Interest: disguised interest: what is disguised interest: the determining factors
Determining factors of disguised interest
For a return to be disguised interest (SAIM2720), ITTOIA05/S381A(4) requires the following features to be present.
The time value of money (section 381A(4)(a))
It must be reasonable to assume that the return is ‘by reference to the time value of that amount of money’. This means that there must be an investment of some sort (or an entitlement to payment of something akin to a debt) in order for the legislation to apply, and the return on that investment must be calculated similarly to the way in which interest is calculated.
Commercial rate of interest (section 381A(4)(b))
The return must, in all the circumstances, be comparable to a commercial rate of interest. The return must only be ‘comparable’ - it does not have to be exactly the same as a commercial rate of interest. In particular, it does not have to be comparable to a ‘deposit’ rate of interest, or a ‘risk-free’ rate. There is likely to be a range of interest rates within which a return could be ‘comparable’ to a commercial rate of interest.
The term ‘in all the circumstances’ conveys the idea that all relevant factors should be taken into account in determining whether the return is comparable to a commercial rate of interest.
One particular factor to note is credit risk. This will reflect such features as the identity and creditworthiness of the counterparty, the relationship between the two parties, the duration of the arrangement and the currency of the transaction(s). The fact that the return includes such credit risk will not prevent it being disguised interest. Many corporate bonds, for example, pay a high interest rate to reflect the degree of risk in the issuer’s business.
Practical likelihood of the return (section 381A(4)(c))
The third determining factor in whether a return is ‘economically equivalent to interest’ is the ‘practical likelihood’ of the return. See SAIM2740.