Issue
Where a redeemable preference share (RPS) is categorised as a debt interest under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997), does section 25-85 of the ITAA 1997 allow a deduction to be claimed under section 8-1 of the ITAA 1997 on an accruals basis from the date of issue of the RPS?
Decision
No. The dividend will not be deductible on an accruals basis from the date of issue of the RPS. It will only be deductible under section 8-1 of the ITAA 1997 on or after the date of each payment.
Facts
A company, which has a tax year ending 30 June, issues non-cumulative, mandatory RPS on 1 January 2004. The RPS will be mandatorily redeemed for cash on 1 January 2009. A dividend will be paid annually at the rate of 7.5% per annum on the 31 July each year.
The RPS will be classified as a debt interest pursuant to Division 974 of the ITAA 1997.
Reasons for Decision
A return paid on a debt interest would be deductible where it meets the general deduction criteria of section 8-1 of the ITAA 1997. Where the return would not otherwise meet the general deduction criteria, it may still be deductible (up to a limit not exceeding the benchmark rate of return plus 150 basis points), by virtue of section 25-85 of the ITAA 1997.
Section 25-85 of the ITAA 1997 deals with certain returns that an entity pays on a debt interest (subsection 25-85(1) of the ITAA 1997). It provides that a deduction will not be prevented merely because the return is contingent on economic performance, or secures a permanent or enduring benefit for the entity or a connected entity (subsection 25-85(2) of the ITAA 1997).
Furthermore, where the return is a dividend, subsection 25-85(3) of the ITAA 1997 applies so that the return will be deductible to the extent that it would be deductible under section 8-1 of the ITAA 1997 if: (a) the payment of the return were the incurring by the entity of a liability to pay the same amount as interest, and (b) that interest were incurred in respect of the finance raised by the entity and in respect of which the return was paid or provided; and (c) the debt interest retained its character as a debt interest for the purposes of subsection (2).
In the present case, the financial benefit to be provided takes the form of a return on a debt interest which is a legal form share. The return will thus be in the form of a dividend. The term 'dividend' is defined in subsection 6(1) of the Income Tax Assessment Act 1936 and includes 'any distribution made by a company to any of its shareholders, whether in money or other property'.
Generally, in order to deduct an outgoing under section 8-1 of the ITAA 1997, it must have been incurred.
Paragraph 25-85(3)(a) of the ITAA 1997 specifically fixes the point in time at which a dividend is incurred for the purposes of section 8-1 of the ITAA 1997.
Thus, the 'payment' of the dividend is to be treated as the point in time in which, had the return been interest, the liability would have been incurred by the entity. The linkage of incurring to the actual payment of the return has the result that the liability is not incurred until the dividend is paid.
Paragraph 25-85(3)(b) of the ITAA 1997 then provides for a linkage between the 'interest' incurred (being the dividend that has been paid), and the finance raised by the entity from issuing the RPS to enable a determination to be made as to whether the 'interest' satisfies the positive limbs of section 8-1 of the ITAA 1997. However, the meaning of the term 'incurred' in paragraph 25-85(3)(b) is to be found in paragraph 25-85(3)(a) of the ITAA 1997.
As the dividends in this case have not been paid, but only accrued, no deduction is allowable by virtue of sections 8-1 and 25-85 of the ITAA 1997.