Private ruling: Construction and services project
Published: August 2014
Date scheme commenced: Entity Q was established as a Special Purpose Vehicle (SPE) in order to manage the risk of recovery of certain receivables that were either assumed or created by it. Entity Q borrowed funds from Lenders pursuant to a Loan and used the funds to purchase the receivables from Entity F that are payable by Entity P as well as to make another loan.

Ruling: Q1: Will Division 250 to the Income Tax Assessment Act 1997 (ITAA 1997) apply to Entity Q in relation to Receivables it purchases from the Entity F? | A1: No | Q2: Will Entity Q meet the conditions in subsection 820-39(3) of the ITAA 1997? | A2: Yes

Relevant facts and circumstances: Entity Q was established as a Special Purpose Vehicle (SPE) in order to manage the risk of recovery of certain receivables that were either assumed or created by it. Entity Q borrowed funds from Lenders pursuant to a Loan and used the funds to purchase the receivables from Entity F that are payable by Entity P as well as to make another loan. Entity Q was established solely for the purpose of purchasing the receivables and to facilitate the financing for a Project to be completed by Entity P. The Loan is a debt interest for Australian income tax purposes. The value of the Loan is at least 50% of the receivables. The Loan will have a Maturity Date which is less than 10 years Entity Q is restricted through various contractual requirements to activities necessary to perform the role of facilitating finance. Entity Q may not engage in any business or activity other than that which is necessary for, or incidental to, its role. Entity Q is restricted from issuing other debt. At least one Director appointed to the Board of Entity Q will be an 'Independent Director The Constitution of Entity Q and the contractual requirements prohibit Entity Q from: • Merging or consolidating with another entity; • Issuing any shares, units or grant any rights to acquire shares or units; • Selling, disposing of an interest in its property other than that permitted within the transaction documents; and Amending its Constitution and the relevant transaction documents. Entity Q will ensure that it maintains its separateness from any other entity Entity Q will display sound Management by keeping proper books and records, conducting its business in Entity Q's name only, carrying on and conducting its business in accordance with all applicable laws Any recourse will be limited to the certain property specified in the finance documents and will be limited to transaction parties.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 40 | Income Tax Assessment Act 1997 Section 40-30 | Income Tax Assessment Act 1997 subsection 40-30(1) | Income Tax Assessment Act 1997 Division 43 | Income Tax Assessment Act 1997 Division 250 | Income Tax Assessment Act 1997 Section 250-15 | Income Tax Assessment Act 1997 paragraph 250-15(a) | Income Tax Assessment Act 1997 paragraph 250-15(b) | Income Tax Assessment Act 1997 paragraph 250-15(c) | Income Tax Assessment Act 1997 paragraph 250-15(d) | Income Tax Assessment Act 1997 paragraph 250-15(e) | Income Tax Assessment Act 1997 Division 820 | Income Tax Assessment Act 1997 Section 820-39 | Income Tax Assessment Act 1997 Sub section 820-39(3) | Income Tax Assessment Act 1997 Paragraph 820-39(3)(a) | Income Tax Assessment Act 1997 Paragraph 820-39(3)(b) | Income Tax Assessment Act 1997 Paragraph 820-39(3)(c) | Income Tax Assessment Act 1997 Subsection 974-15(1) | Income Tax Assessment Act 1997 Subsection 974-20(1) | Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision: Summary: Summary Division 250 will not apply to Entity Q in relation to Receivables it purchases from the Entity F. Detailed reasoning Division 250 denies or reduces capital allowance deductions that would otherwise be available in relation to an asset if the asset is put to a tax preferred use in certain circumstances. The general test for application of Division 250 is set out in section 250-15 which provides that the Division will apply to a taxpayer and an asset at a particular time if: (a) the asset is put to a tax preferred use; and (b) the arrangement period for the tax preferred use of the asset is greater than 12 months; and (c) financial benefits in relation to the tax preferred use of the asset have been, will be or can reasonably to be expected to be provided to you by a tax preferred end user; and (d) disregarding this Division you would be entitled to a capital allowance in relation to a decline in value of the asset; or expenditure in relation to the asset; and (e) you lack a predominant economic interest in the asset at that time. Each of the conjunctive requirements in paragraphs 250-15(a)-(e) must be present for the general test to be satisfied. If one of the paragraph requirements is not present, it is sufficient to conclude that the general test is not satisfied and, accordingly, that Division 250 does not apply. For paragraph 250-15(d) to be satisfied, the taxpayer must be entitled to deductions for capital allowances pursuant to Division 40 or for expenditure on project works pursuant to Division 43 (disregarding the application of Division 250). Division 40 - Capital Allowances The object of Division 40 is to allow a deduction for the decline in value of a depreciating asset. A depreciating asset is defined in subsection 40-30(1) as: | Detailed Reasoning - 40-30(1): A depreciating asset is an asset that has a limited * effective life and can reasonably be expected to decline in value over the time it is used, except: (a) land; or (b) an item of * trading stock; or (c) an intangible asset, unless it is mentioned in subsection (2). The Receivable is not an asset that has a limited effective life which declines in value over the time it is used. Therefore, Entity Q would not otherwise be entitled to a capital allowance deduction pursuant to Division 40. Division 43 - Deduction for Capital Works Subsection 43-20(1) states that Division 43 applies to capital works being a building, or an extension, alteration or improvement to a building. The Receivable is not capital works. Therefore, Entity Q would not otherwise be entitled to a deduction pursuant to Division 43. Therefore, as Entity Q will not satisfy the requirements in paragraph 250-15(d), Division 250 will not apply. | Detailed Reasoning - Question 2: Summary The thin capitalisation rules under Division 820 will not apply to disallow any debt deductions of Entity Q as the conditions in subsection 820-39(3) of the ITAA 1997 will be satisfied. Detailed Reasoning The conditions in subsection 820-39(3) are: (a) the entity is one established for the purposes of managing some or all of the economic risk associated with assets, liabilities or investments (whether the entity assumes the risk from another entity or creates the risk itself); and (b) the total value of *debt interests in the entity is at least 50% of the total value of the entity's assets; and (c) the entity is an insolvency-remote special purpose entity according to the criteria of an internationally recognised rating agency that are applicable to the entity's circumstances. Each of these must be met for the requirements of subsection 820-39(3) to be satisfied. | Detailed Reasoning - Paragraph 820-39(3)(a) Managing economic risk: The Commissioner accepts that in the circumstances of Entity Q, the requirement of paragraph 820-39(3)(a) is met as Entity Q was established for the purpose of managing some or all the risk associated with an asset that was either assumed or created by Entity Q, being the recovery of the receivable payments. As part of the arrangement, Entity Q will assume some or all of the economic risks associated with the underlying receivables since Entity Q's return is contingent on the recoverability of the receivables. That is at least part of the credit risk of the receivables will pass from Entity F to Entity Q. | Detailed Reasoning - Paragraph 820-39(3)(b) Value of debt interests: If the loans held in Entity Q constitutes a debt interest for the purposes of the ITAA 1997, the paragraph 820-39(3)(b) requirement will be satisfied as the total value of the loans will be at least half the value of Entity Q's assets. Debt Interest Subsection 995-1(1) of the states that: debt interest in an entity has the meaning given by Subdivision 974-B. Subsection 974-15(1) states: A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity. The relevant scheme for subsection 974-15(1) is each draw-down made pursuant to the Loan and not the Loan itself that is the debt interest ; ATO Interpretive Decision ATO ID 2006/230. Subsection 974-20(1) states: A scheme satisfies the debt test in this subsection in relation to an entity if: (a) the scheme is a financing arrangement for the entity; and (b) the entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; and (c) the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when: (i) the financial benefit referred to in paragraph (b) is received if there is only one; or (ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and (d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and (e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil. For a scheme to constitute a debt interest, each of the conjunctive requirements in paragraphs 974-20(1)(a) - (e) must be present. Paragraph 974-20(1) (a): Financing arrangement Entity Q enters into each draw-down to the Loan mainly for the purpose of obtaining sufficient funds to purchase an asset. Therefore, each draw-down is a scheme that raises finance for Entity Q. Paragraph 974-20(1) (b): Receipt of financial benefits A 'financial benefit' is defined in paragraph 974-160(1)(a) to mean '… anything of economic value …' even where obligations are imposed on the entity under the transaction under which the benefit is conferred on the entity. Entity Q will obtain funds by way of successive draw-downs. Each draw-down that Entity Q makes will result in Entity Q receiving a financial benefit for the purposes of paragraph 974-20(1)(b). Paragraph 974-20(1) (c): Effectively non-contingent obligation to provide financial benefits to one or more entities Entity Q has obligations to repay the amounts advanced by the lenders as well as pay the Interest rate for each applicable Interest period. Therefore Entity Q is under an effectively non-contingent obligation to provide financial benefits in respect of the loan to other entities in the form of repayments of principal and payments of the interest for each Interest period, as well as other amounts such as certain fees and charges. Paragraph 974-20(1) (d): Substantially more likely the value provided will at least be equal to the value received The paragraph 974-20(1)(d) requirement is to be satisfied in nominal terms if there is an effectively non-contingent obligation to repay all principal outstanding (as well as any Interest and fees such as the commitment fee) in 10 years or less; subparagraph 974-35(1)(a)(i). Where greater than 10 years, the paragraph 974-20(1)(d) requirement is to be satisfied in present value terms pursuant to the formula set out in section 974-50; subparagraph 974-35(1)(a)(ii). As the maturity date is less than 10 years the paragraph 974-20(1)(d) requirement is satisfied on nominal terms pursuant to subparagraph 974-35(1)(a)(i). Paragraph 974-20(1) (e): The values provided and received are not both nil Entity Q will receive funds by way of successive draw-downs pursuant to the Loan, the value of which is not nil. Therefore Entity Q will be required to provide financial benefits in the repayment of the loan which is also not nil. The paragraph 974-20(1)(e) requirement that the value provided, and the value received, by Entity Q are not both nil is satisfied. As each of the requirements in paragraphs 974-20(1)(a) - (e) are met, the Loan will satisfy the debt test for income tax purposes. Paragraph 820-39(3)(b)Conclusion This requirement is satisfied as the Loan is a debt interest and the value of Entity Q's debt interests is at least 50% of Entity Q's assets. Therefore Entity Q will at all times be predominantly funded by debt. | Detailed Reasoning - Paragraph 820-39(3)(c) Entity Q is an insolvency-remote special purpose entity: Whether Entity Q will satisfy the criteria of an internationally recognised rating agency is a question of fact, which includes a consideration of criteria published by internationally recognised ratings agencies. Entity Q was created to satisfy Standard & Poor's Criteria for Special-Purpose Entities in Project Finance Transactions, issued 20 November 2000 and revised 4 March 2011 ( Criteria ). The requirement of meeting such Criteria can be met without a determination by a rating agency; subsection 820-39(4). In the Criteria document, S&P set out that a Special Purpose Entity (SPE) will achieve insolvency remoteness by adopting some form of the characteristics identified in the Criteria . Therefore, Entity Q does not need to satisfy each criterion in in order to be assessed as insolvency remote. The characteristics set out in the Criteria to assess insolvency remoteness are: • Restrictions on objects and powers; • Debt Limitations; • Independent director; • No merger or reorganisation; • Non-petition language in contracts to which the SPE is a party; and • Separateness The Constitution of Entity Q provides that Entity Q has the sole purpose of conducting the activities necessary to effect the transaction. The Constitution restricts Entity Q from undertaking any activity other than the sole purpose. Entity Q is prohibited from incurring additional debt. Entity Q will have at least one Director appointed to the Board that is an Independent Director. Entity Q is prohibited from selling or otherwise disposing of any relevant property. Entity Q is also prohibited from merging or consolidating with any other entity. The Criteria set out that every agreement between the SPE and a creditor is required to include non-petition language pursuant to which the creditor will agree not to initiate insolvency proceedings against the SPE and not to join any such proceedings. Every agreement between Entity Q and a creditor includes non-petition language in which the creditor agrees not to initiate insolvency proceedings against Entity Q and not to join any such proceedings. The Constitution of Entity Q also contains 'separateness covenants' which are similar to those in the Criteria , that is: '… maintaining separate records, books, accounts, assets, financial statements, stationary, etc. as well as holding itself out to be a separate entity.' The Commissioner accepts that in the circumstances of Entity Q, the 'characteristics' of bankruptcy remoteness in the S&P Criteria are satisfied, and therefore the requirements of paragraph 820-39(3)(c) will in turn be satisfied. Conclusion As each of the requirements set out in paragraphs 820-39(3)(a), (b) and (c) are present in the circumstances of Entity Q, the conditions in subsection 820-39(3) are satisfied.

Reasons for decision: All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.