EXPLANATORY STATEMENT

 

Select Legislative Instruments 2005 No. 102

 

Issued by authority of the Minister for Revenue
and Assistant Treasurer

Income Tax Assessment Act 1997

Income Tax Assessment Amendment Regulations 2005 (No. 3)

Subsection 909-1(1) of the Income Tax Assessment Act 1997 (the Act) provides that the Governor-General may make regulations prescribing matters required or permitted by the Act to be prescribed, or necessary or convenient to be prescribed for carrying out or giving effect to the Act.

Paragraph 974-135(8)(a) of the Act provides that the regulations may make further provisions relating to what constitutes a “non-contingent obligation” for the purposes of section 974-135 of the Act.  Subsection 974-10(6) provides that regulations made under a provision of Division 974 of the Act may clarify the meaning of words and phrases, and give guidance on the detailed operation of particular provisions.  Subsection 974-10(7) provides that the regulations may specify different rules for different classes of circumstances. 

The objects of Division 974 of the Act, which deals with debt and equity interests, are outlined in subsections 974-10(1) to (3).  The objects include establishing a test for determining whether a scheme (or the combined operation of a number of schemes) gives rise to a debt interest or an equity interest.  They also ensure that the test operates on the basis of the economic substance of the rights and obligations arising under a scheme or schemes rather than merely on the basis of their legal form.

The Regulations amend the Income Tax Assessment Regulations 1997 to clarify, for paragraph 974-135(8)(a) of the Act, that an obligation to redeem or buy back a preference share is not a contingent obligation merely because it is subject to certain legislative conditions aimed at protecting creditors’ interests.  The legislative conditions are that the redemption or buy back must not prejudice the company’s ability to pay its creditors, or cause the company’s remaining assets to become insufficient to pay any debts for which provision for payment has not otherwise been made.  The Regulations ensure that these legislative conditions do not preclude redeemable preference shares from being debt interests.  Whether individual instruments are debt interests or equity interests will continue to depend on the application of Division 974 to the particular circumstances.  For the purposes of the income tax law, returns on debt interests may be deductible but are not frankable.

The Treasurer announced the Government’s intention to clarify this aspect of the debt/equity provisions in Press Release 102 of 4 December 2003.

Details of the Regulations are set out in the Attachment.

Schedule 1 to the Regulations is generally taken to have commenced on 1 July 2001, which is also the commencement date of Division 974 of the Act.  Schedule 2, which contains shifting amendments only, commences on the day after the Regulations are registered on the Federal Register of Legislative Instruments.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ATTACHMENT

Details of the Income Tax Assessment Amendment Regulations 2005 (No. 3)

Regulation 1

Regulation 1 sets out the name of the Regulations as the Income Tax Assessment Amendment Regulations 2005 (No. 3).

Regulation 2

Regulation 2 provides that regulations 1 to 4 and Schedule 1 are taken to have commenced on 1 July 2001.  Also, it provides that Schedule 2 commences on the day after the Regulations are registered on the Federal Register of Legislative Instruments.

Regulation 3

Regulation 3 provides that Schedules 1 and 2 amend the Income Tax Assessment Regulations 1997 (the Principal Regulations).

Regulation 4

Regulation 4 provides that the amendments in Schedule 1 do not apply to the extent that, in the period commencing on 1 July 2001 and ending at the end of the day when the Regulations are registered, a person other than the Commonwealth (or an authority of the Commonwealth) would be disadvantaged or liabilities would be imposed on the person.

Schedule 1

Item 1

Item 1 inserts into Part 6 of the Principal Regulations a new Division 974A, headed ‘Debt and equity interests’, and Subdivision 974A-F, headed ‘Related concepts’.

Regulation 974A-135C

The Australian corporations law – and the corporations law of many other jurisdictions – restricts the ability of companies to reduce their share capital, with the aim of protecting creditors’ rights.  In respect of a capital reduction by way of redemption or buy back of preference shares, the following two legislative requirements often apply:

·               the redemption or buy back must be out of profits or the proceeds of a fresh        issue of shares; and

·               more generally, a company must be able to meet creditors’ claims after the           reduction, particularly by having sufficient assets left after the reduction.

In broad terms, a condition for an instrument to satisfy the test for a debt interest under the debt/equity provisions in the income tax law is that the issuer of the instrument has an effectively non-contingent obligation to provide an amount or amounts, the value of which at least equals what has been received by the issuer under the instrument. 

In respect of a redeemable preference share, the legislative requirements described above would mean that the issuer’s obligation to provide an amount by way of redemption is contingent.  This may preclude the preference share from satisfying the test for a debt interest.

However, subsection 974-135(5) of the Act provides that an obligation to redeem a preference share is not contingent merely because of the first legislative requirement described above. 

The effect of regulation 974A-135C is to ensure that the obligation to redeem or buy back a preference share is not contingent merely because of the second legislative requirement described above.

Example A:  Paragraph 257A(a) of the Corporations Act 2001 provides that a company may buy back its own shares only if the buy back does not materially prejudice the company’s ability to pay its creditors.  By virtue of paragraph
974A-135C(a), an obligation to buy back a preference share is not contingent merely because of this legislative requirement.

Example B:  Paragraph 244(b) of the Delaware (United States of America) General Corporation Law provides that a corporation’s capital may be reduced only if the assets of the corporation remaining after the reduction are sufficient to pay any debts for which payment has not otherwise been provided.  By virtue of paragraph
974A-135C(b), an obligation to redeem a preference share is not contingent merely because of this legislative requirement.

Schedule 2

Item 1

Item 1 removes the reference and heading to Division 974A.

Item 2

Item 2 removes the reference and heading to Subdivision 974A-F.

Item 3

Item 3 relocates regulation 974A-135C as regulation 974-135C in Subdivision 974-F.