On 10 October 2016, the Federal Government released an Exposure Draft to amend the debt and equity rules in Division 974 of Income Tax Assessment Act 1997 (ITAA 97) for the purpose of implementing recommendations made by the Board of Taxation in its April 2015 report Review of the Debt and Equity Tax Rules.
Division 974 of the ITAA 97 aims to classify interests under financing schemes as either “debt” or “equity” and ensure that the appropriate taxation treatment is applied to a taxpayer’s entitlement to deductions or franking credits. The purpose of the rules is to ensure that a taxpayer does not achieve a tax outcome different to the economic substance of the financing scheme.
The draft legislation proposes to amend Division 974 by including integrity rules to prevent taxpayers from artificially splitting a single scheme into multiple schemes in order to achieve a favourable tax outcome.
Currently, section 974-155(1) of the ITAA 97 allows for two or more schemes that are ‘related to one another in any way’ to be treated as related schemes that when combined, could give rise to either a debt or equity interest. Section 970-80 provides an “equity override” integrity provision. The application of the latter provision has been uncertain and contentious in the context of complex financing schemes. Consistent with the Board of Taxation’s recommendations to address this uncertainty, the Exposure Draft proposes to repeal these provisions and insert new aggregation rules.
The new rules are aimed at ensuring that multiple schemes are treated as an “aggregate scheme” where this accurately reflects the economic substance of the scheme. Under the draft legislation the following factors will be considered in determining whether schemes are to be aggregated (proposed new s 974-155(1)):
- the pricing, terms and conditions of the schemes are linked in a way that would change their classification and tax treatment under Division 974; and
- having regard to the following, it would be concluded that the schemes were designed to operate together to produce their combined economic effect:
- the nature and extent of any involvement by the parties to one of the schemes in any of the other schemes;
- the way the schemes are entered into or carried out;
- any dealing, between any of the parties to any of the schemes, that is not at arm’s length;
- the relationships between any of the parties to any of the schemes;
- normal commercial understandings and practices;
- any other relevant matters.
The closing date for submissions on the draft legislation is Monday, 21 November 2016.
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