Non-share equity interests issued ‘at or through a permanent establishment’ of an Australian Deposit-taking Institution
Banking on Tax, Issue 8
In July, the Commissioner of Taxation released Taxation Determination TD 2012/19 (TD 2012/19), which considers the ability of an authorised deposit-taking institution (ADI) to issue a non-share equity interest that pays unfranked distributions. The threshold test is whether the non-share equity interest is ‘issued at or through a permanent establishment’ for the purposes of paragraph 215-10(1)(c) of the Income Tax Assessment Act 1997.
Where this threshold test and the other requirements of section 215-10 are satisfied, certain non-share dividends, such as dividends on a stapled Tier 1 hybrid security paid by an ADI, are unfrankable.
In broad terms, the Commissioner’s view in TD 2012/19 is that ‘issued at or through a permanent establishment’ requires the capital raising transaction to be part of the business carried on at or through the permanent establishment (PE). Practically, this would mean that:
- The security must be offered to investors in the course of the business conducted by the ADI at or through its PE
- The allocation of the security to the investor must be by personnel conducting the business of the PE
- Transaction documents must be executed at the PE
- The transaction documents must provide that the security is transferred at the PE and, at the time of transfer, it is the personnel conducting the business at the PE that relinquish control over the security.
The Commissioner draws out his views through three examples. To summarise his view from these examples, merely creating and executing the transaction documents at the PE will not be sufficient for section 215-10 to be satisfied and for the distribution on the instrument to be unfranked. While some activities in relation to any capital-raising, such as seeking approvals from APRA, ASIC and ASX, are able to be undertaken in Australia, the marketing and allocation of the security are key steps that must be undertaken at or through the PE.
The Commissioner also indicates that a practice of an ADI controlling the issue of a non-share instrument marketed to Australian investors would mean that such instruments are not issued at or through the permanent establishment and, hence, distributions on those instruments will be required to be franked.
The conduct of activity by personnel of the PE and those in Australia will need to be carefully allocated to ensure that the facts support that the instrument has been ‘issued at or through a permanent establishment’.
The approach by the Commissioner seems to be overly restrictive, and makes the application of section 215-10 very difficult to satisfy. The policy intent of section 215-10 was to remove a competitive disadvantage that Australian ADIs would suffer in raising Tier 1 capital following the introduction of the debt equity rules. In the absence of this provision, Australian ADIs have to frank distributions on Tier 1 securities issued through branch structures, resulting in an additional cost of raising capital that would not arise from issuing similar securities through a foreign subsidiary or would not be incurred by independent foreign competitors. From TD 2012/19, there are, in the Commissioner’s view, a narrow range of circumstances where ADIs through their PE can achieve the competitive neutrality sought to be offered by section 215-10.
However, in situations, where 215-10 is not satisfied and distributions on a Tier 1 security are prima facie frankable, further consideration is required of the anti-avoidance provisions of section 177EA of the Income Tax Assessment Act 1936. If section 177EA did apply, the creation of a franking debit (to the issuer) or the cancellation of franking credits (for the investor) would be a penal cost to any capital-raising.