Private ruling: Division 250 of the Income Tax Assessment Act 1997 - Tax Preferred Use
Published: October 2012
Ruling period: 1 July 2012 to 30 June 2019
Date scheme commenced: 2013 income year

Ruling: Q1: Does the Commissioner of Taxation consider the assets of the Company are not put to a tax preferred use pursuant to paragraph 250-15(a) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: The Company is an Australian propriety company. The Company is the head company of a tax consolidated group. The business of the Company, including its subsidiaries, is limited to owning, maintaining and operating the assets. The Company employs a General Manager who has been delegated the power to manage the day-to-day operations of the business. The General Manager reports directly to the board of the Company. The Company also employs other personal who are experienced in the operation of the assets and who report to the General Manager. The Company has entered into a construction agreement and a service agreement with Entity A for the construction of the assets and the provision of certain services in the operation and maintenance of the assets. Entity A will have reporting obligations to the General Manager of the Company. The Company has also entered into a financial derivative arrangement with Entity A in order to manage particular commercial risks. Entity A is a tax preferred entity as defined in section 995-1 of the ITAA 1997. The Company also has a commercial agreement with Entity B. Entity B is a company limited by guarantee established under the Corporations Act 2001 and is responsible for providing certain facilities and services for sale to customers in accordance with certain terms of Entity B's constitution. Entity B collects all monies due for providing the facilities and services to the customers and in turn pays the monies to the Company, less Entity B's costs. Entity B is a tax preferred entity as defined in section 995-1 of the ITAA 1997. There are no lease agreements between the Company and Entity A, or between the Company and Entity B.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 40-60; | Income Tax Assessment Act 1997 section 250-15; | Income Tax Assessment Act 1997 section 250-15(a); | Income Tax Assessment Act 1997 section 250-50(1); | Income Tax Assessment Act 1997 section 250-50(2); | Income Tax Assessment Act 1997 section 250-50(3); | Income Tax Assessment Act 1997 section 250-55(a); | Income Tax Assessment Act 1997 section 250-60; | Income Tax Assessment Act 1997 section 250-60(1); | Income Tax Assessment Act 1997 section 250-60(2); | Income Tax Assessment Act 1997 section 250-60(2)(a)(ii); | Income Tax Assessment Act 1997 section 250-60(2)(b)(i); | Income Tax Assessment Act 1997 section 250-60(3)(f); | Income Tax Assessment Act 1997 section 250-160(3); | Income Tax Assessment Act 1997 section 995-1(1).

Reasons for decision: Summary: Division 250 of the ITAA 1997 will deny capital allowance deductions where an arrangement effectively passes on the risks and benefits of ownership from a legal owner to an end user that is a tax exempt entity. Arrangements which come within the scope of Division 250 of the ITAA 1997 will be taxed as a financial arrangement on a compounding accruals basis. In order for Division 250 of the ITAA 1997 to apply, all of the requirements set-out in the general test under section 250-15 of the ITAA 1997 must be present. Section 250-15 of the ITAA 1997 states: This division applies to you and an asset at a particular time if: (a) the asset is *put to a tax preferred use; … Whether an asset is put to a tax preferred use is set-out in section 260-60 of the ITAA 1997. Subsection 250-60(1) of the ITAA 1997 provides that an asset is put to a tax preferred use at a particular time if an end user holds the rights to the asset under a lease. The assets of the Company are not subject to a lease, therefore subsection 250-60(1) of the ITAA 1997 is not applicable in this instance. An alternative definition of put to a tax preferred use is set-out in subsection 250-60(2) of the ITAA 1997, which states: An asset is also put to a tax preferred use at a particular time if: a) at the time the asset is, or is to be, used (whether or not by you) wholly or partly in connection with: i. the production, supply, carriage, transmission or delivery of goods; or ii. the provision of services or facilities; and b) either or both of the following paragraphs is satisfied at that time: i. some or all the goods, services, or facilities are, or are to be, produced for or supplied, carried, transmitted or delivered to or for an *end user who is a *tax preferred end user because of paragraph 250-55(a) (tax preferred entity) but is not an *exempt foreign government agency; ii. the asset is, or is to be, used wholly or principally outside Australia and an end user of the asset is a tax preferred end user because of paragraph 250-55(b) (foreign resident). The assets of the Company are used in connection with providing certain services and facilities for the purposes of subsection 250-60(2) of the ITAA 1997. In applying subsection 250-60(2) of the ITAA 1997 to the assets of the Company it is necessary to determine if some or all of these services of facilities are to be produced for or supplied, carried, transmitted or delivered to or for an 'end user' who is a 'tax preferred end user' because of paragraph 250-55(a) of the ITAA 1997. Paragraph 250-55(a) of the ITAA 1997 defines a 'tax preferred end user' as an end user who is a tax preferred entity. 'Tax preferred entity' is defined pursuant to subsection 995-1(1) of the ITAA 1997. Entity A and Entity B are both tax preferred entity's as defined under subsection 995-1(1) of the ITAA 1997. The key issue is whether either Entity A or Entity B is an 'end user' of the assets of the Company in determining whether they are 'tax preferred end users' for the purposes of applying subsection 250-60(2) of the ITAA 1997. The term 'end user' is defined in subsection 250-50(1) of the ITAA 1997 as: An entity (other than you) is an end user of an asset if the entity (or a *connected entity): (a) uses, or effectively controls the use of, the asset; or (b) will use, or effectively control the use of, the asset; or (c) is able to use, or effectively control the use of, the asset; or (d) will be able to use, or effectively control the use of, the asset. Subsection 250-50(2) stipulates that control can be either direct or indirect. Therefore, in order for Entity A or Entity B to be an 'end user' of the assets of the Company they have to either 'use' or 'effectively control the use' of the assets. The term 'use' is not a defined term in Australian taxation legislation. The Explanatory Memorandum to Tax Laws Amendment (2007 Measures No.5) Act 2007 (the EM) at paragraph 1.29 states that Division 250 of the ITAA 1997 will apply to a taxpayer in respect of an asset only if, in a practical sense , a tax preferred end user has, or will have, the control or use of the asset during the arrangement period. This would suggest (without going into a full discussion of the relevant case law - for example, Tourapark Pty Ltd v. FCT (1982) 149 CLR 176; (1982) 40 ALR 465; (1982) 56 ALJR 316; 82 ATC 4105; 12 ATR 842, Hamilton Island Pty Ltd v. FCT (1982) 43 ALR 519; 82 ATC 4302; (1982) 13 ATR 220 and Air Liquide Australia Ltd v. FCT (1996) 32 ATR 510; 96 ATC 4468) that the use required would be more than mere incidental use and would require a real and requisite direct use of the asset itself by the end user. Entity A will be providing certain services to the Company in relation to the construction, operation and maintenance of the assets. Under the terms of the relevant agreements these services will be provided on a fee-for-service basis, using a methodology common to many services industries. Entity A's fees are obtained solely from the services it provides and are not a percentage of the income generated from the operation of the assets of the Company. Entity A will therefore not be considered to 'use' the assets of the Company. The financial derivatives that Entity A acquires under certain contractual terms will also not amount to Entity A having 'use' of the assets of the Company. The derivatives do not create any rights for Entity A over the Company's assets; it is merely an agreement for it to purchase the derivatives at a predetermined price. Under the terms of the commercial agreement that the Company has with Entity B, Entity B will pay the Company for certain facilities and services provided to customers pursuant to the terms of Entity B's constitution. Entity B will therefore not be considered to 'use' the assets of the Company. Like the term 'use', the term 'effectively controls the use' is also not a defined term in Australian taxation legislation. Paragraph 1.34 of the EM does however suggest that Division 250 of the ITAA 1997 applies a test of effective control that is consistent with the test in section 51AD and Division 16D of the Income Tax Assessment Act 1936 ('ITAA 1936'). The Commissioner has expressed his view of the meaning of the term 'effective control' for the purposes of applying both these statutory provisions in Taxation Ruling 96/22 Income Tax: section 51AD - deductions not allowable if an asset financed by non-recourse debt is used by a tax exempt or other entity ('TR 96/22') and Taxation Ruling IT 2602 Income Tax: privately owned power stations: control by state electricity authorities ('IT 2602'). These rulings continue to be relevant in determining what is meant be the term 'effectively controls the use' for the purposes of applying subsection 250-50(1) of the ITAA 1997. Paragraph 9 of TR 96/22 relevantly states: Control of use is effective control of the property. Effective control means day-to-day or de facto control. While paragraph 42 of TR 96/22 stipulates: Effective control is a broad test that is not limited to the strict legal rights resulting from agreements or arrangements but includes any other arrangements, including financial ones that could affect the question of who controls the use of the property for the production of goods or provision of services. IT 2602 specifically considers the issue of control of use in the context of privately owned power stations. However, the elements which are relevant to considering whether the indicia of effective control by an exempt entity exist in that context can be applied more broadly to other facilities and assets. These indicators include: · day-to-day operation; · financial arrangements; and · reversion of the property to the exempt entity. Day-to-day operation Paragraph 7 of IT 2602 states: It is accepted that where a taxpayer's power station is to supply power as part of the State grid, the State authority will need to coordinate the activities of the private station with other stations on the grid. In particular, the State authority may need to vary outputs or institute shutdowns. Where the State authority has such a coordinating or supervisory role which is limited only to such matters that are necessary to ensure a reliable and continuous supply of electricity on the grid, economy of operation of the grid, or public health and safety in emergency conditions, the State authority will not, on that basis alone, be regarded as controlling the use of the power station. (Emphasis added) Paragraph 8 of IT 2602 goes on to state: In the context of the day-to-day operation of a power station, this Office sees effective control as meaning that a person, organisation or authority either operates the station on a day-to-day basis through its employees or agents or has an immediate supervisory role (not in the sense explained in the previous paragraph) that enables it to direct others in that day-to-day operation. The staffing arrangements will be important in this regard, particularly where the legal owner has no previous experience or expertise in the management and operation of a power station. The Company employs a General Manager who has been delegated the power to manage the day-to-day operations of the business. The General Manager reports directly to the board of the Company. The Company also employs other personal who are experienced operating the assets and who report to the General Manager. The staff members will be responsible for the daily operation of the assets of the Company, including the co-ordination and management of any contractors. The staffing arrangements to be used by the Company in the operation and maintenance of its assets will be consistent with paragraphs 10 and 11 of IT 2602 in establishing that the Company effectively controls the use of the assets, and that neither Entity A or Entity B effectively controls the use of the assets on a day-to-day basis. Financial Arrangements Paragraph 13 of IT 2602 states: While economic relationships will not generally be determinative of the question of control of a power station, examination of the whole commercial arrangement surrounding the ownership and operation of the station may point to a situation where the taxpayer's interest is largely of a financing kind, with the result that there is little incentive or purpose (apart from being seen to comply with the "control" test in section 51AD) in taking part in the management and operation of the station. Paragraphs 14 to 19 of IT 2602 go on to stipulate that the presence of fixed return charges or a fixed fee arrangement would be indicative of this type of relationship. The payments that the Company makes to Entity A under the terms of the relevant construction agreement and service agreement are done so on a fee-for-service basis. Entity A will not be assuming any cost risk in the provision of the relevant services and will recoup all of its costs from the Company. These fees will therefore not be considered to be a financial arrangement under which Entity A, rather than the Company, effectively controls the use of the assets. The financial derivatives agreement between Entity A and the Company does not create any rights for Entity A over the Company's assets. The payments made by Entity A to the Company are merely an agreement for Entity A to purchase the derivatives at a predetermined price and allow the Company to manage certain financial risks. The financial derivative arrangement will therefore not be considered to be a financial arrangement under which Entity A, rather than the company, controls the use of the assets. With regards to the payments made to the Company by Entity B, Entity B will not be considered to exert any financial control over the assets of the Company on the basis that the financial benefits provided by Entity B are: · not fixed return charges; · not a fixed fee agreement; and · there is not agreement to transfer ownership of the assets. The financial benefits provided to the Company by Entity B will represent the market price for the provision of the relevant facilities and services. Reversion of property to an exempt entity Paragraph 43 of TR 96/22 states: (R)eversion of the property to the government authority after a certain number of years, or an option for the government authority to acquire the property at a future time, may amount to an attempt by the government authority to acquire property without the need to raise finance directly, with the transfer of tax benefits to the taxpayer. The Company owns the assets. The contractual terms between the Company and Entity A, and between the Company and Entity B do not indicate that ownership of the assets will revert to either Entity A or Entity B in the future. For these reasons neither Entity A nor Entity B will be an end user of the assets of the Company as neither Entity will use or effectively control the use of the assets of the Company for the purposes of applying section 250-50 of the ITAA 1997. As there is no use or effective control of use by a tax preferred entity of the assets of the Company, it follows that the assets will not be put to a tax preferred use as set-out in subsection 250-60(2) of the ITAA 1997. As a result, the assets of the Company will not be put to a tax preferred use for the purposes of applying paragraph 250-15(a) of the ITAA 1997.

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