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Is the notional interest charged by an issuer on any outstanding amount for the purchase of an underlying share that is the subject of an endowment warrant deductible to the holder of the endowment warrant under subsection 8-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The notional interest charged by an issuer on any outstanding amount for the purchase of an underlying share that is the subject of an endowment warrant will not be allowable as a deduction to the holder of the endowment warrant under subsection 8-1(1) of the ITAA 1997.

The taxpayer is the holder of an endowment warrant which may be traded on the Australian Stock Exchange (ASX).

The taxpayer is not in the business of trading in endowment warrants or other securities.

The endowment warrant is an agreement for the sale and purchase of a share in an ASX listed company (the underlying share), the completion of which is at the option of the holder of the endowment warrant. That is, the endowment warrant gives the holder the right to purchase the underlying share (a call option), exercisable at a date typically known as the completion date. The issue price of an endowment warrant is typically between 30%-65% of the market value of the underlying share at the time of issue.

The endowment warrant does not confer on the holder any interest or right in respect of the underlying share, and thus the holder has no entitlement to receive any dividends or other distributions in respect of that share. It is only if the holder exercises their option to complete the purchase on the completion date that the holder will have an interest in the underlying share.

To complete the purchase of the underlying share, the holder makes a final payment on the completion date. This final payment will be a variable amount (predominantly comprised of an amount typically known as the outstanding amount).

The outstanding amount is established at the start of the issue of the endowment warrant. In broad terms, the outstanding amount will be the difference between the market value of the underlying share at the time of issue (plus any issuer costs, profit and premium) and the issue price of the endowment warrant. During the period of the endowment warrant, the balance of the outstanding amount will be: • increased by an interest rate factor (notional interest amount), and • reduced by notional amounts representing any payments made in respect of the underlying share (such as dividends and other distributions).

Generally, the completion date for the endowment warrant will be 30 business days after the earlier of the expiry date (generally 10 years from the date of purchase) and the date when the outstanding amount is reduced to zero.

If the holder does not complete the purchase of the underlying share (that is, the holder does not exercise their right of purchase under the endowment warrant), the endowment warrant lapses, or terminates.

Subsection 8-1(1) of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they: (a) are incurred in gaining or producing the assessable income, or (b) are necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

The taxpayer does not incur any loss or outgoing under the endowment warrant as a result of the debit adjustments to the outstanding amount in respect of the notional interest charges. There is no obligation incurred or actual expenditure made by the holder, nor does any other depletion of the holder's resources occur as a result of these debit adjustments to the outstanding amount. Accordingly, the notional interest charged by an issuer on any outstanding amount for the purchase of an underlying share that is the subject of an endowment warrant will not be allowable as a deduction to the holder of the endowment warrant under subsection 8-1(1) of the ITAA 1997.

On the completion date, the outstanding amount (as adjusted) will be relevant in determining final payment to be made by the holder if it exercises its option to complete the purchase of the underlying share. The entire final payment (including any part made up of adjustments for the notional interest charge) is a capital amount paid in respect of the acquisition of the underlying share. Subsection 8-1(2) of the ITAA 1997 provides that a loss or outgoing of capital, or of a capital nature cannot be deducted under section 8-1 of the ITAA 1997.