Law

Debentures

Interest you receive as the holder of a company bond or debenture is included in your tax return as interest income. Special rules apply if you sell a company bond before the company returns the money that it borrowed, or if the bond is exchanged for shares in the borrowing company or another company.

Debt-Equity Rules

Under the debt and equity rules 974-70(1)(b) & (a), the dividends on some shares are treated in the same way as interest on a loan for some tax law purposes. These shares are called non-equity shares. In some circumstances, a redeemable preference share may be a non-equity share. The side of the debt/equity borderline shows where interest of a company lies that is relevant in determining the tax treatment of a return on interest, whether frankable or deductible. “Whether an interest is a debt interest or an equity interest matters because returns on debt interests are not frankable but may be deductible while returns on equity interests are not deductible but may be frankable.” (Div 974). The definition of debt also is a key component of thin capitalisation rules, as such what deductions are disallowed. They also allow for equity holders to be separated from creditor holders. However, a mis-characterisation can occur under the thin capitalisation rules as the definition of debt is based more on the legal form than economic substance.

Under the new law in part 3-5 ITAA 1997, an interest in a company is a debt interest (satisfying the debt test 974-15(1)), if at the time of its issue, there is a scheme that is a financing arrangement under which the company has an effectively non-contingent obligation to pay an amount (or several amounts) to the holder of the interest at least equal to its issue price.

Profit Participating Debentures 11+ Years

If the term of the interest is 10 years or less, the amount paid to the holder must equal or exceed the issue price in nominal value terms 974-35. If the term is greater than 10 years, the amount to be paid to the holder must equal or exceed the issue price in present value terms 974-50.

Perpetual Debenture (principle is only repayable on liquidation)

It is defined as the bond with no maturity date. The difference in tax consequence would be defined in Act 2001 paragraph 2.193. Sometimes it is necessary to calculate the present value of an indefinite number of returns because the instrument is perpetual. In cases like these where the value or amount of the financial benefit received is the same for each year, as the term ‘n’ in the formula in subsection 974 50(4) approaches infinity the total value of the returns on a present value basis can be approximated as: amount or value of financial benefit in nominal terms adjusted benchmark rate of return.

Calculating present value for perpetual instruments. The deduction under 25-85 capped the benchmark rate of return + 1.5%. The value of the financial benefit provided will be the sum of the present value of these financial benefits discounted using an adjusted benchmark rate of return. Therefore, because the present value of the financial benefits to be provided in the future exceeds the issue price of the notes, the notes constitute debt interests.

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