies as a deductible return on a debt interest under the Australian debt equity tax rules.
The foreign country has a tax exemption for dividends received by its residents from another country. The MRPS distribution received by Group Treasury Co from ABC Co is treated as an exempt dividend under the tax rules of the foreign country.
ABC Co therefore expects there is a mismatch in tax outcomes that is attributable to the terms of the MRPS financial instrument.
ABC Co answers Yes at item 19a, and writes $1,000,000 at C item 19a.
End of example