ATO Interpretative Decision
ATO ID 2007/52
Income Tax
Redeemable Preference Shares: accumulated dividends forming part of redemption amountFOI status: may be released
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
For the purposes of subsection 974-135(5) of the Income Tax Assessment Act 1997 (ITAA 1997), does the 'redemption amount' in respect of a redeemable preference share include any accumulated but unpaid dividends that the company has an effectively non-contingent obligation to pay on redemption?
Decision
Yes. For the purposes of subsection 974-135(5) of the ITAA 1997, the 'redemption amount' in respect of a redeemable preference share does include accumulated but unpaid dividends that the company has an effectively non-contingent obligation to pay on redemption.
Facts
X Company Pty Ltd enters into a financing arrangement whereby it issues a redeemable preference share (RPS) to investors. Under the terms of issue, X Company Pty Ltd is under an effectively non-contingent obligation to redeem the RPS for its 'redemption amount' after twelve years.
The RPS gives the shareholder a right to an annual fixed dividend entitlement on 30 June of each year over the life of the share provided X Company Pty Ltd has sufficient profits at that time to pay the dividend. Any dividends that are not declared and paid in full will accumulate and become due and payable on redemption, forming part of the 'redemption amount'.
The shares are all fully paid up.
Reasons for Decision
Subsection 974-135(5) of the ITAA 1997 provides that 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. Further, regulation 974-135C of the Income Tax Regulations 1997 provides that an obligation to redeem or buy back a preference share in relation to a company is not a contingent obligation merely because a requirement exists, under a law, to the effect that the redemption or buy back must not prejudice the company's ability to pay its creditors or must not cause the company's remaining assets to become insufficient to pay any of the company's debts.
These provisions have the effect of disregarding a contingency which would otherwise exist.
Under the terms of issue, dividends on the RPS accumulate and the amount of any unpaid dividend entitlement is to be included in the 'redemption amount' payable by X Company Pty Ltd upon redemption of the RPS.
On a plain reading of the provision, there is no basis for restricting 'redemption amount' in subsection 974-135(5) of the ITAA 1997 to only the issue price component of the redemption amount if it is defined to also include any accumulated but unpaid dividends (so that the holder is entitled to a fixed dividend regardless of whether that dividend is declared). Nor is there anything in the extrinsic materials relating to the provision that suggests a different outcome was intended.
In such a case, subsection 974-135(5) of the ITAA 1997 will apply to the whole of the redemption amount (including the accumulated dividends which the issuer has an effectively non-contingent obligation to pay on redemption).
Date of decision: 5 March 2007Year of income: Year ended 30 June 2004 Year ended 30 June 2005 Year ended 30 June 2006 Year ended 30 June 2007 Year ended 30 June 2008
Legislative References:
Income Tax Assessment Act 1997
subsection 974-135(5)
ATO ID 2003/527
Keywords
Debt equity borderline
Debt test
Equity test
Redeemable preference shares
Effectively non-contingent obligation
ISSN: 1445-2782
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).
