Edited version of your private ruling

Authorisation Number: 1012466928101

Ruling

Subject: Application of section 8-1 and Division 250 of the ITAA 1997

Question 1

Are the Licence Payments under the Agreement allowable deductions under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will Division 250 of the ITAA 1997 apply?

Answer

No

This ruling applies for the following periods:

The scheme commences on:

The date the agreement was executed

Relevant facts and circumstances

An entity entered into an agreement with the Originator to design, construct, commission, maintain and provide services to an asset (the Facility) for the Originator (the Project).

The Project comprised of a design and construction phase followed by an operating phase. At the conclusion of the Project, the entity's rights to access the Facilities under the Agreement will come to an end and the Originator will have unencumbered legal ownership of the Facility. The terms of the Agreement are such that the entity will have no underlying proprietary right to the Facility.

Finance Co. will provide finance to the entity.

Agreement

The entity entered into the Agreement with the Originator. Under the Agreement, the Originator will, amongst other things:

• Procure the design, construction and finance of the Facility from the entity in consideration for the Construction Price; and

• Procure the provision of certain facilities management services from the entity.

Design and Construction Phase

The Originator granted the entity a right to access the area necessary for the construction of the Facility for the duration of the design and construction phases.

The entity subcontracted the design and construction of the Facility.

In consideration for the entity constructing the Facility, the Originator will pay a Construction Payment to the entity over the construction phase. The Construction Payments will equal the design and construction costs incurred by the entity.

Operating Phase

Upon completion of construction the Originator granted the entity a Licence over the Facility for the purposes of providing the services under the Agreement.

The entity will pay Licence Payments to the Originator over the term of the Operating Licence from commencement of the Operating Licence.

The Operating Licence will give the entity non-exclusive rights to enter, occupy and access the Facility for the term of the Licence and the entity will not acquire permanent ownership rights over the Facility. All rights granted under the Operating Licence will revert to the Originator upon expiry of the Licence, and the entity will not have any right to remove assets fixed to the land.

Provided certain performance standards are met, the Originator will pay Service Payments to the entity for the duration of the Operating Licence, as consideration for the provision of the services under the Agreement.

The entity will subcontract the provision of services.

The Receivables Purchase Deed

The Originator, the entity and Finance Co will enter into the Receivables Purchase Deed at Financial Close.

Under the Receivables Purchase Deed, the Originator will assign its right, title to, and interest in, all of the Licence Payments to Finance Co (as they fall due) at a specified point in time. The Originator, the entity and Finance Co will also enter into a payment directions deed (Payment Directions Deed).

In consideration for the assignment of the Licence Payments, Finance Co will pay the Receivables Purchase Price to the Originator.

Starting at the Date of Commercial Acceptance and continuing until the end of the Project term, the entity will have an obligation to pay Licence Payments to the Originator. Following the assignment under the Receivables Purchase Deed on the Date of Commercial Acceptance, the entity will pay the Licence Payments to Finance Co in accordance with the Receivables Purchase Deed and the payment directions in the Payment Direction Deed.

The Originator will use the Receivables Purchase Price to pay the Construction Payments to the entity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Paragraph 8-1(1)(a)

Income Tax Assessment Act 1997 Paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 Paragraph 8-1(2)(b)

Income Tax Assessment Act 1997 Paragraph 8-1(2)(c)

Income Tax Assessment Act 1997 Paragraph 8-1(2)(d)

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 Subsection 230-20(4)

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Section 40-40

Income Tax Assessment Act 1997 Subdivision 40-I

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Section 43-75

Income Tax Assessment Act 1997 Division 250

Income Tax Assessment Act 1997 Section 250-15

Income Tax Assessment Act 1997 Paragraph 250-15(a)

Income Tax Assessment Act 1997 Paragraph 250-15(b)

Income Tax Assessment Act 1997 Paragraph 250-15(c)

Income Tax Assessment Act 1997 Paragraph 250-15(d)

Income Tax Assessment Act 1997 Paragraph 250-15(e)

Income Tax Assessment Act 1997 Subparagraph 250-15(d)(i)

Income Tax Assessment Act 1997 Subparagraph 250-15(d)(ii)

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

All legislative references are to provisions of the Income Tax Assessment Act 1997 unless otherwise stated.

Issue 1

Question 1

Summary

The Licence Payments will be deductible under section 8-1.

Detailed reasoning

Taxation of Financial Arrangements (ToFA) rules

The ToFA rules contained in Division 230 set out the income tax treatment of gains and losses on financial arrangements. Subsection 230-20(4) provides that if the ToFA rules apply then section 8-1 will not apply. Prior to considering whether section 8-1 applies it is necessary to consider if the ToFA rules apply to the payments and receipts under the Licence.

The ATO accepts that Licence Payments made in respect of the Licence will not be subject to the ToFA rules. Should the Licence constitute a 'financial arrangement' for the purposes of Division 230, it is the subject of an exception as 'an arrangement that is a licence to use real property' pursuant to paragraph 230-460(2)(e).

Section 8-1 of the ITAA 1997

Section 8-1 states:

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:
(a)  it is incurred in gaining or producing your assessable income; or

(b)  it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a)  it is a loss or outgoing of capital, or of a capital nature; or…

Paragraph 8-1(1)(a): Licence Payments incurred in gaining or producing the entity's assessable income?

The connection between a taxpayer's outgoings and the generation of assessable income was considered in Ronpibon Tin NL and Tongkah Compound NL v FC of T (1949) 78 CLR 47. The High Court of Australia stated at 56-57 that:

For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income.

and:

In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.

Under the Agreement, the entity must perform its contractual obligations to provide the Services or ensure the provision of the Services. In return the entity will derive assessable income from the Originator.

As part of the arrangements under which the entity is to perform the Services, the Originator will grant the entity the non-exclusive right to access the Facility. The entity will pay the Licence Payments in exchange for the right.

The occasion of the payment of the Licence Payments will be found in what will be productive of the entity's assessable income. Each Licence Payment will be an outgoing incurred by the entity in gaining or producing its assessable income for the purpose of paragraph 8-1(1)(a).

Having satisfied the positive limb in subsection 8-1(1), the Licence Payments must also not fall within any of the negative limbs in subsection 8-1(2).

Negative Limbs

In the current case, the relevant negative limb in subsection 8-1(2) is whether the interest is capital, or of a capital nature pursuant to paragraph 8-1(2)(a).

Paragraph 8-1(2)(a): Will the Licence Payments be outgoings of capital, or of a capital nature?

The courts have established a number of principles or tests to be applied in determining whether a loss or outgoing is capital, or of a capital nature (as opposed to being of a revenue nature). In Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 (Sun Newspapers) at 359 Dixon J said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

and at 363:

There are, I think, three matters to be considered [in determining whether expenditure is on revenue or capital account], (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play a part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

Character of the advantage sought

In considering these matters in Hallstroms Pty Ltd v FC of T (1946) 72 CLR 634 Dixon J said (at 646-647):

…it may be useful to recall the general consideration that the contrast between the two forms of expenditure [income and capital] corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it…. What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.

and at 648:

What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view...

In Colonial Mutual Life Assurance Society Ltd v FC of T (1953) 89 CLR 428 at 454 Fullagar J said:

The questions which commonly arise in [determining whether expenditure is on revenue or capital account] are (1) What is the money really paid for? - and (2) Is what it is really paid for, in truth and in substance, a capital asset?

In FC of T v CityLink Melbourne Limited 2006 ATC 4404 the High Court stated at 4427 that:

The characterisation of an outgoing depends on what it is calculated to effect to be judged from a practical and business point of view…The character of the advantage sought by the making of the expenditure is critical.

In relation to the character of the advantage sought by the expenditure it is necessary to examine whether the expenditure secures an enduring benefit for the business. This test was outlined in British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 at 213-214 by Viscount Cave where he stated:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

Enduring benefit for the business

In FCT v CityLink Melbourne Limited 2006 ATC 4404 (CityLink) the High Court of Australia considered the deductibility of concession fees paid by a taxpayer to the State of Victoria in consideration for the right to design, construct, operate and impose a toll in respect of certain City Link roads. The concession fees were payable in two instalments per year and adjusted pro-rata for any part year periods. The majority of the High Court found that the concession fees did not secure any enduring asset in terms of the roads built but, rather, resulted in the acquisition of the right to build, operate and earn a profit from the tolls charged for the use of those roads for the duration of the concession period. Crennan J (with whom Gleeson CJ, Gummow J, Callinan J and Heydon J agreed) applied the 'three matters' laid down by Dixon J in Sun Newspapers in determining that 'concession fees' paid to the State in respect of a public private partnership arrangement were on revenue account and stated at 4427 that:

The characterisation of an outgoing depends on what it is calculated to effect to be judged from a practical and business point of view .. [and] .. [t]he character of the advantage sought by the making of the expenditure is critical.

In particular, Crennan J noted, at paragraph 154:

The concession fees are only payable during the term of the concession period. The respondent does not acquire permanent ownership rights over the roads or lands used. All rights granted under the Concession Deed revert to the State at the expiry of the concession period [cf Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 14]. Unlike periodic instalments paid on the purchase price of a capital asset, the concession fees are periodic licence fees in respect of the Link infrastructure assets, from which the respondent derives its income, but which are ultimately "surrendered back" to the State. Accordingly, they are on revenue account.

Similarly, the entity does not and will not acquire permanent ownership rights over the Facility. All rights granted under the Licence revert to the Originator on the expiration or termination of the Licence. Further, the Licence Payments do not reflect the purchase price of a capital asset. Accordingly, this factor supports the view that the Licence Payments are on revenue account.

Advantage Sought

In FC of T v Star City Pty Ltd (2009) FCR 39 at 51-52, Goldberg J said:

The primary judge correctly identified the relevant principles to apply in determining whether [the outgoing] was an item of revenue or of capital and in determining the character of the advantage sought and the characterisation of the [outgoing]. In particular, the primary judge observed that an examination of the character of the advantage sought was assisted by asking two questions: What was the [outgoing] really paid for; and, is what it was really paid for, in truth and in substance, a capital asset? Her Honour accepted that the answer to these questions…depended upon what the expenditure was calculated to effect from a practical and business point of view.

The character of the advantage sought provides important guidance as to the nature of the expenditure because it says the most about the essential character of the expenditure itself. The decision of the High Court in GP International Pipecoaters Pty Ltd v Commissioner of Taxation (1990) 170 CLR 124 at 137; (1990) 90 ATC 4413 at 4419; (1990) 21 ATR 1 at 7 emphasised this, stating:

The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd. and Associated Newspapers Ltd. v Federal Commissioner of Taxation (1938) 61 C.L.R 337, at p.363 ...

In relation to the character of the advantage sought by the expenditure it is necessary to examine whether the expenditure secures an enduring benefit for the business. This test was outlined in British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 at 213-214 by Viscount Cave where he stated:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

The Licence Payments will be payable by the entity on a recurring basis and allows the entity access to the Facility. This is part of the contractual arrangements under which the entity performs contracted Services under the Agreement in return for Service Payments.

In terms of the character of the advantage which is sought by the entity, the periodic payment of the Licence Payments over duration of the Agreement enables the entity to operate and manage the Facilities and profit from the operation and management of the Facilities.

When the matters stated by Dixon J in the Sun Newspapers Case are considered, the character of the advantage sought by making the expenditure is the chief, if not the critical factor in determining the character of what is paid. The nature or character of the expenditure will therefore follow the advantage that is sought to be gained by incurring the expenditure.

The Licence Payments are, from a practical and business point of view, expenditure calculated to effect the entity's provision of its Services to fulfil its obligations under the Agreement. Each Licence Payment secures for the entity the right to access and use the Facility to provide the Services for the period to which the Licence Payment relates.

The character of the advantage sought by the entity is the fulfilment of its obligations to deliver the Services to the Originator under the Agreement, allowing derivation of its ordinary business income. Each Licence Payment is a recurring expense the entity and represents an outgoing in the ordinary course of carrying on the entity's business rather than an outgoing to establish its business organisation or structure. This advantage does not have any lasting quality or enduring benefit beyond the period to which the Licence Payment relates.

Therefore, the Commissioner regards the Licence Payments as revenue in nature and the character of the Licence Payments is not altered by virtue of the fact that the payments will occur over an extended period of time.

Therefore, the Licence Payments incurred are not capital, or of a capital nature and accordingly, will not fall within any of the negative limbs in subsection 8-1(2).

Issue 2

Question 1

Summary

Division 250 will not apply as the entity is not entitled to a deduction for capital allowances for the decline in value of an asset or for capital expenditure in relation to an asset arising from its interest in the Project.

Detailed reasoning

Division 250 denies or reduces capital allowance deductions that would otherwise be available in relation to an asset if the asset is put to a tax preferred use and the taxpayer has insufficient economic interest in the asset.

The general test for application of Division 250 is set out in section 250-15 which provides that the Division will apply to a taxpayer and an asset at a particular time if:

(a) the asset is put to a tax preferred use; and

(b)  the arrangement period for the tax preferred use of the asset is greater than 12 months; and

(c)  financial benefits in relation to the tax preferred use of the asset have been, will be or can reasonably to be expected to be provided to you by a tax preferred end user; and

(d) disregarding this Division you would be entitled to a capital allowance in relation to a decline in value of the asset; or expenditure in relation to the asset; and

(e) you lack a predominant economic interest in the asset at that time.

Each of the conjunctive requirements in paragraphs 250-15(a)-(e) must be present for the general test to be satisfied. If one of the paragraph requirements is not present, it is sufficient to conclude that the general test is not satisfied and, accordingly, that Division 250 does not apply.

The entity is in the business of procuring, facilitating and managing the design, construction, and provision of the Services in respect of the Facility. It conducts this business by subcontracting the services. The income it receives from the Originator is incidental and relevant to its activities as the Facilitator of the services and will be included in its assessable income.

Similarly the payments the entity makes to the sub-contractors under the relevant agreements are made in the ordinary course of its business. Further, these payments are not capital, or of a capital nature for the same reasons as stated in Reasons for Question 1 in respect of the Licence Payments and as such are allowable deductions pursuant to section 8-1.

Therefore, Division 250 does not apply to the entity on the basis that it is not and will not be entitled to a deduction for capital allowances, as required by paragraph 250-15(d).

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