If schemes include finance provided by a related-party financier or preferred financier, we seek to rule on the tax benefits of those finance arrangements. We also provide product rulings on schemes where participants pay the initial period fees to the manager under a terms agreements ('terms payments'). This helps give certainty to participants on the tax benefits available under the arrangement.
We have had concerns about some finance arrangements and have looked at these in detail. Some finance arrangements are structured in such a way that Part IVA of the ITAA 1936 may apply. This issue was considered by the General Anti-Avoidance Rules Panel (GAAR Panel), which includes a number of external members, and the GAAR Panel strongly agreed with our concerns.
To help promoters structure their arrangement so that it is acceptable to us for participants to claim tax benefits, we have issued financing principles that reduce the likelihood of Part IVA applying. We will issue a product ruling on a tax effective scheme where the financing arrangements described are consistent with these financing principles.
Those financing arrangements that are inconsistent with the financing principles will be subject to a comprehensive consideration of finance terms, which may include a referral to the GAAR Panel. Alternately, those wanting to invest in a scheme with finance terms that are inconsistent with these principles may apply for a private ruling.
We will not issue a product ruling for an arrangement involving non-recourse or limited recourse financing.
Included within the notion of non-recourse or limited recourse financing is any arrangement where, viewed as a whole, the participant is put in a position where they are not personally at risk of having to repay the loan in full.
Financing features that may call into question the potential application of an anti-avoidance tax law include:
- mechanisms to reduce or eliminate the borrower's liabilities to the lender, whether or not legally enforceable
- if repayment of principal and payment of interest is linked to deriving income from the scheme
- 'round-robin' transactions, or equivalent, that do not appear to provide the responsible entity with sufficient funds to be able to carry out its obligations.
It is not sufficient to assert that an arm's-length financier is being used. It is possible to arrange limited-recourse financing from an arm's-length provider by the use of significant security deposits, or other back-to-back arrangements. We will generally need to be satisfied that no such elements are present before we can issue a ruling.
A related-party financier is a financier that is an associate of any of the principal entities taking part in the scheme. This includes financiers associated with the responsible entity, the manager, and the landowner/lessor/licensor of the land. A product ruling will issue if loans offered by such financiers are consistent with all of the following financing principles:
- Loans do not include any interest-only period.
- Loans have a repayment term not exceeding 80% of the term of the scheme or 15 years, whichever is the lesser (for example, the term of the loan cannot exceed eight years for a 10 year scheme and cannot exceed 15 years for a 25 year scheme).
- Loans offered by related-party financiers will be repaid over the term of the loan in equal monthly principal-and-interest repayments.
- The terms and conditions of the loan, including the interest rate, must be commercially comparable to loans being offered by arm's-length lenders in the market.
Note: If a primary production scheme is being promoted by a bank or financial institution, loans offered to participants in that scheme by that bank or financial institution will also be reviewed to determine if they are consistent with the above principles and, if not, will be subject to a comprehensive consideration of finance terms.
A preferred financier is a financier that has entered into a formal or informal arrangement with any entity associated with the scheme, where the financier agrees to consider applications for loans from persons wishing to invest in the scheme.
For a product ruling to be issued, any loans offered by preferred financiers to participants in the scheme must be offered on the same terms as set out above for related-party financiers, save for two variations noted below.
We accept that loans provided by a preferred financier present a lesser risk that Part IVA may apply. As a result, we will issue a product ruling for an arrangement where a preferred financier is offering a relatively short interest-only period within the term of the loan. That is, loans offered by a preferred financier must be consistent with the following financing principles:
- The interest-only period can be 20% of the term of the scheme, up to a maximum of three years.
- The loan term must not exceed 80% of the term of the scheme.
In effect, for a 10-year scheme, the loan term can be no more than eight years, including an interest-only period of two years or less, followed by equal periodic repayments of principal and interest, and based on normal commercial terms.
An external financier is a financier that is not a related-party financier or a preferred financier, as described above.
A finance arrangement entered into between a participant in a scheme and an external financier will not covered by a product ruling. If a participant is able to negotiate a loan with an external financier on more favourable terms than those offered by a related-party financier or a preferred financier, that is a matter between the participant and the external financier. Taxpayers who want certainty on the tax benefits available from such arrangements can apply for a private ruling. The private ruling can then consider all aspects of the financing arrangement as it applies to the participant's investment in the scheme.
Terms payment finance arrangements, in the context of schemes, are typically for a shorter period and are interest-free.
Where the participant is offered an option to pay the initial-period fees to the manager under a terms payment finance arrangement, a product ruling will only issue where those fees are paid in full to the manager within 12 months of the participant entering the scheme. This recognises three things:
- Under a terms payment finance arrangement the manager has not received funds from a financier on behalf of a borrower
- The fees charged by the manager are for services to be provided in the initial period
- The finance arrangement ensures the manager has sufficient funds to carry out the services it has contracted to provide.
This set of guidelines assists promoters to structure their scheme so that we may provide a product ruling. If a terms payment finance arrangement does not satisfy the guidelines, a product ruling will not issue and participants wishing certainty on the tax benefits of the scheme will need to seek a private ruling.
12-month interest-free loans
We recognise that a 12-month interest-free loan, from a related-party financier or a preferred financier, is similar to a terms payment arrangement. A 12-month interest-free loan differs from a terms payment arrangement in that the manager is put 'in funds' by a financier on behalf of a borrower.
If a participant is offered a 12-month interest-free loan from a related party financier or a preferred financier, a product ruling will only issue if the loan is to be repaid in full by the participant within 12 months. The funds to repay the loan cannot be obtained from any further manager loans. This is to ensure that the manager has access to funds to conduct the required activities.
Some schemes have proposed to accept applications subject to the approval of finance. In such cases, the scheme manager proposes to execute scheme agreements and allot identifiable interests to participants on the closing date for applications. The agreements will be expressed to be subject to the provision of finance from third parties.
Where such applications are expressed as being subject to the provision of finance, there will be doubt as to whether there is an existing liability at 30 June, and whether it can be said that the participant has incurred the outgoings subject to finance. See Taxation Ruling TR 97/7 Income tax: section 8-1 – meaning of 'incurred' – timing of deductions.
We also have concerns that financing arrangements may result in the full amount of subscription monies not being immediately available to fund the scheme. If a financing arrangement has been examined, and is acceptable to us based on the circumstances of that particular scheme, that arrangement will be described in the product ruling.
Accordingly, where applications are accepted but subscription monies are not paid in full by 30 June, except under an arrangement approved by us and described in the 'Arrangement' section of a product ruling, we will exclude those participants from the class of persons to whom the ruling applies. This is because it is not possible to conclude with sufficient certainty, that the application of the tax law for those participants will be identical to the application of the tax law for those participants who pay subscription monies in full by 30 June.
We may visit the offices of promoters following the end of the income year to confirm that applications have been accepted and agreements have been executed in accordance with the 'Arrangement' section of the product ruling and the relevant scheme agreements.
Q. Why has the ATO imposed restrictions on internal financiers and preferred financiers?
A. Product rulings are issued to provide certainty to participants who invest in schemes. As part of providing that certainty, we need to ensure that the general anti-avoidance provisions will not apply to the scheme. Our purpose in publishing financing principles is to ensure that promoters have guidance in structuring any financing arrangements associated with a scheme. This should ensure that a product ruling application is dealt with in a timely manner.
Q. How can the ATO decide not to provide product rulings?
A. Product rulings enable us to rule publicly on the availability of claimed tax benefits from 'products'. Being a type of public ruling, product rulings issue under Division 358 of schedule 1 to the Taxation Administration Act 1953. Under these provisions, we have an unfettered right to decide as to whether or not to issue a product ruling in relation to any particular scheme. In the event that we cannot provide certainty to participants regarding their ability to claim tax benefits, we cannot provide a product ruling.
Q. How can the ATO restrict promoters in developing their schemes?
A. We are not restricting promoters from applying for product rulings for schemes that include finance arrangements inconsistent with the financing principles. We have issued guidelines to assist promoters with the development of finance arrangements for which we are more readily able to provide a product ruling and thus participant certainty. Applicants can still apply for a product ruling for schemes with financing arrangements that are inconsistent with the financing principles. However, those arrangements will be the subject of a more thorough examination to ensure participant certainty can be provided through a product ruling. Alternately, individual participants can apply for a private ruling if they want certainty about any finance arrangements they enter into.
Q. How did the ATO decide that it would not provide a product ruling where financing arrangements are inconsistent with the financing principles – for example, the repayment term exceeds 80% of the term of the scheme?
A. The financing principles take into account our concern with some finance arrangements and the views of the GAAR Panel. Financing arrangements that are consistent with the financing principles reduce the likelihood that Part IVA of the ITAA 1936 will apply to the scheme.
Q. Why is the ATO only applying limitations to loans provided by internal and preferred financiers?
A. There is less of a risk of Part IVA of the ITAA 1936 applying where the financier and the finance arrangement are completely unrelated to both the scheme and the scheme entities. Also, because external finance does not form part of the arrangement described in a product ruling, it is not covered by the ruling, including that part of the ruling dealing with Part IVA. Individual participants are able to apply for a private ruling if they want certainty about any external finance arrangements they enter into.
Q. Can promoters set up arrangements with banks and other independent financiers to consider loan applications from applicants to their schemes?
A. Applicants can certainly do this, but in such instances we would see the bank as falling within the description of a 'preferred financier' and the financing principles would need to be considered.
Q. What about the situation where a major bank is both the arranger and the finance provider?
A. We will not be differentiating between banks and any other type of financier. If their relationship to the scheme is that of a related-party financier or preferred financier, the finance arrangements that can be offered to participants will need to be consistent with the financing principles.
Q. If an individual participant can go to an external financier and obtain finance terms that are inconsistent with the financing principles, why are there restrictions only on internal and preferred financiers who may offer participants similar terms?
A. There may be situations where individual participants are able to negotiate finance terms with external financiers that are inconsistent with the financing principles. As external finance does not form part of the arrangement described in a product ruling, it will not be covered by the product ruling, including that part of the ruling dealing with Part IVA. Conversely, as the product ruling covers participants using related-party or preferred financiers and provides a ruling on Part IVA, we are required to form an opinion on the application of Part IVA to the scheme. If we are of the opinion that Part IVA may apply to related-party financier, preferred financier and external financing arrangements (particularly those that are inconsistent with the financing principles) we will not issue a product ruling, because we cannot provide certainty on the application of Part IVA to participants.
Q. How can an individual participant utilising an external financier obtain certainty on the application of Part IVA to their finance arrangements?
Individual participants can apply for a private ruling if they want certainty about any finance arrangements they enter into. The application for a private ruling should detail the individual circumstances of the participant and provide the necessary loan details and supporting documentation to enable us to form an opinion on the tax consequences of the finance arrangement.
Q. What can promoters do if they disagree with the ATO view?
A. Being a type of public ruling, the law does not allow an objection against a product ruling. However, the private rulings system allows promoters to challenge the ATO view in court.
See also:Common issues for product ruling applications for agribusiness projects that are either forestry or non-forestry.