The income tax implications for each special purpose entity in the standard form model of the social infrastructure PPP are detailed below.
Finance Co income tax implications
External loans/facility agreements entered by Finance Co and third-party financiers (alternatively referred to as D&C financiers and O&M financiers)
The income tax implications are as follows:
- Subject to thresholds, the Taxation of Financial Arrangements (TOFA) rules apply under section 230-45 of the Income Tax Assessment Act 1997 (ITAA 1997).
- There will be a loss from those arrangements under TOFA to the extent that the payments made to the financiers reflect a return on those financiers’ investment.
- Unless Finance Co makes an election under Division 230 of ITAA 1997, the accruals or realisation method in Subdivision 230-B will apply to the loss.
- Except in unusual circumstances (such as the project’s viability being unclear, or the government potentially defaulting on its obligations), the accruals method would apply to that loss.
- We will generally accept that the TOFA accruals method could be satisfied by Finance Co relying on the effective interest method as defined in Accounting Standard AASB 9 (which supersedes AASB 139), provided this is applied consistently by Finance Co across its financial arrangements.
- The interest payable on these loans may qualify for section 128F of the Income Tax Assessment Act 1936 (ITAA 1936) withholding tax-free status in some circumstances. The requirements of section 128F include, but are not limited to, the offer being properly and widely made, and not being made to one or more 'associate' lenders or 'associates' of the company. We may examine whether withholding tax-free status pursuant to section 128F applies.
D&C Loan entered by Finance Co and Project Trust
The income tax implications are as follows:
- Subject to thresholds, the TOFA rules apply.
- There will be a gain for Finance Co from that arrangement under TOFA, to the extent that the payments made to Finance Co reflect a return on its investment.
- Unless Finance Co makes an election under Division 230 of ITAA 1997, the accruals or realisation method in Subdivision 230–B will apply to the gain.
- Except in unusual circumstances (such as the project’s viability being unclear, or the government potentially defaulting on its obligations), the accruals method would apply to that gain.
- We will generally accept that the TOFA accruals method could be satisfied by Finance Co relying on the effective interest method as defined in Accounting Standard AASB 9 (which supersedes AASB 139), provided this is applied consistently by Finance Co across its financial arrangements.
Securitisation agreement entered by Finance Co and the government
The income tax implications are as follows:
- Subject to thresholds, the TOFA rules apply as though
- the receivables purchase payment was the equivalent of a principal investment, and
- the securitised licence payments were the equivalent of the repayment of that principal with interest.
- This means that there should be a gain to which the accruals method under TOFA will apply (unless the unusual circumstances mentioned above arise).
- As with the above, we generally accept that the TOFA accruals method could be satisfied by Finance Co relying on the effective interest method as defined in Accounting Standard AASB 9 (which supersedes AASB 139), provided this is applied in a consistent manner across its financial arrangements.
Thin capitalisation
- The thin capitalisation rules may not apply to Finance Co where an exemption under section 820-39 of ITAA 1997 is available, even if the consortium members are non-residents. Refer to the thin capitalisation section for more details.
The equalisation swap entered by Finance Co and Project Trust
The income tax implications are as follows:
- Under the equalisation swap
- net receipts of Finance Co will be assessable income, and
- net payments made by Finance Co will be deductible.
- For completeness, we have general concerns with the use of swaps and other instruments which shift economic returns between entities. Specific guidance should be sought in relation to swaps outside this limited context.
Project Trust income tax implications
Construction payments and availability payments received by Project Trust from the government
The income tax implications are as follows:
- These are assessable, under section 6-5 of ITAA 1997, to Project Trust on the basis that both payments constitute ‘income’ according to ordinary concepts in the hands of Project Trust. They are not capital in nature.
- The TOFA rules do not apply to either payments because they involve the obligation to procure the design and construction of the infrastructure.
- In determining the timing recognition of assessable income, a method of accounting which has the effect of allocating, on a reasonable basis, the ultimate profit or loss made by Project Trust in relation to the construction over the years taken to complete the construction will be acceptable. This is consistent with the ideas and principles set out in Taxation Ruling TR 2018/3 Income tax: tax treatment of long-term construction contracts. However, the conditions and provisos around the reasonability and consistency of the method chosen as set out in TR 2018/3 would similarly apply in this situation.
- To avoid doubt, the profit on the construction (if any) should be assessable over the construction phase, not over the term of the overall project.
- We would expect once an acceptable method has been adopted for Project Trust, it is to be applied consistently to all income years.
Payments made by Project Trust to the D&C and O&M subcontractors
The income tax implications are as follows:
- The payments to the subcontractors are made for Project Trust to fulfil its contractual obligations to build and operate the infrastructure assets, and thus earn the assessable income referred to above. Therefore, the expenditure should fall within the first limb of section 8-1 of ITAA 1997.
- Additionally, the incurring of the construction costs will not result in any tangible asset or enduring benefit for Project Trust because it is not the legal owner of the infrastructure asset (legally the government owns the relevant asset).
- Therefore, the expenditure should not fall within the capital-related negative limb of section 8-1 of ITAA 1997, and as a result, will remain deductible to Project Trust.
- In relation to the timing of deductions for payments made to the D&C contractor, it is acceptable, as described above, to allocate, on a reasonable basis, the ultimate profit or loss made by Project Trust over the years taken to complete the construction.
The licence payments made by Project Trust to the government
The income tax implications are as follows:
- The licence payments are purportedly made periodically to secure Project Trust’s ongoing right to access the land. The payments will be set at a level able to be sold (securitised) by the government to fund the construction cost. The ATO will not seek to challenge the licence characterisation, provided the standard form securitised licence structure described above is followed.
- With respect to their deductibility, the recurrent licence payments meet Project Trust’s continuous need to access the land and do not enlarge Project Trust’s profit-yielding structure or secure any enduring benefit. As a result, the expenditure should not fall within the capital-related negative limb of section 8-1 of ITAA 1997 and should therefore be deductible.
Capital allowance under Division 40 of ITAA 1997
The income tax implications are as follows:
- Project Trust will not be entitled to capital allowances under Division 40 of ITAA 1997 because it will not ‘hold’ any depreciating assets under section 40-40.
- Neither will there be deductions under Division 43 of ITAA 1997 because neither the payments to government nor the subcontractors constitute capital expenditure (subsection 43-70(1)).
- The fact that there are no capital allowances also means that Division 250 of ITAA 1997 has no application (subsection 250-15(d)).
The equalisation swap entered by Finance Co and Project Trust
The income tax implications are as follows:
- Under the equalisation swap
- net receipts of Project Trust will be assessable income, and
- net payments made by Project Trust will be deductible.
- For completeness, we have general concerns with the use of swaps and other instruments which shift economic returns between entities. Specific guidance should be sought in relation to swaps outside this limited context.
Other tax considerations
Part IVA
Subject to the provisos outlined in this guidance, the Commissioner would not generally apply compliance resources to the application of Part IVA of ITAA 1936 to the standard form securitisation PPP arrangement outlined in this guidance. This is not confirmation that the Commissioner will never look to apply Part IVA of ITAA 1936 to transactions adopting the above 'standard' social infrastructure PPP structure.
The following aspects arising in relation to a standard form transaction structure would generally not attract our compliance resources:
- The application of the exemption for special purpose entities in section 820-39 of ITAA 1997 to Finance Co.
- Project Trust securing greater deductions under section 8-1 of ITAA 1997 than the deductions it would have obtained under Divisions 40 and 43 of ITAA 1997 under a counterfactual in which Project Trust
- constructs the assets
- retains title to it (or otherwise holds it for capital allowances purposes), and
- transfers it to the government at the end of the O&M phase.
However, there may be aspects of the pricing, terms and conditions of the transactions, as well as the wider circumstances, that cause us to consider the application of Part IVA of ITAA 1936 to a standard form structure. Without limitation, we consider that increased scrutiny and possible compliance activity may be warranted where:
- the tax outcomes as between Project Trust and Finance Co are asymmetric
- there are material timing differences in the recognition of assessable income or allowable deductions
- there is inconsistent or non-arm’s-length pricing of arrangements between those entities.
We are also concerned if your arrangement uses, or seeks to use, existing cash flows (referred to as a 'fabricated PPP arrangement').
We discourage taxpayers from entering into structures or transactions that depart from the standard form structure other than the 2 variations outlined later in this guidance.
However, we acknowledge that there may be other proposed variations to the standard form structure. If such variations are to be proposed, we would want to understand their nature and commercial rationale and expect that you would approach us to discuss your proposal.
Thin capitalisation – Section 820-39 of ITAA 1997
Section 820-39 of ITAA 1997 exempts certain bona fide securitisation and origination entities from the application of the thin capitalisation rules.
Taxation Determination TD 2014/18 Income tax: can the exemption in section 820-39 of the Income Tax Assessment Act 1997 apply to the special purpose finance entity established as part of the 'securitised licence structure' used in some social infrastructure Public Private Partnerships? acknowledges, in certain circumstances, the exemption in section 820-39 of ITAA 1997 may apply to entities in the position of Finance Co, that is, to special purpose finance entities established as part of the ‘securitised licence structure’ used in some social infrastructure PPPs.
The application of the section 820-39 exemption in this context is subject to 4 important qualifications as follows:
- Paragraph 820-39(3)(a) of ITAA 1997 is satisfied in the situation outlined in TD 2014/18 because Finance Co is investing in securitised licence payments. If Finance Co did not invest in a securitised cash flow or did anything in addition to investing in a securitised cash flow, then TD 2014/18 could not be relied on.
- The total value of the debt provided to Finance Co must be at least 50% of the total value of Finance Co's assets to satisfy paragraph 820-39(3)(b). This will mean that a variation where equity is invested into Finance Co may mean Finance Co is no longer exempt from the thin capitalisation rules.
- For paragraph 820-39(3)(c) of ITAA 1997 to be satisfied, Finance Co must be an 'insolvency-remote special purpose' entity according to criteria of an internationally recognised rating agency that are applicable to its circumstances. Where the applicable rating agency criteria apply to both Project Trust and Finance Co on a consolidated project basis, the ATO would expect the analysis of insolvency-remoteness to be undertaken in relation to both entities, and not merely in relation to Finance Co on a stand-alone basis.
- The ATO considers there to be a high risk of non-compliance in circumstances of any variation to the above transaction where Project Trust provides any form of financing to Finance Co, or where the investors or any related party of the investors provide any form of financing directly or indirectly through interposed entities to Finance Co. Such a variation may put Finance Co outside the scope of TD 2014/18 and the requirements of paragraphs 820-39(3)(a) and 820-39(3)(c) of ITAA 1997. Further, where it appears that Project Trust is providing financing to Finance Co for the dominant purpose of obtaining a tax benefit, Part IVA of ITAA 1936 may also apply in such a case.