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New Business Tax System (Debt and Equity) Act 2001 (163 of 2001)

Schedule 1 Debt and equity interests

Part 1 Amendment of the Income Tax Assessment Act 1997

Income Tax Assessment Act 1997

34 After Division 960

Insert:

[The next Division is Division 974.]

Division 974 - Debt and equity interests

Table of Subdivisions

974-A General

974-B Debt interests

974-C Equity interests

974-D Common provisions

974-E Non-share distributions by a company

974-F Related concepts

Subdivision 974-A - General

Guide to Division 974

974-1 What this Division is about

This Division tells you whether an interest is a debt interest, or an equity interest, for tax purposes. An interest that could be characterised as both a debt interest and an equity interest will be treated as a debt interest for tax purposes (except for certain interests that fund returns on equity interests).

Whether an interest is a debt interest or an equity interest matters because returns on debt interests are not frankable but may be deductible while returns on equity interests are not deductible but may be frankable.

This Division extends beyond shares the range of interests that are recognised as equity in a company. An interest that is an equity interest in a company but is not a share will be treated in the same way as a share for some tax purposes (particularly in relation to the determination of the tax treatment of returns on the interest).

This Division also tells you how to work out which distributions made in respect of a non-share equity interest in a company will be non-share dividends and which will be non-share capital returns. Those that are non-share dividends will be treated, for most tax purposes, in the same way as dividends.

Table of sections

974-5 Overview of Division

Operative provisions

974-10 Object

974-5 Overview of Division

Test for distinguishing debt and equity interests

(1) The test for distinguishing between debt interests and equity interests focuses on economic substance rather than mere legal form (see subsection 974-10(2)). The test is designed to assess the economic substance of an interest in terms of its impact on the issuer's position.

Debt interests

(2) Subdivision 974-B tells you when an interest is a debt interest in an entity. The basic test is in section 974-20.

Equity interests

(3) Subdivision 974-C tells you when an interest is an equity interest in a company. The basic test is in section 974-75.

Tie breaker between debt and equity

(4) If an interest satisfies both the debt test and the equity test, it is treated as a debt interest and not an equity interest.

Distributions in relation to equity interests that are not shares

(5) If you have an equity interest in a company that is not a share, Subdivision 974-E tells you what will count as a non-share distribution, a non-share dividend and a non-share capital return in relation to the interest.

Concepts used in the debt and equity tests

(6) Subdivision 974-F defines a number of concepts that are used in the debt and equity tests (financing arrangement, effectively non-contingent obligation, benchmark rate of return and converting interest).

[This is the end of the Guide.]

Operative provisions

974-10 Object

(1) 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.

Note: The test is used, for example, for:

(a) identifying distributions that may be frankable and which may be subject to dividend withholding tax; and

(b) identifying returns that may be deductible to the company making the return; and

(c) resolving uncertainty as to the proper tax treatment for debt/equity hybrid interests (interests that have some debt qualities and some equity qualities); and

(d) identifying debt capital for the purposes of Division 820 (thin capitalisation rules).

(2) Another object of this Division is that the test referred to in subsection (1) is to operate on the basis of the economic substance of the rights and obligations arising under the *scheme or schemes rather than merely on the basis of the legal form of the scheme or schemes.

Note 1: The basic indicator of the economic character of a debt interest is the non-contingent nature of the returns. The basic indicator of the economic character of an equity interest, on the other hand, is the contingent nature of the returns (or convertibility into an interest of that nature).

Note 2: The test is intended to operate, for example, to:

(a) deny deductibility (but allow franking) for "interest" in relation to a scheme that has the legal form of a loan if the economic substance of the rights and obligations arising under the relevant scheme gives the interest characteristics that are the same as or similar to those of a dividend on an ordinary share (and thereby prevent deductible returns on equity); and

(b) allow a deduction (but not franking) for a "dividend" in relation to a scheme that has the legal form of an ordinary share if the economic substance of the rights and obligations arising under the relevant scheme gives the dividend characteristics that are the same as or similar to those of deductible interest on an ordinary loan (and thereby prevent frankable returns on debt).

This will not happen if a provision in this Act specifically provides for a different treatment for the interest or dividend.

(3) Another object of this Division is that the combined effect of *related schemes be taken into account in appropriate cases:

(a) to ensure that the test operates effectively on the basis of the economic substance of the rights and obligations arising under the schemes rather than merely on the basis of the legal form of the schemes; and

(b) to prevent the test being circumvented by entities merely entering into a number of separate schemes instead of a single scheme.

(4) Another object of this Division is to identify the distributions and credits made in respect of *non-share equity interests in a company that are to be treated as *dividends ( non-share dividends ) and those that are to be treated as returns of capital ( non-share capital returns ).

Note: Non-share dividends will generally be included in the recipient's assessable income and may be frankable.

(5) The Commissioner must have regard to the objects stated in subsections (1) to (3) in exercising the power to make a determination under any of the following provisions:

(a) subsection 974-15(4);

(b) subsection 974-60(3), (4) or (5);

(d) subsection 974-70(4);

(e) subsection 974-150(2).

Note: An entity can apply to the Commissioner to have a determination made and can object under Part IVC of the Taxation Administration Act 1953 if it is dissatisfied with a determination (see section 974-112).

(6) Regulations may also be made under the provisions of this Division:

(a) to clarify the meaning of certain words and phrases in the light of emerging commercial practices, conditions and products; and

(b) to give guidance on the detailed operation of particular provisions.

The regulations must be consistent with the objects stated in subsections (1) to (3).

(7) Without limiting subsection 46(2) of the Acts Interpretation Act 1901, the regulations made for the purposes of this Division may specify different rules for different classes of circumstances.

Subdivision 974-B - Debt interests

Table of sections

974-15 Meaning of debt interest

974-20 The test for a debt interest

974-25 Exceptions to the debt test

974-30 Providing a financial benefit

974-35 Valuation of financial benefit - general rules

974-40 Valuation of financial benefits - rights and options to terminate early

974-45 Valuation of financial benefits - convertible interests

974-50 Valuation of financial benefits - value in present value terms

974-55 The debt interest and its issue

974-60 Debt interest arising out of obligations owed by a number of entities

974-65 Commissioner's power

974-15 Meaning of debt interest

Single scheme giving rise to debt interest

(1) A *scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity.

Note 1: A debt interest can also arise under subsection (2) (related schemes) or section 974-65 (Commissioner's discretion).

Note 2: Section 974-55 defines various aspects of the debt interest that arises.

Related schemes giving rise to debt interest

(2) Two or more *related schemes (the constituent schemes ) together give rise to a debt interest in an entity if:

(a) the entity enters into, participates in or causes another entity to enter into or participate in the constituent schemes; and

(b) a scheme with the combined effect or operation of the constituent schemes (the notional scheme ) would satisfy the debt test in subsection 974-20(1) in relation to the entity if the notional scheme came into existence when the last of the constituent schemes came into existence; and

(c) it is reasonable to conclude that the entity intended, or knew that a party to the scheme or one of the schemes intended, the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of a debt interest.

This is so whether or not the constituent schemes come into existence at the same time and even if none of the constituent schemes would individually give rise to that or any other *debt interest.

Note: Section 974-105 explains the effect, for tax purposes, of actions taken under the schemes.

(3) Subsection (2) does not apply if each of the *schemes individually gives rise to a *debt interest in the entity.

(4) Two or more *related schemes do not give rise to a debt interest in an entity under subsection (2) if the Commissioner determines that it would be unreasonable to apply that subsection to those schemes.

(5) Without limiting subsection 974-10(5), the Commissioner must, in exercising the power to make a determination under subsection (4), have regard to the following:

(a) the purpose of the *schemes (considered both individually and in combination);

(b) the effects of the schemes (considered both individually and in combination);

(d) whether the schemes (when considered either individually or in combination) provide the basis for, or underpin, an interest issued to investors with the expectation that the interest can be assigned to other investors;

(e) whether the schemes (when considered either individually or in combination) comprise a set of rights and obligations issued to investors with the expectation that it can be assigned to other investors;

(f) any other relevant circumstances.

(6) If:

(a) 2 or more *related schemes give rise to a *debt interest in an entity; and

(b) one or more of those schemes (the hedging scheme or schemes ) are schemes for hedging or managing financial risk; and

(c) the other scheme or schemes give rise to a debt interest in the entity even if the hedging scheme or schemes are disregarded;

the debt interest that arises from the schemes is taken, for the purposes of Division 820 (the thin capitalisation rules), not to include the hedging scheme or schemes.

Note: This means that in these circumstances the losses associated with the hedging scheme or schemes are not debt deductions under section 820-40.

974-20 The test for a debt interest

Satisfying the debt test

(1) 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.

The scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company).

Note: Section 974-30 tells you when a financial benefit is taken to be provided to an entity.

(2) The value provided is:

(a) the value of the *financial benefit to be provided under the *scheme by the entity or a *connected entity if there is only one; or

(b) the sum of the values of all the financial benefits provided or to be provided under the scheme by the entity or a connected entity of the entity if there are 2 or more.

Note: Section 974-35 tells you how to value financial benefits.

(3) The value received is:

(a) the value of the *financial benefit received, or to be received, under the *scheme by the entity or a *connected entity of the entity if there is only one; or

(b) the sum of the values of all the financial benefits received, or to be received, under the scheme by the entity or a connected entity if there are 2 or more.

(4) For the purposes of paragraph (1)(b) and subsections (2) and (3):

(a) a *financial benefit to be provided under the *scheme by the entity or a *connected entity is taken into account only if it is one that the entity or connected entity has an *effectively non-contingent obligation to provide; and

(b) a financial benefit to be received under the scheme by the entity or a connected entity is taken into account only if it is one that another entity has an effectively non-contingent obligation to provide.

Multiple financial benefits

(5) Paragraphs (1)(b) and (c) apply to 2 or more *financial benefits whether they are provided at the same time or over a period of time.

Regulations

(6) The regulations:

(a) may specify circumstances in which paragraph (1)(d) is satisfied or not satisfied; and

(b) may otherwise specify rules to be applied in determining whether or not paragraph (1)(d) is satisfied.

974-25 Exceptions to the debt test

Short term schemes

(1) A *scheme does not satisfy the debt test in subsection 974-20(1) in relation to an entity if:

(a) at least a substantial part of a *financial benefit mentioned in that subsection does not consist of either of the following or a combination of either of the following:

(i) a liquid or monetary asset;

(ii) an amount of money; and

(b) the scheme requires the financial benefit mentioned in paragraph 974-20(1)(c) to be provided within a period of no more than 100 days of the receipt of the first financial benefit mentioned in paragraph 974-20(1)(b); and

(i) is in fact provided within that period; or

(ii) is not provided within that period because the entity required to provide the benefit neglects to provide the benefit within that period (although willing to do so); or

(iii) is not provided within that period because the entity required to provide the benefit is unable to provide the benefit within that period (although willing to do so); and

(d) the scheme is not one of a number of *related schemes that together are taken to give rise to a *debt interest under subsection 974-15(2).

Regulations

(2) The regulations may make provision in relation to the application or operation of subsection (1). Without limiting this, the regulations may:

(a) specify what constitutes a substantial part of a *financial benefit for the purposes of paragraph (1)(a); or

(b) specify a period to be substituted for the period referred to in paragraph (1)(b).

974-30 Providing a financial benefit

Issue of equity interest

(1) The following do not constitute the provision of a *financial benefit by an entity or a *connected entity of the entity:

(a) the issue of an *equity interest in the entity or a connected entity of the entity; or

(b) an amount that is to be applied in respect of the issue of an equity interest in the entity or a connected entity of the entity.

Providing a financial benefit to an entity

(2) A *financial benefit is taken to be provided to an entity if it is provided:

(a) to the entity; or

(b) on the entity's behalf; or

Obligation to provide future financial benefit

(3) For the avoidance of doubt, if you have a present obligation to provide a *financial benefit to an entity at some time in the future:

(a) the financial benefit is taken to be a financial benefit to be provided in the future; and

(b) the obligation to provide the financial benefit is taken not to be a financial benefit being provided at the present.

974-35 Valuation of financial benefits - general rules

Value in nominal terms or present value terms

(1) For the purposes of this Subdivision:

(a) the value of a *financial benefit received or provided under a *scheme is its value calculated:

(i) in nominal terms if the performance period (see subsection (3)) must end no later than 10 years after the interest arising from the scheme is issued; or

(ii) in present value terms (see section 974-50) if the performance period must or may end more than 10 years after the interest arising from the scheme is issued; and

(b) the regulations may make provisions relating to the valuation of a financial benefit.

Assume scheme runs its full term

(2) The value of a *financial benefit received or provided under a *scheme is calculated assuming that the interest arising from the scheme will continue to be held for the rest of its life.

Note 1: Section 974-40 makes specific provision for cases in which there is a right or option to terminate the interest early.

Note 2: Section 974-45 makes specific provision for cases involving convertible interests.

Performance period

(3) The performance period is the period within which, under the terms on which the interest is issued, the *effectively non-contingent obligations of the issuer, and any *connected entity of the issuer, to provide a *financial benefit in relation to the interest have to be met.

(4) An obligation is treated as having to be met within 10 years after the interest is issued if:

(a) the issuer; or

(b) the *connected entity of the issuer;

has an *effectively non-contingent obligation to terminate the interest within that 10 year period even if the terms on which the interest is issued formally allow the obligation to continue after the end of that 10 year period.

Benefit dependent on variable factor

(5) If:

(a) a *financial benefit received or provided in respect of an interest depends on a factor that may vary over time (such as a variable interest rate); and

(b) that factor is one commonly used in commercial arrangements; and

(c) it would be unreasonable to expect any of the parties to the *scheme to know, or to anticipate accurately, the future value of that factor; and

(d) that factor has a particular value (the starting value ) when the scheme is entered into;

the value of the financial benefit is calculated assuming that the factor's value will retain the starting value for the whole of the life of the scheme.

Note: For example, the value of a return based on a floating interest rate is calculated on the basis that the interest rate remains the interest rate that is applicable when the scheme is entered into.

Scheme wholly in foreign currency etc.

(6) If all the *financial benefits provided and received under a *scheme are denominated in a particular foreign currency or in terms of quantities of a particular commodity or other unit of account, they are not to be converted into Australian currency for the purpose of comparing their relative values for the purposes of this Subdivision.

974-40 Valuation of financial benefits - rights and options to terminate early

(1) This section deals with the situation in which a party to a *scheme has a right or option to terminate the scheme early (whether by discharging an obligation early, converting the interest arising from the scheme into another interest or otherwise).

Note 1: An example of terminating a scheme early by discharging an obligation early is terminating a loan by discharging the obligation to repay the principal (and any outstanding interest) early.

Note 2: In certain circumstances, conversion of an interest into another interest can terminate its life (see section 974-45).

(2) The existence of the right or option is to be disregarded in working out the length of the life of the interest arising from the *scheme for the purposes of this Subdivision if the party does not have an *effectively non-contingent obligation to exercise the right or option.

(3) If the party does have an *effectively non-contingent obligation to exercise the right or option, the life of the interest ends at the earliest time at which the party will have to exercise the right or option.

(4) This section does not limit subsection 974-35(2).

974-45 Valuation of financial benefits - convertible interests

(1) This section deals with the situation in which a *scheme gives rise to an *interest that will or may convert into an *equity interest in a company.

(2) The life of the interest ends no later than the time when it converts into that *equity interest.

(3) The possibility of the conversion is to be disregarded in working out the length of the life of the interest arising from the *scheme for the purposes of section 974-35 if it is uncertain:

(a) whether the interest will ever convert; or

(b) when the interest will convert.

Note: Section 974-40 deals with the situation in which a party to the scheme may exercise a right or option to convert the interest.

(4) This section does not limit subsection 974-35(2).

974-50 Valuation of financial benefits - value in present value terms

(1) Subject to the regulations made for the purposes of subsection (5), the value in present value terms of a *financial benefit to be provided or received in respect of an interest (the test interest ) is calculated under subsection (4).

(2) If you need to calculate the values in present value terms of a number of *financial benefits, the value of each financial benefit is to be calculated separately.

(3) The value of a *financial benefit is to be calculated assuming that all amounts to be paid by an entity in respect of the test interest are paid at the earliest time when the entity becomes liable to pay them.

(4) The value of a *financial benefit in present value terms is:

Amount or value of financial benefit in nominal terms / ([1 + Adjusted benchmark rate of return]^n)

where:

adjusted benchmark rate of return is 75% of the *benchmark rate of return on the test interest.

n is the number of years in the period starting on the day on which the test interest is issued and ending on the day on which the *financial benefit is to be provided. If the period includes a part of a year, that part is to be expressed as the fraction:

(Number of days in that period / Number of days in the year)

year means a period of 12 calendar months.

(5) The regulations may provide for the method of calculating the value in present value terms of a *financial benefit.

(6) Without limiting subsection (5), the regulations may:

(a) provide for an entirely different method of calculating the present value of the *financial benefit; or

(b) specify the adjusted *benchmark rate of return; or

(d) specify rules for determining whether a *debt interest is an *ordinary debt interest.

974-55 The debt interest and its issue

(1) If a *scheme, or 2 or more *related schemes, give rise to a *debt interest in an entity, the debt interest:

(a) consists of the interest that carries the right to receive a *financial benefit that the entity or a *connected entity has an *effectively non-contingent obligation to provide under the scheme or any of the schemes; and

(b) is taken, subject to section 974-60, to be a debt interest in the entity; and

(d) is issued when the entity (or a connected entity of the entity) first receives a *financial benefit under the scheme or any of the schemes; and

(e) is on issue while an effectively non-contingent obligation of the entity (or a connected entity of the entity) to provide a financial benefit under the scheme or any of the schemes remains unfulfilled.

(2) The interest referred to in paragraph (1)(a) may take the form of a proprietary right, a chose in action or any other form.

974-60 Debt interest arising out of obligations owed by a number of entities

(1) This section deals with the situation in which a *scheme, or a number of *related schemes together, would, apart from this section, give rise to the same *debt interest in 2 or more entities.

Note: A scheme may give rise to the same debt interest in 2 or more entities if each of those entities has non-contingent obligations to provide financial benefits under the scheme.

(2) The *debt interest:

(a) is a debt interest in the entity identified under subsection (3) or (4); and

(b) is not a debt interest in the other entity or entities.

(3) The *debt interest is a debt interest in the entity identified using the following method statement:

Method statement

Step 1. Work out, for each of the entities, the total value of the *financial benefits that the entity is under an *effectively non-contingent obligation to provide under the *scheme or schemes: this is the entity's obligation value .

Step 2. The *debt interest is taken to be a debt interest in the entity with the greatest obligation value.

Step 3. If it is not possible to determine which entity has the greatest obligation value (whether because of an equality of, or uncertainty as to, obligation values or otherwise), the *debt interest is taken to be a debt interest in the entity agreed on by all the entities.

Step 4. If the entities do not agree, the interest is taken to be a *debt interest in the entity determined by the Commissioner.

(4) Despite subsection (3), the Commissioner may determine that the *debt interest is a debt interest in the entity specified in the determination.

(5) The Commissioner may make the determination only if satisfied, having regard to the economic substance of the relevant transactions, that the *debt interest is properly considered from a commercial point of view to be an interest in the entity specified in the determination.

974-65 Commissioner's power

(1) Despite subsection 974-20(1) (the debt test), the Commissioner may determine that a *scheme gives rise to a debt interest in an entity if the Commissioner considers that:

(a) the scheme would satisfy paragraphs 974-20(1)(a), (b), (c) and (e); but

(b) instead of satisfying paragraph 974-20(1)(d), the scheme would satisfy all the following subparagraphs:

(i) it is substantially more likely than not that the value of the *financial benefit to be provided by the entity (or a *connected entity of the entity) under the *effectively non-contingent obligation will be at least equal to the substantial part of the value of the financial benefit received or to be received by the entity (or its connected entity) under the scheme;

(ii) it is substantially more likely than not that other financial benefits will be provided by the entity (or its connected entity) to one or more entities under the scheme;

(iii) it is substantially more likely than not that the sum of the values of the financial benefits mentioned in subparagraphs (i) and (ii) will be at least equal to the value of the financial benefit received by the entity (or its connected entity) under the scheme.

(2) In making the determination, the Commissioner must have regard to the following:

(a) the difference between the value of the *financial benefit received and the value of the financial benefit to be provided under the *effectively non-contingent obligation;

(b) the degree of likelihood of other financial benefits being provided under the *scheme;

(c) the degree of likelihood of the sum of the value of the financial benefits mentioned in subparagraphs (1)(b)(i) and (ii) being equal to or greater than the value of the financial benefit received under the scheme;

(d) the particular circumstances surrounding the scheme (including circumstances of the parties to the scheme and their purposes for entering into the scheme).

(3) If the Commissioner determines under this section that a *scheme gives rise to a *debt interest, the scheme has that effect for all purposes of this Division.

Subdivision 974-C - Equity interests in companies

Table of sections

974-70 Meaning of equity interest in a company

974-75 The test for an equity interest

974-80 Equity interest arising from arrangement funding return through connected entities

974-85 Right or return contingent on economic performance

974-90 Right or return at discretion of company or connected entity

974-95 The equity interest

974-70 Meaning of equity interest in a company

Scheme giving rise to equity interest

(1) A *scheme gives rise to an equity interest in a company if, when the scheme comes into existence:

(a) the scheme satisfies the equity test in subsection 974-75(1) in relation to the company because of the existence of an interest; and

(b) the interest is not characterised as, and does not form part of a larger interest that is characterised as, a *debt interest in the company, or a *connected entity of the company, under Subdivision 974-B.

Note 1: An equity interest can also arise under subsection (2) if a notional scheme with the combined effect of a number of related schemes would give rise to an equity interest under this subsection. To do this, the notional scheme would need to satisfy paragraph (b). This means that the related schemes will not give rise to an equity interest if the notional scheme would be characterised as (or form part of a larger interest that would be characterised as) a debt interest in the company or a connected entity.

Note 2: An equity interest can also arise under section 974-80 (arrangements for funding return through connected entities).

Note 3: Section 974-95 defines various aspects of the equity interest that arises.

Related schemes giving rise to equity interest

(2) Two or more *related schemes (the constituent schemes ) are taken together to give rise to an equity interest in a company if:

(a) the company enters into, participates in or causes another entity to enter into or participate in the constituent schemes; and

(b) a scheme with the combined effect or operation of the constituent schemes (the notional scheme ) would give rise to an *equity interest in the company under subsection (1) if the notional scheme came into existence when the last of the constituent schemes came into existence; and

(c) it is reasonable to conclude that the company intended, or knew that a party to the scheme or one of the schemes intended, the combined economic effects of the constituent schemes to be the same as, or similar to, the economic effects of an equity interest.

This is so whether or not the constituent schemes come into existence at the same time and even if none of the constituent schemes would individually give rise to that or any other equity interest.

Note: Section 974-105 explains the effect, for tax purposes, of actions taken under the schemes.

(3) Subsection (2) does not apply if each of the constituent *schemes individually gives rise to an *equity interest in the company.

(4) Two or more related *schemes do not give rise to an *equity interest in a company under subsection (2) if the Commissioner determines that it would be unreasonable to apply that subsection to those schemes.

(5) Without limiting subsection 974-10(5), the Commissioner must, in exercising the power to make a determination under subsection (4), have regard to the following:

(a) the purpose of the *schemes (considered both individually and in combination);

(b) the effects of the schemes (considered both individually and in combination);

(f) any other relevant circumstances.

974-75 The test for an equity interest

Basic test for equity interest

(1) A *scheme satisfies the equity test in this subsection in relation to a company if it gives rise to an interest set out in the following table:

Equity interests
Item	Interest
1	An interest in the company as a member or stockholder of the company.
2	An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is in substance or effect contingent on the economic performance (whether past, current or future) of: (a) the company; or (b) a part of the company's activities; or (c) a connected entity of the company or a part of the activities of a connected entity of the company. The return may be a return of an amount invested in the interest.
3	An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is at the discretion of: (a) the company; or (b) a *connected entity of the company. The return may be a return of an amount invested in the interest.
4	An interest issued by the company that: (a) gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or a connected entity of the company; or (b) is an interest that will, or may, convert into an equity interest in the company or a connected entity of the company.

This subsection has effect subject to subsection (2) (requirement for financing arrangement).

Note: Section 974-90 allows regulations to be made clarifying when a right or return is taken to be at discretion of a company or connected entity.

Financing arrangement

(2) A *scheme that would otherwise give rise to an *equity interest in a company because of an item in the table in subsection (1) (other than item 1) does not give rise to an equity interest in the company unless the scheme is a *financing arrangement for the company.

Form interest may take

(3) The interest referred to in item 2, 3 or 4 in the table in subsection (1) may take the form of a proprietary right, a chose in action or any other form.

Exception for certain at call loans - until 31 December 2002

(4) If:

(a) a *financing arrangement takes the form of a loan to a company by a *connected entity; and

(b) the loan does not have a fixed term; and

(d) the arrangement was entered into on or after 21 February 2001;

the arrangement does not give rise to an equity interest in the company. Instead, the arrangement is taken, despite anything in Subdivision 974-B, to give rise to a debt interest in the company. This subsection ceases to have effect on 1 January 2003.

974-80 Equity interest arising from arrangement funding return through connected entities

(1) This section deals with the situation in which:

(a) an interest carries a right to a variable or fixed return from a company; and

(b) the interest is held by a *connected entity of the company; and

(ca) the *scheme that gives rise to the interest is a *financing arrangement for the company; and

(d) there is a scheme, or a series of schemes, designed to operate so that the return to the connected entity is to be used to fund (directly or indirectly) a return to another person (the ultimate recipient ).

(2) The interest is an equity interest in the company if:

(a) the amount of the return to the ultimate recipient is in substance or effect *contingent on the economic performance (whether past, current or future) of:

(i) the company; or

(ii) a part of the company's activities; or

(iii) a *connected entity of the company or a part of the activities of a connected entity of the company; or

(b) either the right itself, or the amount of the return to the ultimate recipient, is at the discretion of:

(i) the company; or

(ii) a connected entity of the company; or

(c) the interest in respect of which the return to the ultimate recipient is made or another interest that arises from the scheme, or any of the schemes, referred to in paragraph (1)(d):

(i) gives the ultimate recipient (or a connected entity of the ultimate recipient) a right to be issued with an *equity interest in the company or a connected entity of the company; or

(ii) is an *interest that will, or may, convert into an equity interest in the company or a connected entity of the company;

and if the interest does not form part of a larger interest that is characterised as a *debt interest in the entity in which it is held, or a *connected entity, under Subdivision 974-B. The return may be a return of an amount invested in the interest.

Note 1: Section 974-90 allows regulations to be made clarifying when a right or return is taken to be at the discretion of a company or connected entity.

Note 2: Paragraphs (a), (b) and (c) parallel items 2, 3 and 4 of the table in subsection 974-75(1).

Example: Company A, Company B1, Company B2 and Company B3 are connected entities.

Company B1 operates Trust Fund C. An interest in Trust Fund C is issued to person H and the return on that interest is contingent on the economic performance of Company A.

Trust Fund C lends the money paid by H for the purchase of the interest to Company B1 which lends the money to Company B2 which lends the money to Company B3 which lends the money to Company A.

Under the arrangements under which the interest is issued and the loans made, payments of interest by Company A on the loan that Company B3 makes to Company A are intended to pass back through Company B2 and Company B1 to fund the return on H's interest in Trust Fund C.

Under subsection (2), Company B3 will have an equity interest in Company A. If the return to Company B3 were itself contingent on Company A's performance, Company B3's interest would be an equity interest in Company A under item 2 of the table in subsection 974-75(1) (and not under subsection (2) of this section).

Company B2 has an equity interest in Company B3 and Company B1 has an equity interest in Company B2. This is because the returns they get are intended to fund the return on H's interest in Trust Fund C and that return is contingent on the economic performance of Company A (which is related to both Company B3 and Company B2).

(3) The interest referred to in paragraph (1)(a) or (2)(c) may take the form of a proprietary right, a chose in action or any other form.

974-85 Right or return contingent on economic performance

(1) A right, or the amount of a return, is not contingent on the economic performance of an entity, or a part of the entity's activities, merely because the right or return is contingent on:

(a) the ability or willingness of an entity to meet the obligation to satisfy the right to the return; or

(b) the receipts or turnover of the entity or the turnover generated by those activities.

(2) The regulations may specify circumstances in which a right or return is to be taken to be contingent, or not contingent, on the economic performance of an entity or a part of an entity's activities.

(3) The regulations may provide that paragraph (1)(b) does not apply in the circumstances specified in the regulations.

(4) The regulations may provide that an interest that:

(a) is covered by item 2 in the table in subsection 974-75(1) or paragraph 974-80(2)(a); and

(b) arises in the circumstances specified in the regulations;

is not an equity interest because of:

(c) the limited extent to which the right or return that the interest carries is *contingent on the economic performance of an entity or a part of the entity's activities; or

(d) the practical insignificance of the right or return that the interest carries being contingent on that performance.

974-90 Right or return at discretion of company or connected entity

The regulations may specify circumstances in which a right, or the amount of a return, is to be taken to be at the discretion of a company or a *connected entity of the company.

974-95 The equity interest

(1) If a *scheme gives rise to an *equity interest in a company because of an item of the table in subsection 974-75(1), the equity interest consists of the interest referred to in that item.

(2) If 2 or more *related schemes give rise to an *equity interest in a company because of an item of the table in subsection 974-75(1), the equity interest consists of the combination of interests under the schemes that satisfy the requirements of that item.

(3) Subsection 974-80(2) also provides that certain interests are *equity interests in a company.

(4) If the returns on a *non-share equity interest in a company are payable to 2 or more entities:

(a) each entity is taken to be the holder of a non-share equity interest in the company; and

(b) each entity's non-share equity interest consists of the interests that:

(i) constitute the non-share equity interest; and

(ii) are held by that entity.

(5) The company in which an *equity interest exists is taken to be the issuer of the interest.

Subdivision 974-D - Common provisions

Table of sections

974-100 Treatment of convertible and converting interests

974-105 Effect of action taken in relation to interest arising from related schemes

974-110 Effect of material change

974-100 Treatment of convertible and converting interests

(1) If a *debt interest is an *interest that will or may convert into an *equity interest, the conversion is taken, for the purposes of this Division to give rise to a new interest (and is not treated merely as a continuation of the debt interest).

(2) If an *equity interest is an *interest that will or may convert into a *debt interest, the conversion is taken, for the purposes of this Division to give rise to a new interest (and is not treated merely as a continuation of the equity interest).

974-105 Effect of action taken in relation to interest arising from related schemes

(1) If:

(a) a *scheme, or schemes, give rise to a *debt interest in an entity or an *equity interest in a company; and

(b) the entity or company pays a return, or undertakes any other transaction, in respect of any of the following (the component element ):

(i) the scheme; or

(ii) a part of the scheme; or

(iii) one of those schemes; or

(iv) a part of one of those schemes;

then, for the purposes of the provisions that subsection (2) covers, the return is taken to be paid, or the transaction to have been undertaken, in respect of the debt interest or equity interest and not in respect of the component element.

Example: Company A issues a convertible note to Company B. Company C, a connected entity of Company B, provides a binding collateral undertaking to Company A that Company B will exercise the option to convert the note into shares in Company A. The convertible note and the undertaking are related schemes that may give rise to an equity interest in Company A if their combined effect satisfies section 974-20. If so, the returns on the note are taken to be returns in respect of the equity interest.

(2) This subsection covers:

(a) the provisions of this Division (other than this section); and

(b) any other provision of this Act whose operation depends on an expression whose meaning is given by this Division.

974-110 Effect of material change

Change to existing scheme

(1) If:

(a) a *scheme or schemes give rise to a *debt interest (or an *equity interest) in a company; and

(b) the scheme, or one or more of the schemes, are subsequently changed; and

(c) the scheme or schemes as they exist immediately after the change would give rise to an equity interest (or a debt interest) in the company if they came into existence when the change occurred;

this Division applies after the change as if the scheme or schemes as they exist immediately after the change came into existence when the change occurred.

Note 1: This will mean that the characterisation of the interest will change at that time.

Note 2: This section can apply to an interest a number of times so that, for example, an interest that is equity when issued may change to debt because of one subsequent change and then back to equity because of a later change.

Note 3: There will be an adjustment to the company's non-share capital account when the change occurs (see subsections 164-15(2) and 164-20(4)).

Entering into a new related scheme

(2) If:

(a) a *scheme or schemes give rise to a *debt interest (or an *equity interest) in a company; and

(b) the company subsequently enters into, participates in or causes another entity to enter into or participate in a new *related scheme; and

(i) the new related scheme; and

(ii) any other related scheme that the entity (or company) enters into, participates in or causes another entity to enter into or participate in before the new related scheme is entered into;

would give rise to an equity interest (or a debt interest) in the company if they all came into existence when the new related scheme is entered into;

this Division applies after the new related scheme is entered into as if all the schemes referred to in paragraph (c) had come into existence when the new related scheme is entered into.

Note 1: This will mean that the characterisation of the interest will change at that time.

Note 3: There will be an adjustment to the company's non-share capital account when the change occurs (see subsections 164-15(2) and 164-20(4)).

All prior changes to be taken into account

(3) In applying paragraphs (1)(c) and (2)(c) to the *scheme or schemes, take into account:

(a) all changes to the scheme or schemes that occur before the change or before the new related scheme is entered into; and

(b) all *related schemes entered into before the change or before the new related scheme is entered into; and

(c) all changes to related schemes referred to in paragraph (b) that occur before the change or before the new related scheme is entered into.

974-112 Determinations by Commissioner

Determinations covered by this section

(1) This section covers a determination by the Commissioner under any of the following provisions:

(a) subsection 974-15(4);

(b) subsection 974-60(3), (4) or (5);

(d) subsection 974-70(4);

(e) subsection 974-150(2).

Determination on own initiative or on application

(2) The Commissioner may make a determination covered by this section:

(a) on his or her own initiative; or

(b) on an application made under subsection (3).

Application for determination

(3) An entity may apply to the Commissioner for a determination covered by this section in relation to:

(a) an interest of which the entity is the issuer; or

(b) an interest of which the entity would be the issuer:

(i) if the determination were made; or

(ii) if the determination were not made.

Note: Paragraph (b) may apply, for example, if the effect of the determination applied for would be to allow, or to prevent, a number of related schemes giving rise to a debt interest or an equity interest.

(4) The application:

(a) must be in writing; and

(b) must set out the grounds on which the applicant thinks the determination should be made; and

Review of determinations

(5) A taxpayer who is dissatisfied with a determination covered by this section may object against the determination in the manner set out in Part IVC of the Taxation Administration Act 1953.

Subdivision 974-E - Non-share distributions by a company

Table of sections

974-115 Meaning of non-share distribution

974-120 Meaning of non-share dividend

974-125 Meaning of non-share capital return

974-115 Meaning of non-share distribution

A company makes a non-share distribution to you if:

(a) you hold a *non-share equity interest in the company; and

(b) the company:

(i) distributes money to you; or

(ii) distributes other property to you; or

(iii) credits an amount to you;

as the holder of that interest.

974-120 Meaning of non-share dividend

(1) Subject to subsection (2), all *non-share distributions are non-share dividends .

(2) A *non-share distribution is not a non-share dividend to the extent to which the company debits the distribution against:

(a) the company's *non-share capital account; or

(b) the company's share capital account.

974-125 Meaning of non-share capital return

A non-share capital return is a *non-share distribution to the extent to which it is not a *non-share dividend.

Subdivision 974-F - Related concepts

Table of sections

974-130 Financing arrangement

974-135 Effectively non-contingent obligation

974-140 Ordinary debt interest

974-145 Benchmark rate of return

974-150 Schemes

974-155 Related schemes

974-160 Financial benefit

974-165 Convertible and converting interests

974-130 Financing arrangement

(1) 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).

(2) The following are examples of *schemes that are generally entered into or undertaken to raise finance:

(a) a bill of exchange;

(b) income securities;

Note: Paragraph (a) is likely to be relevant for debt interests, paragraph (b) for equity interests and paragraph (c) for both.

(3) The following are examples of *schemes that are generally not entered into or undertaken to raise finance:

(a) a derivative that is used solely for managing financial risk;

(b) a contract for personal services entered into in the ordinary course of a business.

Note: These may be relevant for both debt interests and equity interests.

(4) For the purposes of subsection (1), the following *schemes are taken not to be entered into or undertaken to raise finance:

(a) a lease or bailment that satisfies all of the following:

(i) the property leased or bailed is not property to which Division 16D of Part III of the Income Tax Assessment Act 1936 (arrangements relating to the use of property) applies;

(ii) the lease or bailment is not a relevant agreement for the purposes of section 128AC of that Act (deemed interest in respect of hire-purchase and certain other arrangements);

(iii) the lease or bailment is not an arrangement to which Division 42A in Schedule 2E to that Act (leasing of luxury cars) applies;

(iv) the lease or bailment is not an arrangement to which Division 240 of Part 3-10 of this Act (hire-purchase arrangements treated as a sale and loan) applies;

(v) the lessee or bailee, or a *connected entity of the lessee or bailee, is not to, and does not have an obligation (whether contingent or not) or a right to, acquire the leased or bailed property;

(b) a securities lending arrangement under section 26BC of the Income Tax Assessment Act 1936;

(d) a scheme for the payment of royalties (within the meaning of the Income Tax Assessment Act 1936) other than:

(i) a qualifying arrangement for the purposes of Division 16D of Part III of the Income Tax Assessment Act 1936; or

(ii) a relevant agreement for the purposes of section 128AC of that Act.

(5) The regulations may:

(a) specify that particular *schemes are not financing arrangements ; and

(b) specify circumstances in which a scheme will not be a financing arrangement .

974-135 Effectively non-contingent obligation

(1) There is an effectively non-contingent obligation to take an action under a *scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation (see subsections (3), (4) and (6)) to take that action.

(2) Without limiting subsection (1), that subsection applies to:

(a) providing a *financial benefit under the *scheme; or

(b) terminating the scheme.

(3) An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a *connected entity of that entity), other than the ability or willingness of that entity or connected entity to meet the obligation.

(4) The existence of the right of the holder of an *interest that will or may convert into an *equity interest in a company to convert the interest does not of itself make the issuer's obligation to repay the investment not non-contingent.

(5) An obligation to redeem a preference share is not contingent merely because there is a legislative requirement for the redemption amount to be met out of profits or a fresh issue of *equity interests.

(6) In determining whether there is in substance or effect a non-contingent obligation to take the action, have regard to the artificiality, or the contrived nature, of any contingency on which the obligation to take the action depends.

Note: The artificiality, or the contrived nature, of a contingency would tend to indicate that there is, in substance or effect, a non-contingent obligation to take that action.

(7) An obligation of yours is not effectively non-contingent merely because you will suffer some detrimental practical or commercial consequences if you do not fulfil the obligation.

Note: For example, a contingent obligation to make payments in respect of an income security issued by an approved deposit-taking institution (ADI) is not effectively non-contingent merely because of the detrimental effect non-payment would have on the ADI's business.

(8) The regulations may make further provisions relating to the following:

(a) what constitutes a non-contingent obligation;

(b) what does not constitute a non-contingent obligation;

(d) what does not constitute an effectively non-contingent obligation.

974-140 Ordinary debt interest

(1) A *debt interest arising from a scheme is an ordinary debt interest if none of the obligations under the scheme is in substance or effect *contingent on the economic performance of:

(a) the issuer of the interest; or

(b) a *connected entity; or

(2) The regulations may specify rules for determining whether a *debt interest is an *ordinary debt interest.

974-145 Benchmark rate of return

(1) The benchmark rate of return for an interest (the test interest) in an entity is the annually compounded internal rate of return on an *ordinary debt interest that:

(a) is issued, immediately before the test interest is issued, by the entity, or an equivalent entity, to an entity that is not a *connected entity; and

(b) has a comparable maturity date; and

(d) is issued in the same market; and

(e) has the same credit status; and

(f) has the same degree of subordination to debts owed to the ordinary creditors of the issuer.

(2) If there is no interest that satisfies subsection (1), the benchmark rate of return for the test interest is the annually compounded internal rate of return on an interest that is closest to the test interest in the respects referred to in that subsection (adjusted appropriately to take account of the differences between that interest and the test interest).

(3) The regulations may:

(a) specify the meaning to be given to an expression used in this section; or

(b) provide for a different method of determining the *benchmark rate of return.

974-150 Schemes

(1) Scheme has the meaning given in section 995-1.

(2) The Commissioner:

(a) may determine that what would otherwise be a single *scheme is to be treated for the purposes of this Division as 2 or more separate schemes; and

(b) may determine that the schemes are to be taken for the purposes of this Division to not be *related schemes.

(3) Without limiting subsection 974-10(5), the Commissioner must, in exercising the power to make a determination under subsection (2), have regard to the following:

(a) the purpose of the *scheme (considered both as a whole and in terms of its individual components);

(b) the effects of the scheme and each of its components (considered both as a whole and in terms of its individual components);

(c) the rights and obligations of the parties to the scheme (considered both as a whole and in relation to its individual components);

(d) whether the scheme (when considered as a whole or in terms of its individual components) provides the basis for, or underpins, an interest issued to investors with the expectation that the interest can be assigned to other investors;

(e) whether the scheme (when considered as a whole or in terms of its individual components) comprises a set of rights and obligations issued to investors with the expectation that it can be assigned to other investors;

(f) any other relevant circumstances.

(4) The regulations:

(a) may provide that, in the circumstances specified in the regulations, what would otherwise be a single *scheme is to be treated for the purposes of this Division as 2 or more separate schemes; and

(b) may provide that the schemes are to be taken for the purposes of this Division to not be *related schemes.

974-155 Related schemes

(1) Subject to subsection (3), 2 *schemes are related to one another if they are related to one another in any way.

(2) Without limiting subsection (1), 2 *schemes are related to each other if:

(a) the schemes are based on stapled instruments; or

(b) one of the schemes would, from a commercial point of view, be unlikely to be entered into unless the other scheme was entered into; or

(d) one scheme complements or supplements the other; or

(e) there is another scheme to which both the schemes are related because of a previous application or applications of this subsection.

(3) Two *schemes are not related to one another merely because:

(a) one refers to the other; or

(b) they have a common party.

(4) The regulations may specify circumstances in which 2 *schemes:

(a) are taken to be related to one another; or

(b) are taken not to be related to one another.

974-160 Financial benefit

(1) In this Act:

financial benefit :

(a) means anything of economic value; and

(b) includes property and services; and

even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.

(2) In applying subsection (1), benefits and obligations are to be looked at separately and not set off against each other.

(3) The regulations may provide that a thing specified in the regulations is a financial benefit for the purposes of this Act.

974-165 Convertible and converting interests

An interest (the first interest ) is an interest that will or may convert into another interest (the second interest ) if:

(a) the first interest, or a part of the first interest, must be or may be converted into the second interest; or

(b) the first interest, or a part of the first interest, must be or may be redeemed, repaid or satisfied by:

(i) the issue or transfer of the second interest (whether to the holder of the first interest or to some other person); or

(ii) the acquisition of the second interest (whether by the holder of the first interest or by some other person); or

(iii) the application in or towards paying-up (in whole or in part) the balance unpaid on the second interest (whether the second interest is to be issued to the holder of the first interest or to some other person); or

(c) the holder of the first interest has, or is to have, a right or option to have allotted or transferred to the holder or to some other person, or for the holder or some other person otherwise to acquire:

(i) the second interest; or

(ii) a right or option to acquire the second interest.

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