Issue
Whether a participating loan provided by a managed investment scheme (MIS) is among 'other securities' for the purposes of the definition of 'eligible investment business' in subparagraph 102M(b)(ii) of Division 6C of the Income Tax Assessment Act 1936 (ITAA 1936)?
Decision
Yes. The participating loan is among 'other securities' for the purposes of the definition of 'eligible investment business' in subparagraph 102M(b)(ii) of the ITAA 1936.
Facts
Investors will subscribe for units in a unit trust which is also a (MIS) for the purposes of section 9 of the Corporations Act 2001 . The MIS will use the subscription monies, together with external borrowings, to provide what is called a participating loan to an unrelated entity (entity X).
Entity X will use the funding provided by the MIS under the participating loan to acquire a number of new residential properties which will be rented to tenants at arms-length. The funding provided by the MIS under the participating loan will represent a percentage of the cost to be incurred by entity X in acquiring all residential properties.
The participating loan provided by the MIS to entity X will have the following features: • it will not bear any interest • no periodic repayments will be required to be made by entity X • it will have a term of ten years • at the end of this term, entity X will be required to pay the MIS the amount due and payable under the participating loan agreement. The amount due and payable will be equal to 80% of the 'adjusted net sales value' of all the residential properties, and • the amount payable by entity X under the participating loan agreement will be secured by mortgages held by the MIS over the residential properties
The concept of 'adjusted net sales value' is a defined term under the participating loan agreement and represents an agreed valuation of all the residential properties at the end of this term. Under the participating loan agreement, the 'adjusted net sales value' will be determined on the basis that all properties are fully and properly maintained during the ten year term.
Reasons for Decision
Subparagraph 102M(b)(ii) to the ITAA 1936 provides that:
In this Division, unless the contrary intention appears: ' eligible investment business' means one or more of: (a) ...; or (b) investing or trading in any or all of the following: (i) ...; (ii) bonds, debentures, stock or other securities; (iii) ...; (iv) ...; (xiii) any similar financial instruments; or (c) ...
The term '...other securities' is not a defined term in Division 6C of the ITAA 1936, and accordingly, the question of whether the participating loan is properly characterised as within '...other securities' will need to be determined by reference to its ordinary meaning.
The precise wording of subparagraph 102M(b)(ii) of the ITAA 1936 is bonds, debentures, stock or other securities.
The Commissioner's view of the ordinary meaning of 'security' is found in the interpretation of the statutory definition of 'security' in paragraph 159GP(1)(a) of the ITAA 1936. That paragraph provides: " security " means: - (a) stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;
Although the wording of subparagraph 102M(b)(ii) of the ITAA 1936 is not exactly the same as that used in paragraph 159GP(1)(a) of the ITAA 1936, the list of securities mentioned in paragraph 159GP(1)(a) does mention all the securities in subparagraph 102M(b)(ii).
The Commissioner's views in this regard are set out in Taxation Ruling 'TR 96/14 Income Tax: Traditional Securities'. Specifically, the following interpretation is provided there: • paragraph (a) of the definition of 'security' in subsection 159GP(1) of the Act includes securities which are generally regarded as debt instruments (TR 96/14, paragraph 4(i)), • paragraph (a) of the definition refers to items which are usually taken to be a security, with the normal meaning of security being to denote a debt or claim the payment of which is in some way secured; or written undertakings securing repayment of money (TR 96/14, paragraphs 24-26), and • whilst appreciating the difficulty of finding one genus in paragraph (a), the view is taken that the term 'or other security' in the context it is used encompasses instruments that evidence or secure an obligation on the part of the issuer or drawer to pay an amount to the holder or acceptor, whether during the term of the instrument or at its maturity. This is on the basis that the listed items in paragraph (a) evidence such an obligation. These types of securities will generally be recognised as debt instruments (TR 96/14, paragraph 29)
The Commissioner's views in TR 96/14 do not limit traditional securities to those which are for the repayment of a loan but includes securities for the payment of other amounts. With respect to the participating loan, an obligation is imposed upon entity X at the time of entering into the participating loan agreement to make a future payment to the MIS. The participating loan secures a claim by the MIS for an amount which is determined upon redemption of the participating loan and the payment of which is secured by mortgages held by the MIS over the residential properties.
Accordingly, the participating loan meets the ordinary meaning of 'security', being an instrument which evidences and secures an obligation on the part of the issuer (entity X) to pay an amount to the holder (the MIS) upon maturity/termination of the instrument. The fact that the amount ultimately paid cannot be calculated until the maturity date, and is referenced to the anticipated net sales value of the residential properties, does not alter this view.
The MIS provided the participating loan as a matter of purely commercial judgment and in the reasonable expectation of achieving an overall gain from the payment due under the participating loan agreement. The Commissioner is of the view that when the MIS provides the participating loan it invests in 'other securities' for the purposes of subparagraph 102M(b)(ii) of the ITAA 1936.