(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 1: 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).
Note 2: Subdivision 167-A has special rules for working out rights to dividends and capital distributions in a company whose shares do not all carry the same rights to those matters. Those rules include disregarding debt interests.
(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);
(c) section 974- 65;
(d) subsection 974-70(4);
(e) subsection 974-150(1).
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 13(3) of the Legislation Act 2003 , the regulations made for the purposes of this Division may specify different rules for different classes of circumstances.
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