Edited version of private ruling

Authorisation Number: 1011756918141

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Ruling

Subject: Public Private Partnership

Issue 1

Will the entity be entitled to deductions for the fees payable pursuant to section 8-1 of the Income Tax Assessment Act 1997 ( ITAA 1997)?

Answer

Yes.

Issue 2

Is the entity a Partnership and subject to the provisions of Division 5 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Issue 3

Is the entity a Corporate Limited Partnership within the meaning of section 94D of the ITAA 1936?

Answer

No.

Issue 4

Will any losses made by the entity be deducible under subsection 230-15(2) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period<s>:

1 July 2010 to completion

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The project members will form an entity to carry on the business activities and derive the income earned by the entity in relation to the Project.

Each project member of the entity will be jointly and severally liable for the entity's obligations. The project members are expected to be special purpose entities established solely for the purpose of investing in the entity.

The project members will enter into an equity holders agreement under which:

§ income and losses of the entity will be attributed to the project members in proportion to their member interest;

§ assets of the entity will be jointly owned by the project members in proportion to their member interest; and

§ liabilities of the entity will be jointly borne by the project members in proportion to their membership interests.

The entity will undertake all business activities necessary to carry on business on behalf of the project members in relation to the Project, including having a joint bank account for the entity's funds, maintaining business records such as accounts, meeting minutes, etcetera on behalf of the entity.

The project members will be in receipt of income jointly. It is intended that the project members will jointly maintain a joint bank account and will be in receipt of interest income jointly during the design and construction phase of the Project.

Each project member of the entity will indemnify and hold harmless another project member against any losses arising out of an action undertaken by the project member;

§ on behalf of the indemnified parties in connection with the entity and not authorised pursuant to any Project documents; and

§ from action properly taken under any Project document which results in a loss to the extent that such loss is paid to another project member in an amount in excess of their respective agreed proportions.

The entity will be responsible for providing services and maintaining facilities.

The terms and conditions will be governed by the Agreement between the entity and the other parties.

The entity will pay the relevant fees to the other party until the Expiry Date.

The Agreement confers no ownership, control or legal entitlement to possession in respect of the relevant areas to the entity, nor will it extend to the entity an entitlement to certain fees or profits.

Pursuant to the Agreement, the Fees payable by the entity will be assigned to another Party in exchange for a Payment which will be payable at the end of the relevant period. The size of this payment is linked to the quantum of the fees.

The entity will be responsible for providing services of the provision, maintenance and replacement of all goods, services and other utilities procured for the purposes of the Project.

The Project Agreement will be amended such that the entity:

§ has the obligation to procure the equipment on behalf of the other Party in accordance with the Project Agreement; and

§ does not obtain at any stage beneficial title to the plant and equipment nor a right to remove any of the plant and equipment from the Site.

Upon termination of the Agreement, the future obligations to pay the fees to the entity will cease and the entity must handover the Project to the other party.

Other Facts

It is reasonably expected that the overall gain or loss attributable to the On-loan Facility entered into by the entity calculated using the reliance on financial reports method will be equivalent to the overall gain or loss determined under the compounding accruals method.

It is reasonably expected that the gain or loss the entity makes from the On-loan Facility for each income year to which this ruling relates, calculated using the reliance on financial reports method will not be substantially different to the gain or loss recognised pursuant to the compounding accruals method.

Assumptions

For the purposes of this ruling request, the Commissioner has assumed that:

(A) In the income year entity enters into the Facility, it will make:

(a) an election pursuant to subsection 230-455(7) of the ITAA 1997, and

(b) an election under subsection 230-395 of the ITAA 1997; and

(B) for each of the income years to which the ruling applies, the entity will meet certain eligibility requirements in subsection 230-395(2) of the ITAA 1997 for adopting the 'Reliance on financial reports' method as follows:

(a) the entity will prepare a financial report:

(i) in accordance with accounting standards, and

(ii) which is audited in accordance with auditing standards,

(b) the entity's auditor will not qualify the auditor's report in a respect that is relevant to the tax treatment of financial arrangements; and

(c) the entity's accounting systems and controls and internal governance processes are reliable; and

(d) no report of an audit or review will include an adverse assessment of the entity's accounting systems in a respect that is relevant to the tax treatment of financial arrangements.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1);

Income Tax Assessment Act 1936 Division 5;

Income Tax Assessment Act 1936 section 94D;

Income Tax Assessment Act 1997 section 8-1;

Income Tax Assessment Act 1997 subsection 230-15(2);

Income Tax Assessment Act 1997 section 230-45;

Income Tax Assessment Act 1997 subsection 230-45(1);

Income Tax Assessment Act 1997 paragraphs 230-45(1)(d) to (f)

Income Tax Assessment Act 1997 paragraph 230-45(2)(a);

Income Tax Assessment Act 1997 section 230-50;

Income Tax Assessment Act 1997 section 230-55;

Income Tax Assessment Act 1997 subsection 230-55(4);

Income Tax Assessment Act 1997 section 230-85;

Income Tax Assessment Act 1997 Subdivision 230-B

Income Tax Assessment Act 1997 Subdivisions 230-C,

Income Tax Assessment Act 1997 Subdivisions 230-D,

Income Tax Assessment Act 1997 Subdivisions 230-E,

Income Tax Assessment Act 1997 Subdivisions 230-F

Income Tax Assessment Act 1997 subsection 230-395;

Income Tax Assessment Act 1997 subsection 230-395(1);

Income Tax Assessment Act 1997 subsection 230-395(2);

Income Tax Assessment Act 1997 paragraphs 230-395(2)(a)-(e);

Income Tax Assessment Act 1997 paragraphs 230-395(2)(b);

Income Tax Assessment Act 1997 paragraph 230-410(1);

Income Tax Assessment Act 1997 paragraph 230-410(1)(a);

Income Tax Assessment Act 1997 paragraph 230-410(1)(c);

Income Tax Assessment Act 1997 paragraph 230-410(1)(d);

Income Tax Assessment Act 1997 paragraph 230-410(1)(e);

Income Tax Assessment Act 1997 paragraph 230-410(1)(f);

Income Tax Assessment Act 1997 paragraph 230-420(1)(a);

Income Tax Assessment Act 1997 subsection 230-425(3);

Income Tax Assessment Act 1997 subdivisions 230-G,

Income Tax Assessment Act 1997 paragraph 230-435(1)(b);

Income Tax Assessment Act 1997 subsection 230-445(1);

Income Tax Assessment Act 1997 subsection 230-445(6);

Income Tax Assessment Act 1997 subsection 230-455(7);

Income Tax Assessment Act 1997 paragraph 974-160(1)(a);

Income Tax Assessment Act 1997 section 995-1;

Reasons for decision

Issue 1

Will the entity be entitled to deductions for the fees payable pursuant to section 8-1 of the ITAA 1997?

Summary

The entity will be entitled to deductions for the fee payable pursuant to section 8-1 of the ITAA 1997.

Reasoning

Business expenditure is deductible as a general (revenue nature) deduction if it has the necessary and relevant connection with the operation or activities which directly gain or produce assessable income ( Charles Moore & Co (WA) Pty Ltd v. Federal Commissioner of Taxation (1956) 95 CLR 344; 11 ATD 147; 6 AITR 379, Federal Commissioner of Taxation v. Smith (1981) 147 CLR 578; (1981) 11 ATR 538; (1981) 81 ATC 4114, Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Provided that a loss or outgoing can be objectively viewed as a necessary or natural consequence of the taxpayer's income earning activities, it will be 'incidental and relevant' to the income earning activities of the taxpayer and deductible as a revenue deduction under section 8-1 of the ITAA 1997, except to the extent that it is a loss or outgoing of capital or of a capital nature (see discussion of the High Court in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139).

The established principles on the distinction between capital and income are well known; see for example, Dixon J's judgement in Sun Newspapers Ltd & Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87 (Sun Newspapers Case), and the Full Federal Court decision in FC of T v. Email (1999) 99 ATC 4868 at 4873; 42 ATR 698 at 704). The character of the advantage sought provides guidance as to the nature of the expenditure as it says most about the essential character of the expenditure itself. The decision of the High Court in G.P. International Pipecoaters v. Federal Commissioner of Taxation (90 ATC 4413; (1990) 170 CLR 124; 21 ATR 1) in a joint judgement by Brennan, Dawson, Toohey, Gaudron and McHugh JJ.: emphasised this, stating:

the character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337, at 363; 1 AITR 353.

The entity will carry on the business activities of managing and maintaining the Facility in return for service fees.

The entity will be granted a licence to access the Project. The entity is required to pay access fees to the other Party in order to perform its contracted services of managing and maintaining the Facility. The service fees are assessable income of the joint venture in the conduct of its business, and are to be derived over the period of the scheme. On these facts the access fees would have a clear connection to the derivation of assessable income in the form of service fees.

As the expenditure does not involve the entity incurring expenditure for the acquisition or construction of a capital asset or otherwise for the enduring benefit of the entity, the access fee payments under the Agreement payable by the entity to the other Party will be deductible under section 8-1 of the ITAA 1997.

Issue 2

Is the entity a partnership and subject to the provisions of Division 5 of the ITAA 1936?

Summary

The entity is a partnership and subject to the provisions of Division 5 of the ITAA 1936.

Reasoning

Taxation Ruling TR 94/8: Income tax - whether business is carried on in partnership including 'husband and wife' partnerships, considers whether persons carrying on business constitute a partnership for Australian income tax purposes. Paragraph 4 of TR 94/8 outlines the factors necessary to determine whether or not a person carrying on a business constitutes a partnership and is evidenced by the:

. . . conduct of the parties towards one another and towards third parties during the course of carrying on business.

The factors set out at paragraph 4 of TR 94/8 are:

Intention

- the mutual assent and intention of the parties

Conduct

(a) joint ownership of business assets

(b) registration of business name

(c) joint business account and the power to operate it

(d) extent to which parties are involved in the conduct of the business

(e) extent of capital contributions

(f) entitlements to a share of net profits

(g) business records

(h) trading in joint names and public recognition of the partnership

The weight to be given to these factors varies with the individual circumstances. The above list of factors is not exhaustive and no single factor is decisive, although the entitlement to a share of net profits is essential, paragraph 5 of TR 94/8.

The relevant factors to the proposed arrangement include:

§ the service fees provide a sufficient economic return to investors;

§ the entry into the an agreement is prima facie evidence of the mutual assent and intention of the project members to act as partners;

§ the terms of the business relationship entered into by the project members includes the requisite joint ownership of assets as well as joint and several liability for the debts of the business;

§ having a joint bank account, registering and trading under the name of the entity, maintaining joint business records such as accounts, meeting minutes, contracting with relevant parties;

§ hold, interest in the entity; and

§ the income and losses of the entity will be attributed to the project members in proportion to their member interests.

Each of the above factors supports the conclusion that the entity will constitute a partnership and be subject to the provisions of Division 5 of the ITAA 1936.

Issue 3

Will the entity constitute a corporate limited partnership within the meaning of section 94D of the ITAA 1936?

Summary

The entity will not constitute a corporate limited partnership within the meaning of section 94D of the ITAA 1936.

Reasoning

Section 94D of the ITAA 1936 provides that a limited partnership that is formed during the 1996 year of income or a later year of income is a corporate limited partnership for the purposes of Division 5A of the ITAA 1936. The term 'limited partnership' is not defined in Division 5A. However, subsection 6(1) of the ITAA 1936 provides that the term 'limited partnership' bears the same meaning as provided for in section 995-1 of the ITAA 1997.

Pursuant to the definition in subsection 995-1 (1) of the ITAA 1997, a 'limited partnership' means:

(a)  an association of persons (other than a company) carrying on business as partners or in receipt of ordinary income or statutory income jointly, where the liability of at least one of those persons is limited; or

(b)  an association of persons (other than one referred to in paragraph (a)) with legal personality separate from those persons that was formed solely for the purpose of becoming a ^*VCLP, an ^*ESVCLP, an ^*AFOF or a ^*VCMP and to carry on activities that are carried on by a body of that kind.

Paragraph (b)

The entity is not a Venture Capital Limited Partnership (VCLP), an Early Stage VCLP (ESVCLP), an Australian venture capital Fund of Funds (AFOF), nor a Venture Capital Management Partnership (VCMP).

Paragraph (a)

The term 'limited partnerships' within the meaning of section 94D of the ITAA 1936 is discussed in Taxation Determination TD 2008/15: Income tax: can an unincorporated association of persons acting only in Australia who do not carry on a business in common with a view to profit be a corporate limited partnership within the meaning of section 94D of the Income Tax Assessment Act 1936. Paragraph 12 of the TD 2008/15 states:

12. A key requirement to satisfying paragraph (a) is that the liability of at least one of the persons in the association of persons is limited, in respect of their carrying on of business as partners or in respect of their joint receipt of income, whichever character their association has.

While there is extensive discussion in paragraphs 13 - 22 of TD 2008/15 as to the meaning of 'limited liability' for the purposes of the definition, the discussion can be reduced to the following two key principles:

First principle

A partnership cannot be a limited partnership unless the association of persons carries on a business with a view to profit (and cannot be a corporate limited partnership either).

Second principle

There is limitation of liability of at least one of the persons that is a partner in a partnership as stated in paragraph 13 of TD 2008/15.

Conclusion to first principle

As ruled for Question 2, the entity constitutes a partnership in accordance with an Australian state law. In arriving at this conclusion, the Commissioner accepts that the entity constitutes a partnership for Australian income tax purposes which includes carrying on business with the requisite view or intention to profit.

Conclusion to second principle

Members of the entity will enter into another agreement under which:

§ income and losses of the entity will be attributed to the project members in proportion to their member interests;

§ assets of the entity will be jointly owned by the project members in proportion to their member interests; and

§ liabilities of the entity will be jointly borne by the project members in proportion to their member interests.

The entity will undertake all business activities necessary to carry on business on behalf of the project members in relation to the Project (including having a joint bank account for the funds and maintaining business records such as accounts, meeting minutes and so on).

The project members will be in receipt of income jointly. It is intended for project members to 'jointly maintain a joint bank account' and to receive interest income jointly.

All the members of the entity will be general partners - that is, no project member will be a limited partner as no project member will have its liability in respect of the partnership limited.

There will be full recourse to the assets of the entity and all project members will have joint and severable liability.

There will be cross indemnities in place between the project members.

That is, no project member will have its liability to contribute to, the debts, obligations or other liabilities of the entity partnership, and therefore the partnership will neither be a 'limited partnership' as defined for income tax purposes nor a 'corporate limited partnership' for the purposes of section 94D of the ITAA 1936. This is not affected by any cross indemnities nor by certain other limitations.

Each of the above factors supports the conclusion that the entity is not a limited partnership, and therefore it cannot constitute a 'corporate limited partnership' for the purposes of section 94D of the ITAA 1936.

Issue 4

Will any losses made by the entity under the Facility be deducible under subsection 230-15(2) of the ITAA 1997?

Summary

A loss on the Facility will be deductible under subdivision 230-15(2) of the ITAA 1997, if it is a loss made from a financial arrangement to which Division 230 of the ITAA 1997 applies and either of paragraphs 230-15(2)(a) or (b) of the ITAA 1997are satisfied.

Reasoning

Identification of the arrangement under subsection 230-55(4) of the ITAA 1997

The definition of 'financial arrangement' determines the unit of taxation in respect of which gains and losses are recognised under Division 230 of the ITAA 1997. In order to determine whether gains and losses arise under a financial arrangement, it is first necessary to establish whether the rights and obligations under the Facility Agreement give rise to an 'arrangement' that in turn constitutes a financial arrangement.

An arrangement is defined in subsection 995-1(1) of the ITAA 1997 and includes any arrangement, agreement, understanding, promise or undertaking, whether express or implied. Section 230-55 of the ITAA 1997 modifies this broad notion of 'arrangement' and provides guidance in subsection 230-55(4) of the ITAA 1997 as to which specific rights and obligations will make up the relevant arrangement to be tested for the purposes of the Division.

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. A contract will often define the boundaries of a relevant arrangement, especially where the form of the contract is consistent with its substance. Relevantly, paragraph 2.47 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (the EM) states:

…[T]he contract is typically viewed on a stand alone basis. In this context, the contract is neither aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230.

However, section 230-55 of the ITAA 1997 is not limited by the form of a single contract in the identification of an arrangement. 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 must be determined having regard to each of the factors listed in subsection 230-55(4) of the ITAA 1997. The way various rights and obligations are combined under subsection 230-55(4) is an objective enquiry, the purpose of which is to identify the correct 'unit of taxation' upon which the provisions of Division 230 of the ITAA 1997 apply.

It is considered having regard to each of the factors listed in subsection 230-55(4) of the ITAA 1997 and the facts provided by the Applicant, that the Facility is a single arrangement for the purposes Division 230 of the ITAA 1997.

Specifically it is considered that the following matters support this conclusion:

§ the Facility is entered into to finance the Project; and

§ the amounts loaned under the Facility are repaid on the basis of a common schedule, that is, amounts loaned form an overall outstanding balance owing by the borrower and interest is calculated on that overall outstanding balance. Commercially this indicates that the Facility and the amounts loaned under it are regarded as a series of rights and obligations that form a whole; and

§ the objects of Division 230 of the ITAA 1997 broadly stated, are to align more closely tax and commercial recognition of gains and losses and to minimise compliance costs. These objects support a conclusion that the Facility is a single arrangement.

This arrangement must meet the definition of a 'financial arrangement' before it will be subject to Division 230.

Is the arrangement identified a financial arrangement under section 230-45 of the ITAA 1997?

Subdivision 230-A of the ITAA 1997 provides the test for determining whether an arrangement is a financial arrangement. Broadly, an arrangement will be a financial arrangement if it satisfies the 'primary definition' of a financial arrangement under section 230-45 of the ITAA 1997 (cash settlable rights and obligations to financial benefits) or the 'secondary definition' under section 230-50 of the ITAA 1997 (equity interests and rights and obligations to equity interests).

Subsection 230-45(1) of the ITAA 1997 provides:

You have a financial arrangement if you have, under an arrangement:

(a) a cash settlable legal or equitable right to receive a financial benefit; or

(b) a cash settlable legal or equitable obligation to provide a financial benefit; or

(c) a combination of one or more such rights and/or one or more such obligations;

unless:

(d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and

(e) for one or more of the rights and/or obligations covered by paragraph (d):

(i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or

(ii) the right or obligation is not cash settlable; and

(f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).

The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.

The secondary definition of a financial arrangement in subsection 230-50 of the ITAA 1997 does not apply.

The entity's relevant rights to receive and obligations to provide financial benefits under the Facility must be tested against section 230-45 of the ITAA 1997. The relevant rights and obligations under the Facility are as follows:

§ the right to receive a financial accommodation under the facility;

§ the obligation to provide a financial benefit being to pay interest on the principal amount;

§ the obligation to provide financial benefits, being payment or reimbursement of certain costs, expenses and other amounts of the Lender as set out in the Facility Agreement; and

§ the obligation to provide financial benefits, being the repayment of the principal amount.

For the avoidance of doubt, the ATO notes that for the purposes of Division 230 of the ITAA 1997, contingent rights and obligations are treated as rights and obligations (section 230-85 of the ITAA 1997).

The rights and obligations that arise under the Facility are rights or obligations to receive or provide financial benefits (as defined in paragraph 974-160(1)(a) of the ITAA 1997) for the purposes of section 230-45 of the ITAA 1997. Further, the rights and obligations will be cash settlable within the meaning of paragraph 230-45(2)(a) of the ITAA 1997 as they are rights and obligations to receive or provide monetary amounts.

As the rights and obligations under the On-loan Facility are cash settlable rights to receive and obligations to provide financial benefits, the exclusions to the definition of a financial arrangement set out in paragraphs 230-45(1)(d) to (f) of the ITAA 1997 have no application.

Therefore the Facility will be a financial arrangement for the purposes of section 230-45 of the ITAA 1997.

Is the facility a financial arrangement to which Division 230 of the ITAA 1997 applies?

In order for the entity to deduct any loss under subsection 230-15(2) of the ITAA 1997, it must make a loss from a financial arrangement to which Division 230 of the ITAA 1997 applies. For the purposes of this ruling it has been assumed that the entity will make an election pursuant to subsection 230-455(7) of the ITAA 1997 in the income year in which the Facility is entered into. It is also clear that exclusion rules in sections 230-450 and 230-460 of the ITAA 1997 have no application on the facts presented. Accordingly the Facility will be a Division 230 financial arrangement as defined in subsection 995-1(1) of the ITAA 1997.

Application of the tax-timing methods

The gain or loss from a financial arrangement is brought to account in the manner prescribed in Subdivision 230-B and 230-G of the ITAA 1997, unless one of the elective tax timing methods in Subdivisions 230-C, 230-D, 230-E, or 230-F of the ITAA 1997 apply.

In this regard, an assumption to this ruling is that the joint venture will make an election under subsection 230-395 of the ITAA 1997 to rely on its financial reports. As a consequence, to the extent joint venture satisfies the requirements of subsection 230-395(2) and paragraphs 230-410(1)(e) and (f) of the ITAA 1997 in each of the relevant income years, any gain or loss from the Facility made in a particular income year is included in assessable income or is deductible as determined by the tax timing methods in Subdivisions 230-F and the balancing adjustment in Subdivision 230-G of the ITAA 1997.

Is joint venture eligible to make the election to rely on financial reports?

The financial reports method allows taxpayers to calculate the gains and losses from financial arrangements by reference to accounting standards. A taxpayer who is eligible to, and makes, a financial reports election can effectively rely on their financial reports (to the extent that they are prepared in accordance with accounting standards) for the purposes of complying with their tax obligations in respect of Division 230 of the ITAA 1997 financial arrangements.

A taxpayer may make an election to rely on financial reports if they are eligible under subsection 230-395(2) of the ITAA 1997 to make the election for the income year in which the taxpayer makes the election; refer to subsection 230-395(1) of the ITAA 1997.

In accordance with the assumptions made for each income year to which the ruling relates, that:

(a) the entity will prepare a financial report:

(i) in accordance with accounting standards, and

(ii) which is audited in accordance with auditing standards,

(b) the entity's auditor will not qualify the auditor's report in a respect that is relevant to the tax treatment of financial arrangements,

(c) the entity's accounting systems and controls and internal governance processes are reliable, and

(d) no report of an audit or review will include an adverse assessment of the entity's accounting systems in a respect that is relevant to the tax treatment of financial arrangements,

the entity will be eligible to rely on its financial report for those income years to which the ruling applies (paragraphs 230-395(2)(a)-(e) of the ITAA 1997).

Does the election to rely on financial reports apply to the Facility?

Pursuant to subsection 230-410(1) of the ITAA 1997 an election to rely on financial reports will apply to the Facility financial arrangement held by the entity if it meets the criteria identified. The relevant criteria in subsection 230-410(1) will be satisfied as follows:

§ the Facility is a Division 230 of the ITAA 1997 financial arrangement as defined in subsection 995-1(1) [paragraph 230-410(1)(a) of the ITAA 1997],

§ the entity has advised that:

o it will make an election pursuant to subsection 230-455(7) of the ITAA 1997 in the income year in which the is Facility is entered into; and

o it will make an election under subsection 230-395(1) of the ITAA 1997 to rely on its financial reports for the purposes of complying with its tax obligations in the year in which the Facility is entered into.

Accordingly, paragraph 230-410(1)(b) of the ITAA 1997 will be satisfied,

§ the entity will prepare its own audited financial reports. Under the Accounting Standard the amounts loaned under the Facility will be recognised in the financial reports of the entity. In addition, the requirements in paragraphs 230-395(2)(a) and (b) of the ITAA 1997 will have been met; refer above. Therefore, the financial arrangement will satisfy the requirement in paragraph 230-410(1)(c) of the ITAA 1997,

§ the taxpayer reasonably expects that the overall gain or loss attributable to the Facility entered into by the entity calculated using the reliance on financial reports method will be equivalent to the overall gain or loss determined under the compounding accruals method. To the extent that the taxpayer continues to hold this reasonable expectation in each of the income years to which the ruling relates, paragraph 230-410(1)(e) of the ITAA 1997 will be satisfied, and

§ the taxpayer reasonably expects that the gain or loss the entity makes from the Facility for each income year to which this ruling relates, calculated using the reliance on financial reports method, will not be substantially different to the gain or loss recognised pursuant to the compounding accruals method. To the extent that the taxpayer continues to hold this reasonable expectation in each of the income years to which the ruling relates, paragraph 230-410(1)(f) of the ITAA 1997 will be satisfied.

Accordingly, the election to rely on financial reports will apply to the financial arrangement constituted by the Facility. However, the election will cease to have effect from the start of the income year if the entity ceases to be eligible to make an election to rely on financial reports; refer to subsection 230-425(1) of the ITAA 1997. The election will also cease to apply from the start of the income year in which the arrangement fails any of the requirements in paragraphs 230-410(1)(c), (d), (e) and (f) of the ITAA 1997; refer to subsection 230-425(3) of the ITAA 1997.

Effect of the election to rely on financial report

When you elect to rely on financial reports applies to a financial arrangement, the gain or loss from the arrangement for an income year is the gain or loss that the standards referred to in paragraph 230-395(2)(a) of the ITAA 1997 require you to recognise in profit and loss from that arrangement for that income year; refer to paragraph 230-420(1)(a) of the ITAA 1997.

Therefore, for each income year, the losses that joint venture makes under the financial arrangement constituted by the Facility will be those which joint venture is require to recognise in its profit or loss in accordance with the AASB Australian Accounting Standards (paragraph 230-420(1)(a) of the ITAA 1997).

Subdivision 230-G - the balancing adjustment

A balancing adjustment will occur when the entity's financial arrangement constituted by the Facility ceases (paragraph 230-435(1)(b) of the ITAA 1997)

The method statement in subsection 230-445(1) of the ITAA 1997 is used to calculate any additional amount of a gain or loss that the entity will be taken to have made at the time the balancing adjustment occurs in relation to a financial arrangement, being the Facility (subsection 230-445(6) of the ITAA 1997).

To the extent that the application of the method statement in subsection 230-445(1) of the ITAA 1997 to the Facility results in a loss, that loss will be taken to have been made by the entity in the income year in which it ceases to have rights and obligations under Facility (subsection 230-445(6) of the ITAA 1997).

Are the losses described above deductible?

Subsection 230-15(2) of the ITAA 1997 states that you can deduct a loss you make from a financial arrangement but only to the extent that you:

a. make it in gaining or producing your assessable income; or

b. you necessarily make it in carrying on your business for the purposes of gaining or producing your assessable income.

The entity obtains funds through borrowing and pays interest on those borrowed funds. It derives assessable income through the recognition of a Payment using a recognised method and then service payments.

Accordingly, any losses that the entity makes under the Facility are made in gaining or producing the entity's assessable income. Accordingly those losses will be deductible under subsection 230-15(2) of the ITAA 1997.

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