08 Nov 2012

Treasury releases income tax relief for Tier 2 instruments

by Louise McCoach, Mark Friezer, Alex Chernishev

The draft regulations would mean eligible Tier 2 instruments issued by ADIs on or after 1 January 2013 are not precluded from being treated as debt for tax purposes.

The Australian Government announced proposals in July to amend tax legislation to ensure that from the commencement of the Basel III capital reforms in Australia on 1 January 2013, eligible Tier 2 instruments issued by authorised deposit-taking institutions (ADIs) on or after that date are not precluded from being treated as debt for tax purposes. On 31 October 2012, the Commonwealth Government released draft tax regulations to implement these amendments for comment.

The draft regulations are directed at all Tier 2 instruments which, under Basel III, will be required to contain "bail-in provisions" from 1 January 2013. A bail-in provision is a mechanism under which regulatory capital instruments (such as Tier 2 instruments) are required to be written off or converted into ordinary shares if the Australian Prudential Regulation Authority (APRA) decides that the issuing ADI would otherwise become non-viable.

Currently, the inclusion of the Basel III bail-in provisions is likely to render an ADI's obligation to pay principal and interest on Tier 2 instruments as "contingent" for the purposes of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), because payment would be contingent on the non-occurrence of a bail-in trigger event. This may result in the affected Tier 2 instruments being treated as equity for tax purposes, in which case interest payable on the instruments would not be tax deductible.

How does the relief work?

The draft regulations provide that principal and interest obligations under certain notes (referred to as "relevant term cumulative subordinated notes") are not to be considered "contingent" obligations just because they contain a bail-in provision. "Relevant term cumulative subordinated notes" are defined as having the following features:

  • a fixed term by the end of which the note must be repaid;
  • payment under the note is subordinated to the interests of more senior creditors;
  • the note is issued by an APRA regulated entity;
  • the note qualifies as Tier 2 capital under the Basel III reforms;
  • the note has a term of 30 years or less and does not include an unconditional right to extend its term beyond a total term of 30 years;
  • the note contains a condition that any deferred interest will accumulate until payment is made or the bail-in event trigger occurs; and
  • the issuer of the note does not have an unconditional right to decline to provide a financial benefit that is equal, in nominal value, to the issue price of the note to settle the obligations under the note.

It is important to note that the draft regulations will not result in all Tier 2 instruments automatically qualifying as debt for tax purposes. They merely ensure that the inclusion of the mandatory bail-in trigger will not preclude Tier 2 instruments from being classified as "non-contingent" obligations. However, in order for Tier 2 instruments to be treated as debt they must still satisfy the debt test in subsection 974-20(1) of the ITAA 1997.

Next steps

The draft regulations are open for consultation and submissions. Interested parties may lodge submissions to the Treasury by 14 November 2012. It is expected that the draft regulations will ultimately be enacted as a legislative instrument.


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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.