Private ruling: Public private partnership - deductibility of licence payments & application of Division 250 of the Income Tax Assessment Act 1997
Published: July 2012
Ruling period: 1 July 2011 to 30 June 2042 | The scheme will commence on | During the year ended 30 June 2012.

Ruling: Q1: Will the licence payments under the operating licence be deductible to Project Co under section 8-1 of the Income Tax Assessment Act 1997 when they are incurred? | A1: Yes. | Q2: Will Division 250 of the Income Tax Assessment Act 1997 apply to Project Co in relation to its interest in the Project with the State? | A2: No.

Relevant facts and circumstances: General The rulee (Project Co) has been selected by a State Government ("the State") to build, and operate an infrastructure project ("the Project") on State owned land. The business of Project Co will consist of: · During the construction phase, Project Co will construct, manufacture and install the assets that will comprise the Project for the State in consideration of the State making periodic construction payments. · Project Co will manage, operate, maintain and repair the Project during the operations phase, in consideration of the State paying quarterly service payments. Contractual Arrangements Project Co and the State will enter into a deed which specifies each parties' obligations in relation to the Project. Amongst other things, under the deed, Project Co will agree to partially finance, design, construct and commission the Project. In consideration, the State will make construction payments. Project Co and the State will enter into a construction licence agreement, under which the State will grant Project Co a non-exclusive construction licence to enter and occupy the area required for Project construction. Project Co will be required to pay the nominal construction licence payments. Pursuant to the deed, Project Co will not have the right to remove any assets or fixtures from the Project under the construction licence. Project Co will not have legal ownership over any of the assets, including any depreciating assets that comprise the Project. The title to the assets that comprise the Project will always vest in the State. Project Co will not have the option to acquire the Project. Construction Phase Project Co will enter into a construction contract with a building contractor ("the builder). The builder will undertake construction of the Project in return for a construction fee payable by Project Co ("construction fee"). Project Co will use the construction payments it receives from the State, as well as equity funding, to satisfy its contractual payment obligations to the Builder under the construction contract. Project Co will return the construction payments from the State as assessable income in accordance with Taxation Ruling IT 2450 Income Tax: recognition of income from long term construction contracts ("IT 2450"). At no time over the course of the construction phase, or upon completion of the Project, will Project Co have a proprietary interest in the assets that comprise the Project. Project Co's exclusive function up to the time of completion of the Project is to procure the design and construction of the Project. All title to and ownership of the assets, including any depreciating assets that comprise the Project will rest with and remain with the State. Project Co does not have any right to remove any asset that is being constructed under the deed in respect of the licences granted by the State to construct and operate the Project. Project Co will incur expenditures that are business related costs for the purposes of section 40-880 of the ITAA 1997 or are project amounts for the purposes of section 40-840 of the ITAA 1997. Operations Phase - services subcontract Project Co will enter into a services management contract with a company that will operate the Project ("the services contractor") under which it will subcontract to the services contractor its obligations under the deed to manage, operate, maintain and repair the Project ("the Services"). Project Co will make services management payments to the services contractor as consideration for the services contractor performing the Services. Commercial Acceptance At commercial acceptance, the State will licence the completed works to Project Co under an operating licence ("the operating licence"). As consideration for grant of the operating licence, the licence payments will be payable by Project Co to the State. The licence payments do not provide Project Co with rights or title over any assets that comprise the Project. The licence payments will be set at a fixed amount to be paid quarterly. Pursuant to the deed, the operating licence will not provide Project Co with the right to remove assets fixed to the area of land that is subject of the operating licence. However, Project Co will be required to repair and replace the Project assets as part of its obligations to manage, operate, maintain and repair the Project, and for which Project Co will be paid the quarterly service payments by the State. The quarterly service payments will be included in the assessable income of Project Co when derived. Prior to the operating licence being granted, the State will grant Project Co a non-exclusive licence over a part of the Project under which Project Co will have the right to access and operate that part of the Project. Pursuant to the deed, that licence will not provide Project Co with the right to remove assets fixed to the area of land that is the subject of that licence. Project Co will use the quarterly service payments to: · make the services management payments and other operating payments; · pay the licence payments · pay debt service; and · pay returns to investors. There are no other specific sections of the Income Tax Assessment Act 1997 (ITAA 1997) (including Division 230 of the ITAA 1997) or the Income Tax Assessment Act 1936 (ITAA 1936) which prevent Project Co from deducting the licence payments. There are no other specific sections of the ITAA 1997 or the ITAA 1936 which prevent Project Co from deducting the construction fee and services management payments.

Relevant legislative provisions: Section 8-1 of the ITAA 1997 | Paragraph 8-1(1)(a) of the ITAA 1997 | Paragraph 8-1(2)(a) of the ITAA 1997 | Division 40 of the ITAA 1997 | Section 40-40 of the ITAA 1997 | Section 43-75 of the ITAA 1997 | Division 43 of the ITAA 1997 | Section 43-75 of the ITAA 1997 | Division 40-I of the ITAA 1997 | Division 250 of the ITAA 1997 | Section 250-15 of the ITAA 1997 | Section 995-1 of the ITAA 1997

Reasons for decision: Summary: The licence payments will be incurred in gaining or producing Project Co's assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997. The licence payments will not be outgoings of capital, or of a capital nature for the purpose of paragraph 8-1(2)(a) of the ITAA 1997. The licence payments will be deductible to Project Co under section 8-1 of the ITAA 1997 when they are incurred. | Detailed Reasoning - Detailed reasoning: To the extent it is relevant to this scheme, section 8-1 of the ITAA 1997 states: 8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income. 8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or… Will the licence payments be incurred in gaining or producing Project Co's assessable income? The connection between a taxpayer's outgoings and the generation of assessable income was considered in Ronpibon Tin NL and Tongkah Compound NL v FC of T (1949) 78 CLR 47. The High Court stated at 56-57 that: For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income. and: In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income. Under the deed, Project Co must perform its obligations in respect of the Project and provide services for the operating term. In return for performing the services, Project Co will derive as income the quarterly services payments from the State and revenue derived from the public operation of part of the Project. The quarterly services payments and the revenue will be ordinary income derived by Project Co and be included in Project Co's assessable income under section 6-5 of the ITAA 1997. To enable Project Co to perform the Services the State will grant it a right to access the Project in return for the licence payments. Without access to the Project and the payment of the licence payments, Project Co cannot conduct its business and will not be able to provide the services that will produce its assessable income. The licence and the licence payments are integral to the production of Project Co's ordinary income in that they allow Project Co to operate the Project and provide the services in order to derive assessable income. The occasion of the payment of the licence payments is found in what will be productive of Project Co's assessable income. Each licence payment will be an outgoing incurred by Project Co in gaining or producing its assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997. | Detailed Reasoning - Will the licence payments be general deductions?: On that facts of the scheme, none of paragraphs 8-1(2)(b), (c) or (d) of the ITAA 1997 apply to prevent Project Co deducting the licence payments as a general deduction. Accordingly, it is only necessary to consider the application of paragraph 8-1(2)(a) of the ITAA 1997. | Detailed Reasoning - Will the licence payments be outgoings of capital, or of a capital nature?: In Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 ( Sun Newspapers ) at 359 Dixon J said: The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. and at 363: There are, I think, three matters to be considered [in determining whether expenditure is on revenue or capital account], (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play a part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. In considering these matters in Hallstroms Pty Ltd v FC of T (1946) 72 CLR 634 Dixon J said (at 646-647): …it may be useful to recall the general consideration that the contrast between the two forms of expenditure [income and capital] corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it…. What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. and at 648: What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view... In Colonial Mutual Life Assurance Society Ltd v FC of T (1953) 89 CLR 428 at 454 Fullagar J said: The questions which commonly arise in [determining whether expenditure is on revenue or capital account] are (1) What is the money really paid for? - and (2) Is what it is really paid for, in truth and in substance, a capital asset? These propositions have been applied in more recent cases. In FCT v CityLink Melbourne Limited 2006 ATC 4404 (CityLink) the High Court considered the deductibility of concession fees paid by a taxpayer to the State of Victoria in consideration for the right to design, construct, operate and impose a toll in respect of certain City Link roads. The concession fees were payable in two instalments per year and adjusted pro-rata for any part year periods. The majority of the High Court found that the concession fees did not secure any enduring asset in terms of the roads built but, rather, resulted in the acquisition of the right to build, operate and earn a profit from the tolls charged for the use of those roads for the duration of the concession period. Crennan J (with whom Gleeson CJ, Gummow J, Callinan J and Heydon J agreed) applied the 'three matters' laid down by Dixon J in Sun Newspapers in determining that 'concession fees' paid to the State in respect of a public private partnership arrangement were on revenue account and stated at 4427 that: The characterisation of an outgoing depends on what it is calculated to effect to be judged from a practical and business point of view .. [and] .. [t]he character of the advantage sought by the making of the expenditure is critical. In particular, Crennan J noted, at paragraph 154: The concession fees are only payable during the term of the concession period. The respondent does not acquire permanent ownership rights over the roads or lands used. All rights granted under the Concession Deed revert to the State at the expiry of the concession period [cf Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 14]. Unlike periodic instalments paid on the purchase price of a capital asset, the concession fees are periodic licence fees in respect of the Link infrastructure assets, from which the respondent derives its income, but which are ultimately "surrendered back" to the State. Accordingly, they are on revenue account. In FC of T v Star City Pty Ltd (2009) FCR 39 at 51-52 Goldberg J said: The primary judge correctly identified the relevant principles to apply in determining whether [the outgoing] was an item of revenue or of capital and in determining the character of the advantage sought and the characterisation of the [outgoing]. In particular, the primary judge observed that an examination of the character of the advantage sought was assisted by asking two questions: What was the [outgoing] really paid for; and, is what it was really paid for, in truth and in substance, a capital asset? Her Honour accepted that the answer to these questions…depended upon what the expenditure was calculated to effect from a practical and business point of view. The character of the advantage sought provides important guidance as to the nature of the expenditure because it says the most about the essential character of the expenditure itself. The decision of the High Court in GP International Pipecoaters Pty Ltd v Commissioner of Taxation (1990) 170 CLR 124 at 137; (1990) 90 ATC 4413 at 4419; (1990) 21 ATR 1 at 7 emphasised this, stating: The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd. and Associated Newspapers Ltd. v Federal Commissioner of Taxation (1938) 61 C.L.R 337, at p.363 .... In relation to the character of the advantage sought by the expenditure it is necessary to examine whether the expenditure secures an enduring benefit for the business. This test was outlined in British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 at 213 - 214 by Viscount Cave where he stated: But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital. When the matters stated by Dixon J in the Sun Newspapers Case are considered, the character of the advantage sought by making the expenditure is the chief, if not the critical factor in determining the character of what is paid. The nature or character of the expenditure will therefore follow the advantage that is sought to be gained by incurring the expenditure. If the advantage to be gained is capital or of a capital nature, then the expenditure incurred in gaining the advantage will also be capital or of a capital nature. The licence payments Project Co incurs are, from a practical and business point of view, expenditure calculated to effect Project Co's provision of its services to fulfil its obligations under the deed to design, construct and commission the Project. Each licence payment will secure for Project Co the right to access and use the Project to provide the Services for the period to which the licence payment relates. The character of the advantage sought by Project Co is the fulfilment of its obligations to deliver the Services to the State under the deed, allowing derivation of its ordinary business income. Each licence payment will be a recurring expense of Project Co and will represent an outgoing in the ordinary course of carrying on Project Co's business rather than an outgoing to establish its business organisation or structure. This advantage will not have any lasting quality or enduring benefit beyond the period to which the licence payment relates. Each licence payment will be a recurring expense of Project Co. Each licence payment will be on revenue account, or of a revenue nature. | Summary: Division 250 of the ITAA 1997 will not apply to Project Co as it is not entitled to a capital allowance in relation to the decline in value of an asset or expenditure in relation to an asset in relation to its interest in the project. | Detailed Reasoning - Detailed reasoning: The general test for application of Division 250 of the ITAA 1997 is set out in section 250-15 of the ITAA 1997; it provides that the Division will apply to you 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 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 you lack a predominant economic interest in the asset at that time. As the conditions in paragraphs 250-15(a)-(e) of the ITAA 1997 must each be met for the general test to be satisfied, not meeting one of the conditions is sufficient to conclude that the general test is not satisfied and, accordingly, that Division 250 of the ITAA 1997 does not apply. A capital allowance is defined in subsection 995-1(1) of the ITAA 1997 as: capital allowance means a deduction under: (a) Division 40 (capital allowances) of this Act; or (ab) Division 43 (capital works) of this Act; or …. Deductions for capital allowances are only available if the taxpayer is the holder of a depreciating asset. The table in section 40-40 of the ITAA 1997 explains how to work out who holds a depreciating asset. On the facts, only items 3 and 10 of the table have potential application. On the facts, Project Co will not be the legal owner of any depreciating assets in relation to its interest in the Project. Accordingly, it will not be a holder of any assets in relation to the Project under Item 10 of the table in section 40-40 of the ITAA 1997. Item 3 of the table in section 40-40 of the ITAA 1997 broadly provides that where the depreciating asset is an improvement to land subject to a quasi-ownership right then the owner of the quasi-ownership right (while it exists) will be the holder of the depreciating asset if the improvement to land was made or itself improved by the owner of the quasi-ownership right for their own use (but only where they do not have the right to remove the asset). ATO Interpretative Decision 2005/278 Income Tax Capital Allowances: - hold - depreciating asset constructed by a contractor (ATO ID 2005/278) provides that a taxpayer that carries on a construction business and that has entered into an arrangement for the construction of a facility for which a lump sum construction payment is received will not hold the depreciating assets it has constructed for the purposes of item 3 of the table in section 40-40 of the ITAA 1997. In this case, the State, in making the Construction Payments, incurs capital expenditure in return for the carrying out by Project Co of the design and construction services on the land that the State owns. The State, and not Project Co, receives the enduring benefit of the improvements including any depreciating assets constructed. It has engaged Project Co to improve the land which enables it to enter into the subsequent operation and maintenance contractual arrangements. The State is therefore the entity that has enabled itself, by the construction payments to access the economic benefits of the constructed depreciating assets. Consistent with the principle in ATO ID 2005/278, it is the State that has 'made' the improvements to the land for the purpose of item 3 of the table in section 40-40 of the ITAA 1997. The Construction Payments will constitute assessable income of Project Co and will be returned by it as income in accordance with IT 2450 whereby expenditure incurred in construction will be calculated in determining the profit that will constitute assessable income of Project Co. Project Co is providing design and construction services on revenue account and will not incur capital expenditure in relation to the project. As such, Project Co would not be entitled to any deduction for the decline in value of depreciating assets under Division 40 of the ITAA 1997. ATO Interpretative Decision 2005/277 Income Tax Capital Works: construction area expenditure (ATO ID 2005/277) provides that a taxpayer that does not incur capital expenditure in constructing works does not have a 'construction expenditure area' of capital works for the purpose of section 43-75 of the ITAA 1997. Project Co has been contracted to provide construction services on revenue account. It will receive the construction payments and will account for construction expenditure in the calculation of profit that will constitute income in accordance with IT 2450. Consistent with the principle in ATO ID 2005/277, it will not have a construction expenditure area of capital works for the purposes of section 43-75 of the ITAA 1997 and will not be entitled to any capital works deductions under Division 43 in relation to its interest in the Project. ATO Interpretative Decision 2010/31 Income Tax Division 250: assets put to tax preferred use (ATO ID 2010/31) addresses the circumstance where a taxpayer that is not entitled to a capital allowance under Division 40 or Division 43 of the ITAA 1997 in relation to assets which are being put to tax preferred use is, however, entitled to a capital allowance under Subdivision 40-I of the ITAA 1997 in relation to certain other capital expenditure it incurs. On the facts, Project Co will incur capital expenditures that are business related costs for the purposes of section 40-880 of the ITAA 1997 or are project amounts for the purposes of section 40-840 of the ITAA 1997. ATO ID 2010/31 provides that such expenditure by itself will not give rise to a separate asset to which Division 250 of the ITAA 1997 can apply. Project Co's expenditure will not entitle it to a capital allowance in relation to the decline in value of an asset for the purposes of subparagraph 250-15(d)(i) of the ITAA 1997. Consistent with the principle in ATO ID 2010/3, for the purposes of subparagraph 250-15(d)(ii) of the ITAA 1997 the expenditures Project Co incurs that are business related costs for the purposes of section 40-880 of the ITAA 1997 or project amounts for the purposes of section 40-840 of the ITAA 1997 are not in relation to an asset for which Project Co will be entitled to a capital allowance under either Division 40 or 43 of the ITAA 1997. As Project Co will not be entitled to a capital allowance under Division 40 or Division 43 of the ITAA 1997 in relation to a decline in value of an asset or expenditure in relation to an asset in relation to its interest in the Project, the condition at paragraph 250-15(d) of the ITAA 1997 will not be satisfied. It follows that Division 250 of the ITAA 1997 will not apply. In that circumstance, it is unnecessary to consider paragraphs 250-15(a), (b), (c) or (e) of the ITAA 1997.

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