The classification of debt and equity for taxation purposes in Australia is about to undergo significant change if the provisions of the New Business Tax System (Debt & Equity) Bill 2001 are enacted.
The Bill classifies financing arrangements on an "in substance" basis, which is a significant departure from the present legal basis of classification.
Basically, a debt interest is an arrangement under which the entity receives a "financial benefit", has an "effectively non-contingent obligation" and the value of the benefit to be provided is at least equal to the value of the benefit received.
In contrast, an equity interest is basically a share in a company, or an interest with a return contingent on the economic performance or payable at the discretion of the company, or an interest convertible into equity, and is not a debt interest.
Under the new measures it is possible for:
- a loan of money to be an equity interest - payments non-deductible and (frankable) dividends; and
- a shareholding to be a debt interest - distributions deductible and (unfrankable) payments.
As a result, the Bill creates greater uncertainty about the tax treatment of many common financial transactions, such as leases and convertible notes, and classification may be different in Australia than in other countries.
The Bill is proposed to take effect from July 1 2001 with limited transitional relief. It is necessary therefore that entities evaluate the classification of existing and proposed financial arrangements. Incorrect classification may result in the denial of deductions, incorrect franking of distributions and payment of withholding tax.
Stephanie Randell and Scott Sanders