solution., page-10

nathanb 1985

I like your thinking. A difficulty with convertible notes is that under Australian income tax law they usually get treated as equity. This ultimately depends on the terms of the instrument, but the because repayment is usually “not effectively non-contingent” (sorry about the double negative but that is the legal test) they fail the debt test and get treated as equity. This means interest payments are treated a debt dividends, which are frankable but not deductible. This would probably raise Centro’s weighted average cost of capital (due to non-deductibility) and if the dividends cannot be franked an Australian investor such as a Super Fund or even a Bank probably will not be interested. The other reason an Australian Bank might not be interested is that they might have a fight to claim a tax deduction for the bad debt if they have to take a write (because the note is viewed as an investment rather than a loan made by a moneylender – depends on the facts). A foreign Bank might be more interested because they do not give a stuff about franking credits and their tax laws might be substance based and view the note as debt.

In Australia certain types of redeemable preference shares are a more popular because they are regarded as debt for income tax purposes and equity for accounting purposes.

One might say the last thing Centro needs to worry about is how any instrument would be treated for tax. However, Centro management are not acting like the company is on it’s knees and you cannot ignore the tax impact for the holder.