Revolving credit facility: Facility Agreement - debt interest

If each respective drawdown under a Facility Agreement passes the debt test in section 974-20 of the Income Tax Assessment Act 1997 (ITAA 1997), will the Facility Agreement itself be treated as the debt interest under Division 974 of the ITAA 1997?

No. Even though each respective drawdown under the Agreement passes the debt test in section 974-20 of the ITAA 1997, the Facility Agreement itself is not a debt interest under Division 974 of the ITAA 1997.

A Company (the Borrower) enters into a syndicated loan Facility Agreement with arms length parties (the Lenders).

The Lenders will commit to advance funds in staged drawdowns up to an agreed credit limit, provided certain pre-requisites are met. These include the completion and service by the Borrower to the Lenders a valid Notice of Drawdown stating, amongst other things, the amount to be drawn down and the term required.

The loan Facility Agreement itself will terminate in 5 years and each drawdown can be for a maximum term of 6 months provided that the term will be completed before the loan Facility Agreement terminates. Each successful Notice of Drawdown imports the terms and conditions contained in the Facility Agreement.

There is an effectively non-contingent obligation to repay the principal advanced under each drawdown, with an accrued market rate of interest thereon, at the end of the term of the drawdown. As a consequence, each respective drawdown under the Facility Agreement will pass the debt test in section 974-20 of the ITAA 1997.

Subsection 974-15(1) of the ITAA 1997 provides that: A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity.

Section 995-1 of the ITAA 1997 defines 'scheme' to mean any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Thus, while it could be argued that the entering into the Facility Agreement by the Borrower will constitute a scheme under this wide definition, that scheme would not of itself be a scheme that satisfies the debt test at the date it comes into existence, as required by subsection 974-15(1) of the ITAA 1997. For example, at the instance the Facility Agreement is entered into there would not exist any effectively non-contingent obligations between either of the parties to the arrangement. Rather, it will be the 'action' of drawing down an Advance in accordance with the terms of the Facility Agreement that will be the 'scheme' that is tested to see if that drawdown passes the debt test. In this regard subsection 974-55(1) provides:

If a scheme, or 2 or more related schemes, give rise to a debt interest in an entity, the debt interest: (a) consists of the interest that carries the right to receive a financial benefit that the entity or a connected entity has an effectively non-contingent obligation to provide under the scheme or any of the schemes; and (c) is taken to be issued by the entity; and (d) is issued when the entity (or a connected entity of the entity) first receives a financial benefit under the scheme or any of the schemes; and (e) is on issue while an effectively non-contingent obligation of the entity (or a connected entity of the entity) to provide a financial benefit under the scheme or any of the schemes remains unfulfilled.

While each successful Notice of Drawdown imports the terms and conditions contained in the Facility Agreement to each drawdown, it does not result in a conclusion that, if the debt test is passed on each respective drawdown, it is the Facility Agreement itself that is the debt interest. Rather, the 'interest that carries the right to receive a financial benefit that the entity or a connected entity has an effectively non-contingent obligation to provide under the scheme' would be each separate and respective drawdown. At the time the Facility Agreement is entered, the Borrower only has a contingent right to receive a financial benefit under the scheme. This contingent right will crystallise into an effectively non-contingent right once the Borrower satisfies all the necessary pre-requisites under the Facility Agreement, and the Lenders thereafter advance the funds.

Thus, the debt interest will not arise until such an Advance is actually drawn down, and each drawdown made under the terms of the Facility Agreement will form a separate debt interest for the purposes of Division 974 of ITAA 1997. The related scheme provisions in section 974-15 have no application to the Advances because each Advance will individually give rise to a debt interest: refer to subsection 974-15(3) of the ITAA 1997.