Senate

Tax Laws Amendment (2007 Measures No. 5) Bill 2007

Tax Laws Amendment (2007 Measures No. 5) Act 2007

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)
This memorandum takes account of amendments made by the House of Representatives and to the Bill as introduced.

Chapter 1 - Tax preferred entities (asset financing)

Outline of chapter

1.1 Schedule 1 to this Bill amends the income tax law to modify the taxation treatment of leasing and similar arrangements between taxpayers and tax preferred end users (such as tax-exempt entities and non-residents) for the financing and provision of infrastructure and other assets.

1.2 Division 250 of the Income Tax Assessment Act 1997 (ITAA 1997) will apply to a taxpayer if, broadly:

·
a tax preferred end user directly or indirectly uses, or effectively controls the use of, an asset; and
·
the taxpayer does not have the predominant economic interest in the asset.

1.3 Certain relatively short-term and lower value arrangements are specifically excluded from the scope of Division 250.

1.4 If Division 250 applies to an arrangement, capital allowance deductions will be denied and the arrangement will be treated as a deemed loan that is taxed as a financial arrangement on a compounding accruals basis.

Context of amendments

1.5 Section 51AD and Division 16D of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) were enacted in the 1984-85 income year to deny access to tax benefits (such as deductions for capital expenditure) in relation to property used by or for tax-exempt entities (including non-residents).

1.6 A general principle of the income tax law is that, in order to claim deductions for expenditure relating to ownership of an asset (such as capital allowances), the owner must show that the asset is used for the purpose of producing assessable income or in carrying on a business for that purpose.

1.7 Arrangements were developed to circumvent this principle. While the taxpayer was the legal owner of the asset and derived assessable income through rental of the asset, arrangements developed under which the taxpayer transferred some or all of the risks and benefits associated with ownership of the asset to the entity that was the 'real' or 'end' user of the asset. This end user was typically either a government body whose income was exempt from tax or a non-resident that used the asset outside Australia for the purpose of producing income that was exempt from Australian tax (ie, in both cases, a 'tax-exempt entity').

1.8 Often the arrangements between the taxpayer and the tax-exempt entity took the form of a finance lease with, in some cases, a predetermined payment for the asset at the end of the arrangement period. The tax-exempt entity effectively guaranteed the taxpayer a return of the taxpayer's investment in the relevant asset. Thus, the taxpayer was effectively lending money to the tax-exempt entity and had little or no interest in the economic performance of the asset - that is, the taxpayer was essentially the legal but not the economic owner of the asset.

1.9 The tax advantages of such arrangements flowed from tax deferral in a low risk setting. The tax deferral arose from the profile of taxable income over the arrangement. A typical situation was the existence of tax losses in the early years of an arrangement. These tax losses were created by the annual deductions related to the asset (such as capital allowance deductions and interest deductions) being greater than the predetermined annual income under the arrangement. The taxpayer could use these losses to offset assessable income from other sources. While income in later years might exceed allowable deductions, in present value terms the arrangement was tax advantaged.

1.10 Part of the tax benefit from the arrangement was generally passed back to the tax-exempt entity through lower finance charges, thereby lowering the cost to the entity of using the relevant asset.

1.11 Section 51AD was designed to operate as an 'anti-avoidance' provision against this background because the large scale nature of the arrangements posed a significant threat to the revenue base. Section 51AD effectively prevents a tax-exempt body from accessing tax benefits in relation to an asset it uses or effectively controls that is financed by highly leveraged non-recourse debt. If section 51AD applies to an arrangement, the taxpayer is assessed on all the proceeds derived from the arrangement but is denied access to all deductions in respect of the asset (such as capital allowances and interest deductions).

1.12 Division 16D operates to deny capital allowance deductions for the cost of, or capital expenditure on, property which a tax-exempt body uses or effectively controls under a finance lease or similar arrangement. Division 16D does not apply where section 51AD applies. If Division 16D applies, the arrangement is treated as a loan and payments made under that arrangement are treated as having an interest and principal component. If the asset is not transferred to the tax-exempt end user at the end of the arrangement, then an unrealised loss is effectively allowed for any excess of loan principal over the value of the asset at the end of the arrangement.

1.13 The amendments will replace section 51AD and Division 16D of Part III of the ITAA 1936 with Division 250 of ITAA 1997. Division 250 will improve the taxation regime for asset financing arrangements between taxpayers and the tax-exempt sector as:

·
the harsh impact of section 51AD will be removed;
·
certain relatively short-term and lower value arrangements will be specifically excluded from the scope of the regime; and
·
arrangements which come within the scope of the regime will be taxed as a financial arrangement on a compounding accruals basis.

Summary of new law

1.14 Division 250 will apply to a taxpayer if, broadly:

·
an asset is being put to tax preferred use;
·
the taxpayer is entitled to capital allowances in relation to the asset; and
·
the taxpayer does not have the predominant economic interest in the asset.

1.15 An asset is being put to tax preferred use if a tax preferred end user directly or indirectly uses, or effectively controls the use of, the asset.

1.16 The taxpayer does not have the predominant economic interest in the asset if:

·
more than 80 per cent (or 55 per cent for non-residents) of the cost of acquiring or constructing the asset is financed by limited recourse debt;
·
a member of the tax preferred sector has a right to acquire the asset at the end of the arrangement period for consideration that does not reflect the market value of the asset;
·
the arrangement is effectively non-cancellable and the arrangement period exceeds the lesser of 30 years or 75 per cent of the remaining effective life of the asset; or
·
either:

-
the asset has a guaranteed residual value;
-
the arrangement is a debt interest; or
-
the sum of the present value of financial benefits provided in relation to the tax preferred use of the asset exceeds 70 per cent of the adjustable value of the asset.

1.17 Certain relatively short-term and lower value arrangements are specifically excluded from the scope of Division 250. That is, the Division will not apply to a taxpayer if, broadly:

·
the arrangement period does not exceed 12 months;
·
the taxpayer is a small business entity for the income year in which the arrangement starts;
·
the financial benefits that are reasonably expected to be provided by the tax preferred sector do not exceed $5 million; or
·
the arrangement satisfies certain operating and finance risk tests, and:

-
the arrangement period does not exceed three years (or five years if the arrangement is a lease of real property);
-
the financial benefits that are reasonably expected to be provided by the tax preferred sector do not exceed $30 million (or $50 million if the arrangement is a lease of real property); or
-
the total values of assets put to tax preferred use do not exceed $20 million (or $40 million if the arrangement is a lease of real property).

1.18 If Division 250 applies to an arrangement, capital allowance deductions will be denied and the arrangement will be treated as a deemed loan that is taxed as a financial arrangement on a compounding accruals basis.

Comparison of key features of new law and current law

New law Current law
Division 250 applies where, broadly:

·
a tax preferred end user directly or indirectly uses, or effectively controls the use of, an asset; and
·
the taxpayer does not have the predominant economic interest in the asset.


Certain relatively lower value and short-term arrangements are specifically excluded from the scope of Division 250.
If Division 250 applies, capital allowance deductions are denied and the arrangement is treated as a deemed loan that is taxed as a financial arrangement on a compounding accruals basis.
Section 51AD applies where, broadly:

·
a tax preferred end user directly or indirectly uses, or effectively controls the use of, an asset; and
·
the property is financed predominantly by non-recourse debt.


If section 51AD applies, deductions (such as capital allowances and interest deductions) are denied and all the proceeds from the arrangement are assessable.
Division 16D of Part III applies where, broadly:

·
a tax preferred end user directly or indirectly uses, or effectively controls the use of, an asset;
·
the taxpayer does not have the predominant economic interest in the asset; and
·
section 51AD does not apply.


If Division 16D applies, capital allowance deductions are denied and the arrangement is treated as a deemed loan that is taxed on a cash receivables basis.

Detailed explanation of new law

Objects of Division 250

1.19 The main objects of Division 250 are:

·
to deny or reduce capital allowance deductions in respect of an asset if the asset is put to a tax preferred use and the taxpayer has insufficient economic interest in the asset; and
·
if capital allowance deductions are denied or reduced, to treat the arrangement for the tax preferred use of the asset as a loan that is taxed as a financial arrangement (on a compounding accruals basis).

Schedule 1, item 1, section 250-5]

1.20 Division 250 will replace section 51AD and Division 16D of Part III of the ITAA 1936. Changes to the wording or the style used in the replacement provisions in Division 250 do not change the objectives of the law as it currently operates under section 51AD and Division 16D of Part III of the ITAA 1936 (see section 1-3 of the ITAA 1997).

Some key concepts

1.21 Key concepts that are central to the operation of Division 250 are:

·
the asset that Division 250 applies to;
·
who is the end user of the asset;
·
what is a lease;
·
what is a tax preferred entity;
·
what is a tax preferred end user;
·
who are members of the tax preferred end user group;
·
who are members of the tax preferred sector; and
·
what are financial benefits.

Division 250 applies in respect of an asset

1.22 Division 250 applies to a taxpayer in respect of an asset. For these purposes:

·
Division 250 applies to an improvement to land or to a fixture on land, whether the improvement or fixture is removable or not, as if it were an asset separate from the land;
·
it is a matter of fact and circumstance as to whether a particular composite item is itself an asset or whether its components are separate assets;
·
Division 250 applies to a renewal or extension of an asset that is a right as if the renewal or extension was a continuation of the original right. This ensures that Division 250 will apply consistently with Division 40 (subsection 40-3(5)) to one asset rather than several assets; and
·
Division 250 applies to an asset (an underlying asset) in which both a taxpayer and one or more other entities have an interest as if the taxpayer's interest in the underlying asset were itself the underlying asset.

[Schedule 1, item 1, section 250-75]

1.23 The identification of the relevant asset is a question that needs to be determined on the facts and circumstances of a particular case. The existing practice of the Commissioner of Taxation (Commissioner) for determining this question will apply for the purposes of Division 250.

Who is the end user of an asset?

1.24 An entity (other than the taxpayer) is an end user of an asset if the entity (or a connected entity):

·
uses, or effectively controls the use of, the asset;
·
will use, or effectively control the use of, the asset;
·
is able to use, or effectively control the use of, the asset; or
·
will be able to use, or effectively control the use of, the asset.

[Schedule 1, items 1 and 6, subsection 250-50(1) and definition of 'end user' in subsection 995-1(1) of the ITAA 1997]

1.25 For these purposes, the control of the asset may be direct control or indirect control. [Schedule 1, item 1, subsection 250-50(2)]

1.26 An entity will not be taken to be the end user of an asset if that entity takes control of the asset temporarily for the purpose of ensuring public health or safety, protecting the environment or continuing the supply of an essential service. [Schedule 1, item 1, subsection 250-50(3)]

1.27 The question as to whether an entity takes control of the asset temporarily for the purpose of ensuring public health or safety, protecting the environment or continuing the supply of an essential service needs to be determined on the facts and circumstances of a particular case.

Example 1.1 A statutory authority enters into a concession arrangement with a JF Co, a private sector transport company, for the supply of transport to a city. Under the arrangement, the statutory authority has step-in rights to temporarily take control of the assets in the event of default. As these rights are temporary rights for the purpose of ensuring the supply of an essential service, the statutory authority will not be taken to be the end user of those assets under section 250-50 merely because of the step-in rights.

1.28 To avoid doubt, an entity is taken to be an end user of an asset if the entity (or a connected entity) holds rights as a lessee under a lease of the asset. [Schedule 1, item 1, subsection 250-50(4)]

1.29 Section 250-50 explains the relationship that must exist between an entity and an asset for the entity to be the end user of the asset. However, Division 250 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.

1.30 To determine whether an entity effectively controls the use of an asset, it is necessary to examine the whole commercial arrangement, including the financial arrangements, surrounding the ownership and operation of the asset. This question ultimately turns on the facts and circumstances of each particular case.

1.31 One key factor that is relevant in determining the question is the day-to-day operations surrounding the ownership and operation of the asset (including staffing arrangements). For example, if the tax preferred entity, rather than the taxpayer, has responsibility for the day-to-day operations of the arrangement (including the power to employ and direct staff), that would be factor that would indicate that the tax preferred entity effectively controls the use of an asset.

1.32 A second key factor that is relevant in determining the question is the financial arrangements relating to the acquisition of the asset, the output generated by the asset and the purchase of inputs needed to operate the asset. In this regard, particular arrangements that may be encountered that might suggest that a tax preferred entity, rather than the taxpayer, effectively controls the use of an asset include:

·
fixed return charges whereby the tax preferred entity agrees to buy the output of the taxpayer's asset on a fixed return basis;
·
fixed fee arrangements whereby the tax preferred entity agrees to pay a minimum or maximum regular fixed amount to the taxpayer regardless of the amount of output actually supplied;
·
an agreement to transfer ownership of the asset to the tax preferred entity after a specified number of years, or an option for the tax preferred entity to acquire the asset at a future time; and
·
contracts for the supply of inputs by the tax preferred entity to the taxpayer that do not reflect arm's length prices and a relatively long supply period.

1.33 While any of these factors may be present in any particular arrangement, no one factor will necessarily be decisive of the question of control.

1.34 Division 250 applies a test of effective control that is consistent with the test in section 51AD and Division 16D. In addition, because Division 250 contains specific exclusions and has more generous safe harbour tests, it is likely that Division 250 will have a narrower scope than section 51AD and Division 16D.

Example 1.2 Nu Co, a taxable Australian company, enters into an arrangement with a state government (a tax preferred entity) to build and operate a hospital for a period of 20 years. Under the arrangement, Nu Co must comply with the directions of the state government in relation to the building and operation of the hospital. If Nu Co fails to comply with the state government's directions, the state government can step in and take control over the operation of the hospital. In these circumstances, the state government will be taken to be the end user of the hospital under section 250-50.

1.35 If the arrangement is primarily for the provision of services, the taxpayer (rather than the service recipient) would generally have control of the use of the assets used to provide the services (and therefore the arrangement would generally be outside the scope of Division 250).

1.36 An entity will generally not be taken to be the end user of an asset under section 250-50 merely because an asset reverts to entity at the end of the arrangement period.

Example 1.3 Coal Co is a subsidiary of a publicly listed mining company and has developed a coal mine to supply thermal coal to a neighbouring power station. It is the owner and manager of the mine. Coal Co has all the day-to-day operational control over the coal mine and carries all the commercial risks associated with the operation of the mine.The power station is owned and managed by State Power Co (which is a tax-exempt entity wholly-owned by a state government).A long-term coal supply agreement is entered into with State Power Co prior to the construction of the mine. The coal supply agreement is executed between Coal Co and State Power Co requiring five million tonnes of coal to be supplied to State Power Co each year. A set price per tonne is negotiated between the parties. This price remains in place for the entire period of the agreement, but is indexed each year by movements in the consumer price index. The long-term price provides an appropriate risk weighted return on Coal Co's assets. There is an opportunity for either party to seek a renegotiation of the price every five years. There is no take or pay obligation, but ordinary rights exist for both parties to sue for damages if either party does not meet its obligations under the contract. The coal supply agreement is not classified as a lease for accounting purposes.The question as to whether State Power Co effectively controls the use of Coal Co's assets can only be determined having regard to all the facts and circumstances of the particular arrangement. The terms of the coal supply agreement between Coal Co and State Power Co is one factor that needs to be considered in determining this question but, by itself, would not lead to the conclusion that Division 250 applies to the arrangement. Other features of the arrangement, such as the fact that Coal Co maintains the day-to-day control over the operation of the assets, are also relevant in determining where effective control lies.Even if the conclusion is reached that State Power Co effectively controls the use of Coal Co's assets, Division 250 would not apply to those assets if, because of the operation of the safe harbour tests, Coal Co does not lack a predominant economic interest in the assets. Example 1.4 Gas Co owns a number of petroleum leases from which it extracts coal bed methane gas. It has also built a gas production facility, from which it processes the gas and distributes it into a gas pipeline owned by a private sector infrastructure trust. Gas Co has all the day-to-day operational control over the gas production facility and carries all of the commercial risks associated with the operation of the facility.Gas Co has entered into a long-term gas supply agreement with State Energy Co (which is a tax-exempt entity wholly-owned by a state government). State Energy Co takes the gas from the pipeline and on-sells it to a number of industrial users.Under the gas supply agreement, State Energy Co must take or pay for 70 per cent of the output of Gas Co's facility. The price agreed is contained in a formula, which includes a fixed capacity charge, a variable charge based on output taken, and a profit margin. The price negotiated between the parties provides an appropriate risk weighted return on Gas Co's assets. The gas supply agreement is not classified as a lease for accounting purposes.A take or pay arrangement is an agreement between a purchaser and a seller that provides for the purchaser to pay specified amounts periodically in return for products or services. The purchaser must make the specified minimum payments even if it does not take delivery of the contracted products or services. In this regard, the take or pay arrangement between Gas Co and State Energy Co is a fixed fee arrangement that is not dependant on the output actually supplied by Gas Co to State Energy Co and therefore exhibits features which may indicate that State Energy Co effectively controls the use of Gas Co's assets.However, the question as to whether State Energy Co effectively controls the use of Gas Co's assets can only be determined having regard to all the facts and circumstances of the particular arrangement. The terms of the take or pay arrangement between Gas Co and State Energy Co is one factor that needs to be considered in determining this question but, by itself, would not lead to the conclusion that Division 250 applies to the arrangement. Other features of the arrangement, such as the fact that Gas Co maintains the day-to-day control over the operation of the assets, are also relevant in determining where effective control lies.Even if the conclusion is reached that State Energy Co effectively controls the use of Gas Co's assets, Division 250 would not apply to those assets if, because of the operation of the safe harbour tests, Gas Co does not lack a predominant economic interest in the assets. Example 1.5 A statutory authority enters into a concession arrangement with AR Ltd to build and operate a user-pay toll-road on leased Crown land. At the end of the 30-year lease arrangement period, the toll-road will revert to the statutory authority for no consideration. The statutory authority will not be taken to be the end user of the toll-road under section 250-50 merely because of the reversion of the asset to the statutory authority at the end of the lease.

1.37 An entity will generally not be taken to be the end user of an asset under section 250-50 if it merely has the incidental use or control of the asset.

Example 1.6 The statutory authority in Example 1.5 retains rights to travel on the toll-road, inspect or test facilities, and perform various monitoring and traffic management activities during the arrangement period. The statutory authority also retains rights to perform certain activities on the toll-road in the event of an emergency. As these rights merely give the statutory authority the incidental or temporary control or use of the toll-road, the statutory authority will not be taken to be the end user of the toll-road under section 250-50. Example 1.7 A statutory authority enters into a contract with RK Co, a private sector energy supply company, for the supply of electricity to a city. Under the contract, the statutory authority has the right to read electricity meters of the residential users of the electricity. As these rights merely give the statutory authority the incidental control or use of the assets used to supply the electricity, the statutory authority will not be taken to be the end user of those assets under section 250-50.

What is a lease?

1.38 For the purposes of Division 250, a lease includes an arrangement that, in substance or effect:

·
depends on the use of a specific asset that is real property, or goods or a personnel chattel (other than money or a money equivalent); and
·
gives a right to control the use of the asset (other than temporarily for the purpose of ensuring public health or safety, protecting the environment or continuing the supply of an essential service).

[Schedule 1, item 1, section 250-80]

1.39 The question as to whether an arrangement is a lease for the purposes of Division 250 primarily turns on whether, in substance or effect, the arrangement gives a right to control the use of an asset (other than temporarily for the purpose of ensuring public health or safety, protecting the environment or continuing the supply of an essential service). The classification of the arrangement as lease under the accounting standards does not necessarily determine this question.

1.40 Even if an arrangement between a taxpayer and a tax preferred entity is treated as a lease because of section 250-80, the requirements in section 250-50 still need to be satisfied before an entity can be an end user of the asset. In addition, the requirements of section 250-60 need to be satisfied before Division 250 will apply to the arrangement.

Example 1.8 BF Co enters into a contract with a state government for the use of a sporting stadium. The contract is not in the form of a lease but effectively gives the state government the right to control the use of the stadium.As the contract gives the state government the right to control the use of the stadium, it is in substance or effect a lease. Section 250-80 will ensure that the contract is taken to be a lease for the purposes of Division 250.

What is a tax preferred entity?

1.41 A tax preferred entity is an exempt entity, an exempt Australian government agency, an associated government entity of an exempt Australian government agency, a 'prescribed excluded STB' (State/Territory body) as defined in section 24AT of the ITAA 1936 or an 'exempt foreign government agency' as defined in subsection 995-1(1) of the ITAA 1997. [Schedule 1, items 8, 16 and 23, definitions of 'excluded STB' , ' prescribed excluded STB' and 'tax preferred entity' in subsection 995-1(1) of the ITAA 1997]

Who is a tax preferred end user?

1.42 An end user of an asset is a tax preferred end user if:

·
the end user (or a connected entity) is a tax preferred entity; or
·
the end user is an entity that is not an Australian resident.

[Schedule 1, items 1 and 22, section 250-55 and definition of 'tax preferred end user' in subsection 995-1(1) of the ITAA 1997]

Who are the members of the tax preferred end user group?

1.43 If an asset is being put to a tax preferred use, then the members of the tax preferred end user group are the tax preferred end user and connected entities of the tax preferred end user. [Schedule 1, items 1 and 12, subsection 250-60(4) and the definition of 'member of the tax preferred end user group' in subsection 995-1(1) of the ITAA 1997]

Who are the members of the tax preferred sector?

1.44 If an asset is being put to a tax preferred use, then the members of the tax preferred sector are the tax preferred end user (and connected entities), any tax preferred entity (or connected entity) and any non-resident entity. [Schedule 1, items 1 and 13, subsection 250-60(4) and the definition of 'member of the tax preferred sector' in subsection 995-1(1) of the ITAA 1997]

What are financial benefits?

1.45 The term 'financial benefit' is defined in section 974-160 of the ITAA 1997 to mean, broadly, anything of economic value. Something is of economic value if it is money, a money equivalent, or a non-monetary benefit (such as property or services) even if the transaction that confers the benefit on an entity also imposes an obligation on the entity. Therefore, financial benefits include the provision of economic benefits in relation to the use of an asset (including benefits such as repairs and improvements, asset risk insurance or loan guarantees). General tax and charges exemptions will be financial benefits only if there is an obligation on the taxpayer to pay those taxes and charges.

1.46 A money equivalent is defined to mean a right to receive money or something that is a money equivalent. [Schedule 1, item 14 and the definition of 'money equivalent' in subsection 995-1(1) of the ITAA 1997]

When does Division 250 apply?

1.47 Division 250 applies to a taxpayer in respect of an asset at a particular time if the general test in section 250-15 is satisfied and none of the specific exclusions apply. [Schedule 1, item 1, section 250-10]

1.48 The specific exclusions, which are outlined in paragraphs 1.109 to 1.137, primarily ensure that Division 250 does not apply to certain relatively short-term and lower value arrangements - that is, broadly, where:

·
the arrangement period does not exceed 12 months;
·
the taxpayer is a small business entity for the income year in which the arrangement starts;
·
the financial benefits that are reasonably expected to be provided by the tax preferred sector do not exceed $5 million; or
·
the arrangement satisfies certain operating and finance risk tests, and:

-
the arrangement period does not exceed three years (or five years if the arrangement is a lease of real property);
-
the financial benefits that are reasonably expected to be provided by the tax preferred sector do not exceed $30 million (or $50 million if the arrangement is a lease of real property); or
-
the total values of assets put to tax preferred use do not exceed $20 million (or $40 million if the arrangement is a lease of real property).

1.49 In addition, Division 250 will not apply to hire purchase arrangements with a tax preferred entity that come within the scope of Division 240. This is because taxpayers are not entitled to a deduction for capital allowances for assets acquired under hire purchase arrangements.

The general test for applying Division 250

1.50 Under the general test, Division 250 will apply to a taxpayer in respect of an asset at a particular time if:

·
the asset is being put to a tax preferred use; and
·
the arrangement period for the tax preferred use of the asset is greater than 12 months; and
·
financial benefits in relation to the tax preferred use of the asset have been, will be or can reasonably be expected to be, provided to the taxpayer (or a connected entity) by:

-
a tax preferred end user (or a connected entity); or
-
any tax preferred entity (or a connected entity); or
-
any entity that is not an Australian resident; and

·
disregarding Division 250, the taxpayer would be entitled to a capital allowance in relation to a decline in the value of the asset or expenditure in relation to the asset; and
·
the taxpayer lacks a predominant economic interest in the asset.

[Schedule 1, item 1, section 250-15]

First element of the general test - the asset is being put to a tax preferred use

1.51 The first element of the general test for applying Division 250 to a taxpayer in respect of an asset is that the asset is being put to a tax preferred use. [Schedule 1, item 1, paragraph 250-15(a)]

Tax preferred use if the end user is a lessee

1.52 If an end user (or a connected entity) holds rights as lessee under a lease of an asset, then the asset is put to a tax preferred use if:

·
the asset is, or is to be, used by or on behalf of an end user who is a tax preferred end user because they are a tax preferred entity; and/or
·
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 they are a non-resident.

[Schedule 1, items 1 and 24, subsection 250-60(1) and definition of 'tax preferred use' in subsection 995-1(1) of the ITAA 1997]

1.53 In this event, the tax preferred use of the asset is the lease of the asset. [Schedule 1, item 1, subsection 250-60(1)]

Tax preferred use if goods, services or facilities are provided to the end user

1.54 If an asset is, or is to be, used (whether or not by the taxpayer) wholly or partly in connection with:

·
the production, supply, carriage, transmission or delivery of goods; or
·
the provision of services or facilities (including hospital or medical facilities, prison facilities, educational facilities, land transport facilities, other transport facilities, the supply of water, gas or electricity, housing or accommodation, or premises from which to operate a business or other undertaking),

then the asset is put to a tax preferred use if:

·
some or all of 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 they are a tax preferred entity (other than an exempt foreign government agency); and/or
·
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 they are a non-resident.

[Schedule 1, items 1 and 24, subsections 250-60(2) and (3) and definition of 'tax preferred use' in subsection 995-1(1) of the ITAA 1997]

1.55 In this event, the tax preferred use of the asset is the production, supply, carriage, transmission, delivery or provision of the goods, services or facilities. [Schedule 1, item 1, subsection 250-60(2)]

1.56 The exclusion of exempt foreign government agencies from the scope of subparagraph 250-60(2)(b)(i) will ensure that Division 250 will not apply to, for example, an arrangement involving the use of assets in Australia by a taxpayer who enters into a long-term contract with a foreign government for the supply of minerals.

Example 1.9 NS Petroleum Co, a taxable Australian company, enters into a long term contract to supply gas to a foreign government agency. The assets used by NS Petroleum Co to satisfy its contractual obligations will be outside the scope of Division 250 because of the operation of subparagraph 250-60(2)(b)(i).

1.57 The tax-exempt use of an asset does not generally include a situation where a government owned corporation merely provides services to the owner of the asset provided the owner effectively controls the use of that asset.

Second element of the general test - the arrangement period for the tax preferred use must be greater than 12 months

1.58 The second element of the general test for applying Division 250 to a taxpayer in respect of an asset is that the arrangement period for the tax preferred use of the asset must be greater than 12 months. [Schedule 1, item 1, paragraph 250-15(b)]

Start of the arrangement period

1.59 Generally, the arrangement period for a particular tax preferred use of an asset begins when an asset is first put to a tax preferred use. [Schedule 1, items 1 and 2, subsection 250-65(1) and the definition of 'arrangement period' in subsection 995-1(1) of the ITAA 1997]

End of the arrangement period

1.60 The arrangement period for a particular tax preferred use of an asset ends on the earliest of:

·
the day that the tax preferred use may reasonably be expected to, or is likely to, end; and
·
the day that Division 250 no longer applies to the taxpayer and the asset.

[Schedule 1, item 1, subsections 250-65(2) and (3)]

1.61 In determining when the arrangement period for a tax preferred use of an asset ends, the taxpayer must have regard to:

·
the terms of, and any other circumstances relating to, any arrangement dealing with the tax preferred use of the asset; and
·
the terms of, and any other circumstances relating to, any arrangement dealing with the provision of financial benefits in relation to that tax preferred use.

[Schedule 1, item 1, paragraph 250-65(4)(a)]

1.62 For this purpose, the taxpayer must assume that any right that an entity has to renew or extend such an arrangement will not be exercised unless it is reasonable to assume that the right to renew or extend will be exercised because of the commercial consequences for the entity (or a connected entity) of not exercising that right. [Schedule 1, item 1, paragraph 250-65(4)(b)]

1.63 In determining the arrangement period, the tax preferred use of an asset by an entity and the tax preferred use of the same asset by a connected entity are taken to be a single tax preferred use of an asset. [Schedule 1, item 1, subsection 250-65(5)]

1.64 It follows that, where there is a right to renew or extend an arrangement, the arrangement period will include the extended period only if it is reasonably likely that the taxpayer would incur a significant financial penalty if the right was not exercised. For example:

·
the taxpayer may suffer a loss of financial benefits that are payable at the end of the arrangement period;
·
the taxpayer may be subject to a fine; or
·
the taxpayer may lose the right to enter into future business with the tax preferred entity.

Example 1.10 Nu Co, a taxable Australian company, enters into an arrangement with a state government (a tax preferred entity) to build and operate a hospital for a period of 20 years. Under the arrangement, the state government is the end user of the hospital. The state government has two options to extend the arrangement for a further 10 years. The first option may be exercised at the end of 20 years while the second option may be exercised (if applicable) at the end of 30 years.The arrangement period for the tax preferred use of the asset will be 20 years. However, if it is reasonable to assume that the first option will be exercised (because of the significant adverse commercial consequences for the state government of not doing so), the arrangement period for the tax preferred use of the asset will be 30 years. The arrangement period would extend to 40 years only if it is reasonable to assume that both options to extend will be exercised.

Continued tax preferred use of an asset after the end of arrangement period

1.65 If the arrangement period for the tax preferred use of an asset to which Division 250 applies ends on a particular date (the termination date) and the tax preferred use of the asset continues beyond that date, the tax preferred use beyond the termination date is taken to be a separate and distinct tax preferred use of the asset. [Schedule 1, item 1, section 250-70]

1.66 As a consequence, the new tax preferred use arrangement will be retested under section 250-15 to determine whether Division 250 will apply to the taxpayer and the asset against the circumstances as they stand immediately before the termination date.

1.67 This is an integrity measure that ensures the correct treatment under Division 250 where the tax preferred use of an asset continues beyond the original arrangement period. In the absence of this provision there may be an incentive to understate the arrangement period so that subsequent tax preferred use falls outside Division 250.

Third element of the general test - financial benefits must be provided in relation to the tax preferred use of the asset

1.68 The third element of the general test for applying Division 250 to a taxpayer in respect of an asset is that financial benefits in relation to the tax preferred use of the asset have been, or will be or can reasonably be expected to be, provided to the taxpayer (or a connected entity) by:

·
a tax preferred end user (or a connected entity);
·
any tax preferred entity (or a connected entity); or
·
any entity that is not an Australian resident.

[Schedule 1, item 1, paragraph 250-15(c)]

What financial benefits are provided in relation to the tax preferred use of an asset?

1.69 For the purposes of Division 250, the financial benefits provided in relation to the tax preferred use of an asset include:

·
a financial benefit provided directly or indirectly in relation to the readying of the asset for tax preferred use (such as bringing the asset into a state, condition or location in which it can be put to tax preferred use);
·
a financial benefit provided directly or indirectly in relation to the end of the tax preferred use of the asset (including the amount of any guaranteed residual value of the asset);

-
an asset has a guaranteed residual value if the tax preferred sector provides a guarantee to the effect that it will pay the taxpayer (or a connected entity) up to a specified amount if the disposal value of the asset at the end of the arrangement period is less than that specified amount;

·
a financial benefit provided directly or indirectly in relation to the termination or expiration of an arrangement that deals with the tax preferred use of the asset or provision of financial benefits in relation to the tax preferred use of the asset;
·
a financial benefit provided directly or indirectly in relation to the purchase of the asset by, or transfer of the asset to, the tax preferred entity user or a connected entity; and
·
if an asset is put to a tax preferred use and the entity is an end user because it manages the asset or the use to which it is put, any financial benefit provided directly or indirectly by the entity that is calculated by reference to receipts, revenue or income generated by the use of the asset.

[Schedule 1, items 1, 11 and 18, subsections 250-85(1) to (4) , section 250-90 and the definitions of 'guaranteed residual value' and 'provided in relation to a tax preferred use of an asset' in subsection 995-1(1) of the ITAA 1997]

1.70 However, financial benefits do not include any payments merely collected by a member of the tax preferred sector on behalf of an entity that is not a member of the tax preferred sector. [Schedule 1, item 1, subsection 250-85(5)]

1.71 For example, financial benefits do not include:

·
road tolls paid by road users that are merely collected by a tax preferred entity to the extent that they are passed on to the taxpayer; or
·
financial benefits provided under the national marketing and distribution arrangements for electricity by a tax preferred authority to the generators of electricity that would represent financial benefits payable by the users of the electricity.

1.72 In addition, financial benefits do not include payments in relation to the tax preferred use of an asset to the extent that those payments are solely for routine maintenance of the asset. [Schedule 1, item 1, subsection 250-85(6)]

1.73 If a financial benefit is provided in relation to the use of a number of assets, a separate financial benefit is to be reasonably attributed to each of the assets. [Schedule 1, item 1, subsection 250-85(7)]

1.74 A financial benefit may be provided in relation to a tax preferred use of an asset even though it is provided before the tax preferred use of the asset starts. [Schedule 1, item 1, subsection 250-85(8)]

1.75 A financial benefit that is not a monetary amount (such as a financial benefit in the form of goods or services) is taken to become due and payable when the entity (including the tax preferred end user or a connected entity of the tax preferred end user) providing the benefit becomes liable to provide the benefits and is taken to be paid when it is provided. [Schedule 1, item 1, paragraph 250-85(9)(a)]

1.76 A financial benefit that is paid without becoming due and payable is taken to have become due and payable on the day on which it was paid. [Schedule 1, item 1, paragraph 250-85(9)(b)]

What are the expected financial benefits in relation to an asset put to tax preferred use?

1.77 The expected financial benefits at a particular time in relation to an asset that is put to a tax preferred use are the financial benefits that at that time have been, will be (assuming normal operating conditions), or can reasonably be expected to be (assuming normal operating conditions) provided in relation to the tax preferred use of the asset by a member of the tax preferred sector to someone who is not a member of the tax preferred sector. [Schedule 1, item 1, section 250-95]

What is the present value of a financial benefit that has already been provided?

1.78 The present value of a financial benefit at a particular time that has been provided before that time is the nominal amount or value of the financial benefit. [Schedule 1, item 1, section 250-100]

Fourth element of the general test - the taxpayer would be entitled to capital allowances

1.79 The fourth element of the general test for applying Division 250 to a taxpayer in respect of an asset is that, disregarding Division 250, the taxpayer would be entitled to a capital allowance in relation to a decline in the value of the asset or expenditure in relation to the asset. [Schedule 1, item 1, paragraph 250-15(d)]

Fifth element of the general test - the taxpayer lacks a predominant economic interest in the asset

1.80 The fifth element of the general test for applying Division 250 to a taxpayer in respect of an asset is that the taxpayer lacks a predominant economic interest in the asset. [Schedule 1, item 1, paragraph 250-15(e)]

1.81 The taxpayer lacks a predominant economic interest in an asset at a particular time only if one or more of the following tests apply to the taxpayer and the asset at that time:

·
the 'limited recourse debt test';
·
the 'right to acquire asset test';
·
the 'effectively non-cancellable, long term arrangement test'; and/or
·
the 'level of expected financial benefits test'.

[Schedule 1, item 1, section 250-110]

1.82 The predominant economic interest tests effectively operate as safe harbour tests. An arrangement will come within the scope of Division 250 if it fails one or more of the safe harbour tests.

The 'limited recourse debt test'

1.83 Under the 'limited recourse debt test' the taxpayer lacks a predominant economic interest in an asset at a particular time if:

·
where the asset is put to tax preferred use by an end user that is a tax preferred entity, more than the 80 per cent of the cost of acquiring or constructing the asset is financed (directly or indirectly) by limited recourse debt; or
·
where the asset is put to tax preferred use by an end user that is a non-resident, more than the 55 per cent of the cost of acquiring or constructing the asset is financed (directly or indirectly) by limited recourse debt.

[Schedule 1, item 1, subsections 250-115(1) and (3)]

1.84 'Limited recourse debt' is defined in section 243-20 to mean, broadly, an obligation imposed on an entity (the debtor) to pay another entity (the creditor) where the rights of the creditor as against the debtor in the event of default in payment of the debt or of interest are limited wholly or predominantly to:

·
rights in relation to the debt property, use of the debt property, goods produced or services provided by means of the debt property, or the loss or disposal of the debt property;
·
rights in respect of the mortgage or other security over the debt property; or
·
rights that arise out of any arrangement relating to the financial obligations of an end user over the financed property towards the debtor and are financial obligations in relation to the financed property.

1.85 However, for the purpose of applying the 'limited recourse debt test' in section 250-115:

·
the amount of limited recourse debt is to be reduced by the value of any debt property (other than the financed property) that is provided as security for the debt; and
·
if the limited recourse debt finances the acquisition or construction of two or more assets, only the amount of the debt that is reasonably attributable to the asset that is being put to tax preferred use is to be taken into account.

[Schedule 1, item 1, subsection 250-115(2)]

Example 1.11 VR Co acquires two assets that are put to tax preferred use costing $10 million and $20 million respectively.The amount of limited recourse debt used to acquire the assets is $25 million (which is greater than 80 per cent of the cost of acquiring the asset).Property (debt property), other than the financed property, to the value of $2 million is provided as security.The limited recourse debt amount is reduced by the $2 million to $23 million (which is less than the 80 per cent of the cost of acquiring the asset). Therefore, VR Co will not lack the predominant economic interest in the assets because of the operation of the limited recourse debt test.

1.86 If the taxpayer is a corporate tax entity, the limited recourse debt test does not apply if:

·
the tax preferred use of the asset:

-
is not the lease or hire of an asset; or
-
is the lease of an asset that is real property where members of the tax preferred sector occupy as tenants less than half of the area within the property that is occupied or available to be occupied by tenants; and

·
the asset is put to the tax preferred use wholly or principally in Australia; and
·
no member of the tax preferred sector provides financing, or support for financing, in relation to the taxpayer's interest in the asset (including by way of a loan, a guarantee, an indemnity, a security, hedging or undertaking to provide financial benefits in the event of the termination of the arrangement).

[Schedule 1, item 1, subsections 250-115(4) and (5)]

1.87 If the taxpayer is a trust, the limited recourse debt test does not apply if:

·
the tax preferred use of the asset is the lease of real property where members of the tax preferred sector occupy as tenants less than half of the area within the property that is occupied or available to be occupied by tenants;
·
the asset is put to the tax preferred use wholly or principally in Australia; and
·
no member of the tax preferred sector provides financing, or support for financing, in relation to the taxpayer's interest in the asset (including by way of a loan, a guarantee, an indemnity, a security, hedging or undertaking to provide financial benefits in the event of the termination of the arrangement).

[Schedule 1, item 1, subsection 250-115(6)]

Example 1.12 BF Co owns a 30 storey office building. Ten floors of the building are leased by BF Co to a Australian government department. Another four floors are leased to a state government public authority. As members of the tax preferred sector occupy as tenants less than half of the area within the building that is occupied or available to be occupied by tenants, the limited recourse debt test will not apply to the arrangement.

1.88 The effect of the 'limited recourse debt test' (in combination with the level of expected financial benefits test) is that for the duration of the arrangement the taxpayer must hold some equity or investment effectively at risk in an asset to be treated as having the predominant economic interest in the asset. This is appropriate because, if an arrangement is outside the scope of Division 250, the taxpayer is entitled to capital allowance deductions in respect of assets used under the arrangement.

The 'right to acquire asset test'

1.89 Under the 'right to acquire asset test' the taxpayer lacks a predominant economic interest in an asset at a particular time if the asset is to be transferred to a member of the tax preferred sector after the end of the arrangement period and the consideration for the transfer is not fixed as the market value of the asset at the time of the transfer. [Schedule 1, item 1, subsection 250-120(1)]

1.90 In addition, the taxpayer lacks a predominant economic interest in an asset at a particular time under this test if:

·
a member of the tax preferred end user group has, or will have:

-
a right or an obligation to purchase or acquire the asset or a legal or equitable interest in the asset; or
-
a right to require the transfer of the asset or a legal or equitable interest in the asset; and

·
the consideration for the purchase, acquisition or transfer of the asset is not fixed as the market value of the asset at the time of purchase, acquisition or transfer.

[Schedule 1, item 1, subsection 250-120(2)]

1.91 The 'right to acquire an asset test' does not apply to an asset just because a taxable entity's interest in the asset is one that ceases to exist after the passing of a particular period of time. [Schedule 1, item 1, subsection 250-120(2) ]

Example 1.13 Nu Co, from Example 1.10, builds the hospital on leased crown land. The interest in the land will revert to the state government at the end of the lease for no consideration if it is not renewed during the lease period. Accordingly, the right to acquire the asset test will not apply to the arrangement.

1.92 The 'right to acquire asset test' is relevant in determining whether the taxpayer has the predominant economic interest in an asset because the right or obligation of the tax preferred end user to acquire the asset during or at the end of the arrangement indicates that the arrangement is a financing arrangement as the tax preferred end user effectively has the risks and benefits of ownership of the asset.

The 'effectively non-cancellable, long term arrangement test'

1.93 Under the 'effectively non-cancellable, long term arrangement test' the taxpayer lacks a predominant economic interest in an asset at a particular time if:

·
any arrangement that relates to the tax preferred use of the asset, or that relates to the financial benefits to be provided by the members of the tax preferred sector in relation to the tax preferred use of the asset, is effectively non-cancellable; and
·
the arrangement period for the tax preferred use of the asset is:

-
greater than 30 years; or
-
if the arrangement period is less than or equal to 30 years - 75 per cent or more of that part of the asset's effective life that remains when the tax preferred use starts (disregarding any statutory caps specified in section 40-102).

[Schedule 1, item 1, section 250-125]

1.94 An arrangement in relation to the tax preferred use of an asset is effectively non-cancellable if:

·
the arrangement can be cancelled only with the permission of the taxpayer, a connected entity of the taxpayer, or an agent of or an entity acting on behalf of a taxpayer or a connected entity; or
·
if the arrangement can be cancelled without such permission (including default), a member of the tax preferred sector would be required to enter into a replacement arrangement or incur a penalty of such magnitude that it would discourage cancellation (such as a payment equivalent to the unrecouped investment in the asset).

[Schedule 1, items 1 and 5, section 250-130 and the definition of 'effectively non-cancellable' in subsection 995-1(1) of the ITAA 1997]

1.95 The 'effectively non-cancellable long term arrangement test' is relevant in determining whether the taxpayer has the predominant economic interest in an asset because it discourages the tax preferred end user from cancelling the arrangement. This generally means that the end user has to make payments in relation to the asset for a period that is unrelated to the effective use of the asset. The payments are therefore likely to cover all or a substantial proportion of the unrecouped cost of the asset. Consequently, all or a substantial proportion of the risks and benefits of ownership of the asset are borne by the tax preferred end user rather than the taxable entity.

Example 1.14 Under the arrangement between Nu Co and the state government to build and operate a hospital, the state government is able to cancel the arrangement if Nu Co fails to achieve specified service standards. If the state government cancels the arrangement in these circumstances, it is not required to pay any financial benefits on cancellation (other than any unpaid amounts for services provided).The arrangement between Nu Co and the state government will not satisfy the 'effectively non-cancellable long term arrangement test' because:

·
Nu Co's permission is not required to cancel the contract; and
·
there is no requirement for the state government to enter into a new contract or make any penalty or other agreed payment.

The 'level of expected financial benefits test'

1.96 Under the 'level of expected financial benefits test' the taxpayer lacks a predominant economic interest in an asset at a particular time if the asset has a guaranteed residual value at that time. [Schedule 1, item 1, subsection 250-135(1)]

1.97 An asset has a guaranteed residual value if the tax preferred sector provides a guarantee to the effect that it will pay the taxpayer (or a connected entity) up to a specified amount if the disposal value of the asset at the end of the arrangement period is less than the specified amount. [Schedule 1, items 1 and 11, subsection 250-85(3) and the definition of 'guaranteed residual value' in subsection 995-1(1) of the ITAA 1997]

1.98 In addition, the taxpayer lacks a predominant economic interest in an asset at a particular time under the 'level of expected financial benefits test' if:

·
the arrangement under which the asset is put to the tax preferred use (either alone or together with any other arrangement in relation to the tax preferred use of the asset or the provision of financial benefits in relation to the tax preferred use of the asset) is a debt interest; or
·
the sum of the present values of the expected financial benefits that members of the tax preferred sector have provided, or are or are reasonably likely to provide, to the taxpayer (or a connected entity) in relation to the tax preferred use of the asset exceeds:

-
if (assuming Division 250 did not apply) the taxpayer would be entitled to capital allowance deductions in relation to the asset, 70 per cent of the market value of the relevant asset; or
-
if (assuming Division 250 did not apply) the taxpayer would be entitled to a deduction for capital expenditure, 70 per cent of so much of the market value that is attributable to the capital expenditure.

[Schedule 1, item 1, subsection 250-135(2)]

1.99 For these purposes, for a newly acquired asset, the market value of the relevant asset or capital expenditure will generally reflect the cost of acquiring the asset that is recognised for capital allowance purposes.

1.100 The discount rate to be used in working out the present value of a future amount under section 250-135 is a rate that reflects a constant periodic rate of return (worked out on a compounding basis) on the investment in the relevant asset, or the relevant capital expenditure, that is implicit in the arrangements under which the asset is put to a tax preferred use and financial benefits are provided in relation to that tax preferred use. [Schedule 1, item 1, subsection 250-105(2)]

1.101 For these purposes, the investment in the relevant asset or capital expenditure will generally reflect the market value of the asset or expenditure and includes the estimated end value of the asset.

1.102 The level of expected financial benefits test is relevant in determining whether the taxpayer has the predominant economic interest in an asset because it is an indicator of whether the arrangement is in the nature of financing by the taxpayer of an asset purchased for a tax preferred entity.

Retesting of predominant economic interest against the 'level of expected financial benefits test'

1.103 If the 'level of expected financial benefits test' (section 250-135) does not apply when the tax preferred use of the asset starts, the test is taken to continue not to apply unless the taxpayer (or a connected entity), or a member of the tax preferred sector, does something, or omits to do something, at a particular time that increases the value of the expected financial benefits in relation to the tax preferred use of the asset. [Schedule 1, item 1, subsections 250-140(1) to (4) and (6)]

1.104 For the purpose of retesting against the 'level of expected financial benefits test', financial benefits provided before the time of retesting are disregarded. [Schedule 1, item 1, subsection 250-140(5)]

1.105 This ensures that taxpayers do not need to continuously retest the 'level of expected financial benefits test' to determine whether the taxpayer has the predominant economic interest in an asset.

1.106 That is, if the 'level of expected financial benefits test' does not apply to the arrangement when the tax preferred use of the asset starts, the arrangement does not need to be retested against section 250-135 unless a party to the arrangement does something that increases the value of the expected financial benefits in relation to the tax preferred use of the asset.

1.107 If, after the arrangement has been retested, the taxpayer continues to have a predominant economic interest in the asset that is put to tax preferred use under the arrangement, then the arrangement will continue to be outside the scope of Division 250.

1.108 Alternatively, if, after the arrangement has been retested, the taxpayer lacks a predominant economic interest in the asset that is put to tax preferred use under the arrangement, then Division 250 will start to apply to the arrangement (assuming that all the other requirements for Division 250 to apply are satisfied).

Specific exclusions from Division 250

1.109 Specific exclusions ensure that Division 250 does not apply to:

·
arrangements where the arrangement period does not exceed 12 months;
·
arrangements involving taxpayers that are small business entities;
·
arrangements where the financial benefits do not exceed $5 million;
·
certain short term or lower value operating arrangements;
·
arrangements where the present value of the Division 250 assessable amount is less than the amount otherwise assessable; and
·
arrangements that are excluded at the discretion of the Commissioner.

The first exclusion - arrangement period less than 12 months

1.110 Division 250 will not apply to a taxpayer and an asset if the arrangement period for the tax preferred use of the asset does not exceed 12 months. [Schedule 1, item 1, paragraph 250-15(b)]

The second exclusion - small business entities

1.111 Division 250 will not apply to a taxpayer and an asset if the taxpayer is a small business entity for the income year in which the arrangement period starts and is able to deduct capital allowances under Subdivision 328-D for the asset. [Schedule 1, item 1, section 250-20]

1.112 Under section 328-110, a taxpayer is a small business entity if:

·
the taxpayer carries on a business; and
·
the taxpayer satisfies the $2 million aggregated turnover test (ie, the taxpayer's aggregated turnover in the prior full income year, or its actual or expected turnover in the current full income year, is less than $2 million).

The third exclusion - financial benefits under $5 million

1.113 Division 250 will not apply to a taxpayer and an asset that is being put to tax preferred use under an arrangement if, at the start of the arrangement period, the total of the nominal values of all the financial benefits that have been, will be, or can reasonably expected to be, provided to the taxpayer (or a connected entity) by members of the tax preferred sector in relation to the tax preferred use of the asset (or any other asset that is being put to a tax preferred use under the arrangement) does not exceed $5 million. [Schedule 1, item 1, subsection 250-25(1)]

1.114 The $5 million threshold is indexed annually in accordance with Subdivision 960-M. That is, the threshold is indexed by movements in the All Groups Consumer Price Index number (being the weighted average of the eight capital cities) first published by the Australian Statistician for a quarter. [Schedule 1, item 1, subsection 250-25(2)]

Example 1.15 PM Co, a cleaning contractor, enters into an arrangement with a local government council to provide office cleaning services. Under the contract, the total financial benefits expected to be payable to PM Co are $4 million.The arrangement will be excluded from Division 250 under section 250-25 because the total amount of the financial benefits that are to be provided to PM Co under the arrangement do not exceed $5 million.

The fourth exclusion - certain short term or lower value operating arrangements

1.115 Division 250 will not apply to a taxpayer and an asset that is being put to a tax preferred use under certain operating arrangements if:

·
the arrangement period for the tax preferred use of the asset does not exceed:

-
in the case of the lease of real property, five years; or
-
in any other case, three years;

·
at the start of the arrangement period, the nominal value of all the financial benefits that have been, or are to be, provided to the taxpayer (or a connected entity) by members of the tax preferred sector in relation to the tax preferred use of the asset, or any other asset that is being, or is to be, put to a tax preferred use under the arrangement, does not exceed:

-
in the case of the lease of real property, $50 million; or
-
in any other case, $30 million; or

·
at the start of the arrangement period, the total of the values of all the assets that are put to tax preferred use under the arrangement does not exceed:

-
in the case of the lease of real property, $40 million; or
-
in any other case, $20 million.

[Schedule 1, item 1, subsection 250-30(1)]

1.116 The monetary thresholds are indexed annually in accordance with Subdivision 960-M. That is, the thresholds are indexed by movements in the All Groups Consumer Price Index number (being the weighted average of the eight capital cities) first published by the Australian Statistician for a quarter. [Schedule 1, item 1, subsection 250-30(2)]

1.117 As a result of this exclusion, Division 250 will not apply to many short term operating leases and service arrangements that come within the monetary thresholds. However, an arrangement will not qualify for the exclusion under section 250-30 if any of the tests in section 230-35 are satisfied.

1.118 First, an arrangement will not qualify for the exclusion under section 250-30 if the arrangement (either alone or together with any arrangement in relation to the tax preferred use of the asset or the provision of financial benefits in relation to the tax preferred use of the asset) is a debt interest. [Schedule 1, item 1, subsections 250-35(1) and (2)]

1.119 Second, an arrangement will not qualify for the exclusion under section 250-30 if, under the arrangement, a member of the tax preferred sector has:

·
a right, or an obligation, to purchase or acquire the asset or a legal or equitable interest in the asset for an amount other than the market value of the asset at the end of the arrangement period;
·
a right to require the transfer of the asset or a legal or equitable interest in the asset for an amount other than the market value of the asset at the end of the arrangement period; or
·
a residual or reversionary interest in the asset that will arise or become exercisable at or after the end of the arrangement period for an amount other than the market value of the asset at the end of the arrangement period.

[Schedule 1, item 1, subsection 250-35(3)]

1.120 For these purposes, a residual or reversionary interest in the asset will not arise or become exercisable at or after the end of the arrangement period merely because of the operation of a statutory provision that has no connection to the arrangement (such as the expiration of a 99-year lease in respect of property held in the Australian Capital Territory).

1.121 Third, an arrangement will not qualify for the exclusion under section 250-30 if, under the arrangement, a member of the tax preferred sector provides financing, or support for financing, in relation to the taxpayer's interest in the asset (including by way of a loan, a guarantee, an indemnity, a security, hedging or undertaking to provide financial benefits in the event of the termination of the arrangement). [Schedule 1, item 1, subsection 250-35(4)]

1.122 In this regard, a long term supply agreement that is entered into on arm's length commercial terms with a tax-exempt entity which is necessary for the commencement of a project would not generally be taken to be support for financing.

1.123 Fourth, an arrangement will not qualify for the exclusion under section 250-30 if the arrangement in relation to the tax preferred use of the asset, or the provision of financial benefits in relation to the tax preferred use of the asset, is or involves a finance lease, a non-cancellable operating lease, or a service concession or similar arrangement that generally accepted accounting principles (as in force at the start of the arrangement period) require to be included as an asset or a liability in the balance sheet of the taxpayer. [Schedule 1, item 1, subsection 250-35(5)]

1.124 Fifth, an arrangement will not qualify for the exclusion under section 250-30 if, under the arrangement, the financial benefits that have been, or are to be, provided to the taxpayer (or a connected entity) by members of the tax preferred sector in relation to the tax preferred use of the asset:

·
are not provided on a regular periodic basis (and at least annually);
·
are not based on comparable market-based rates; or
·
do not reflect the value of the tax preferred use of the asset.

[Schedule 1, item 1, subsection 250-35(6)]

1.125 Finally, the arrangement will not qualify for the exclusion under section 250-30 if:

·
the tax preferred use of the asset is a lease or hire of an asset (or the use of an asset under a lease or hire arrangement), and:

-
the asset is so specialised that the end user could not carry out one or more of its functions without the asset; and
-
the taxpayer would be unlikely to be able to re-lease, re-hire or resell the asset to another person who is not a member of the tax preferred end user group; or

·
the tax preferred use of the asset is not the lease or hire of an asset (or the use of an asset under a lease or hire arrangement), and:

-
a member of the tax preferred sector has a right, if particular circumstances occur, to manage or to assume control over the asset (other than temporarily for the purpose of ensuring public health or safety, protecting the environment or continuing the supply of an essential service);
-
the asset is so specialised that it is unlikely that it could effectively be put to any use other than the tax preferred use; or
-
the taxpayer (or a connected entity) does not have effective day to day control and physical possession of the asset.

[Schedule 1, item 1, subsections 250-35(7) and (8)]

1.126 The question as to whether an entity takes control of the asset temporarily for the purpose of ensuring public health or safety, protecting the environment or continuing the supply of an essential service needs to be determined on the facts and circumstances of a particular case.

1.127 Similarly, the question as to whether an asset is so specialised that it is unlikely that it could effectively be put to any use other than the tax preferred use also needs to be determined on the facts and circumstances of a particular case. However, examples of assets that might be specialised assets include special purpose buildings (such as hospitals and court houses) and rolling stock.

Example 1.16 BF Co leases a building to a Australian government department for a period of five years. The total amount of the financial benefits that are to be provided to the BF Co under the lease arrangement are $50 million. The value of the building that is being leased is $25 million. The lease arrangement satisfies the conditions in section 250-35.The lease arrangement will be excluded from Division 250 under section 250-30 because the conditions in section 250-35 are satisfied and the arrangement period does not exceed five years.

The fifth exclusion - arrangements where the present value of the Division 250 assessable amount is less than the amount otherwise assessable

1.128 Division 250 will not apply to a taxpayer and an asset that is being put to tax preferred use under an arrangement if, when that tax preferred use of the asset starts, the Division 250 assessable amount is less than the alternative assessable amount. [Schedule 1, item 1, subsection 250-40(1)]

1.129 This calculation is a once-off calculation that is made at the start of the arrangement period.

1.130 The Division 250 assessable amount is the sum of the present values of all the amounts that would be likely to be included in assessable income under the Division in relation to the tax preferred use of an asset. [Schedule 1, item 1, subsection 250-40(2)]

1.131 The alternative assessable amount is the difference between:

·
the present values of the amounts that would be included in assessable income in relation to the financial benefits provided in relation to the tax preferred use of the asset during the arrangement period if Division 250 did not apply; and
·
the present values of the amounts that would be deductible as capital allowances in relation to the asset in relation to the arrangement period if Division 250 did not apply.

[Schedule 1, item 1, subsection 250-40(3)]

1.132 The discount rate to be used in working out the present value of a future amount under section 250-40 is:

·
the average, expressed as a decimal fraction, of the assessed secondary market yields in respect of 10-year non-rebate Treasury bonds published by the Reserve Bank during the financial year in which the relevant arrangement period starts; or
·
if no assessed secondary market yield in respect of bonds of that kind was published by the Reserve Bank during the year, the decimal fraction determined by the Treasurer for the purposes of the definition of 'long-term bond rate' in section 2 of the Petroleum Resource Rent Tax Assessment Act 1987 in relation to the financial year in which the relevant arrangement period starts.

[Schedule 1, item 1, subsection 250-105(1)]

1.133 The long-term bond rate determined by the Treasurer for the purposes of the Petroleum Resource Rent Tax Assessment Act 1987 in 2006 was 5.40 per cent. This rate is published annually on the Australian Taxation Office (ATO) website.

1.134 Section 250-40 ensures that Division 250 does not apply to an arrangement that would otherwise come within its scope if the arrangement is not tax advantaged. Consistent with a similar exclusion in the current law, the practical operation of this exclusion may result in the building component of many ordinary commercial long-term property leasing arrangements falling outside the scope of Division 250. The operation of this exclusion is illustrated in Example 1.26.

The sixth exclusion - Commissioner's discretion

1.135 To ensure that Division 250 will not apply inappropriately, a taxpayer may request the Commissioner to make a determination, having regard to the circumstances under which Division 250 would apply and other relevant circumstances, that it is unreasonable that Division 250 should apply to the taxpayer and the asset. [Schedule 1, item 1, section 250-45]

1.136 In making the determination, the Commissioner should give consideration to the objects of the Division set out in section 250-5.

1.137 It is expected that the Commissioner would consider applying the discretion, for example, to prevent an arrangement from coming within the scope of Division 250 due to:

·
an unintended or marginal breach of one of the safe harbour tests; or
·
an unintended or marginal breach of one of the tests that need to be satisfied to qualify for the specific exclusion for certain operating and service arrangements.

Example 1.17 BF Co owns a 30 storey office building. Ten floors of the building are leased by BF Co to a Australian government department. Another four floors are leased to a state government public authority. The Australian government department temporarily enters into a short term lease for an additional two floors of the building.The building is financed by limited recourse debt. If the limited recourse debt test in section 250-115 did not apply, the lease arrangement would be outside the scope of Division 250.Even though the members of the tax preferred sector occupy as tenants more than half of the area within the building that is occupied or available to be occupied by tenants, the Commissioner may exercise his discretion not to apply the limited recourse debt test because of the temporary nature of the short term lease for an additional two floors of the building. Example 1.18 RP Co, a cleaning contractor, enters into an arrangement with a local government council to provide office cleaning services. Under the contract, the total financial benefits expected to be payable to RP Co are $5.1 million.The arrangement does not qualify for the exclusion under section 250-25 because the total financial benefits expected to be payable under the arrangement marginally exceed the $5 million threshold.However, bearing in mind the compliance cost implications of applying Division 250 to the arrangement and that the threshold for the exclusion in section 250-25 was only marginally exceeded, the Commissioner may exercise his discretion to exclude the arrangement from the scope of Division 250.

What happens if an arrangement comes within the scope of Division 250?

1.138 If Division 250 applies to an arrangement:

·
capital allowance deductions are denied; and
·
the arrangement is treated as a deemed loan that is taxed as a financial arrangement on a compounding accruals basis.

Capital allowance deductions are denied

1.139 If Division 250 applies to a taxpayer and an asset at a particular time, during the arrangement period the taxpayer is generally taken not to satisfy any condition that needs to be satisfied for the taxpayer to be able to deduct an amount under a capital allowance provision in relation to:

·
a decline in the value of the asset; or
·
expenditure in relation to the asset.

[Schedule 1, item 1, section 250-145]

1.140 A 'capital allowance' is defined in subsection 995-1(1) to mean a deduction under:

·
Division 40 (capital allowances);
·
Division 43 (capital works);
·
Subdivision 328-D (capital allowances for small business entities);
·
Division 10BA of Part III of the ITAA 1936 (Australian films);
·
Division 10B of Part III of the ITAA 1936 (copyright in Australian films); or
·
section 73B of the ITAA 1936 (research and development).

Capital allowance partly allowed in some circumstances

1.141 In some circumstances a partial capital allowance deduction may be allowed in respect of the asset that is put to tax preferred use. A partial capital allowance deduction will be allowed if:

·
Division 250 applies to the taxpayer and the asset;
·
it is reasonable to expect that during the arrangement period for the tax preferred use of the asset, particular financial benefits will be provided to the taxpayer (or a connected entity);
·
it is reasonable to expect that those financial benefits will be provided in relation to a use of the asset that is not a tax preferred use or a private use or will be provided for tax preferred use of the asset but are not attributable to financial benefits provided by members of the tax preferred sector (disregarding financial benefits that are provided under an arrangement that is a debt interest);
·
the amount or value of those financial benefits is known or can reasonably be estimated; and
·
the taxpayer chooses for the section to apply.

[Schedule 1, item 1, subsection 250-150(1)]

1.142 The choice to apply the apportionment rule:

·
must be made before the day that the taxpayer lodges an income tax return for the income year in which the arrangement period for the tax preferred use of the asset starts;
·
must be for the whole of the arrangement period for the tax preferred use of the asset;
·
must extend to all assets that are, or are to be, put to tax preferred use under the arrangement; and
·
is irrevocable.

[Schedule 1, item 1, subsection 250-150(2)]

1.143 If the taxpayer makes a choice under section 250-150, capital allowance deductions in respect of the asset are denied only to the extent of the 'disallowed capital allowance percentage'. [Schedule 1, items 1 and 4, subsection 250-150(3) and the definition of 'disallowed capital allowance percentage' in subsection 995-1(1) of the ITAA 1997]

1.144 The disallowed capital allowance percentage is worked out applying the following formula (expressed as a percentage):

The sum of the present values of the financial benefits that are subject to deemed loan treatment / Market value of asset

[Schedule 1, item 1, subsection 250-150(4)]

1.145 The discount rate to be used in working out the present values of the financial benefits provided, or to be provided, by the members of the tax preferred sector for the tax preferred use of the asset under subsection 250-150(4) is a rate that reflects a constant periodic rate of return (worked out on a compounding basis) on the investment in the relevant asset, or the relevant capital expenditure, that is implicit in the arrangements under which the asset is put to a tax preferred use and financial benefits are provided in relation to that tax preferred use. [Schedule 1, item 1, subsection 250-105(2)]

1.146 For these purposes, the investment in the relevant asset or capital expenditure will generally reflect the market value of the asset or expenditure.

1.147 If the disallowed capital allowance percentage worked out under subsection 250-150(4) is inappropriate, the Commissioner may approve an alternative method for working out the disallowed capital allowance percentage. The alternative method must be approved by the Commissioner before the day that the taxpayer lodges an income tax return for the income year in which the arrangement period for the tax preferred use of the asset starts. [Schedule 1, item 1, subsection 250-150(5)]

1.148 If the Commissioner approves an alternative method under subsection 250-150(5), the disallowed capital allowance percentage is percentage worked out in accordance with that alternative method. [Schedule 1, item 1, subsection 250-150(6)]

Example 1.19 Nu Co enters into an arrangement involving the tax preferred use of an asset. As some financial benefits will be provided in relation to a use of the asset that is not a tax preferred use, Nu Co makes an election under section 250-150 so that not all capital allowance deductions in respect of the asset are denied.The sum of the present values of the financial benefits that are subject to deemed loan treatment is $25 million and the market value of the asset is $40 million. Therefore, the disallowed capital allowance percentage is to be 62.5 per cent ($25 million ÷ $40 million × 100).Consequently, Nu Co is entitled to 37.5 per cent of the capital allowances in respect of the asset.

The arrangement is treated as a deemed loan

1.149 If Division 250 applies to a taxpayer and an asset at a particular time in an income year, a financial arrangement in the form of a loan is taken to exist at that time for the purposes of working out the taxpayer's taxable income for that income year. The characteristics of the loan are set out in section 250-155. [Schedule 1, item 1, subsection 250-155(1)]

Who is the lender?

1.150 The taxpayer is taken to be the lender in relation to the deemed loan. [Schedule 1, item 1, subsection 250-155(2)]

What is the amount lent at the start of the arrangement period?

1.151 The amount that is taken to be the amount lent by the taxpayer at the start of the arrangement period is, generally:

·
if (assuming Division 250 did not apply) the taxpayer would be entitled to capital allowance deductions in relation to the asset, the adjustable value of the asset at the start of the arrangement period reduced by the sum of all financial benefits that are subject to deemed loan treatment and that have become due and payable before the start of the arrangement period; or
·
if (assuming Division 250 did not apply) the taxpayer would be entitled to a deduction for capital expenditure, the amount of the undeducted capital expenditure (in the case of a Division 40 asset) or the undeducted construction expenditure (in the case of a Division 43 asset) reduced by the sum of all financial benefits that are subject to deemed loan treatment and that have become due and payable before the start of the arrangement period.

[Schedule 1, item 1, subsections 250-155(3) to (5)]

1.152 If the taxpayer has made a choice under subsection 250-150(3), the amount that is taken to be the amount lent by the taxpayer at the start of the arrangement period is:

·
if (assuming Division 250 did not apply) the taxpayer would be entitled to capital allowance deductions in relation to the asset, the disallowed capital allowance percentage of adjustable value of the asset at the start of the arrangement period reduced by the sum of all financial benefits that are subject to deemed loan treatment and that have become due and payable before the start of the arrangement period; or
·
if (assuming Division 250 did not apply) the taxpayer would be entitled to a deduction for capital expenditure, the disallowed capital allowance percentage of the amount of the undeducted capital expenditure (in the case of a Division 40 asset) or the undeducted construction expenditure (in the case of a Division 43 asset) reduced by the sum of all financial benefits that are subject to deemed loan treatment and that have become due and payable before the start of the arrangement period.

[Schedule 1, item 1, subsections 250-155(3) to (5)]

When is an amount paid by the borrower under the loan?

1.153 Any financial benefit that a person provides and is subject to deemed loan treatment is taken to be an amount that the borrower pays to the taxpayer under the loan. [Schedule 1, item 1, subsection 250-155(6)]

What is the period of the loan?

1.154 The arrangement period is taken to be the period of the loan. [Schedule 1, item 1, subsection 250-155(7)]

How does Subdivision 250-E apply to the loan?

1.155 The amount of the gain or loss included in a taxpayer's assessable income in respect of a deemed loan that is taken to be a financial arrangement because of section 250-155 is worked out under Subdivision 250-E. For the purposes of applying Subdivision 250-E to the deemed loan:

·
the taxpayer is taken to have an overall gain from the deemed loan and that overall gain is taken to be sufficiently certain at the start of the loan;
·
the amount of that overall gain is taken to be the sum of the financial benefits that are subject to deemed loan treatment reduced by the amount that is taken to be lent at the start of the arrangement period;
·
the taxpayer is taken:

-
to start to have the loan at the start of the arrangement period; and
-
to cease to have the loan at the end of the arrangement period;

·
any right that the taxpayer (or a connected entity) has to a financial benefit that is subject to deemed loan treatment is taken to be a right that the taxpayer has under the loan;
·
if a connected entity transfers to another person a right to a financial benefit subject to deemed loan treatment:

-
the taxpayer is taken to transfer the right to that other person; and
-
any consideration that the connected entity receives in relation to the transfer is taken to be consideration that the taxpayer receives in relation to the transfer;

·
if a right that a connected entity has to a financial benefit subject to deemed loan treatment ceases and the connected entity receives consideration in relation to that cessation, the taxpayer is taken to receive that consideration in relation to the cessation; and
·
the taxpayer is taken to start to have the financial arrangement, or to cease to have the financial arrangement, as consideration for something else if the taxpayer starts to have the rights to the financial benefits that are subject to deemed loan treatment, or cease to have those rights, as consideration for that thing.

[Schedule 1, item 1, paragraphs 250-155(8)(a) to (g)]

1.156 In addition, in working out the balancing adjustment at the end of the arrangement under section 250-265 to section 250-275:

·
the amount that is taken to have been lent are the only financial benefits that the taxpayer is taken to provide under the deemed loan; and
·
the financial benefits received by the taxpayer, or that the taxpayer has a right to receive, under the deemed loan are taken to include financial benefits that are subject to deemed loan treatment that a person is, at the end of the arrangement period, liable to provide to the taxpayer.

[Schedule 1, item 1, paragraph 250-155(8)(h)]

1.157 If a particular percentage of a reasonable estimate of the end value of the asset is taken to be a financial benefit that is subject to deemed loan treatment, subsection 250-275(1) applies to the loan at the end of the arrangement period as if the taxpayer had received under the loan a financial benefit equal to the relevant percentage of the end value of the asset. [Schedule 1, item 1, subsection 250-155(9)]

Example 1.20 Nu Co sells its interest in the asset to another taxpayer entity. The arrangement between Nu Co and the tax preferred entity ends and section 250-275 applies. The relevant percentage of the end value of the asset would be included in the section 250-275 calculations. The sale of the asset would be treated as a transaction occurring immediately after Division 250 ceases to apply to Nu Co.

Financial benefits subject to deemed loan treatment

1.158 A financial benefit is subject to deemed loan treatment if:

·
the financial benefit has been, will (assuming normal operating conditions) be or can (assuming normal operating conditions) reasonably be expected to be provided to a taxpayer (or a connected entity of the taxpayer);
·
the financial benefit has been, will be or can reasonably be expected to be provided directly or indirectly by a member of the tax preferred sector in relation to the tax preferred use of the asset (as distinct, for example, from the performance of services);
·
the right to receive, or the obligation to provide, the financial benefit is cash settlable; and
·
the financial benefit has not been, will not be or can be expected not to be provided by a connected entity of the taxable entity.

[Schedule 1, items 1 and 21, subsection 250-160(1) and the definition of 'subject to deemed loan treatment' in subsection 995-1(1) of the ITAA 1997]

Example 1.21 PT Co enters into a project deed with a state government agency. The project deed requires PT Co to construct a facility for use by the tax preferred entity. Once the facility is constructed, PT Co will service the facility for 30 years. PT Co finances the construction wholly by limited recourse debt and subcontracts the construction to another entity. At the completion of the construction, the state government agency starts to make payments to PT Co. The payments partly cover the debt obligations of PT Co and partly cover the costs of servicing the facility. The servicing of the facility has been subcontracted to a service entity. The payments to PT Co that are attributable to the servicing of the debt would be subject to deemed loan treatment.

1.159 The relevant percentage of a reasonable estimate of the end value of the asset is also taken to be a financial benefit that is subject to the deemed loan treatment if:

·
the asset is not to be purchased or acquired by or transferred to the tax preferred end user or a connected entity at the end of the arrangement accrual period under a legally enforceable arrangement; or
·
the asset is a privatised asset or would become a privatised asset if it were a depreciating asset - this ensures that section 250-160 interacts appropriately with Division 58 of the ITAA 1997.

[Schedule 1, items 1 and 21, subsection 250-160(2) and the definition of 'subject to deemed loan treatment' in subsection 995-1(1) of the ITAA 1997]

1.160 The relevant percentage is:

·
if section 250-150 applies, the disallowed capital allowance percentage; or
·
otherwise, 100 per cent.

[Schedule 1, item 1, subsection 250-160(2)]

1.161 A financial benefit is subject to the deemed loan treatment only to the extent to which it represents a return of or on an investment in the asset as distinct from, for example, representing consideration for services rendered or the recovery of production costs. [Schedule 1, item 1, subsection 250-160(3)]

Example 1.22 Under a long term arrangement that falls within the scope of Division 250, Nu Co receives monthly payments from a state government. Forty five per cent of the monthly payments represent consideration for services provided by Nu Co in connection with the arrangement for the tax preferred use of the asset. The remaining 55 per cent of the monthly payments represent financial benefits that are subject to the notional loan treatment.

1.162 In determining the extent that the financial benefits reflect a return of or on an investment in an asset, factors to be considered include the market value of the asset, the discount rate implicit in the arrangement for the asset and the taxpayer's cost in relation to funding the asset. The regulations may provide rules to determine the extent to which a financial benefit is a return on an asset. [Schedule 1, item 1, subsection 250-160(3)]

1.163 If the tax preferred use of an asset started before Division 250 starts applying to the asset, only those financial benefits provided after Division 250 starts applying to a taxpayer and an asset are subject to the deemed loan treatment. [Schedule 1, item 1, subsection 250-160(4)]

What is a financial arrangement?

1.164 If Division 250 applies to a taxpayer and an asset at a particular time in an income year, a financial arrangement in the form of a loan is taken to exist at that time. The financial arrangement is taken to exist (with the characteristics provided for in section 250-155) whether or not the definition of a 'financial arrangement' is otherwise satisfied. [Schedule 1, item 1, subsection 250-155(1)]

1.165 Financial benefits subject to deemed loan treatment that a person provides are taken to be the relevant financial benefits paid to the taxpayer under the loan which is the financial arrangement. The right to receive, or obligation to provide, these financial benefits must be cash settlable. In this sense, notwithstanding that the definition of 'financial arrangement' itself may not always have to be relied on, the concept of cash settlable is crucial for financial arrangements deemed to exist under section 250-155. [Schedule 1, items 1 and 3, subsection 250-155(6) , paragraph 250-160(1)(c) and the definition of 'cash settlable' in subsection 995-1(1) of the ITAA 1997]

Cash settlable financial arrangements

1.166 A taxpayer has a financial arrangement if, under an arrangement, the taxpayer has a cash settlable legal or equitable right to receive or obligation to provide a financial benefit, or a combination of one or more such rights and/or obligations, unless:

·
in comparison with this right, obligation or combination, the taxpayer also has, under the arrangement, one or more significant legal or equitable rights or obligations to receive or provide something where:

-
the thing that the taxpayer has the right to receive, or the obligation to provide, is not a financial benefit; or
-
the right or obligation is not cash settlable.

[Schedule 1, item 1, subsection 250-165(1)]

1.167 If the entity meets these conditions at any time under an arrangement, then at that time the entity will have a financial arrangement that consists only of any cash settlable legal or equitable rights to receive and obligations to provide financial benefits under that arrangement. That is, the cash settlable legal or equitable right, obligation or combination constitutes the financial arrangement. [Schedule 1, items 1 and 10, subsection 250-165(1) and the definition of 'financial arrangement' in subsection 995-1(1) of the ITAA 1997]

When is a financial benefit cash settlable?

1.168 A right that a taxpayer has to receive, or an obligation a taxpayer has to provide, a financial benefit is cash settlable if, and only if:

·
the benefit is money or a money equivalent (which includes a right to receive money and a right to receive such rights);
·
in the case of a right - the taxpayer intends to satisfy or settle it by receiving money or a money equivalent or by starting to have, or ceasing to have, another financial arrangement;
·
in the case of an obligation - the taxpayer intends to satisfy or settle it by providing money or a money equivalent or by starting to have, or ceasing to have, another financial arrangement;
·
the taxpayer has a practice of satisfying or settling similar rights or obligations by receiving or paying money or a money equivalent, or by starting or ceasing to have another financial arrangement (whether or not the taxpayer intends to satisfy or settle the right or obligation in that way);
·
the taxpayer deals with the right or obligation, or with similar rights or obligations, in order to generate a profit from short-term fluctuations in price, from a dealer's margin, or from both;
·
none of above points apply but:

-
the financial benefit is readily convertible into money or a money equivalent or there is a market for the financial benefit that has a high degree of liquidity; and
-
the taxpayer does not have, as their sole or dominant purpose for entering into the arrangement under which they are to receive or provide the financial benefit, the purpose of receiving or delivering the benefit as part of the expected purchase, sale or usage requirements in the ordinary course of business; or

·
the taxpayer is able to settle the right or obligation by receiving or paying money or a money equivalent, or by starting or ceasing to have another financial arrangement (whether or not the taxpayer intends to satisfy or settle the right or obligation in that way) and the taxpayer does not have, as the their sole or dominant purpose for entering into the arrangement under which they are to receive or provide the financial benefit, the purpose of receiving or delivering the financial benefit as part of the expected purchase, sale or usage requirements in the ordinary course of business.

[Schedule 1, item 1, subsection 250-165(2)]

An equity interest or right or obligation in relation to an equity interest

1.169 A taxpayer also has a financial arrangement if the taxpayer has an equity interest. In this case, the equity interest constitutes the financial arrangement. [Schedule 1, items 1 and 10, subsection 250-170(1) and the definition of 'financial arrangement' in subsection 995-1(1) of the ITAA 1997]

1.170 A taxpayer also has a financial arrangement if:

·
the taxpayer has, under an arrangement:

-
a legal or equitable right to receive or obligation to provide an equity interest, or a combination of one or more such rights or obligations where this does not constitute a cash settlable financial arrangement; or
-
a legal or equitable right to receive or obligation to provide such a right, obligation or combination where this does not constitute a cash settlable financial arrangement; and

·
the right, obligation or combination does not constitute a financial arrangement under section 250-165.

[Schedule 1, item 1, subsection 250-170(2)]

1.171 In this case, the right, obligation or combination constitutes the financial arrangement. [Schedule 1, items 1 and 10, subsection 250-170(2) and the definition of 'financial arrangement' in subsection 995-1(1) of the ITAA 1997]

Grouping and disaggregation rules

1.172 For the avoidance of doubt, if a taxpayer has a right to receive (or obligation to provide) two or more financial benefits, the taxpayer is taken, for the purposes of Division 250, to have a separate right to receive (or obligation to provide) each of those financial benefits. [Schedule 1, item 1, subsections 250-175(1) to (3)]

1.173 For the purposes of Division 250, whether a number of rights and/or obligations are themselves an arrangement or are two or more separate arrangements is a question of fact and degree that is determined having regard, both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other, to the following:

·
the nature of the rights and/or obligations;
·
the terms and conditions (including those relating to any payment or other consideration for them) of the rights and/or obligations;
·
the circumstances surrounding the creation of the rights and/or obligations and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the persons involved);
·
whether the rights and/or obligations can be dealt with separately or must be dealt with together;
·
normal commercial understandings and practices in relation to the rights and/or obligations (including whether they are regarded commercially as separate things or as a group or series as whole); and
·
the objects of Division 250.

[Schedule 1, item 1, subsection 250-175(4) of the ITAA 1997]

End value of an asset

1.174 If the asset has a guaranteed residual value, the end value of the asset is:

·
if (assuming Division 250 did not apply) the taxpayer would be entitled to capital allowance deductions for a decline in value of the asset, the guaranteed residual amount; or
·
if (assuming Division 250 did not apply) the taxpayer would be entitled to a deduction for capital expenditure, so much of the guaranteed residual amount that is attributable to the expenditure.

[Schedule 1, items 1 and 7, subsections 250-180(1) and (2) and the definition of 'end value' in subsection 995-1(1) of the ITAA 1997]

Example 1.23 A long term arrangement between AR Ltd and a state government in relation to an asset falls within the scope of Division 250 because the state government is the end user of the asset. Under the arrangement, the state government guarantees to pay $10 million to AR Ltd on the disposal of the asset at the end of the arrangement period. As the asset has a guaranteed residual value, the end value of the asset is $10 million.

1.175 If the asset does not have a guaranteed residual value and is a depreciating asset, the end value of the asset is:

·
if (assuming Division 250 did not apply) the taxpayer would be entitled to capital allowance deductions for a decline in value of the asset, the amount that would have been the adjustable value of the asset at the end of the arrangement period if Division 250 had not applied to the asset and the decline in the asset's value were worked out on the basis of the asset's effective life (disregarding any statutory caps specified in section 40-102) and using the prime cost method; or
·
if (assuming Division 250 did not apply) the taxpayer would be entitled to a deduction for capital expenditure, so much of the amount that would have been the adjustable value of the asset at the end of the arrangement period if Division 250 had not applied to the asset and the decline in the asset's value were worked out on the basis of the asset's effective life (disregarding any statutory caps specified in section 40-102) and using the prime cost method that is attributable to the expenditure.

[Schedule 1, items 1 and 7, subsections 250-180(1), (3) and (4) and the definition of 'end value' in subsection 995-1(1) of the ITAA 1997]

Example 1.24 A long term arrangement between AR Ltd and a state government in relation to an asset falls within the scope of Division 250. The asset does not have a guaranteed residual value. However, the asset's adjustable value at the end of the arrangement period (disregarding any statutory caps specified in section 40-102 and using the prime cost method) is estimated to be $25 million. Therefore, the end value of the asset will be $25 million.

1.176 If an asset does not have a guaranteed residual value and is not a depreciating asset, and an estimate of the value of the asset is recognised for accounting purposes, the end value of the asset is:

·
if (assuming Division 250 did not apply) the taxpayer would be entitled to capital allowance deductions for a decline in value of the asset, the value of the relevant asset at the end of the arrangement period that would be recognised for accounting purposes; or
·
if (assuming Division 250 did not apply) the taxpayer would be entitled to a deduction for capital expenditure, so much of the value of the relevant asset at the end of the arrangement period that would be recognised for accounting purposes that is attributable to the expenditure.

[Schedule 1, items 1 and 7, subsections 250-180(1) and (5) and the definition of 'end value' in subsection 995-1(1) of the ITAA 1997]

1.177 If none of subsections 250-180(2), (3) and (5) apply to the asset, the end value of the asset is:

·
if (assuming Division 250 did not apply) the taxpayer would be entitled to capital allowance deductions for a decline in value of the asset, a reasonable estimate of the market value of the asset at the end of the arrangement period that does not exceed the amount that is taken have been lent; or
·
if (assuming Division 250 did not apply) the taxpayer would be entitled to a deduction for capital expenditure, so much of a reasonable estimate of the market value of the asset at the end of the arrangement period that is attributable to the expenditure and that does not exceed the amount that is taken have been lent.

[Schedule 1, items 1 and 7, subsections 250-180(1) and (6) and the definition of 'end value' in subsection 995-1(1) of the ITAA 1997]

What happens if financial benefits are subject to deemed loan treatment?

1.178 A financial benefit is not included in a taxpayer's assessable income if the financial benefit:

·
is provided to the taxpayer in relation to the tax preferred use of the asset; and
·
is provided directly or indirectly by a member of the tax preferred sector; and
·
is subject to deemed loan treatment.

1.179 The financial benefit is not assessable income and is not exempt income. [Schedule 1, item 1, section 250-185]

1.180 This ensures that there is no double taxation of any financial benefits that are subject to deemed loan treatment. Any gains or losses on the deemed loan are recognised using the compounding accruals method outlined in Subdivision 250-E.

Taxation of the deemed loan

1.181 Subdivision 250-E outlines the tax treatment of gains and losses from a deemed loan that is taken to be a financial arrangement under section 250-155. Gains and losses from the financial arrangement are recognised over the life of the loan (ignoring distinctions between income and capital) using a compounding accruals method. A change in circumstances may cause a re-estimation of gains and losses that the accruals method is being applied to. A balancing adjustment is made if particular rights or obligations are transferred or cease. [Schedule 1, item 1, section 250-190]

1.182 Subdivision 250-E applies for the purposes of working out the amount of the gain or loss that is to be included in assessable income or allowed as a deduction in relation to the deemed loan financial arrangement. [Schedule 1, item 1, section 250-195]

1.183 The objects of Subdivision 250-E are:

·
to properly recognise gains and losses from the financial arrangement by allocating them to appropriate periods of time; and
·
to minimise tax deferral.

[Schedule 1, item 1, section 250-200]

1.184 Gains from the deemed loan financial arrangement are included in assessable income. [Schedule 1, item 1, subsection 250-205(1)]

1.185 Any losses from the deemed loan financial arrangement are deductible to the extent that they are made in gaining or producing assessable income or are necessarily made in carrying on a business for the purpose of gaining or producing assessable income. [Schedule 1, item 1, subsection 250-205(2)]

1.186 Gains on the deemed loan financial arrangement that are included in assessable income because of Subdivision 250-E, and any associated financial benefits making up the calculation of that gain, are not to any extent included in assessable income or allowable as a deduction under any other provision of the ITAA 1936 or the ITAA 1997. [Schedule 1, item 1, section 250-210]

1.187 Similarly, any losses that are allowable as a deduction because of Subdivision 250-E, and any associated financial benefits making up the calculation of that loss, are not to any extent allowable as a deduction or included in assessable income under any other provision of the ITAA 1936 or the ITAA 1997. [Schedule 1, item 1, section 250-210]

1.188 This anti-overlap rule will ensure that gains and losses from deemed loan financial arrangements (including any component parts of such gains and losses) are only recognised once for tax purposes. The anti-overlap rule does not prevent these amounts from being included in other calculations. For example, these amounts can be included in calculations for various tax-thresholds, such as the thin capitalisation tests in Division 820 of the ITAA 1997 and the calculations for tainted income under the controlled foreign corporation rules in Division 7 of Part X of the ITAA 1936.

Methods to be applied to take account of the gain or loss

1.189 The methods available to take account of the gain or loss that a taxpayer makes from the deemed loan financial arrangement are:

·
the accruals method provided for in sections 250-235 to 250-255; and
·
a balancing adjustment provided for in sections 250-265 to 250-275.

[Schedule 1, item 1, section 250-215]

1.190 A gain or loss that a taxpayer makes from the deemed loan financial arrangement is not taken into account under the accruals method to the extent that it has been taken into account under the balancing adjustment. [Schedule 1, item 1, section 250-215]

Consistency in working out gains or losses

1.191 As an integrity measure, a taxpayer must work out any gains and losses arising under Subdivision 250-E in a consistent manner. Therefore:

·
if Subdivision 250-E provides that a particular method applies to gains or losses a taxpayer makes from a deemed loan financial arrangement and that method allows the taxpayer to choose the particular manner in which to apply that method, the taxpayer must use that manner consistently for the arrangement for all income years; and
·
if Subdivision 250-E provides that a particular method applies to gains or losses a taxpayer makes from two or more deemed loan financial arrangements and that method allows the taxpayer to choose the particular manner in which to apply that method, the taxpayer must use that same manner consistently for all of those financial arrangements that are essentially of the same nature - it is likely that any deemed loan financial arrangements that are taken to arise under Division 250 will be of essentially the same nature.

[Schedule 1, item 1, section 250-220]

Rights and obligations include contingent rights and obligations

1.192 To avoid doubt:

·
a right is treated as a right for the purposes of Division 250 even it is subject to a contingency; and
·
an obligation is treated as an obligation for the purpose of Division 250 even if it is subject to a contingency.

[Schedule 1, item 1, section 250-225]

The gain or loss is worked out using the accruals method

01.193 The accruals method provided for in sections 250-235 to 250-255 applies to a gain or loss a taxpayer makes from a deemed loan financial arrangement if:

·
the gain or loss is an overall gain or loss from the arrangement; and
·
the gain or loss is sufficiently certain at the start of the arrangement period.

[Schedule 1, item 1, section 250-230]

1.194 For these purposes, the taxpayer is taken to have an overall gain from a deemed loan financial arrangement and that overall gain is taken to be sufficiently certain at the start of the arrangement period. [Schedule 1, item 1, paragraph 250-155(8)(a)]

1.195 To work out the gain or loss on the deemed loan financial arrangement the taxpayer must establish:

·
the period over which the gain or loss is spread, which is worked out under section 250-240 (together with paragraph 250-155(8)(c));
·
the method used to allocate the gain or loss to particular intervals within the period over which the gain or loss is spread, which is worked out under section 250-245; and
·
if an interval to which part of the gain or loss is allocated straddles two income years, the method for working out how the gain or loss is allocated between those income years, which is worked out under section 250-250.

[Schedule 1, item 1, section 250-235]

The period over which the gain or loss is to be spread

1.196 The period over which the gain or loss on the deemed loan financial arrangement is to be spread is the period that:

·
starts when the taxpayer starts to have the arrangement; and
·
ends when the taxpayer ceases to have the financial arrangement, assuming that the taxpayer continues to hold the arrangement for the rest of the life of the arrangement.

[Schedule 1, item 1, section 250-240]

1.197 In the case of a deemed loan financial arrangement that arises under Division 250:

·
a taxpayer is taken to start to have the loan at the start of the arrangement period; and
·
the taxpayer is taken to cease to have the loan at the end of the arrangement period.

[Schedule 1, item 1, paragraph 250-155(8)(c)]

1.198 The time when the arrangement period starts and ends is established by section 250-65. It is these times that will determine the period over which the gain or loss on the deemed loan financial arrangement is to be spread.

How the gain or loss is spread

1.199 The gain or loss on the deemed loan financial arrangement is spread using:

·
a compounding accruals method, with intervals to which parts of the gain or loss are allocated not exceeding 12 months and all being of the same length (other than the first and last intervals which may be shorter); or
·
a method whose results approximate those obtained using the compounding accruals method (having regard to the length of the period over which the gain or loss is to be spread).

[Schedule 1, item 1, subsections 250-245(1) to (3)]

1.200 Whichever method is chosen, the method is to be applied to spread the gain or loss on the assumption that the taxpayer will continue to have the deemed loan financial arrangement for the rest of the life of the arrangement. [Schedule 1, item 1, subsection 250-245(4)]

1.201 To apply the compounding accruals method a taxpayer estimates the rate of return (the discount rate) that equates the net present value of all cash flows (financial benefits) to zero. A taxpayer applies that rate to the initial investment to provide an estimated year-by-year gain which forms the basis for taxation. However, the amounts that are brought to account under Subdivision 250-E are to be in nominal terms.

1.202 A method other than the prescribed compounding accruals method may be used to spread a sufficiently certain overall gain or loss where the outcome under that method approximates the outcome under the compounding accruals method. The focus of the provision is in relation to the method used and not only the result from the application of that method. As long as the alternative method can be shown to have approximated what would have been the outcome under the compounding accruals method, that alternative method is acceptable.

1.203 The interval periods at the start and end may be shorter than the other intervals because the start or end of a financial arrangement may occur some time within an interval period. For example, the start or end of the arrangement might be such that it occurs in the middle of what otherwise would have been a three-month interval period. If this occurs that shorter period is taken to be an interval period for the purposes of subsection 250-245(3).

Allocating gain or loss to income years

1.204 That part of an overall gain or loss that has been allocated under the compounding accruals or other acceptable method to a particular interval must be brought to account under section 250-205 as:

·
assessable income in the income year in which the interval falls; or
·
an allowable deduction in the income year in which the interval falls, provided the conditions in subsection 250-205(2) are satisfied.

[Schedule 1, item 1, subsection 250-250(1)]

1.205 If the relevant interval straddles an income year, such that it starts in one income year and ends in the subsequent income year, the part of the gain or loss that relates to that interval must be allocated between the income years on a reasonable basis. The relevant amount that is brought to account under section 250-205 is so much of that part of the gain or loss that has been allocated to each income year. [Schedule 1, item 1, subsection 250-250(2)]

1.206 If a subsidiary member of a consolidated group or multiple entry consolidated group (MEC group) leaves the group and takes a financial arrangement with it, for the purposes of applying section 250-250 to the group and the financial arrangement, an income year of the group is taken to end at the time that the subsidiary member leaves the group - that is, at the exit time. [Schedule 1, item 1, subsection 250-250(3)]

Re-estimation of a gain or loss

1.207 Generally, for many deemed loan financial arrangements, the taxpayer will apply the compounding accruals method to the relevant gain or loss for the term of the arrangement. However, some circumstances may arise where, during the term of the arrangement, the calculation of the gain or loss to be accrued must be re-estimated.

1.208 A taxpayer must re-estimate a gain or loss from a deemed loan financial arrangement if circumstances arise that materially affect:

·
the amount or value of the financial benefits that were taken into account in working out the amount of the gain or loss; or
·
the timing of the financial benefits that were taken into account in working out the amount of the gain or loss.

[Schedule 1, item 1, subsection 250-255(1)]

1.209 The taxpayer must make the re-estimation as soon as reasonably practicable after becoming aware of the material change in circumstances affecting the timing of the financial benefits that were taken into account in working out the amount of the gain or loss. [Schedule 1, item 1, subsection 250-255(1)]

1.210 Particular types of change to the relevant circumstances that would require a re-estimation include, but are not limited to:

·
a material change in market conditions that are relevant to the amount or value of financial benefits that are to be received or provided under the financial arrangement;
·
where the cash flows that were previously estimated become known; and
·
where the right to or part of a right to a financial benefit under the arrangement is written off as a bad debt.

[Schedule 1, item 1, subsection 250-255(2)]

1.211 A taxpayer is not required to do a re-estimation of the amount of the gain or loss if the change to the value or amount of the financial benefit or the timing for when the financial benefit is to be paid or received is not significant. This is reflected in the requirement that the relevant change to those circumstances affecting a financial benefit is a material change. For example, a change to the circumstances in respect of a financial benefit may result in the cash flows that were previously estimated becoming known, but the difference between the estimated value of the cash flows and the actual value of the cash flow is small or negligible. In such a case, the change would not seem to be material.

1.212 A circumstance where a re-estimation will be required is if a financial benefit that has been taken into account in calculating the gain or loss is written off as a bad debt. Taxation Ruling TR 92/18 provides guidance as to when a debt is a bad debt. A debt will not be a bad debt if it is simply doubtful that the debt will be recovered.

1.213 A re-estimate of a gain or loss from a financial arrangement is not required under subsection 250-255(4) merely because of:

·
a change in the credit rating, or the creditworthiness, of a party or parties to the financial arrangement; and/or
·
the impairment (within the meaning of the accounting standards) of the arrangement or a debt that forms part of the arrangement.

[Schedule 1, item 1, subsection 250-255(3)]

1.214 A re-estimation in relation to a gain or loss involves:

·
a fresh determination of the amount of the gain or loss from the deemed loan financial arrangement; and
·
a reapplication of the accruals method to the redetermined gain or loss to make a fresh allocation of that part of the redetermined gain or loss that has not already been allocated to intervals ending before the re-estimation is made to intervals ending after the re-estimation is made.

[Schedule 1, item 1, subsection 250-255(4)]

1.215 The fresh allocation of the gain or loss under subsection 250-255(4) must be made using one of the following methods:

·
the first method is to maintain the rate of return that was used prior to the re-estimation and adjust the amount to which that rate of return is applied to the present value of the estimated future cash flows discounted at the maintained rate of return; or
·
the second method is to maintain the amount to which the rate of return was applied prior to the re-estimation and adjust the rate of return that is applied to that amount.

[Schedule 1, item 1, subsection 250-255(5)]

1.216 The adjusted amount to which the rate of return is applied for the first method refers to a change in the carrying amount of the deemed loan financial arrangement at the time of re-estimation to an amount representing the net present value of the future cash flows under the arrangement using the maintained discount rate. Together with the compensating adjustment for any over-accrued or under-accrued amounts (referred to below), this method will bring to account the remaining part of the redetermined gain or loss calculated under paragraph 250-255(4)(a).

1.217 The object of the two methods is to bring the remainder of the gain or loss based on the new estimates properly to account over the remainder of the period which the gain or loss is spread.

1.218 Compliance cost issues would arise if the taxpayer were required to amend prior year's returns each time a re-estimation of an amount is required. Hence, the fresh allocation of the gain or loss applies from the income year in which the taxpayer makes the re-estimation until the end of the arrangement:

·
Where the first method is used, a wash-up of over-accrued or under-accrued amounts is achieved by way of a specific accrual adjustment (see paragraphs 1.220 to 1.224).
·
Where the second method is used, a similar adjustment is made under the disposal (balancing adjustment) provisions.

1.219 Once a particular basis for a fresh allocation has been adopted in respect of a deemed loan financial arrangement, the taxpayer must apply the same basis to all other re-estimations of gains or losses in respect of all of their deemed loan financial arrangements. [Schedule 1, item 1, subsection 250-255(6)]

Accrual adjustment following a re-estimation

1.220 Where a taxpayer has chosen to make a fresh allocation of the re-estimated gain or loss by maintaining the original rate of return and adjusting the amount to which the rate of return is applied, an amount is brought to account in the income year in which the re-estimation is made. [Schedule 1, item 1, subsection 250-255(7)]

1.221 The adjustment captures the amount of the difference between the amount of the re-estimated gain or loss that should have been brought to account up until the time of re-estimation and the amount of the previously estimated gain or loss that had been brought to account.

1.222 On applying the accrual adjustment provisions, a gain will arise in the income year in which the re-estimation is made if:

·
the re-estimated amount is a gain and the amount to which the maintained rate of return is applied has increased in value as a result of the re-estimation - the amount of the gain is equal to that increase; or
·
the re-estimated amount is a loss and the amount to which the maintained rate of return decreases in value as a result of the re-estimation - the amount of the gain is equal to that decrease.

[Schedule 1, item 1, paragraphs 250-255(7)(a) and (d)]

1.223 On applying the accrual adjustment provisions, a loss will arise in the income year in which the re-estimation is made if:

·
the re-estimated amount is a gain and the amount to which the maintained rate of return is applied has decreased in value as a result of the re-estimation - the amount of the loss is equal to that decrease; or
·
the re-estimated amount is a loss and the amount to which the maintained rate of return increases in value as a result of the re-estimation - the amount of the loss is equal to that increase.

[Schedule 1, item 1, paragraphs 250-255(7)(b) and (c)]

1.224 The gain or loss that is made on applying the accrual adjustment provision in subsection 250-255(6) is brought to account as assessable income or an allowable deduction (provided the conditions in subsection 250-205(2) are satisfied) in the income year in which the re-estimation is made.

Re-estimation if balancing adjustment on partial disposal

1.225 A re-estimate of a gain or loss from a financial arrangement must also be made if a balancing adjustment is made in relation to the financial arrangement under sections 250-265 to 250-275 because:

·
the taxpayer transfers to another person a proportionate share of their rights and/or obligations under the financial arrangement;
·
the taxpayer transfers to another person a right or obligation that the taxpayer has under a financial arrangement to a specifically identified financial benefit; or
·
the taxpayer transfers to another person a proportionate share of a right or obligation the taxpayer has under a financial arrangement to a specifically identified financial benefit.

[Schedule 1, item 1, subsection 250-260(1)]

1.226 The re-estimate must be made as soon as reasonably practicable after the transfer occurs. [Schedule 1, item 1, subsection 250-260(1)]

1.227 Although these conditions would satisfy the requirements of section 250-255, where a partial disposal of the deemed loan financial arrangement has occurred, section 250-260 must be applied to do the re-estimation. That is, there is no choice between applying the method under section 250-255 and the method under section 250-260 in such circumstances.

1.228 The re-estimation in relation to a gain or loss involves:

·
a fresh determination of the amount of the gain or loss, disregarding:

-
financial benefits; and
-
amounts of the gain or loss that have already been allocated to intervals ending before the re-estimation is made, to the extent to which they are reasonably attributable to the proportionate share, or the right or obligation that has been transferred; and

·
a reapplication of the accruals method to the redetermined gain or loss to make a fresh allocation of the gain or loss that has not already been allocated to intervals ending before the re-estimation is made to intervals ending after the re-estimation is made.

[Schedule 1, item 1, subsection 250-260(2)]

1.229 In making the re-estimation, a fresh allocation of the gain or loss is made by maintaining the rate of return being used and adjusting the amount to which the rate of return is applied to the present value of the estimated future cash flows discounted at the maintained rate of return. The object of the fresh allocation is to bring the remainder of the redetermined gain or loss properly to account over the remainder of the period which the gain or loss is spread. [Schedule 1, item 1, subsection 250-260(3)]

1.230 The adjusted amount to which the rate of return is applied for the first method refers to a change in the carrying amount of the deemed loan financial arrangement at the time of re-estimation to an amount representing the net present value of the future cash flows under the arrangement using the maintained discount rate.

1.231 The adjustment under paragraph 250-260(2)(a) ensures that the amount brought to account on the disposal of the relevant rights is taken into account when redetermining the gain. The adjustment under subsection 250-260(3) ensures that the allocation of the redetermined gain takes account of amounts already brought to account in previous years under the accruals methodology.

1.232 The re-estimation is done in the same year as the balancing adjustment under sections 250-265 to 250-275.

What happens when the arrangement comes to an end?

1.233 A balancing adjustment is made under section 250-275 if:

·
the taxpayer transfers to another person all of their rights and obligations under the deemed loan financial arrangement;
·
all of the taxpayer's rights and obligations under the deemed loan financial arrangement otherwise substantially cease; or
·
the taxpayer transfers to another person:

-
a proportionate share of all the rights and/or obligations under the arrangement;
-
a right or obligation under the arrangement to a specifically identified financial benefit; or
-
a proportionate share of a right or obligation under the arrangement to a specifically identified financial benefit.

[Schedule 1, item 1, subsection 250-265(1)]

1.234 However, the following modifications are made if the financial arrangement is an asset of the taxpayer at the time the arrangement comes to an end:

·
paragraphs 250-265(1)(a) and (c) do not apply unless the effect of the transfer is to transfer to the other person substantially all the risks and rewards of ownership of the interest transferred; and
·
for the purposes of applying section 250-275 to the arrangement, the right under the arrangement is taken to be transferred by the taxpayer to another person if:

-
the taxpayer retains the right but assumes a new obligation;
-
the taxpayer's assumption of the new obligation has the same effect, in substance, as transferring the right to another person;
-
the new obligation arises only to the extent to which the right to financial benefits under the financial arrangement is satisfied;
-
the taxpayer cannot sell or pledge the right (other than as security in relation to the new obligation); and
-
the taxpayer must, under the new obligation, provide financial benefits received in relation to the right to the person to whom they owe the new obligation without delay.

[Schedule 1, item 1, subsection 250-265(2)]

1.235 However, a balancing adjustment is not made under section 250-275 if a subsidiary member of a consolidated group or MEC group, that has the deemed loan financial arrangement, ceases to be a member of the group. [Schedule 1, item 1, section 250-270]

What amount is recognised for income tax purposes as a result of the financial arrangement coming to an end?

1.236 The amount to be recognised for income tax purposes as a result of a transfer or cessation (ie, the balancing adjustment) is that amount which ensures that the entity's overall gain or loss from having the deemed loan financial arrangement (or a part of it) is recognised.

1.237 Therefore, amounts recognised prior to the transfer or cessation are taken into account in working out the amount of any balancing adjustment gain or loss. This process corrects for any under-allocation or over-allocation prior to the time of transfer or cessation.

1.238 In broad terms, the way in which the balancing adjustment for cessation or transfer of the whole financial arrangement is worked out for a particular entity under subsection 250-275(1) can be summarised in the formula:

Balancing adjustment = (a + b + c) - (d + e + f)
where:

·
a = total of all financial benefits provided to the taxpayer under the financial arrangement;
·
b = amount or value of any other consideration received by the taxpayer in relation to the transfer or cessation;
·
c = total of amounts that have been (or would have been) allowed as deductions for losses from the financial arrangement (if all the losses until the transfer or cessation were allowable as deductions);
·
d = total of all financial benefits provided by the taxpayer under the financial arrangement;
·
e = amount or value of any other consideration provided by the taxpayer in relation to the transfer or cessation; and
·
f = total of amounts that have been or would have been included in assessable income as gains from the financial arrangement (if all the gains until the transfer or cessation were amounts of assessable income).

1.239 If the balancing adjustment is positive, the amount is a gain made from the financial arrangement. If the balancing adjustment is negative, the amount is a loss made from the arrangement. [Schedule 1, item 1, subsection 250-275(1)]

1.240 If a balancing adjustment arises for a partial disposal, the variables in the above formula are adjusted to take into account the nature of the partial disposal.

1.241 Where there is a disposal of a proportionate share of all the rights and/or obligations under the arrangement, the following variables are reduced by that proportion: a, c, d and f . [Schedule 1, item 1, subsection 250-275(2)]

1.242 Where there is a disposal of a right or obligation under the arrangement to a specifically identified financial benefit, it is necessary to determine what has happened in relation to that right or obligation - for example, in terms of the cost and the previous allocation of gain or loss - in order to determine the gain or loss to be brought to account as a balancing adjustment. This is done by determining, in relation to a, c, d and f , what is reasonably attributable to the right or obligation. [Schedule 1, item 1, subsection 250-275(3)]

1.243 Where there is a disposal of a proportionate share of a right or obligation under the arrangement to a specifically identified financial benefit, the two types of adjustment discussed above are combined. That is, the starting point for a, c, d and f in the formula are amounts reasonably attributable to the particular right or obligation. These amounts are then reduced by the disposal proportion to arrive at the amounts actually used for a, c, d and f in the formula. [Schedule 1, item 1, subsection 250-275(4)]

1.244 Any adjustment to a, c, d and f in respect of one or more particular rights and/or obligations must reflect appropriate and commercially accepted valuation principles that take into account:

·
the nature of the rights and obligations under the financial arrangement;
·
the risks associated with the financial benefits under the arrangement; and
·
the time value of money (ie, characteristics of the financial benefits).

[Schedule 1, item 1, subsection 250-275(5)]

1.245 The gain or loss that is taken to be made under the balancing adjustment is a gain or loss the taxpayer is taken to have made from the deemed loan financial arrangement in the income year in which the balancing adjustment event occurs. [Schedule 1, item 1, subsection 250-275(6)]

1.246 In the case of a deemed loan financial arrangement that arises under Division 250, in working out the balancing adjustment at the end of the arrangement under section 250-265 to section 250-275, or when having to re-estimate the amount of the gain or loss from the deemed loan:

·
the amount that is taken to have been lent are the only financial benefits that the taxpayer is taken to provide under the deemed loan; and
·
the financial benefits received by the taxpayer, or that the taxpayer has a right to receive, under the deemed loan are taken to include financial benefits that are subject to deemed loan treatment that a person is, at the end of the arrangement period, liable to provide to the taxpayer.

[Schedule 1, item 1, paragraph 250-155(8)(h)]

Financial arrangements received or provided as consideration

1.247 If:

·
Subdivision 250-E applies in relation to a taxpayer's gains and losses from the financial arrangement; and
·
the taxpayer starts to have the financial arrangement (or a part of the financial arrangement) as consideration (or as part of the consideration) for:

-
something (the thing provided) that the taxpayer provided, or will provide, to someone else; or
-
something (the thing acquired) that someone else has provided, or is to provide, to the taxpayer; and
-
the thing provided or the thing acquired is not money,

then the amount of the benefit (or that part of the benefit) that the taxpayer obtained for the thing provided, or gave for the thing acquired, is taken, for the purposes of applying the ITAA 1936 or the ITAA 1997 to the taxpayer, to be the market value of the financial arrangement (or that part of the financial arrangement) at the time when the taxpayer started to have the financial arrangement. [Schedule 1, item 1, subsection 250-280(1)]

1.248 If subsection 250-280(1) applies, the taxpayer is taken to have received, or provided, as consideration for starting to have the financial arrangement (or the part of the financial arrangement), financial benefits whose value is equal to the market value of the financial arrangement (or that part of the financial arrangement) at the time when the taxpayer started to have the financial arrangement. [Schedule 1, item 1, subsection 250-280(2)]

1.249 If subsection 250-280(2) would apply to a taxpayer starting to have a financial arrangement, subsections 250-280(1) and (4) will not apply to that financial arrangement. That is, subsection 250-280(2) takes precedence over subsections 250-280(1) and (4). [Schedule 1, item 1, subsection 250-280(3)]

1.250 If:

·
Subdivision 250-E applies in relation to a taxpayer's gains and losses from the financial arrangement; and
·
the taxpayer ceases to have the financial arrangement (or a part of the financial arrangement) as consideration (or as part of the consideration) for:

-
something (the thing acquired) that someone else provides, or is to provide, to the taxpayer; or
-
something (the thing provided) that the taxpayer provided, or will provide, to someone else; and
-
the thing provided or the thing acquired is not money,

then the amount of the benefit (or that part of the benefit) that the taxpayer provided for the thing acquired, or obtained for the thing provided, is taken, for the purposes of applying the ITAA 1936 and the ITAA 1997 to the taxpayer, to be the market value of the financial arrangement (or that part of the financial arrangement) at the time when the taxpayer ceases to have the financial arrangement (or that part of the financial arrangement). [Schedule 1, item 1, subsection 250-280(4)]

1.251 These amounts may be relevant, for example, for the purposes of applying the provisions of the ITAA 1936 and the ITAA 1997 dealing with capital gains, capital allowances or trading stock to the thing provided. For example, where a capital gains tax (CGT) asset is disposed of in return for acquiring a financial arrangement, the proceeds received on disposal of that CGT asset will be taken to be the market value of the financial arrangement at the time the taxpayer starts to have the financial arrangement (instead of the proceeds that would otherwise have been determined under Parts 3-1 and 3-3 of the ITAA 1997).

1.252 If subsection 250-280(4) applies, the taxpayer is taken to have received, or provided, as consideration for ceasing to have the financial arrangement (or the part of the financial arrangement), financial benefits whose value is equal to the market value of the financial arrangement (or that part of the financial arrangement) at the time when the taxpayer ceased to have the financial arrangement. [Schedule 1, item 1, subsection 250-280(5)]

1.253 If subsection 250-280(5) would apply to a taxpayer ceasing to have a financial arrangement, subsections 250-280(1) and (4) will not apply to that financial arrangement. That is, subsection 250-280(5) takes precedence over subsections 250-280(1) and (4). [Schedule 1, item 1, subsection 250-280(6)]

1.254 Without limiting subsections 250-285(1) and (4), the thing provided, or the thing acquired, need not be a tangible thing and may take the form of services, conferring a right, incurring an obligation or extinguishing or varying a right or obligation. [Schedule 1, item 1, subsection 250-280(7)]

Examples illustrating the application of Division 250

1.255 The following examples illustrate the application of Division 250 in two different scenarios.

Example 1.25 Wal Co, a taxable entity, enters into a 30 year agreement with a state government that involves the tax preferred use of a depreciating asset. The arrangement comes within the scope of Division 250.Wal Co acquired the asset for $1 million and incurs additional costs of $115,625 to modify the asset to make it suitable for the tax preferred use. The effective life of the asset is 40 years.The following factors are relevant in determining the gain on the deemed loan that is included in Wal Co's assessable income:

·
the arrangement period starts on 1 July 2008 and ends on 30 June 2038 - that is, a period of 30 years;
·
the adjustable value of the asset at the start of the arrangement is $1,115,625 (ie, $1,000,000 + $115,625);
·
the annual payment for the tax preferred use of the asset by the state government to Wal Co is $90,000 (paid in arrears);
·
the estimated value of the asset at the end of the arrangement period is $178,125 - that is, the estimated adjustable value of the asset after 30 years; and
·
the asset is not to be purchased by the state government at the end of the arrangement period.

Wal Co subsequently decides to sell the asset for $1 million to another taxpayer entity on 30 June 2018 - that is, 10 years after the commencement of the arrangement period. The adjustable value of the asset at the end of the 10 years is $1 million.As Division 250 applies to the arrangement, the arrangement is taken to be a financial arrangement in the form of a loan (subsection 250-155(1)).Wal Co is taken to be the lender in relation to the loan (subsection 250-155(2)).The amount of the loan amount is taken to be the adjustable value at the start of the arrangement period - that is, $1,115,625 (subsections 250-155(3) and (4)).The amount that is taken to be paid under the loan to Wal Co by the borrower is the sum of financial benefits provided by the state government that are subject to deemed loan treatment (subsection 250-155(6)). The sum of the financial benefits that are subject to deemed loan treatment is the sum of financial benefits that can reasonably be expected to be paid or to become due and payable to Wal Co for the tax preferred use of the asset over the arrangement period plus the estimated value of the asset at the end of the arrangement - that is, $2,878,125 ($90,000 × 30 years + $178,125) (section 250-160).The arrangement period is taken to be the period of the loan - that is, 30 years (subsection 250-155(7)).The gain on the deemed loan that is included in Wal Co's assessable income is worked out under Subdivision 250-E, which specifies the taxation treatment of financial arrangements. For the purposes of applying Subdivision 250-E to the deemed loan:

·
Wal Co is taken to have an overall gain from the loan that is taken to be sufficiently certain at the start of the loan (paragraph 250-155(8)(a));
·
the amount of the overall gain is taken to be the sum of the financial benefits that are subject to deemed loan treatment ($2,878,125) less the amount of the loan ($1,115,625) - that is, $1,762,500 (paragraph 250-155(8)(b)); and
·
the loan is taken to start at the start of the arrangement period (1 July 2008) and cease at the end of the arrangement period (30 July 2038) (paragraph 250-155(8)(c)).

The estimated annual compounding accrual rate applicable to work out the amount of gain to be accrued each year is 7.2 per cent - that is, the internal rate of return based on the expected cash flows (including the estimated end value) under the arrangement over the arrangement period.The amount of gain on the deemed loan that is included in Wal Co's assessable income under section 250-205 in each year is illustrated in Table 1.1.
Table 1.1: Gain on the deemed loan that is assessable
Year Gain on the deemed loan that is assessable
2008-09 $80,445
2009-10 $79,756
2010-11 $79,018
2011-12 $78,226
2012-13 $77,377
2013-14 $76,467
2014-15 $75,491
2015-16 $74,445
2016-17 $73,323
2017-18 $72,120
Total $766,668
A balancing adjustment is made under section 250-275 when Wal Co sells the asset on 30 June 2018 for $1 million. The amount of the balancing adjustment is worked out as follows:
Total of financial benefits received
(ie, $90,000 × 10 + $1,000,000)
$1,900,000
Less
Total of financial benefits provided
(ie, the amount of the loan)
($1,115,625)
Total amount assessed ($766,668)
Balancing adjustment $17,707
The balancing adjustment gain of $17,707 is assessable in the 2017-18 income year.Therefore, the total amount that is included in Wal Co's assessable income as a result of Division 250 applying is $784,375(ie, $766,668 + $17,707). This amount is the same as the total amount that would be assessable if Division 250 did not apply. However, Division 250 has the effect of altering the amount that would be assessable in each income year.

Example 1.26 Court Co contracts on 1 July 2007 to design, construct and fit out a special purpose court building on land leased from a state government. There is nominal ground lease rental of $1. Court Co contracts to provide the completed court building to the state government and to provide facilities management services, both commencing from completion of the two-year construction period on 1 July 2009 and ending on 30 June 2034 (ie, a 25-year period).Court Co will receive annual availability charges from the state government commencing on 1 July 2009 for 25 years made up of a capital component of $9.77 million per annum (fixed with no escalation) and a facilities maintenance component (escalating at movements in the consumer price index). The availability charges are subject to abatement for non-availability of facilities and failure to meet performance benchmarks.Court Co has entered into two arm's length fixed price subcontracts:

·
One subcontract is with Construct Co for the design and construction of the buildings and plant for $80 million.
·
The second subcontract is with Services Co for the provision of the facilities management for a 25-year term for a price matching the facilities maintenance component of the availability charge.

The court building will revert to the state government (with nil consideration for the improvements) at expiry of the ground lease on 30 June 2034. Depreciable plant will be transferred to the state government at the same time for nil consideration.The arrangements can be illustrated as follows:

Illustration of arrangements

The project costs for Court Co can be broken down as follows:

·
Division 43 building capital expenditure - $70 million;
·
Division 40 depreciable plant - $10 million;
·
Other incidental costs/reserves - $20 million; and
·
Total Project Funding - $100 million.

For the purposes of applying Division 250, the arrangement period commences at completion of construction on 1 July 2009 (ie, when the tax preferred use commences) and ends on 30 June 2034.The financial benefits that are subject to deemed loan treatment need to be identified and then allocated separately to each asset on a reasonable basis.The capital component of the availability charge (ie, the annual payments of $9.77 million) represents a financial benefit in respect of the investment in the project assets. In the circumstances it is reasonable to allocate:

·
70 per cent of the capital component of the availability charge to the Division 43 capital expenditure; and
·
10 per cent of the capital component of the availability charge to Division 40 depreciable plant.

This represents the proportion of the total project investment represented by those items (subsection 250-160(3)).There is no end value amount required to be included as a financial benefit for either the Division 43 capital expenditure or the Division 40 depreciable plant (subsection 250-160(2)) because the Division 43 asset and the Division 40 depreciable plant will be transferred to the state government for nil consideration at the end of the arrangement period (paragraphs 250-85(1)(b) to (d)).In relation to the Division 43 asset:

·
Table 1.2 illustrates the Division 250 assessable amount in respect of the Division 43 asset - that is, the present value (applying a 5.40 per cent discount rate) of the assessable income calculated under Division 250 in respect of the Division 43 asset; and
·
Table 1.3 illustrates the alternative assessable amount - that is, the present value of the net assessable income of Court Co under general principles.

As the Division 250 assessable amount ($62.107 million) is less than the alternative assessable amount ($68.947 million), the exclusion in section 250-40 will apply and the asset will not be subject to deemed loan treatment.
Table 1.2: Division 250 assessable amount
Year Availability charge
(building capital component)
($'000s)
Division 250 assessable amount
($'000s)
Present value of assessable amount
($'000s)
2010 6,840 5,950 5,645
2011 6,840 5,874 5,288
2012 6,840 5,792 4,947
2013 6,840 5,703 4,621
2014 6,840 5,607 4,310
2015 6,840 5,502 4,013
2016 6,840 5,388 3,729
2017 6,840 5,265 3,457
2018 6,840 5,131 3,196
2019 6,840 4,986 2,946
2020 6,840 4,828 2,707
2021 6,840 4,657 2,477
2022 6,840 4,471 2,257
2023 6,840 4,270 2,045
2024 6,840 4,052 1,841
2025 6,840 3,815 1,644
2026 6,840 3,557 1,455
2027 6,840 3,278 1,272
2028 6,840 2,976 1,096
2029 6,840 2,647 925
2030 6,840 2,291 759
2031 6,840 1,904 599
2032 6,840 1,485 443
2033 6,840 1,030 291
2034 6,840 536 144
Total present value of assessable income 62,107
Table 1.3: Alternative assessable amount
Year Alternative assessable income
($'000s)
Present value of alternative income
($'000s)
Alternative allowable deductions
($'000s)
Present value of alternative deductions
($'000s)
Total alternative present value
($'000s)
2010 6,840 6,489 (1,750) (1,660) 4,829
2011 6,840 6,157 (1,750) (1,575) 4,582
2012 6,840 5,841 (1,750) (1,495) 4,347
2013 6,840 5,542 (1,750) (1,418) 4,124
2014 6,840 5,258 (1,750) (1,345) 3,913
2015 6,840 4,989 (1,750) (1,276) 3,712
2016 6,840 4,733 (1,750) (1,211) 3,522
2017 6,840 4,491 (1,750) (1,149) 3,342
2018 6,840 4,261 (1,750) (1,090) 3,171
2019 6,840 4,042 (1,750) (1,034) 3,008
2020 6,840 3,835 (1,750) (981) 2,854
2021 6,840 3,639 (1,750) (931) 2,708
2022 6,840 3,452 (1,750) (883) 2,569
2023 6,840 3,275 (1,750) (838) 2,437
2024 6,840 3,108 (1,750) (795) 2,313
2025 6,840 2,948 (1,750) (754) 2,194
2026 6,840 2,797 (1,750) (716) 2,082
2027 6,840 2,654 (1,750) (679) 1,975
2028 6,840 2,518 (1,750) (644) 1,874
2029 6,840 2,389 (1,750) (611) 1,778
2030 6,840 2,267 (1,750) (580) 1,687
2031 6,840 2,151 (1,750) (550) 1,600
2032 6,840 2,040 (1,750) (522) 1,518
2033 6,840 1,936 (1,750) (495) 1,441
2034 6,840 1,837 (1,750) (470) 1,367
Total present value of assessable income 68,947
In relation to the Division 40 asset, the asset is subject to Division 250 and deemed loan treatment will apply to the asset.The amount of the deemed loan is $10 million (paragraph 250-155(4)(a)). An amount of 10 per cent of the capital component of the availability charge payment stream received from the state government (ie, $977,000) is treated as repayment of principal and interest under the deemed loan.The amount of the gain on the deemed loan is included in the assessable income of Court Co under subsection 250-205(1).

Treatment of the asset after Division 250 ceases to apply

Implications for Division 40 purposes

1.256 For the purposes of Division 40, the adjustable value of the asset at the end of the arrangement period is modified if:

·
Division 250 ceases to apply to a taxpayer and an asset because the arrangement period for the tax preferred use of the asset ends; and
·
the asset would have had an adjustable value at that time if Division 250 had never applied to the asset.

[Schedule 1, item 1, subsection 250-285(1)]

1.257 In these circumstances, the adjustable value of an asset at the end of the arrangement period is:

·
if section 250-150 does not apply, so that all capital allowances in relation to the asset are denied during the arrangement period because of the operation of Division 250, the amount of the end value of the asset; or
·
if section 250-150 applies, so that only some of the capital allowances in relation to the asset are denied during the arrangement period because of the operation of Division 250, the sum of the following amounts:

-
the amount worked out by multiplying the end value of the asset at the end of the arrangement period by the disallowed capital allowance percentage; and
-
the amount worked out by multiplying the adjustable value of the asset at the end of the arrangement period (worked out under section 40-85) by 100 per cent minus the disallowed capital allowance percentage.

[Schedule 1, item 1, subsection 250-285(1)]

Implications for capital gains tax purposes

1.258 If Division 250 has applied to a taxpayer and an asset and the arrangement period for the tax preferred use of the asset ends, then for the purpose of working out the amount of any capital gain or loss, the cost base and reduced cost base of the asset is adjusted. The adjustments effectively reduce the cost base and the reduced cost base by the capital component of the deemed loan that has been excluded from assessable income (and therefore effectively allowed as a deduction). [Schedule 1, item 1, subsections 250-285(2) and (3)]

1.259 If a net amount is included assessable income in relation to financial benefits that are subject to deemed loan treatment (taking into account the adjustments under Subdivision 250-E), the cost base and reduced cost base are each taken to be reduced at the end of the arrangement period by the difference between:

·
the total financial benefits that were subject to the deemed loan treatment (disregarding the reasonable estimate of the end value of the asset); and
·
the net amount included in assessable income.

[Schedule 1, item 1, subsections 250-285(2) and (6)]

1.260 If a net amount is allowed as a deduction in relation to financial benefits that are subject to deemed loan treatment (taking into account the adjustments under Subdivision 250-E), the cost base and reduced cost base are each taken to be reduced at the end of the arrangement period by the sum of:

·
the total financial benefits that were subject to the deemed loan treatment (disregarding the reasonable estimate of the end value of the asset); and
·
the net amount allowed as a deduction.

[Schedule 1, item 1, subsections 250-285(3) and (6)]

Example 1.27 In Example 1.25, Wal Co sold the asset to another taxable entity for $1 million on 30 June 2018. The cost base of the asset for CGT purposes is $1,115,625 - that is, the sum of the amount paid to acquire the asset ($1 million) plus the cost of modifying the asset to make it suitable for tax preferred use ($115,625).If the asset is a CGT asset, for the purpose of working out the amount of the capital gain included in assessable income on the disposal of the asset, the cost base of the asset is reduced by $115,625 - that is, the difference between:

·
the total financial benefits that were subject to the deemed loan treatment (disregarding the reasonable estimate of the end value of the asset) - that is, $900,000 (ie, $90,000 × 10 years); and
·
the net amount of the gain on the deemed loan that is included in assessable income - that is, $784,375 (ie, the gain on the deemed loan that is assessable ($766,668) plus the balancing adjustment ($17,707)).

Therefore, if the asset is a CGT asset, the capital gain made by Wal Co will be nil - that is, the capital proceeds ($1 million) less the adjusted cost base ($1,115,625 - $115,625 = $1 million).

Implications for assets on revenue account

1.261 If Division 250 has applied to a taxpayer and an asset and the arrangement period for the tax preferred use of the asset ends, then for the purpose of working out the amount of the profit or loss on sale of the asset, the amount that is allowed as a deduction is adjusted. The adjustments effectively increase the taxable profit, or reduces the loss, on the sale of the asset by the capital component of the deemed loan that has been excluded from assessable income (and therefore effectively allowed as a deduction). [Schedule 1, item 1, subsections 250-285(2) and (3)]

1.262 If a net amount is included assessable income in relation to financial benefits that are subject to deemed loan treatment (taking into account the adjustments under Subdivision 250-E), then in determining the profit or loss on the sale of the asset, a deduction is taken to have been allowed for expenditure by the taxpayer in connection with the asset for an amount equal to the difference between:

·
the total financial benefits that were subject to the deemed loan treatment (disregarding the reasonable estimate of the end value of the asset); and
·
the net amount included in assessable income.

[Schedule 1, item 1, subsections 250-285(3) and (6)]

1.263 If a net amount is allowed as a deduction in relation to financial benefits that are subject to deemed loan treatment (taking into account the adjustments under Subdivision 250-E), then in determining the profit or loss on the sale of the asset, a deduction is taken to have been allowed for expenditure by the taxpayer in connection with the asset for an amount equal to the sum of:

·
the total financial benefits that were subject to the deemed loan treatment (disregarding the reasonable estimate of the end value of the asset); and
·
the net amount allowed as a deduction.

[Schedule 1, item 1, subsections 250-285(4) and (6)]

Balancing adjustment under Subdivision 40-D

1.264 For the purposes of applying Subdivision 40-D to an asset, the basis for working out the balancing adjustment is modified if:

·
the arrangement period for the tax preferred use of the asset ends because a particular event happens; and
·
the event would have been a balancing adjustment event for the asset for the purposes of Subdivision 40-D if Division 250 did not apply to the asset when the event happened.

[Schedule 1, item 1, subsection 250-290(1)]

1.265 In these circumstances, the balancing adjustment is made under Subdivision 40-D as if:

·
the event were a balancing adjustment event for the asset;
·
the adjustable value of the asset just before the event happened was the adjustable value worked out under subsection 250-285(1); and
·
section 40-290 (which reduces the balancing adjustment amount where the asset has been put to a non-taxable use) and section 40-292 (which adjusts the balancing adjustment amount where deductions for the decline in value have been allowed under research and development provisions of the ITAA 1936) did not apply.

[Schedule 1, item 1, subsection 250-290(2)]

Example 1.28 In Example 1.25, Wal Co acquired the depreciating asset for $1 million on 1 July 2008 and sold it to another taxable entity for $1 million on 30 June 2018. In working out the amount of the balancing adjustment:

·
the sale of the depreciating asset is taken to be a balancing adjustment event under Subdivision 40-D (section 250-290);
·
the adjustable value of the asset is taken to be the amount that is the end value of the asset at the end of the arrangement period - that is, $1 million (step 2 in the method statement in subsection 250-285(1)).

The amount of the balancing adjustment, which is worked out under section 40-305, is nil - that is, the difference between the amount received by Wal Co on the sale of the asset ($1 million) and the amount that is taken to be adjustable value of the asset ($1 million).

Objections against the Commissioner's determinations and decisions

1.266 A person who is dissatisfied with a determination made by the Commissioner under section 250-45, which allows the Commissioner to make a determination that it is unreasonable that Division 250 applies to a taxpayer and an asset at a particular time, may object against the determination under Part IVC of the Taxation Administration Act 1953 (TAA 1953). [Schedule 1, item 1, subsections 250-295(1) and (3)]

1.267 Similarly, a person who is dissatisfied with a decision made by the Commissioner under subsection 250-150(5), which allows the Commissioner to approve an alternative method for working out the disallowed capital allowance percentage of an asset, may object against the determination or decisions under Part IVC of the TAA 1953. [Schedule 1, item 1, subsections 250-295(2) and (3)]

Application and transitional provisions

Division 250 applies to arrangements entered into on or after 1 July 2007

1.268 Division 250 will apply to all relevant arrangements where the tax preferred use of an asset starts on or after 1 July 2007 under a legally enforceable arrangement that is entered into on or after that date. [Schedule 1, subitem 71(1)]

1.269 Section 51AD and Division 16D of Part III of the ITAA 1936 will not apply to an asset (including property) if the tax preferred use of that asset starts on or after 1 July 2007 under a legally enforceable arrangement that is entered into on or after that date.

Taxpayers can elect to apply Division 250 to certain arrangements entered into before 1 July 2007

1.270 Taxpayers can elect to apply Division 250 to certain arrangements entered into before 1 July 2007. This transitional provision applies if an asset is first put to tax preferred use on or after 1 July 2007. In that event, the taxpayer can elect to apply Division 250 to the arrangement even though the arrangement was entered into before 1 July 2007.

1.271 That is, Division 250 will apply to relevant arrangements where the tax preferred use of an asset starts on or after 1 July 2007 under a legally enforceable arrangement entered into before that date if:

·
section 51AD or Division 16D of Part III of the ITAA 1936 would otherwise apply to the asset; and
·
the taxpayer elects to have Division 250 apply.

[Schedule 1, subitem 71(2)]

1.272 The election to apply Division 250:

·
must be made by the day the taxpayer lodges an income tax return for the income year in which the tax preferred use starts;
·
must be made for the whole of the arrangement period for the tax preferred use of the asset;
·
must extend to all assets that are, or are to be, put to tax preferred use under the arrangement under which the asset is put to that use; and
·
is irrevocable.

[Schedule 1, subitem 71(3)]

1.273 The effect of making an election is that Division 250 (rather than section 51AD or Division 16D) will apply to the tax preferred use of the asset. [Schedule 1, subitem 71(4)]

Division 250 applies where an arrangement is materially altered on or after 1 July 2007

1.274 Division 250 will apply to an arrangement entered into before 1 July 2007 where, broadly:

·
section 51AD or Division 16D did not apply before 1 July 2007; and
·
there was a material alteration to the arrangement after 1 July 2007 that would, in the absence of this transitional provision, cause section 51AD or Division 16D to apply.

1.275 This will ensure that Division 250 applies to an arrangement entered into before 1 July 2007 where that arrangement would otherwise come within the scope of section 51AD or Division 16D because of a material alteration to the arrangement. In practical terms, this proposal will allow arrangements entered into by taxpayers to come within the scope of Division 250 by materially altering an existing arrangement rather than by achieving the same outcome by entering into a new arrangement.

Tax preferred use starts after commencement

1.276 Division 250 will apply to an asset that is put to a tax preferred use where:

·
the tax preferred use starts on or after 1 July 2007;
·
the tax preferred use is under a legally enforceable arrangement entered into before 1 July 2007;
·
immediately before 1 July 2007, neither section 51AD nor Division 16D applied to the asset (assuming that the asset was in existence and was being put to a tax preferred use at that time);
·
the arrangement is materially altered on or after 1 July 2007; and
·
section 51AD or Division 16D would otherwise apply to the asset immediately after the alteration.

[Schedule 1, subitem 71(5)]

1.277 A material alteration to an arrangement will occur only if there is a significant change to the arrangement. For example, a material alteration may arise because the taxpayer subsequently agrees to incur a substantial amount of additional capital expenditure in relation to the arrangement. In contrast, the removal of a contingent equity agreement in relation to an arrangement is not a material alteration of that arrangement.

1.278 For the purpose of determining whether Division 16D would otherwise have applied to the arrangement, section 159GL of the ITAA 1936 is to be disregarded. [Schedule 1, subitem 71(9)]

1.279 Section 159GL excludes from the operation of Division 16D certain qualifying arrangements relating to buildings in respect of which capital expenditure deductions are available under Division 10C or 10D. The section ensures that a taxpayer cannot, because of the application of Division 16D, receive a benefit that would not have been available had Division 16D not applied.

1.280 If subitem 71(5) applies, Division 250 (rather than section 51AD or Division 16D) will apply to the tax preferred use of the asset and the arrangement period will be taken to start on the day on which the alteration occurs. [Schedule 1, subitems 71(6) and (10)]

Tax preferred use starts before commencement

1.281 Division 250 will apply to an asset that it is put to a tax preferred use where:

·
the tax preferred use starts before 1 July 2007;
·
immediately after 1 July 2007 neither section 51AD nor Division 16D applied to the asset;
·
the arrangement is materially altered on or after 1 July 2007; and
·
section 51AD or Division 16D would otherwise apply to the asset immediately after the alteration.

[Schedule 1, subitem 71(7)]

1.282 For the purpose of determining whether Division 16D would otherwise have applied to the arrangement, section 159GL of the ITAA 1936 is to be disregarded. [Schedule 1, subitem 71(9)]

1.283 If subitem 71(7) applies, Division 250 (rather than section 51AD or Division 16D) will apply to the tax preferred use of the asset and the arrangement period will be taken to start on the day on which the alteration occurs. [Schedule 1, subitems 71(8) and (10)]

Section 51AD switched off from 1 July 2003

1.284 Section 51AD will not apply to arrangements entered into before 1 July 2007 where the tax preferred use started between 1 July 2003 and 30 June 2007. In these circumstances, Division 16D will generally apply to these arrangements. However, if there is a material alteration to the arrangement on or after 1 July 2007, Division 250 may apply to the arrangement.

1.285 That is, section 51AD will cease to apply to an asset in respect of an income year beginning on or after 1 July 2007 if:

·
the asset is put to tax preferred use under a legally enforceable arrangement;
·
the arrangement was entered into before 1 July 2007; and
·
the tax preferred use starts on or after 1 July 2003 and before 1 July 2007.

[Schedule 1, subitem 71(11)]

1.286 For the avoidance of doubt, an asset that is put to a tax preferred use includes property that falls within the scope of section 51AD.

1.287 This transitional rule will effectively switch off the adverse consequences of section 51AD with effect from 1 July 2003. This transitional rule will ensure that taxpayers are not disadvantaged by the delay in introducing Division 250 and, in practical terms, will reduce compliance costs as taxpayers will be able to remove contingent equity arrangements entered into for the purpose of avoiding the application of section 51AD.

Amendments to the Taxation Administration Act 1953

1.288 The consequential amendments to the TAA 1953 apply in relation to an income year that begins on or after 1 July 2008. [Schedule 1, subitem 71(2)]

Consequential amendments

Development Allowance Authority Act 1992

1.289 The Development Allowance Authority Act 1992 provides support for major capital works in the form of tax concessions for lenders. The scheme is administered by a certificate being issued for a project. The effect of the certificate is that interest payments made by companies, corporate unit trusts and public trading trusts on capital borrowings related to specific property are not taxable. The ability to apply for new certificates under the scheme was terminated in 1997.

1.290 Section 93R of the Development Allowance Authority Act 1992 requires that an applicant for a certificate does not do anything that causes section 51AD or Division 16D of Part III of the ITAA 1936 to apply to the relevant facilities. Section 93ZB allows the Development Allowance Authority to cancel a certificate if the conditions under which it was granted are not complied with.

1.291 Consequential amendments to section 93R of the Development Allowance Authority Act 1992 will ensure that the conditions for granting the certificate are not altered by the introduction of Division 250 of the ITAA 1997. [Schedule 1, items 25 and 26, subparagraphs 93R(b)(v) and (c)(ii) of the Development Allowance Authority Act 1992]

Income Tax Assessment Act 1936

Section 51AD

1.292 Section 51AD is being replaced by Division 250. If Division 250 applies to an asset (including property), section 51AD will not apply to that asset.

1.293 Section 51AD will continue to apply to property that is put to a tax preferred use under a legally enforceable arrangement that is entered into before 1 July 2007. Therefore, section 51AD will not apply to:

·
property that is put to a tax preferred use if that tax preferred use starts on or after 1 July 2007 under a legally enforceable arrangement that is entered into on or after that date;
·
property that is acquired on or after 1 July 2007 under a legally enforceable arrangement that is entered into on or after that date;
·
property that is put to a tax preferred use if that tax preferred use starts on or after 1 July 2007 under a legally enforceable arrangement that is entered into before that date and the taxpayer makes an election under item 71 to apply Division 250 to the arrangement; or
·
property that Division 16D applies to before 1 July 2007.

[Schedule 1, items 27 and 28, subsections 51AD(1A) to (1D) and (4) of the ITAA 1936]

1.294 For the avoidance of doubt, the reference to 'property that is put to a tax preferred use' in item 27 applies to property that would otherwise fall within the scope of section 51AD.

Research and development activities

1.295 Section 73B allows a deduction for certain expenditure on research and development activities. Section 73BA allows a deduction for certain assets used for the purpose of carrying on those activities.

1.296 Consequential amendments are made to add guidance notes to subsections 73B(15AA) and 73BC(2) that refer to Division 250 in appropriate circumstances. [Schedule 1, items 29 to 31, subsections 73B(15AA) and 73BC(2) of the ITAA 1936]

Consequential amendments related to Subdivision 250-E

1.297 Subdivision 250-E outlines the tax treatment of gains and losses from a deemed loan that is taken to be a financial arrangement because of section 250-155. A consequential amendment is made to the 12-month prepayment rules in the ITAA 1936 to ensure that they interact appropriately with Subdivision 250-E. [Schedule 1, item 32, section 82KZLA of the ITAA 1936]

Division 16D of Part III

1.298 Division 16D is being replaced by Division 250. If Division 250 applies to an asset (including an item of eligible property), Division 16D will not apply to that asset.

1.299 Division 16D will continue to apply to an item of eligible property that is put to a tax preferred use under a legally enforceable arrangement that is entered into before 1 July 2007. Therefore, Division 16D will not apply to:

·
an item of eligible property that is put to a tax preferred use if that tax preferred use starts on or after 1 July 2007 under a legally enforceable arrangement that is entered into on or after that date; or
·
an item of eligible property that is put to tax preferred use if that tax preferred use starts on or after 1 July 2007 under a legally enforceable arrangement entered into before that date and the taxpayer makes an election under item 71 to apply Division 250 to the arrangement.

[Schedule 1, items 33 and 34, subsections 159GH(1A), (1B) and (1) of the ITAA 1936]

1.300 For the avoidance of doubt, the reference to 'eligible property that is put to a tax preferred use' in item 33 applies to eligible property that would otherwise fall within the scope of Division 16D.

Amendment of assessments

1.301 Subsections 170(10) and (10AA) extend the period for amending assessments to give effect to specified provisions (including section 51AD and Division 16D). A consequential amendment ensures that the period for amending assessments to give effect to Division 250 is also extended. [Schedule 1, item 35, subsection 170(10AA) of the ITAA 1936]

Income Tax Assessment Act 1997

Checklists

1.302 The ITAA 1997 contains various checklists to guide the reader. The amendments will insert references to various terms used in Division 250 in the checklist of non-assessable non-exempt income and the checklist of deductions. [Schedule 1, items 36 to 42, sections 11-55 and 12-5]

Capital allowances

1.303 Division 40 contains the capital allowance regime. Section 40-25 allows a taxpayer to deduct the decline in value of a depreciating asset held by a taxpayer during an income year to the extent that, so far as is relevant, the asset is used for a taxable purpose. The amendments will modify the definition of 'taxable purpose' if Division 250 applies to a taxpayer and an asset that is a depreciating asset so that:

·
if section 250-150 applies, the taxpayer will be taken to be using the depreciating asset for a taxable purpose to the extent specified in a determination made under subsection 250-150(3); and
·
otherwise, the taxpayer will be taken not to be using the depreciating asset for a taxable purpose.

[Schedule 1, items 43 and 44, subsections 40-25(7) and (8)]

1.304 Consequential amendments are also made to add guidance notes to various provisions in Division 40 to refer to Division 250 in appropriate circumstances. [Schedule 1, items 45 to 56, sections 40-85, 40-525, 40-630, 40-730, 40-735, 40-750, 40-755, 40-835 and 40-880]

Capital works

1.305 Division 43 allows specific deductions for capital works. Consequential amendments are made to add a guidance note in section 43-140. [Schedule 1, items 57 and 58, subsection 43-140(1)]

Capital gains tax

1.306 Division 110 sets out the cost base and reduced cost base for a CGT asset in most circumstances. Division 112 outlines various modifications to the cost base and reduced cost base. Modifications that are made outside Division 112 are listed in section 112-97. A consequential amendment is being made to add a reference to the cost base modification rules that apply when Division 250 no longer applies to an asset in the list in section 112-97. [Schedule 1, item 59, section 112-97]

1.307 In addition, an amendment is made to the CGT provisions to ensure that a capital gain or loss that is made from a CGT asset is disregarded if the asset is, or is part of, a deemed loan financial arrangement. [Schedule 1, item 60, section 118-27]

Land transport facilities borrowing

1.308 Division 396 allows a lender to get a tax offset for certain interest it derives on an approved borrowing by another entity for the construction of land transport facilities. To qualify for the tax offset, the borrower must, among other things, enter into a land transport facilities borrowings agreement.

1.309 Section 396-85 specifies the conditions that are required to be included in the agreement. One of those conditions is that the borrower must not do anything that causes either section 51AD or Division 16D of Part III of the ITAA 1936 to apply to any of the relevant facilities. This condition is modified so that, in addition, the borrower must not do anything that causes Division 250 to apply to any of the relevant facilities. In addition, the example in subsection 396-75(2) is modified to reflect this change. [Schedule 1, items 61 and 62, subsection 396-75(2) and paragraph 396-85(1)(c)]

Consolidation

1.310 If an entity joins a consolidated group or MEC group, the tax cost of the joining entity's asset must be reset. If the asset is a right to receive a specified amount of Australian currency, for example, the asset is a retained cost base asset (subsection 705-25(5)). In this event, the tax cost setting amount is generally equal to the amount of Australian currency concerned (subsection 705-25(2)).

1.311 An amendment is made to the consolidation provisions to modify this outcome if an entity that joins a consolidated group or a MEC group holds a deemed loan financial arrangement that is a retained cost base asset. In that event:

·
the tax cost setting amount is the terminating value for the retained cost base asset immediately before the joining time; and
·
the terminating value of the deemed loan financial arrangement is equal to the amount of consideration that the joining entity would need to receive were it to dispose of the asset just before the joining time (without an amount being assessable or allowed as a deduction under Subdivision 250-E).

[Schedule 1, items 63 and 64, subsections 705-25(4A) and 705-30(3A)]

Foreign currency rules

1.312 Under the foreign currency and functional currency translation rules in Subdivisions 960-C and 960-D of the ITAA 1997, an amount of foreign currency must be converted into Australian dollars or into the taxpayer's functional currency. This generally applies to all amounts relevant to calculating an entity's income tax liability.

1.313 Generally, if the amount that is taken into account for income tax purposes is the sum of or the result of two or more other amounts, each element of that calculation must be translated into an amount of Australian currency or functional currency (subsections 960-50(1) and 960-80(1)). However, if the amount is a 'special accrual amount', only the amount that is sum of or the result of the calculation is translated into an amount of Australian currency or functional currency (subsections 960-50(5) and 960-80(5)).

1.314 If all the financial benefits provided and received under a deemed loan financial arrangement are denominated in a particular foreign currency, the amount that is included in assessable income under Subdivision 250-E will be a special accrual amount. [Schedule 1, item 20, definition of 'special accrual amount' in subsection 995-1(1) of the ITAA 1997]

1.315 Consequently, if the financial benefits received in respect of a deemed loan financial arrangement are denominated in foreign currency, only the gain on the deemed loan that is included in assessable income must be translated into an amount of Australian currency or functional currency.

Indexation of certain amounts

1.316 The threshold limits in sections 250-25 and 250-30 that apply to determine whether certain arrangements are excluded from Division 250 are indexed. Subdivision 960-M contains provisions to show how to index amounts and how to calculate the indexation factor. A consequential amendment is made to include references to sections 250-25 and 250-30 in the list of provisions for which indexation is relevant. [Schedule 1, item 65, section 960-265]

Debt / equity measures

1.317 Division 974 contains rules to determine whether an interest is a debt interest or an equity interest. Subsection 974-130(1) specifies when a scheme is a financing arrangement.

1.318 Subsection 974-130(4) outlines schemes that are taken not to be entered into or undertaken to raise finance for the purpose of working out whether a scheme is a financing arrangement. Consequential amendments to subsection 974-130(4) ensure that arrangements that come within the scope of Division 250 are treated consistently with arrangements that previously came within the scope of Division 16D. [Schedule 1, items 66 and 67, paragraphs 974-130(4)(a) and (d)]

Taxation Administration Act 1953

1.319 Subdivision 250-E outlines the tax treatment of gains and losses from a deemed loan that is taken to be a financial arrangement because of section 250-155. As gains and losses on deemed loan financial arrangements are statutory income rather than ordinary income, an amendment is made to the TAA 1953 to ensure that these amounts are included in the calculation of a taxpayer's instalment income. Only the net amount, if that amount is positive, of the gains and losses that are attributable to the period are included in instalment income. [Schedule 1, items 68 to 70, sections 45-5, 45-120 and 45-330 of the TAA 1953]

REGULATION IMPACT STATEMENT

Policy objective

1.320 The policy objective of the provisions in the income tax law affecting tax-exempt asset financing arrangements is to restrict the transfer of tax preferences between taxable entities and tax-exempt entities (including non-residents). The objective of this measure is to provide a more coherent and neutral tax treatment that reflects the economic substance of the arrangement.

Background

1.321 Section 51AD and Division 16D of Part III of ITAA 1936 were enacted in the 1984-85 income year to deny access to tax benefits (such as deductions for capital expenditure) in relation to property used by or for tax-exempt entities (including non-residents).

1.322 A general principle of income tax law is that, in order to claim deductions for expenditure relating to ownership of an asset (such as capital allowances), the owner must show that the asset is used for the purpose of producing assessable income or in carrying on a business for that purpose.

1.323 Arrangements were developed to circumvent this principle. While the taxpayer was the legal owner of the asset and derived assessable income through rental of the asset, arrangements developed under which the taxpayer transferred some or all of the risks and benefits associated with ownership of the asset to the entity that was the 'real' or 'end' user of the asset. This end user was typically either a government body whose income was exempt from tax or a non-resident that used the asset outside Australia for the purpose of producing income that was exempt from Australian tax (ie, in both cases, a 'tax-exempt entity').

1.324 Often the arrangements between the taxpayer and the tax-exempt entity took the form of a finance lease with, in some cases, a predetermined payment for the asset at the end of the arrangement period. The tax-exempt entity effectively guaranteed the taxpayer a return of the taxpayer's investment in the relevant asset. Thus, the taxpayer was effectively lending money to the tax-exempt entity and had little or no interest in the economic performance of the asset - that is, the taxpayer was essentially the legal but not the economic owner of the asset.

1.325 The tax advantages of such arrangements flowed from tax deferral in a low risk setting. The tax deferral arose from the profile of taxable income over the arrangement. A typical situation was the existence of tax losses in the early years of an arrangement. These tax losses were created by the annual deductions related to the asset (such as capital allowance deductions and interest deductions) being greater than the predetermined annual income under the arrangement. The taxpayer could use these losses to offset assessable income from other sources. While income in later years might exceed allowable deductions, in present value terms the arrangement was tax advantaged.

1.326 Part of the tax benefit from the arrangement was generally passed back to the tax-exempt entity through lower finance charges, thereby lowering the cost to the entity of using the relevant asset.

1.327 Section 51AD was designed to operate as an 'anti-avoidance' provision against this background because the large scale nature of the arrangements posed a significant threat to the revenue base. Section 51AD effectively prevents a tax-exempt body from accessing tax benefits in relation to an asset it uses or effectively controls that is financed by highly leveraged non-recourse debt. If section 51AD applies to an arrangement, the taxpayer is assessed on all the proceeds derived from the arrangement but is denied access to all deductions in respect of the asset (such as capital allowances and interest deductions).

1.328 Division 16D operates to deny capital allowance deductions for the cost of, or capital expenditure on, property which a tax-exempt body uses or effectively controls under a finance lease or similar arrangement. Division 16D does not apply where section 51AD applies. If Division 16D applies, the arrangement is treated as a loan and payments made under that arrangement are treated as having an interest and principal component. If the asset is not transferred to the tax-exempt end user at the end of the arrangement, then an unrealised loss is effectively allowed for any excess of loan principal over the value of the asset at the end of the arrangement.

1.329 The Review of Business Taxation recommended that:

·
section 51AD be removed; and
·
Division 16D be replaced with a provision under which tax-exempt asset financing arrangements where the taxpayer does not have a predominant economic interest in the relevant asset are taxed as sale and loan arrangements applying a compounding accruals methodology.

1.330 Reflecting these recommendations, the then Minister for Revenue and the Assistant Treasurer announced in Press Release No. C057/02 of 14 May 2002 that the Government would implement changes to reform section 51AD and Division 16D and the taxation of treatment of asset financing arrangements with tax-exempt entities.

Implementation options

Identification of arrangements that come within the scope of the measure

1.331 An asset financing arrangement will come within the scope of the measure if a tax-exempt entity has the predominant economic interest in the asset. Two options were considered for determining which entity has the predominant economic interest in the asset.

Option 1

1.332 Option one would be for asset risk tests to be used to determine which entity has the predominant economic interest in an asset. That is, the tax-exempt entity would have the predominant economic interest in the asset if it carried the greater share of the risks and benefits associated with the ownership of the asset.

1.333 A range of safe harbour tests would apply to exclude arrangements that may satisfy this primary test from the scope of the provisions. In addition, certain relatively short-term and lower value arrangements would be specifically excluded from the scope of the measure.

1.334 This option was recommended by the Review of Business Taxation. The Review recommended this approach because it more accurately reflects who has the predominant economic interest in an asset than a test based on the lease, use or control of use of an asset. Exposure draft legislation reflecting this option was released in June 2003.

1.335 This option was not considered feasible because of stakeholder resistance to this approach. In particular:

·
stakeholders raised concerns about being unfamiliar with the practical operation of the proposed asset risk tests;
·
stakeholders were concerned that, because of this lack of familiarity, the proposed asset risk tests would lead to increased compliance costs; and
·
stakeholders were concerned that, compared to the current law, the proposed asset risk tests would broaden the scope of arrangements that come within the measure.

Option 2

1.336 The second and preferred option is to apply a 'lease, use and control of use' test to determine which entity has the predominant economic interest in an asset. That is, the tax-exempt entity will have the predominant economic interest in the asset if it uses, or effectively controls the use of, the asset. If the arrangement is a lease (in form or in substance), the tax-exempt entity is taken to effectively control the use of the asset.

1.337 A range of safe harbour tests will apply to exclude arrangements that satisfy this primary test from the scope of the provisions. In addition, certain relatively short-term and lower value arrangements will be specifically excluded from the scope of the measure.

1.338 This option was strongly supported by stakeholders because stakeholders are familiar with the practical operation of tests based on the lease, use or control of use of an asset (and therefore there will be no increase in compliance costs). In addition, the financial accounting standards apply tests based on the lease, use or control of use of an asset to these types of arrangements.

Consequences that arise when an arrangement comes within the scope of the measure

1.339 Two options were considered for determining the consequences that arise when an arrangement comes within the scope of the measure.

Option 1

1.340 The first option is to modify the operation of the income tax law so that, if an asset financing arrangement comes within the scope of the measure:

·
capital allowance deductions in relation to the asset will be denied; and
·
the arrangement will be treated as a deemed loan that is taxed as a financial arrangement on a compounding accruals basis.

1.341 This option is preferred because it is broadly consistent with the approach in the existing law and with the financial accounting principles that apply to these arrangements. In addition, this approach was recommended by the Review of Business Taxation.

Option 2

1.342 The second option would be to modify the operation of the income tax law so that, if an asset financing arrangement comes within the scope of the measure, capital allowance deductions would be allowed on a straight line basis over the life of the project (rather than over the life of the asset). As an integrity measure, losses arising from the arrangement would be quarantined so that they could be offset only against income arising from the arrangement.

1.343 This option was not supported because it would be inconsistent with the income tax treatment of similar arrangements and with financial accounting principles. Stakeholders also raised concerns about the operation of the proposed integrity measure.

Assessment of impacts

Impact group identification

1.344 This proposed measure is expected to impact on:

·
corporate taxpayers engaged in arrangements to provide goods and services to tax-exempt entities (including non-residents);
·
tax-exempt entities (including non-residents) who are engaged in arrangements with taxpayers for the provision of goods or services;
·
advisers and consultants who provide advice to parties engaged in these arrangements; and
·
the ATO.

1.345 Consistent with the current law, the amendments are expected to impact primarily on large companies that enter into asset financing arrangements with governments or with non-residents (such as public private partnerships).

1.346 Examples of the types of arrangements that could be affected include:

·
arrangements for the construction of transport infrastructure (such as toll-roads, bridges, railways and harbours);
·
arrangements for the construction of power stations and the supply of electricity;
·
arrangements for the construction of telecommunications facilities;
·
arrangements for the construction and maintenance of public buildings (including hospitals, educational facilities, courts, police stations, correctional facilities, convention centres and public housing); and
·
arrangements involving the long-term leveraged lease of buildings or other property (such as aircraft).

1.347 However, because taxpayers usually structure arrangements to limit the application of the existing law, there is no data available about the number of taxpayers affected.

1.348 In this regard, if section 51AD applies to an arrangement, generally the arrangement will not be commercially viable. Although the harsh impact of section 51AD is being removed, it is likely that, where possible, taxpayers will continue to structure arrangements to limit the application of proposed Division 250 of the ITAA 1997.

1.349 To reduce compliance costs, certain relatively short-term and lower value arrangements are to be specifically excluded from the scope of Division 250. That is, the Division will not apply to a taxpayer if, broadly:

·
the arrangement period does not exceed 12 months;
·
the taxpayer is a small business entity for the income year in which the arrangement starts - that is, if the taxpayer carries on a business and satisfies the $2 million aggregated turnover test;
·
the financial benefits that are reasonably expected to be provided by the tax preferred sector under the arrangement do not exceed $5 million; or
·
the arrangement satisfies certain operating and finance risk tests: and

-
the arrangement period does not exceed three years (or five years if the arrangement is a lease of real property);
-
the financial benefits that are reasonably expected to be provided by the tax preferred sector do not exceed $30 million (or $50 million if the arrangement is a lease of real property); or
-
the total values of assets put to tax preferred use do not exceed $20 million (or $40 million if the arrangement is a lease of real property).

1.350 For the purpose of applying these tests, the financial benefits that are reasonably expected to be provided by the tax preferred sector are generally the amount that the taxpayer expects to receive from the tax preferred sector under the terms of the contract that is entered into between the parties.

1.351 Under the current law, the Commissioner has discretion to exclude arrangements from the scope of the provisions. At the request of stakeholders, this discretion is being retained.

1.352 It is expected that the Commissioner would consider applying the discretion, for example, to prevent an arrangement from coming within the scope of Division 250 due to:

·
an unintended or marginal breach of one of the safe harbour tests; or
·
an unintended or marginal breach of one of the tests that need to be satisfied to qualify for the specific exclusion for certain operating and service arrangements.

Analysis of costs and benefits

Compliance costs

1.353 This proposed measure is largely expected to impact a relatively small number of large corporate taxpayers, along with tax-exempt entities (including state governments) and non-resident entities that enter into certain large asset financing arrangements.

1.354 There has been extensive consultation with stakeholders during the development of the proposed reforms. Due to stakeholder concerns about compliance costs, Division 250 has adopted the same capture tests as section 51AD and Division 16D as these tests are already familiar to stakeholders and their tax advisors. Therefore, the compliance costs to taxpayers in determining whether their arrangements are caught by the new Division 250 are expected to be minimal.

1.355 However, the affected parties may incur some costs in either familiarising themselves with the technical detail of the new law or having advisers familiarise themselves with the new law. It is not expected that these costs of familiarisation will be significant.

1.356 The proposed new rules in Division 250 are designed to utilise the clearer drafting approach adopted in the ITAA 1997 and therefore may reduce compliance costs.

1.357 In addition, compliance costs may be reduced because taxpayers will no longer need to structure their affairs to avoid the harsh impact of section 51AD. In this regard, taxpayers currently enter into contingent equity arrangements that are designed to protect against the possibility that an arrangement will come within the scope of section 51AD.

1.358 The specific exclusions for relatively short-term and lower value arrangements from the scope of Division 250 will also reduce compliance costs.

1.359 A specific estimate of the change in compliance costs cannot be prepared as this would require an assessment of the existing compliance costs borne by taxpayers and the change in these costs following the amendments. It is not possible to isolate these changes independently of any broader changes to the business environment.

Administration costs

1.360 The legislation will be administered by the ATO. In relation to ATO administration costs, the proposed amendments are expected to have minimal impact. In the short term, there may be a small increase in costs associated with the training of ATO staff and with informing taxpayers of the law. However, these are likely to be offset over the long term as the reforms are expected to reduce overall complexity of the taxation law in this area.

Revenue estimate

1.361 The impact on revenue is unquantifiable.

Consultation

1.362 Business, legal and accounting representatives, representatives of state governments and the ATO have been consulted extensively and have actively assisted in developing this measure. A thorough consultation process has been essential because of the complexity of the issues involved and the need to reconcile the different views of various stakeholders.

1.363 Consultation has primarily been conducted on a targeted confidential basis and has included representatives from the following bodies:

·
Infrastructure Partnerships Australia (including the Australian Council for Infrastructure Development);
·
state governments;
·
Institute of Chartered Accountants of Australia;
·
Minerals Council of Australia;
·
Property Council of Australia;
·
Australian Bankers' Association;
·
Energy Supply Association of Australia; and
·
Australian Equipment Lessors Association.

1.364 Key steps in the consultation process were:

·
In June 2003, exposure draft legislation to implement the reform recommendations of the Review of Business Taxation was released. The exposure draft legislation proposed a range of risk tests to determine which arrangements will come within the scope of the reforms.
·
Following extensive consultations with stakeholders, the Government decided to explore alternative options to address concerns raised by stakeholders about the scope and effect of the proposed reforms. To assist consultation on this matter, a discussion paper was released to stakeholders in March 2005.
·
In September 2005, a change in the direction of the reforms was announced. A 'lease, use or control of use of the asset' test to determine which arrangements will come within the scope of the reforms was adopted.
·
Two exposure drafts of the legislation, and draft explanatory material, which detailed the legislative approach to be taken were subsequently circulated to stakeholders.

1.365 In addition, throughout this process, numerous consultation meetings have been held with stakeholders.

1.366 As a result of these consultations, significant changes were made to the legislation in response to stakeholder concerns. Key changes included:

·
the details of the 'lease, use or control of use of the asset' test to determine which arrangements will come within the scope of the reforms;
·
significant refinements to the operation of the safe harbour tests;
·
significant refinements to the exclusions for certain short to medium term and relatively lower value operating leases and service arrangements;
·
the basis for defining the concept of a lease;
·
modifications to the notional loan treatment (such as the basis for working out the end value of an asset); and
·
transitional arrangements that allow Division 250 to apply to arrangements entered into before 1 July 2007 in certain circumstances and that effectively switch off section 51AD with effect from 1 July 2003.

1.367 Some issues raised by stakeholders are not supported. These include:

·
increases in the thresholds for the safe harbour tests;
·
specific exclusions for particular industry groups;
·
modification of the definition of a lease so that it is based on the form, rather than the substance and the effect, of the arrangement; and
·
the removal of the limited recourse debt test as a safe harbour test.

1.368 These issues were not supported as they would significantly reduce the impact of the proposed reforms.

1.369 Some stakeholders also raised concerns about minor technical aspects of the draft legislation.

1.370 However, the introduction of the legislation is strongly supported by most members of the consultation group as it will significantly improve the operation of the existing law.

Conclusion and recommended option

1.371 It is recommended:

·
to apply a 'lease, use and control of use' test to determine which entity has the predominant economic interest in an asset; and
·
if the measure applies, to deny capital allowance deductions and treat the arrangement as a deemed loan that is taxed as a financial arrangement on a compounding accruals basis.

1.372 Stakeholders are familiar with this approach and it is broadly consistent with financial accounting principles.

1.373 This measure is expected to improve the current investment environment for tax-exempt asset financing arrangements through:

·
a more uniform set of rules and less administrative complexity;
·
specific carve outs for relatively short term and lower value arrangements; and
·
less onerous tax treatment for arrangements which meet the provisions - in particular, the removal of section 51AD will mean that taxpayers will no longer need to maintain contingent equity arrangements.

1.374 This measure is to apply to all relevant arrangements where the tax preferred use of an asset starts on or after 1 July 2007 under a legally enforceable arrangement that is entered into on or after that date. Under transitional provisions, this measure will also apply to arrangements entered into before 1 July 2007 in certain circumstances.

1.375 Treasury and the ATO will monitor this taxation measure, as part of the whole taxation system, on an ongoing basis.


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