Edited version of your written advice

Authorisation Number: 1012719039540

Ruling

Subject: Section 51AD/Division 16D/Division 250

Question 1

Will the Commissioner make a determination pursuant to subsection 159GG(4) of the ITAA 1936 that it is unreasonable for the lease arrangements in respect of the capital works assets and depreciating assets entered into pre 1 July 2003 to be regarded as "qualifying arrangements" for the purposes of Division 16D of the ITAA 1936?

Answer

Yes

Question 2

Will the lease arrangements in respect of the capital works assets and depreciating assets that were entered into pre 1 July 2003 transition into Division 250 pursuant to the application of subitems 71(7) and 71(8) of Schedule 1 to the Tax Laws Amendment (2007 Measures No 5) Act 2007?

Answer

Yes

Question 3

Will the Commissioner make a determination pursuant to subsection 159GG(4) of the ITAA 1936 that it is unreasonable for the lease arrangements in respect of the capital works assets and depreciating assets entered into between 1 July 2003 and 1 July 2007 to be regarded as "qualifying arrangements" for the purposes of Division 16D of the ITAA 1936?

Answer

Yes

Question 4

Will the second exclusion in section 250-25 apply to lease arrangements in respect of the capital works assets and depreciating assets entered into post 1 July 2007 or transitioned into Division 250 of the ITAA 1997 (if the answer to Question 2 is in the affirmative) where the financial benefits are under the minimum value limit?

Answer

Yes

Question 5

Will the third exclusion in section 250-30 apply to lease arrangements in respect of the capital works assets and depreciating assets entered into post 1 July 2007 or transitioned into Division 250 of the ITAA 1997 (if the answer to Question 2 is in the affirmative) where the arrangements are short term or low value?

Answer

Yes

Question 6

Will the Commissioner make a determination pursuant to the fifth exclusion in section 250-45 that it is unreasonable for Division 250 to apply to the lease arrangements in respect of the capital works assets and depreciating assets to the extent that the second exclusion in section 250-25 or the third exclusion in section 250-30 is not applicable to these lease arrangements?

Answer

Yes

This ruling applies for the following periods:

A specified period

The scheme commences on:

A specified date

Relevant facts and circumstances

XYZ Limited Partnerships:

The assets were acquired by six limited partnerships (XYZ Limited partnerships).

The partnerships are foreign residents for tax purposes.

Each of the partnerships were initially capitalised with a mixture of:

• Equity from the limited partners;

• Loans from the limited partners;

• Interest bearing loans; and

• Equity from the general partner.

XYZ Trust has invested into the partnerships through interposed foreign entities.

These above funds along with the funds invested by the other related were used to acquire 100% of the assets which are the subject of this ruling.

The partners in the XYZ Limited partnerships are as follows:

B Company is a foreign resident company which is held 50% by "Entity 1" and 50% by "Entity 2".

Australian Holding Structure

XYZ Trust is an Australian resident unit trust. The Trustee of XYZ Trust is XYZ Pty Ltd.

Contingent Equity Deeds ("CEDs"):

XYZ trust has entered into separate CEDs with the six General Partners (partners to the XYZ partnerships).

These CEDs require equity to be contributed by XYZ Trust to the General Partners in the event of default on repayments of principal and interest required to be made by the XYZ Limited Partnerships on the loans from finance entities.

Leases:

There are currently various separate leases in existence. In this regard:

• Some leases were entered into pre 1 July 2003;

• Some leases were entered into between 1 July 2003 and 1 July 2007; and

• Some leases were entered into post 1 July 2007.

Capital Allowances for Assets:

The XYZ Limited Partnerships hold the depreciating assets and are entitled to depreciation deductions under Division 40 of the ITAA 1997 in respect of these assets for Australian income tax purposes.

The XYZ Limited Partnerships also own the capital works assets and are entitled to capital works deductions for the eligible construction costs of these assets for Australian income tax purposes.

Sale of 50% interest:

Entity 2 has entered into an agreement to divest its 50% interest in assets to a foreign based organisation.

As part of the sale, XYZ Co Ltd (as Trustee for XYZ Trust) and the foreign based organisation entered into a Framework Agreement. As part of this agreement, the parties agreed that the existing CEDs would be cancelled if a favourable ruling is obtained from the ATO in respect of the potential application of section 51AD or Division 250 to the lease arrangements entered into by the XYZ Limited Partnerships.

Facts relating to a specific asset lease (No. 1 Lease):

This lease has been entered into between the XYZ Limited Partnership (as lessor) and No. 1 entity (as lessee). The lease was originally entered into in 19xx for a period of xx years (i.e. expiring in 20xx).

The portion of lease income attributable to the No. 1 lease compared to all leases is x%.

The portion of the asset area covered by the No.1 lease compared to the area of all leases is x%.

The portion of the asset area covered by the No.1 lease as compared to the area of all leases (including common areas) is x%.

Facts specifically relating to the Sixth Limb (Qualifying Arrangement test) of Division 16D of the ITAA 1936:

Capital allowance deductions are not being claimed for a significant portion of the assets that are the subject of the 39 Division 16D leases (leases entered into between 1 July 2003 and 1 July 2007). In particular, we note that no capital allowance deductions are being claimed pursuant to Division 43 for assets that are subject to the Division 16D leases. This is because the relevant entitlement conditions for these capital allowance deductions are not satisfied.

The approximate cost of the depreciating assets that are within the ambit of the Division 16D leases at the time that the XYZ Limited Partnerships acquired an interest in the assets has been supplied. This amount has been determined by apportioning the total cost of the depreciating assets to the area covered by the leases based on area size.

The asset additions relating to these Division 16D leases from when the XYZ Limited Partnerships acquired an interest in the assets have also been supplied. This represents x% of the total additions since the XYZ Limited partnerships acquired the assets.

Capital allowance deductions are not being claimed for a significant portion of the assets that are the subject of the pre 1 July 2003 leases. Specifically, no capital allowance deductions are being claimed pursuant to Division 43 for assets that are subject to the pre 1 July 2003 leases. This is because the relevant entitlement conditions for these capital allowance deductions are not satisfied.

The asset additions relating to the pre 1 July 2003 leases from when the XYZ Limited Partnerships acquired an interest in the assets have also been supplied. This represents x% of the total additions since the XYZ Limited partnerships acquired the assets.

The approximate cost of the depreciating assets that are within the ambit of the pre 1 July 2003 leases at the time that the XYZ Limited Partnerships acquired an interest in the assets has also been supplied. This amount has been determined by apportioning the total cost of the depreciating assets to the area covered by the leases based on area size.

Specific documents or relevant parts thereof also formed part of the facts of the ruling.

Relevant legislative provisions

Income Tax Assessment Act 1936, Division 16D

Income Tax Assessment Act 1936, Division 51AD

Income Tax Assessment Act 1936, Section 51AD(4)

Income Tax Assessment Act 1936, Section 51AD (8)

Income Tax Assessment Act 1936, Section 90

Income Tax Assessment Act 1936, Section 92

Income Tax Assessment Act 1936, Subsection 159GG(1)

Income Tax Assessment Act 1936, Subsection 159GG(2)

Income Tax Assessment Act 1936, Subparagraph 159GG(1)(a)(i)

Income Tax Assessment Act 1936, Subparagraph 159GG(1)(a)(ii)

Income Tax Assessment Act 1936, Subparagraph 159GG(1)(a)(iii)

Income Tax Assessment Act 1936, Subparagraph 159GG(1)(a)(iv)

Income Tax Assessment Act 1936, Paragraph 159GG(1)(b)

Income Tax Assessment Act 1936, Paragraph 159GG(1)(c)

Income Tax Assessment Act 1936, Subsection 159GG(4)

Income Tax Assessment Act 1936, Section 159GH(2)

Income Tax Assessment Act 1997, Section 243-20

Income Tax Assessment Act 1997, Division 250

Income Tax Assessment Act 1997, Section 250-15

Income Tax Assessment Act 1997, Section 250-25

Income Tax Assessment Act 1997, Subsection 250-25(1)

Income Tax Assessment Act 1997, Subsection 250-25(2)

Income Tax Assessment Act 1997, Section 250-30

Income Tax Assessment Act 1997, Subparagraph 250-30(a)(i)

Income Tax Assessment Act 1997, Paragraph 250-30(b)

Income Tax Assessment Act 1997, Section 250-35

Income Tax Assessment Act 1997, Section 250-45

Income Tax Assessment Act 1997, Subsection 250-60(1)

Income Tax Assessment Act 1997, Paragraph 250-60(1)(a)

Income Tax Assessment Act 1997, Subparagraph 250-60(1)(b)(ii)

Income Tax Assessment Act 1997, Subsection 250-50(1)

Income Tax Assessment Act 1997, Subsection 250-50(4)

Income Tax Assessment Act 1997, Subsection 250-55(b)

Income Tax Assessment Act 1997, Subsection 250-65(1)

Income Tax Assessment Act 1997, Subsection 250-65(2)

Income Tax Assessment Act 1997, Section 250-110

Income Tax Assessment Act 1997, Section 250-115

Income Tax Assessment Act 1997, Section 250-120

Income Tax Assessment Act 1997, Section 250-125

Income Tax Assessment Act 1997, Section 250-135

Income Tax Assessment Act 1997, Section 243-20

Income Tax Assessment Act 1997, Section 974-160

Taxation Laws Amendment (2007 measures No.5) Act 2007, Subitem 71(7)

Taxation Laws Amendment (2007 measures No.5) Act 2007, Subitem 71(8)

Reasons for decision

Issue 1

Question 1

Summary

The Commissioner will make a determination pursuant to subsection 159GG(4) of ITAA 1936 that it is unreasonable for the lease arrangements in respect of the capital works assets and depreciating assets entered into prior to 1 July 2003 to be regarded as "qualifying arrangements" for the purposes of Division 16D of the ITAA 1936.

The relevant lease arrangements may be regarded as "qualifying arrangements" for the purposes of Division 16D due to the lease arrangements satisfying the sixth limb (159GG(1)(c)) in subsection 159GG(1).

The Commissioner will exercise the discretion in subsection 159GG(4) of Division 16D for these lease arrangements so that Division 16D will not apply to these lease arrangements because in the facts of this case it is considered that the 90% test does not operate as an effective indicator of whether an arrangement is a financing arrangement.

Detailed reasoning

Background

There are leases that the XYZ Limited Partnerships entered (as lessor) with non-resident tenants prior to 1 July 2003. These leases are prima facie within the ambit of section 51AD of the ITAA 1936, unless they satisfy the transitional rules in Item 71 of Schedule 1 to the Tax Laws Amendment (2007 Measures No. 5) Act 2007 and, therefore, transition into Division 250. The leases are also prima facie within the ambit of Section 16D of the ITAA 1936.

Application of Section 51AD of the ITAA 1936

Section 51AD of the ITAA 1936 is about deductions that are not allowable in respect of property used under certain leveraged arrangements.

Subject to subsections (1A), (1B), (1C), (1D) and (8), this section applies, in relation to a taxpayer, to property acquired or constructed by the taxpayer, being property acquired by the taxpayer under a contract entered into after the prescribed time or property constructed by the taxpayer, construction having commenced after that time, if:

(a) at a time when the property is owned by the taxpayer, a person (which person is in this section referred to as the end-user) holds rights as lessee under a lease of the property, and:

(i) in a case where the end-user is not a resident of Australia - while the lease is in force, the property is, or is to be, used by a person other than the taxpayer wholly or principally outside Australia…

Subsection 51AD(4) may apply as the property acquired by the taxpayer is held by an end user (the lessee) who is not a resident of Australia and the assets are used by another person other than the taxpayer wholly outside of Australia.

Section 51AD(8) non-recourse debt test

However, for section 51AD to apply the non-recourse debt test at subsection 51AD(8) must be satisfied. Subsection 51AD(8) states that:

This section does not apply to property, in relation to a taxpayer, unless the whole or a predominant part of the cost of the acquisition or construction, as the case may be, of the property by the taxpayer is financed directly or indirectly by a debt or debts (which debt is, or debts are, referred to in this subsection as the non-recourse debt) and the rights of the creditor or creditors as against the taxpayer in the event of default in the repayment of principal or payment of interest:

(a) are limited wholly or predominantly to any or all of the following:

(i) rights (including the right to moneys payable) in relation to any or all of the following:

(A) the property or the use of the property;

(B) goods produced, supplied, carried, transmitted or delivered, or services provided, by means of the property;

(C) the loss or disposal of the whole or a part of the property or of the taxpayer's interest in the property;

(ii) rights in respect of a mortgage or other security over the property;

(iii) rights arising out of any arrangement relating to the financial obligations of the end-user of the property towards the taxpayer, being financial obligations in relation to the property;

(b) are in the opinion of the Commissioner capable of being so limited, having regard to either or both of the following:

(i) the assets of the taxpayer;

(ii) any arrangement to which the taxpayer is a party; or

(c) where paragraphs (a) and (b) do not apply - are limited by reason that not all of the assets of the taxpayer (not being assets that are security for debts of the taxpayer other than the non-recourse debt) would be available for the purpose of the discharge of the whole of the non-recourse debt (including the payment of interest) in the event of any action or actions by the creditor or creditors against the taxpayer arising out of that debt.

Effect of the Contingent Equity Deeds

As the property is located outside Australia and the end users are non-residents, section 51AD would apply in this circumstance if the property had been acquired using non-recourse debt. The non-recourse debt test (subsection 51AD(8)) will only be triggered if more than 50% of the cost of the property is financed by non-recourse debt (which is present when the rights of creditor in the event of loan default are predominantly limited to rights over the property).

The only assets of the XYZ Limited Partnerships are the leased assets. The acquisition of these assets was funded by interest bearing loans, plus subordinated interest free loans from Entity 1 and Entity 2.

XYZ Trust and C entities entered into the contingent equity deed (CED's) with each of the General Partners. Although the rights of the creditor were not limited under the loan document, because the shopping centre was the only asset, the rights would be effectively limited for paragraph 51AD(8)(b) purposes by the CED's. This is because the CEDs provided additional assets of the taxpayer to the creditor in the event of a default, such that for subsection 51AD(8) purposes the debt was not non-recourse.

Under the CED's the amounts required to be contributed by XYZ Trust and the C entities exceeds 50% of the debt funding used to acquire the property of each XYZ Limited Partnership. At least 50% of the debt funding is not regarded as non-recourse. Conversely, less than 50% of the cost of acquisition of the property of the XYZ Limited Partnerships was financed by non-recourse debt.

Both Australian partners had CED agreements in place so that for the period the agreements subsection 51AD(8) was not satisfied.

Conclusion

Therefore, as the non-recourse debt test in subsection 51AD(8) is not satisfied section 51AD will not apply to the leases entered into before 1 July 2003.

Application of 16D of the ITAA 1936

Division 16D contains rules about certain arrangements relating to the use of property. Although section 51AD takes precedence over Division 16D (per subsection 159GH(2)), as section 51AD does not apply to the 100 leases entered into for the assets with non-resident tenants prior to 1 July 2003 (refer to reasoning above), Division 16D could apply.

In order for Division 16D to apply to an arrangement, it must be regarded as a "qualifying arrangement" for the purposes of Subsections 159GG (1) and (2).

For the purposes of this Division, an arrangement that relates to the use (or control of the use) by a person (the "end-user") of property owned by another person (who is a party to the arrangement) and which also satisfies one of the seven limbs outlined in subsections 159GG(1) and 159GG(2) will be regarded as a "qualifying arrangement".

On the facts provided, the leases entered into for the assets with non-resident tenants prior to 1 July 2003 relate to the use by the non - resident tenants (ie the end-users) of property owned by the XYZ Limited Partnerships, and the XYZ Limited Partnerships are the lessors under these lease arrangements. Thus, if any of the seven limbs are also satisfied, Division 16D may apply to these leases. The seven limbs and their application to the facts are as follows:

First Limb - subparagraph 159GG(1)(a)(i)

Subparagraph 159GG(1)(a)(i) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that:

• If on the termination or expiration of the arrangement, the owner sells or otherwise disposes of the whole of the arrangement property, or part of the arrangement property that is or includes the item of eligible property, to any person; and

• If the owner or an associate receives in respect of the sale or disposal no consideration, or consideration of an amount less than the guaranteed residual value of the property;

the end-user or an associate will pay to the owner or an associate an amount equal to the guaranteed residual value, or to the amount by which the guaranteed residual value exceeds the consideration, as the case may be.

With regard to the application of the first limb, none of the lease arrangements entered into between the XYZ Limited Partnerships and the non-resident tenants include terms to the effect that the non-resident lessees (as the end users) are required to pay an amount (e.g. the guaranteed residual value) to the XYZ Limited Partnerships in respect of the sale of the assets. Therefore the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(i).

Second Limb- Subparagraph 159GG(1)(a)(ii)

Subparagraph 159GG(1)(a)(ii) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that at or after the termination or expiration of the arrangement, the whole of the arrangement property or part of the arrangement property that is or includes the item of eligible property is to be transferred (whether or not for any consideration) to the end-user or an associate.

With regard to the application of the second limb, none of the lease arrangements entered into between the XYZ Limited Partnerships and the non-resident tenants include terms to the effect that the leased property will transfer to the non-resident tenants on termination or expiration of the lease arrangements. Therefore the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(ii).

Third Limb- Subparagraph 159GG(1)(a)(iii)

Subparagraph 159GG(1)(a)(iii) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that the end-user or an associate has or will have the right to purchase or to require the transfer of the whole of the arrangement property or part of the arrangement property that is or includes the item of eligible property.

With regard to the application of the third limb, none of the lease arrangements entered into between the XYZ Limited Partnerships and the lessees contain provisions to the effect that the lessees (as end users) have rights to purchase or require the transfer of the leased property. Therefore, the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(iii).

Fourth Limb- Subparagraph 159GG(1)(a)(iv)

Subparagraph 159GG(1)(a)(iv) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that the arrangement period in relation to the item of eligible property in relation to the arrangement is a period that exceeds 1 year and the end-user or an associate will be liable to carry out, to expend money in respect of or to reimburse the owner or an associate for expenditure in respect of, repairs that may be required to the whole of the arrangement property or to part of the arrangement property that is or includes the item of eligible property.

With regard to the application of the fourth limb, each of the leases have a lease term of greater than one year (as shown in the supplied documentation) and, therefore, the arrangement period should be greater than one year for each of the leases.

Pursuant to the lease arrangements between the XYZ Limited Partnerships and the non-resident lessees, the lessees are unlikely to be liable to cover the cost of repairs that are required to the leased property. Rather, the non-resident lessees should only be liable to cover any repairs to assets that they own. In addition, the XYZ Limited Partnerships as lessors should be liable for any repairs required. Therefore, the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(iv).

Fifth Limb - Paragraph 159GG(1)(b)

Paragraph 159GG(1)(b) provides that an arrangement will be a qualifying arrangement where the arrangement period in relation to the item of eligible property in relation to the arrangement is equal to or greater than:

• Where the item is an item of eligible real property - 50% of the effective life of that item at the commencement of the arrangement period; or

• In any other case - 75% of the effective life of that item at the commencement of the arrangement period.

This requirement may not be met in some cases. Certain lease arrangements may have a term of up to 30 years, and this term may not be equal to or greater than 50% of the effective life of eligible real property. Further, some of the lease arrangements may have a term that is equal to 75% of the effective life of other items (e.g. depreciating assets).

While the leases that may breach these two tests are expected to represent a minor portion of all of the assets that exist, some of the lease arrangements would be "qualifying arrangements" due to the application of paragraph 159GG(1)(b).

Sixth Limb- Paragraph 159GG(1)(c)

Paragraph 159GG(1)(c) provides that an arrangement will be a qualifying arrangement where the sum of:

• The payment portions of arrangement payments that were liable to be made at or before the relevant time in relation to the eligible amount, or in relation to all of the eligible amounts (including any eligible amount in respect of expenditure incurred after the commencement of the arrangement period), in relation to the item of eligible property; and

• The payment portions of arrangement payments that, having regard to the provisions of the arrangement and any other relevant circumstances, are or were, at the relevant time, likely to become liable to be made after the relevant time in relation to the eligible amount, or in relation to all of the eligible amounts (including any eligible amount in respect of expenditure that, having regard to the provisions of the arrangement and any other relevant circumstances, is or was likely to be incurred during the arrangement period), in relation to the item of eligible property;

is equal to or greater than 90% of the sum of:

• The residual amount in relation to the eligible amount, or the sum of the residual amounts in relation to the eligible amounts, in respect of which expenditure was incurred before the commencement of the arrangement period in relation to the item of eligible property, as ascertained at the commencement of the arrangement period; and

• The amount of any expenditure that was, or is likely to be, incurred during the arrangement period, being expenditure giving rise to an eligible amount in relation to the item of eligible property.

With regard to the application of the sixth limb, this requirement may be satisfied by certain lease arrangements. In this regard, the total rental payments (being the "arrangement payments") required to be made by a tenant under the relevant lease arrangement may exceed 90% of the remaining Division 40 depreciation deductions and Division 43 capital works deductions available to the XYZ Limited Partnerships. This is because of the long term nature of the leases.

Therefore, some of the lease arrangements would be "qualifying arrangements" due to the application of paragraph 159GG(1)(c).

Seventh Limb- Subsection 159GG(2)

Subsection 159GG(2) provides that an arrangement will be a qualifying arrangement where

• an item of eligible property is, or is included in, arrangement property in relation to an arrangement relating to the use by a person (in this subsection referred to as the end-user), or to the control by a person (in this subsection also referred to as the end-user) of the use, of property owned by another person who is a party to the arrangement; and

• The ownership of the item of eligible property is transferred to the end-user or an associate within 1 year after the arrangement ceases to be in force (whether by termination or expiration) in relation to the item of eligible property;

The arrangement shall be taken to have been a qualifying arrangement in relation to the item of eligible property at all times during the period during which the arrangement was in force in relation to the item of eligible property.

With regard to the application of the seventh limb, this requirement is not satisfied on the basis that none of the lease arrangements entered into between the XYZ Limited Partnerships and the lessees provide for the transfer of the leased property to the lessees within one year of the expiration of the lease arrangements. Therefore the lease arrangements are not regarded as "qualifying arrangements" due to the application of subsection 159GG(2).

Conclusion

On the basis of the above the pre 1 July 2003 lease arrangements may be regarded as "qualifying arrangements" for the purposes of Division 16D due to the lease arrangements satisfying the fifth and/or the sixth limb in subsection 159GG(1).

As the lease arrangements may be regarded as "qualifying arrangements" you have asked that the Commissioner exercise his discretion for Division 16D to not be applicable to these lease arrangements.

Exercise of Commissioner's Discretion not to apply Division 16D

Subsection 159GG(4) of the ITAA 1936 provides the Commissioner with a discretion to not apply Division 16D in certain circumstances. As Division 16D would apply to the 100 pre July 2003 leases you have asked for the Commissioner to exercise the discretion.

Subsection 159GG(4) provides that:

159GG(4) Where, but for this subsection, an arrangement would be a qualifying arrangement in relation to an item of eligible property at a particular time (in this subsection referred to as the "relevant time") and the Commissioner, having regard to:

a) the circumstances by reason of which the arrangement is a qualifying arrangement in relation to that item of eligible property; and

b) any other relevant circumstances,

considers it unreasonable that the arrangement should be a qualifying arrangement at the relevant time in relation to the item of eligible property, the arrangement shall be taken not to be a qualifying arrangement at the relevant time in relation to the item of eligible property.

It should be noted that subsection 159GH(2) provides an exemption from the application of Division 16D where section 51AD applies to the item of eligible property. As section 51AD will not apply to the leases entered into pre 1 July 2003 this exemption is not available.

With regard to whether the Commissioner will exercise the discretion at Subsection 159GG(4) for Division 16D not to apply, consideration must be given to the 90% test in paragraph 159GG(1)(c); being the limb that is satisfied and effectively triggers the application of Division 16D to the arrangement. Prior to 1 July 2007 (when Division 16D was replaced by Division 250 for arrangements entered into after that date) this test was routinely satisfied by commercial leases. Although this was sufficient to characterise the arrangement as being a qualifying arrangement, it did not of itself determine whether the arrangement is a financing arrangement.

Paragraph 159GG(1)(c) can be contrasted with section 250-135 of the Income Tax Assessment Act 1997 (ITAA 1997), that is satisfied where the present value of financial benefits is equal to 70% of the market value of the assets. In determining whether the arrangement is a financing arrangement, consideration was given to whether the test would be satisfied using the present value of payments (as it would be for the purposes of section 250-135 of the ITAA 1997).

You have confirmed that for the leases entered into prior to 1 July 2003, capital allowance deductions are not being claimed for a significant portion of the assets that are the subject of the pre 1 July 2003 leases. Also, no capital allowance deductions are being claimed pursuant to Division 43 for assets that are subject to the pre 1 July 2003 leases. This is because the relevant entitlement conditions for these capital allowance deductions are not satisfied.

The asset additions relating to the pre 1 July 2003 leases from when the XYZ Limited Partnerships acquired the assets are $xx. This represents xx% of the total additions since of approximately $xx.

The approximate cost of the depreciating assets that are within the ambit of the pre 1 July 2003 leases was approximately $xx at the time that the XYZ Limited Partnerships acquired an interest in the assets. This amount has been determined by apportioning the total cost of the depreciating assets to the area covered by the leases based on area size.

Conclusion

The absence of capital allowance deductions for expenditure incurred, the minor breach of the fifth test, and the absence of satisfaction of other tests of a "qualifying arrangement" at subsections 159GG(1) and (2) indicate that the leases are not finance leases in nature, and that recourse to capital allowance deductions are not an incentive or motivation in the acquisition and provision of the property through the lease.

The facts of the arrangement indicate that satisfaction of the 90% test in the sixth limb does not operate as an effective indicator of whether an arrangement is a financing arrangement.

Therefore, the Commissioner will exercise the discretion in subsection 159GG(4) that it is unreasonable that the arrangements (being the leases entered into prior to 1 July 2003) should be "qualifying arrangements" at the relevant time for the purposes of Division 16D. Consequently Division 16D will not apply to these leases.

Question 2

Summary

Yes, the lease arrangements in respect of the capital works assets and depreciating assets that were entered into prior to 1 July 2003 will transition into Division 250 pursuant to the application of subitems 71(7) and 71(8) of Schedule 1 to the Tax Laws Amendment (2007 Measures No 5) Act 2007. Each of the requirements of subitem 71(7) apply in respect of the leases entered into prior to 1 July 2003. Therefore, in accordance with subitem 71(8), section 51AD does not apply to these leases. Rather, Division 250 of the ITAA 1997 applies to the tax preferred use of the assets after the material alteration to the pre 1 July 2003 leases.

Detailed reasoning

Background

There are leases that were entered into by the XYZ Limited Partnerships (as lessor) with non-resident tenants prior to 1 July 2003. These leases are prima facie within the ambit of section 51AD of the ITAA 1936, unless they satisfy the transitional rules in Item 71 of Schedule 1 to the Tax Laws Amendment (2007 Measures No. 5) Act 2007 and, therefore, transition into Division 250.

Application of the transitional rules

The relevant provisions in the transitional rules to be considered for the leases entered into prior to 1 July 2003 are subitem 71(7) and (8) of Schedule 1 of the Tax Laws Amendment (2007 Measures No. 5) Act 2007. These provisions state that:

"(7) This subitem applies to an asset that is put to a tax preferred use if:

(a) the tax preferred use started before 1 July 2007; and

(b) immediately before 1 July 2007;

(i) section 51AD did not apply to the asset in relation to a taxpayer; and

(ii) Division 16D did not apply to the asset; and

(c) the arrangement under which the tax preferred use of the asset occurs is materially altered on or after 1 July 2007; and

(d) but for this subitem and subitem (8):

(i) section 51AD would apply to the asset in relation to a taxpayer immediately after the alteration; or

(ii) Division 16D would apply to the asset immediately after the alteration.

(8) If subitem (7) applies:

(a) section 51AD and Division 16D do not apply to the asset; and

(b) Division 250 applies to the tax preferred use of the asset after the alteration instead".

Tax Preferred Use- subparagraph 71(7)(a)

The "tax preferred use" of an asset is defined in section 250-60 of the ITAA 1997. In this regard, subsection 250-60(1) states:

An asset is put to a tax preferred use at a particular time if:

(a) an end user (or a connected entity) holds, at that time, rights as lessee under a lease of the asset; and

(b) either or both of the following subparagraphs is satisfied at that time:

(i) the asset is, or is to be, used by or on behalf of an end user who is a tax preferred end user because of paragraph 250-55(a) (tax preferred entity);

(ii) 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 of paragraph 250-55(b) (foreign resident or business).

If this subsection applies, the tax preferred use of the asset is the lease referred to in paragraph (a).

• Is the lessee an end user

The term "end user" is defined in subsection 250-50(1) to include an entity (other than you) that uses or effectively controls the use of the asset. Further, subsection 250-50(4) confirms that an entity is taken to be an end user of an asset if the entity holds rights as a lessee under a lease of the asset.

On this basis, the end users of the assets are the lessees of the shopping centre pursuant to the lease arrangements entered into with the XYZ Limited Partnerships (as lessor). The lessees use and/or effectively control the day to day use of the assets. Further, for the purposes of subsection 250-50(4), lessees under lease arrangements (such as these) are regarded as the end users of the assets.

Therefore, paragraph 250-60(1)(a) is satisfied because the end users (the lessees) hold rights as lessee under a lease of the asset (the leased assets).

• Is the lessee a tax preferred end user

Subparagraph 250-60(1)(b)(ii) is the relevant paragraph in these circumstances as the assets are located outside Australia and are therefore used wholly outside Australia.

Paragraph 250-55(b) states that:

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

…

(b) the end user is:

(i) an entity that is a foreign resident…

In this respect, paragraph 250-55(b) is satisfied on the basis that the lessees of the assets are foreign residents. To this effect, subparagraph 250-60(1)(b)(ii) is satisfied on the basis that the assets are used wholly outside Australia by end users who are foreign residents. Therefore, the lessees as end users will be tax preferred end users.

On the basis of the above, the depreciating assets and capital works assets are put to a tax preferred use as the requirements of subsection 250-60(1) of the ITAA 1997 are satisfied.

Tax preferred use started before 1 July 2007- paragraph 71(7)(b)

The leases were entered into by the XYZ Limited Partnerships before 1 July 2003 (as supplied). Therefore, the tax preferred use of the assets started before 1 July 2007.

Immediately before 1 July 2007, section 51AD did not apply subparagraph 71(7)(b)(i)

Section 51AD is not applicable to the assets immediately before 1 July 2007, refer to the reasoning in Question 1 of this ruling.

Immediately before 1 July 2007, Division 16D did not apply subparagraph 71(7)(b)(ii):

Division 16D does not apply to the leases entered into before 1 July 2003 immediately before 1 July 2007, refer to the reasoning in Question 1 of this ruling.

The arrangement is materially altered on or after 1 July 2007- paragraph 71(7)(c)

The Explanatory Memorandum to the Tax Laws Amendment (2007 Measures No. 5) Act 2007 (the EM) provides the following comments on the phrase "materially altered" at paragraph 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.

In this respect, you (the applicant) submit that there will be a significant change to the lease arrangements that were entered into pre 1 July 2003 such that they have been materially altered after 1 July 2007.

In particular, you submit that as part of the sale of Entity 2's 50% interest to a third party, there will be a 50% change in ownership of the XYZ Limited Partnerships, being the lessors under the lease arrangements with the non-resident tenants. That is, the third party will acquire 100% of the interests in the C Entities (that hold a 49.75% interest in the XYZ Limited Partnerships) and 50% of the General Partners.

The Commissioner's view is that the disposal by Entity 2 of its interest in entities that are partners, and the acquisition of those interests, is not a material alteration to the arrangement with the tax preferred use of the asset. This is because the arrangement between the partnership and the lessees remains undisturbed.

You also submit that as part of the sale to the third party, there will be a change in the manager and operator of the asset to the third party. As a result, various service agreements that exist in relation to the operation and maintenance of the shopping centre will also need to be amended to take into account the new manager and operator. In addition, all tenants will be notified of the change.

The new manager and operator will also be responsible for the maintenance and operation of a certain area of the assets. That is, the new manager and operator will be the end user of this area given the existing lease arrangements will not cover the same. In this respect, this area will form a substantial proportion of the entire asset. However, the Commissioner's view is that a change in manager is not considered a material alteration, rather a routine matter involving operating cost issues.

You submit that there has been additional capital expenditure of $xx incurred by the XYZ Limited Partnerships on the assets since 1 July 2007. This capital expenditure is directly relevant to the assets that are the subject of the lease arrangements and reflects a substantial amount of additional capital expenditure.

The capital allowance expenditure would constitute a material change to the arrangement as provided in the EM. However, if the material alteration is the new capital expenditure it is not apparent that either section 51AD or Division 16D would apply to the asset immediately after the alteration. The additional expenditure was incurred in previous years but neither section 51AD nor Division 16D applied immediately afterwards.

You also submit that given the lapse of time since acquisition, a substantial proportion of the lease arrangements originally entered into by the XYZ Limited Partnerships with the non-resident tenants prior to 1 July 2007 have been subsequently renewed. For the purposes of this ruling application, these lease arrangements have been included in the Division 250 analysis. To this effect, you submit that you would expect any existing lease arrangements that were originally entered into prior to 1 July 2007 to reduce going forward as they are renewed or terminated.

In relation to the CEDs, you submit that in accordance with a specific clause of the Agreement entered into between XYZ Pty Ltd (as trustee for XYZ Trust) and the third party, it was agreed that the existing CEDs would be cancelled if a favourable ruling is able to be obtained from the ATO confirming that section 51AD and/or Division 250 are not applicable to the lease arrangements entered into by the XYZ Limited Partnerships. Further, pursuant to a clause of the CEDs, the Deeds automatically terminate upon such a favourable private binding ruling being obtained.

In this regard, you submit that the removal of the CEDs by itself is not sufficient to amount to a material alteration to the lease arrangements (as noted in paragraph 1.277 of the EM). However, you have submitted that the removal of the CEDs is a relevant consideration in determining whether there has been a material alteration to the lease arrangements and must be considered in the light of the total changes. This is because the removal of the CEDs has only arisen from and been contemplated due to the sale of Entity 2's 50% interest to the third party (a non-Australian resident which is not subject to section 51AD or Division 250). If this sale and a change of manager and operator did not occur, then the removal of the CEDs would not have been considered.

That is, the proposed removal of the CEDS is only one aspect of the broader alteration to the lease arrangements, which includes a change in the ultimate ownership of the lessors (i.e. the XYZ Limited Partnerships) and a change to the manager.

As acknowledged, the removal of a CED is not of itself a material alteration as provided at paragraph 1.277 of the EM. However, you have submitted that the material change is the acquisition of Entity 2's partnership interests which has prompted the proposed removal of the CED for the interest held by Entity 2. The entities that the third party acquires will not be subject to Australian tax on income they derive from the asset.

The acquisition of the partnership interest by the third party means that the CED no longer performs the function for which it was originally employed for the entity that it was intended to benefit, albeit that Entity 1 remains subject to Australian tax on income derived from the shopping centre.

Although the XYZ Limited Partnerships net income will be calculated under section 90 of the ITAA 1936 as if it is a taxpayer who is a resident, the income so calculated is only included in a partners assessable income under section 92 of the ITAA 1936 where the partner is either a resident of Australia, or the income is sourced from Australia. The disallowance of deductions through the application of section 51AD of the ITAA 1936 in respect of derivation of assessable income will therefore only be relevant to a partner that is subject to Australian tax on the distributed income. Therefore this will not be relevant to the XYZ Limited Partnerships.

A partner would need, at the time that another partner removes their contribution to contingent equity, to provide additional assets for section 51AD not to apply to the partnership. Therefore, in these circumstances the material change is not just the change in ownership or the proposed removal of the CED but the change in partnership ownership that renders the CED economically (including for tax consequences) redundant to the new partner, and the consequent removal of the CED.

The CED is removed not to bring the asset within the operation of 250, or to subject the asset to 51AD but because there has been a change in the ownership of a partner (a change independent of an action of the taxpayer); and the new partner will derive no benefit from the continuance of the CED because it cannot be subject to 51AD in the income distributed.

The change in ownership of a partner, bringing about a subsequent removal of the CED, constitutes a material change for the purposes of subitem 71(7).

Immediately after the alteration, section 51AD or Division 16D would apply- paragraph 71(7)(d)

Section 51AD does not apply to the leases entered into before 1 July 2003 because the non-recourse debt requirement in subsection 51AD(8) is not satisfied in respect of these arrangements due to the existence of the CEDs. Refer to question 1.

However, as part of the material alteration to the lease arrangements, the CEDs will be removed and, therefore, the non-recourse debt requirement in 51AD(8) will be satisfied after the removal. On this basis the lease arrangements are subject to section 51AD immediately after the material alteration to the arrangements.

Conclusion

On the basis of the above, each of the requirements of subitem 71(7) apply in respect of the leases entered into prior to 1 July 2003. Therefore, in accordance with subitem 71(8), section 51AD does not apply to these leases. Rather, Division 250 of the ITAA 1997 applies to the tax preferred use of the assets after the material alteration to the pre 1 July 2003 leases.

Question 3

Summary

Yes, the Commissioner will make a determination pursuant to subsection 159GG(4) of the ITAA 1936 that it is unreasonable for the lease arrangements in respect of the capital works assets and depreciating assets entered into between 1 July 2003 and 1 July 2007 to be regarded as "qualifying arrangements" for the purposes of Division 16D of the ITAA 1936. While the relevant 39 lease arrangements may be regarded as "qualifying arrangements" for the purposes of Division 16D due to the lease arrangements satisfying the sixth limb in subsection 159GG(1); the Commissioner will exercise the discretion for Division 16D to not be applicable to these lease arrangements because, as per the detailed reasoning, the 90% test does not operate as an effective indicator of whether an arrangement is a financing arrangement.

Detailed reasoning

There were leases that were entered into by the XYZ Limited Partnerships (as lessor) with non-resident tenants between 1 July 2003 and 1 July 2007. These leases are also prima facie within the ambit of Section 16D of the ITAA 1936.

Division 16D contains rules about certain arrangements relating to the use of property. Although section 51AD takes precedence over Division 16D (per subsection 159GH(2)), as section 51AD does not apply to these leases, Division 16D could apply.

In order for Division 16D to apply to an arrangement, it must be regarded as a "qualifying arrangement" for the purposes of Subsections 159GG (1) and (2).

For the purposes of this Division, an arrangement that relates to the use (or control of the use) by a person (the "end-user") of property owned by another person (who is a party to the arrangement) and which also satisfies one of the seven limbs outlined in subsections 159GG(1) and 159GG(2) will be regarded as a "qualifying arrangement".

All leases relate to the use by the non - resident tenants (ie the end-users) of property owned by the XYZ Limited Partnerships; and the XYZ Limited Partnerships are the lessors under these lease arrangements. Thus, if any of the seven limbs are also satisfied, Division 16D may apply to these leases. The seven limbs and their application to the facts are as follows:

First Limb - subparagraph 159GG(1)(a)(i)

Subparagraph 159GG(1)(a)(i) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that:

• If on the termination or expiration of the arrangement, the owner sells or otherwise disposes of the whole of the arrangement property, or part of the arrangement property that is or includes the item of eligible property, to any person; and

• If the owner or an associate receives in respect of the sale or disposal no consideration, or consideration of an amount less than the guaranteed residual value of the property;

the end-user or an associate will pay to the owner or an associate an amount equal to the guaranteed residual value, or to the amount by which the guaranteed residual value exceeds the consideration, as the case may be.

With regard to the application of the first limb, none of the lease arrangements entered into between the XYZ Limited Partnerships and the non-resident tenants include terms to the effect that the non-resident lessees (as the end users) are required to pay an amount (e.g. the guaranteed residual value) to the XYZ Limited Partnerships in respect of the sale of the assets. Therefore the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(i).

Second Limb- Subparagraph 159GG(1)(a)(ii)

Subparagraph 159GG(1)(a)(ii) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that at or after the termination or expiration of the arrangement, the whole of the arrangement property or part of the arrangement property that is or includes the item of eligible property is to be transferred (whether or not for any consideration) to the end-user or an associate.

With regard to the application of the second limb, none of the lease arrangements entered into between the XYZ Limited Partnerships and the non-resident tenants include terms to the effect that the leased property will transfer to the non-resident tenants on termination or expiration of the lease arrangements. Therefore the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(ii).

Third Limb- Subparagraph 159GG(1)(a)(iii)

Subparagraph 159GG(1)(a)(iii) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that the end-user or an associate has or will have the right to purchase or to require the transfer of the whole of the arrangement property or part of the arrangement property that is or includes the item of eligible property.

With regard to the application of the third limb, none of the lease arrangements entered into between the XYZ Limited Partnerships and the lessees contain provisions to the effect that the lessees (as end users) have rights to purchase or require the transfer of the leased property. Therefore, the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(iii).

Fourth Limb- Subparagraph 159GG(1)(a)(iv)

Subparagraph 159GG(1)(a)(iv) provides that the arrangement will be a qualifying arrangement where it contains provision to the effect that the arrangement period in relation to the item of eligible property in relation to the arrangement is a period that exceeds 1 year and the end-user or an associate will be liable to carry out, to expend money in respect of or to reimburse the owner or an associate for expenditure in respect of, repairs that may be required to the whole of the arrangement property or to part of the arrangement property that is or includes the item of eligible property.

With regard to the application of the fourth limb, (as supplied in the ruling application) each of the leases have a lease term of greater than one year and, therefore, the arrangement period should be greater than one year for each of the leases.

Pursuant to the lease arrangements between the XYZ Limited Partnerships and the non-resident lessees, the lessees are unlikely to be liable to cover the cost of repairs that are required to the leased property. Rather, the non-resident lessees should only be liable to cover any repairs to assets that they own. In addition, the XYZ Limited Partnerships as lessors should be liable for any repairs. Therefore, the lease arrangements are not regarded as "qualifying arrangements" due to the application of subparagraph 159GG(1)(a)(iv).

Fifth Limb - Paragraph 159GG(1)(b)

Paragraph 159GG(1)(b) provides that an arrangement will be a qualifying arrangement where the arrangement period in relation to the item of eligible property in relation to the arrangement is equal to or greater than:

• Where the item is an item of eligible real property - 50% of the effective life of that item at the commencement of the arrangement period; or

• In any other case - 75% of the effective life of that item at the commencement of the arrangement period.

This requirement may not be met in some cases. Certain lease arrangements may have a term of up to 30 years, and this term may not be equal to or greater than 50% of the effective life of eligible real property. Further, some of the lease arrangements may have a term that is equal to 75% of the effective life of other items (e.g. depreciating assets of the property).

While the leases that breach these two tests are expected to represent a minor portion of all of the assets, some of the lease arrangements would be "qualifying arrangements" due to the application of paragraph 159GG(1)(b).

Sixth Limb- Paragraph 159GG(1)(c)

Paragraph 159GG(1)(c) provides that an arrangement will be a qualifying arrangement where the sum of:

• The payment portions of arrangement payments that were liable to be made at or before the relevant time in relation to the eligible amount, or in relation to all of the eligible amounts (including any eligible amount in respect of expenditure incurred after the commencement of the arrangement period), in relation to the item of eligible property; and

• The payment portions of arrangement payments that, having regard to the provisions of the arrangement and any other relevant circumstances, are or were, at the relevant time, likely to become liable to be made after the relevant time in relation to the eligible amount, or in relation to all of the eligible amounts (including any eligible amount in respect of expenditure that, having regard to the provisions of the arrangement and any other relevant circumstances, is or was likely to be incurred during the arrangement period), in relation to the item of eligible property; is equal to or greater than 90% of the sum of:

• The residual amount in relation to the eligible amount, or the sum of the residual amounts in relation to the eligible amounts, in respect of which expenditure was incurred before the commencement of the arrangement period in relation to the item of eligible property, as ascertained at the commencement of the arrangement period; and

• The amount of any expenditure that was, or is likely to be, incurred during the arrangement period, being expenditure giving rise to an eligible amount in relation to the item of eligible property.

With regard to the application of the sixth limb, this requirement may be satisfied by certain lease arrangements. In this regard, the total rental payments (being the "arrangement payments") required to be made by a tenant under the relevant lease arrangement may exceed 90% of the remaining Division 40 depreciation deductions and Division 43 capital works deductions available to the XYZ Limited Partnerships. This is because of the long term nature of the leases.

Therefore, some of the lease arrangements would be "qualifying arrangements" due to the application of paragraph 159GG(1)(c).

Seventh Limb- Subsection 159GG(2)

Subsection 159GG(2) provides that an arrangement will be a qualifying arrangement where

• an item of eligible property is, or is included in, arrangement property in relation to an arrangement relating to the use by a person (in this subsection referred to as the end-user), or to the control by a person (in this subsection also referred to as the end-user) of the use, of property owned by another person who is a party to the arrangement; and

• The ownership of the item of eligible property is transferred to the end-user or an associate within 1 year after the arrangement ceases to be in force (whether by termination or expiration) in relation to the item of eligible property;

The arrangement shall be taken to have been a qualifying arrangement in relation to the item of eligible property at all times during the period during which the arrangement was in force in relation to the item of eligible property.

With regard to the application of the seventh limb, this requirement is not satisfied on the basis that none of the lease arrangements entered into between the XYZ Limited Partnerships and the lessees provide for the transfer of the leased property to the lessees within one year of the expiration of the lease arrangements. Therefore the lease arrangements are not regarded as "qualifying arrangements" due to the application of subsection 159GG(2).

Conclusion

On the basis of the above the leases may be regarded as "qualifying arrangements" for the purposes of Division 16D due to the lease arrangements satisfying the fifth and/or the sixth limb in subsection 159GG(1).

As the lease arrangements may be regarded as "qualifying arrangements" you have asked that the Commissioner exercise his discretion for Division 16D to not be applicable to these lease arrangements.

Exercise of Commissioner's Discretion not to apply Division 16D

Subsection 159GG(4) of the ITAA 1936 provides the Commissioner with a discretion to not apply Division 16D in certain circumstances.

Subsection 159GG(4) provides that:

159GG(4) Where, but for this subsection, an arrangement would be a qualifying arrangement in relation to an item of eligible property at a particular time (the "relevant time") and the Commissioner, having regard to:

a) the circumstances by reason of which the arrangement is a qualifying arrangement in relation to that item of eligible property; and

b) any other relevant circumstances;

considers it unreasonable that the arrangement should be a qualifying arrangement at the relevant time in relation to the item of eligible property, the arrangement shall be taken not to be a qualifying arrangement at the relevant time in relation to the item of eligible property.

Subsection 159GH(2) provides an exemption from the application of Division 16D where section 51AD applies to the item of eligible property. This subsection states that:

This Division does not apply in relation to an item of eligible property at a particular time if at that time section 51AD applies to the item of eligible property in relation to a taxpayer.

As provided in the analysis above in relation to section 51AD, section 51AD will not apply to the leases entered into pre 1 July 2003 or the leases entered into between 1 July 2003 and 1 July 2007. Therefore, the exemption at subsection 159GH(2) is not satisfied.

With regard to whether the Commissioner will exercise the discretion at Subsection 159GG(4) for Division 16D not to apply, consideration must be given to the 90% test in paragraph 159GG(1)(c), being the limb that is satisfied and effectively triggers the application of Division 16D to the arrangement.

Prior to 1 July 2007 (when Division 16D was replaced by Division 250 for arrangements entered into after that date) this test was routinely satisfied by commercial leases. Although this was sufficient to characterise the arrangement as being a qualifying arrangement, it did not of itself determine whether the arrangement is a financing arrangement.

Paragraph 159GG(1)(c) can be contrasted with section 250-135 of the Income Tax Assessment Act 1997 (ITAA 1997), that is satisfied where the present value of financial benefits is equal to 70% of the market value of the assets. In determining whether the arrangement is a financing arrangement, consideration was given to whether the test would be satisfied using the present value of payments (as it would be for the purposes of section 250-135 of the ITAA 1997).

You have confirmed that that for the leases entered into between 1 July 2003 and 1 July 2007, capital allowance deductions under Division 40 of the ITAA 1997 are not being claimed for a significant portion of the assets. Also, no capital allowance deductions are being claimed under Division 43 of the ITAA 1997 for the assets subject to these leases.

The approximate cost of depreciating (Division 40) assets that are within the ambit of the leases was approximately $xx at the time that the XYZ Limited Partnerships acquired its interest in the assets. It is advised that this amount has been determined by apportioning the total cost of the depreciating assets to the area covered by the leases based on area size.

The asset additions relating to the leases from when the XYZ Limited Partnerships acquired the assets are approximately $xx; and that this represents xx% of the total additions of approximately $xx. The acquisition cost of the 50% interest was $xx.

Conclusion

The absence of capital allowance deductions for expenditure incurred, the minor breach of the fifth test, and the absence of satisfaction of other tests of a "qualifying arrangement" at subsections 159GG(1) and (2) indicate that the leases are not finance leases in nature, and that recourse to capital allowance deductions are not an incentive or motivation in the acquisition and provision of the property through the lease.

The facts of the arrangement indicate that satisfaction of the 90% test in the sixth limb does not operate as an effective indicator of whether an arrangement is a financing arrangement.

Therefore, the Commissioner will exercise the discretion in subsection 159GG(4) that it is unreasonable that the arrangements (being, the leases entered into between 1 July 2003 and 1 July 2007) should be "qualifying arrangements at the relevant time for the purposes of Division 16D. Consequently Division 16 will not apply to these leases.

Question 4

Summary

Yes, the second exclusion in section 250-25 will apply to xx of the xx lease arrangements in respect of the capital works assets and depreciating assets.

These xx lease arrangements are from both the:

• leases entered into post 1 July 2007 and

• leases transitioned into Division 250 of the ITAA 1997

and have financial benefits under the minimum value limit of $5 million.

Detailed Reasoning

Application of Division 250:

There are xx leases that were entered into between the XYZ Limited Partnerships and tenants post 1 July 2007 to which Division 250 may apply. There are also leases for which the Division 250 transitional rules apply (refer to question 2) and, therefore, Division 250 may apply following the material alteration to these lease arrangements.

Section 250-15 of the ITAA 1997 contains the general test, which provides that:

"This Division applies to you and an asset at a particular time if:

(a) the asset is being 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 be expected to be, provided to you (or a connected entity) by:

(i) a tax preferred end user (or a connected entity); or

(ii) any tax preferred entity (or a connected entity); or

(iii) any entity that is a foreign resident; and

(d) disregarding this Division, you would be entitled to a capital allowance in relation to:

(i) a decline in the value of the asset; or

(ii) expenditure in relation to the asset; and

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

These five requirements must be satisfied in order for Division 250 to apply. In relation to the xx leases entered into post 1 July 2007, the application of these requirements is as follows:

Requirement 1 - asset must be put to a tax preferred use:

The end users of the capital works assets and depreciating assets are the lessees under the lease arrangements because the lessees use or effectively control the use of the assets under these arrangements. Subsection 250-50(4) confirms that an entity that holds rights as lessee under a lease of an asset is taken to be an "end user".

The assets are used wholly outside Australia by end users who are foreign residents, and therefore "tax preferred end users" pursuant to subparagraph 250-55(b)(i).

Thus, the requirements in subsection 250-60(1) in respect of an asset that is "put to a tax preferred use" are satisfied for the lease arrangements. To this effect, the tax preferred use of the assets are the lease arrangements and the requirement in 250-15(a) is satisfied.

Requirement 2 - arrangement period for the tax preferred use is greater than 12 months:

Pursuant to subsections 250-65(1) and (2) of the ITAA 1997, the "arrangement period" for the tax preferred use of the asset starts when that tax preferred use starts and ends on the date on which the tax preferred use of the asset is reasonably expected to end.

Documents supplied with this ruling application outlined the terms of each of the relevant lease arrangements entered into between the foreign resident lessees and the XYZ Limited Partnerships. The majority of the lease arrangements have a term greater than 12 months.

Therefore, the arrangement period for the tax preferred use of the depreciating assets and capital works assets under the leases is greater than 12 months and the requirement in 250-15(b) is satisfied.

Requirement 3 - Financial benefits provided by a tax preferred end user, tax preferred entity or a foreign resident:

The term "financial benefits" is defined in section 974-160 of the ITAA 1997 to include "anything of economic value".

The lessees (who are foreign residents and also tax preferred end users) are required to pay rent to the XYZ Limited Partnerships pursuant to the relevant lease arrangements depreciating assets and capital works assets.

Therefore, the rental payments made by the lessees are regarded as "financial benefits" and the requirement in 250-15(c) is satisfied.

Requirement 4 - The taxpayer would otherwise be entitled to a capital allowance:

The XYZ Limited Partnerships are entitled to deductions under Division 40 for the decline in value of the depreciating assets on the basis that the XYZ Limited Partnerships are the legal owners of these assets and, therefore, regarded as the "holder" for Division 40 purposes.

The XYZ Limited Partnerships are entitled to deductions under Division 43 for the undeducted construction cost of the capital works assets on the basis that they are the owners of the relevant construction expenditure area.

Therefore, requirement 250-15(d) is satisfied on the basis that the XYZ Limited Partnerships would, aside from the application of Division 250, be entitled to capital allowance deductions in respect of the depreciating assets and capital works assets.

Requirement 5 - The taxpayer lacks a predominant economic interest in the asset:

Pursuant to section 250-110, a taxpayer lacks a predominant economic interest in an asset at a particular time if one (or more) of the following tests is satisfied:

• Limited recourse debt test (section 250-115);

• Right to acquire asset test (section 250-120);

• Effectively non-cancellable, long term arrangement test (section 250-125); and

• Level of expected financial benefits test (section 250-135).

Accordingly, failure of one test is enough for a taxpayer to lack a predominant economic interest. The relevant test which may be failed is the limited recourse debt test. Broadly, this test states that a taxpayer lacks a predominant economic interest in an asset at a particular time if, for assets that are put to a tax preferred use because the end use is by foreign residents, 55% of the cost of acquiring or constructing the asset is financed by "limited recourse debt".

"Limited recourse debt" is broadly defined in section 243-20 of the ITAA 1997 as an obligation where the rights of the creditor as against the debtor in the event of default are limited to rights in relation to the debt property, or to goods or services provided by means of the debt property.

With the CEDs in place between XYZ Trust and the General Partners, this requirement is not satisfied on the basis that less than 55% of the cost of acquiring or constructing the assets was financed by "limited recourse debt". However, once the CEDs are removed, this requirement is satisfied in respect of the lease arrangements given there will no longer be assets other than the leased property in the XYZ Limited Partnerships. That is, the rights of the creditors on default will be limited to rights in respect of the assets as the XYZ Limited Partnerships do not hold any other assets.

Therefore, the limited recourse debt test at section 250-115 and the requirement of 250-15(e) will be satisfied upon removal of the CEDs.

Conclusion:

On the basis of the above application of the requirements of 250-15 to the facts, upon the removal of the CEDs, Division 250 will apply to the xx leases entered into post 1 July 2007, as well as the leases entered into prior to 1 July 2007 that have transitioned into Division 250.

As the general test in Division 250 will apply, the next step is to consider if any of the exclusions to Division 250 are satisfied.

Second Exclusion - financial benefits under minimum value:

Division 250 contains five exclusions. Subsections 250-25(1) and 250-25(2) specifically contains the second exclusion for financial benefits under a minimum value. These sections provide:

1) This Division does not apply to you and an asset that is being put to a tax preferred use under a particular arrangement if, at the start of the arrangement period, the total of the nominal values of all the financial benefits that have been, or will be or can reasonably be expected to be, provided to you (or a connected entity):

(a) by members of the tax preferred sector; and

(b) 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 $5 million

"(2) The amount referred to in subsection (1) is indexed annually".

The test is of each particular lease arrangement. Supplied documents show the number of the lease arrangements over the depreciating assets and capital works assets where the total nominal value of the financial benefits at the start of the lease arrangement that will be provided to the XYZ Limited Partnerships (i.e. the rent payable by the non-resident tenant) does not exceed $5 million.

On the basis of the documents suppled, the second exclusion applies to xx of the xx leases over the depreciating assets and capital works assets that are within the ambit of Division 250.

Thus, Division 250 will not apply to the xx leases entered into post 1 July 2007 or transitioned into Division 250 of the ITAA 1997 where the financial benefits are under the minimum value limit.

Question 5

Summary

Yes, the third exclusion in section 250-30 will apply to xx of the remaining xx lease arrangements in respect of the capital works assets and depreciating assets.

These xx lease arrangements are from both the:

• leases entered into post 1 July 2007 and

• leases transitioned into Division 250 of the ITAA 1997

And the arrangements are short term or low value (subparagraph 250-30(1)(c)(i)) and, none of the exceptions at subsection 250-35 (including for non-cancellable leases) will apply.

Detailed Reasoning

Upon the removal of the CEDs, Division 250 will prima facie apply to the xx leases entered into post 1 July 2007, as well as the leases entered into prior to 1 July 2007 that have transitioned into Division 250.

As stated above in question 4, the exclusion at Subsection 250-25(1) will apply to xx leases. Therefore, xx leases will still be within the ambit of Division 250. Division 250 will not apply to the xx leases if another exclusion to Division 250 applies.

Third Exclusion - Certain Short Term or Low Value Arrangements:

Subsection 250-30(1) states that:

This Division does not apply to you and an asset that is being *put to a tax preferred use under a particular *arrangement if:

(a) the *arrangement period for the *tax preferred use of the asset does not exceed:

(i) 5 years if the asset is real property and the tax preferred use of the asset is a lease; or

(ii) 3 years in any other case; or

(b) 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 be expected to be, provided to you (or a *connected entity):

(i) by *members of the tax preferred sector; and

(ii) 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:

(iii) $50 million if the asset is real property and the tax preferred use of the asset is a lease; or

(iv) $30 million in any other case; or

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

(i) $40 million if the asset is real property and the tax preferred use of the asset is a lease; or

(ii) $20 million in any other case.

This subsection has effect subject to the exceptions in section 250-35.

Subparagraph 250-30(1)(a)(i)

Pursuant to subparagraph 250-30(1)(a)(i), Division 250 does not apply if the arrangement period for the tax preferred use of the asset does not exceed 5 years if the asset is real property and the tax preferred use of the asset is a lease. None of the remaining xx leases have a lease term of less than 5 years. Therefore, this requirement is not satisfied in respect of any of the lease arrangements over the depreciating assets and capital works assets of the shopping centre.

Subparagraph 250-30(1)(b)(iii)

Pursuant to paragraph 250-30(1)(b), Division 250 does not apply 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 be expected to be, provided to the taxpayer:

• By members of the tax preferred sector; and

• 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 $50 million if the asset is real property and the tax preferred use of the asset is a lease.

In this regard, the financial benefits will be provided to the XYZ Limited Partnerships by members of the tax preferred sector (i.e. the non-resident lessees) in relation to the tax preferred use of the assets under the lease arrangements.

Xx of the remaining xx leases have a total nominal value of financial benefits of less than $50 million. The total nominal value of financial benefits has been determined as the rent payable under the relevant lease at the start of the lease term.

The third exclusion in subparagraph 250-30(1)(b)(iii) applies to xx of the lease arrangements over the depreciating assets and capital works assets, subject to the application of the exceptions to 250-30 contained in 250-35.

Subparagraph 250-30(1)(c)(i)

Pursuant to subparagraph 250-30(1)(c)(i), Division 250 does not apply if at the start of the arrangement period, the total of the values of all the assets that are put to a tax preferred use under the arrangement does not exceed $40 million if the asset is real property and the tax preferred use of the asset is a lease.

Conclusion

On the basis of the above, the third exclusion prima facie applies to all but 1 of the remaining xx lease arrangements, subject to the application of any exceptions. To summarise:

• none of the remaining xx leases will have a lease term of 5 years or less for paragraph 250-30(1)(a);

• xx of the xx leases will satisfy subparagraph 250-30(b)(iii) as the total of the nominal values of all financial benefits to be provided does not exceed $50 million; and

• All but 1 of the leases will satisfy subparagraph 250-30(1)(c)(i) as the total of all values that are put to a tax preferred use under the arrangement does not exceed $40 million.

Exceptions to section 250-30:

There are seven exceptions to the third exclusion outlined in section 250-35. If one (or more) of these exceptions apply, then the taxpayer cannot rely on the third exclusion in section 250-30. None of the exceptions contained in 250-35(1), 250-35(3), 250-35(4), 250-35(5), 250-35(6), 250-35(7) or 250-35(8) apply. For the purposes of completeness the application of the exception in 250-35(5) is now considered.

Subsection 250-35(5)

This subsection states that:

Section 250-30 does not apply if an *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) a finance lease; or

b) a non-cancellable operating lease; or a

c) 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 on the balance sheet.

Effectively non-cancellable is defined in section 250-130; although the expression in 250-35(5)(b) does not include 'effectively' but includes non-cancellable operating lease, the definition in 250-130(1) does identify that non-cancellable means it can only be cancelled with permission, or can be cancelled without permission but would incur a penalty that would discourage cancellation.

In this case it is considered that the lease arrangements would be non-cancellable operating leases. Each lease is for a specified term, and is a standard commercial lease as such the lease would not be able to be terminated at will by a tenant without an obligation to pay rent for the remaining period. Each lease has an obligation to provide the asset by the lessor for the agreed term and an obligation on the lessee to pay for the agreed term with a penalty payable that would discourage cancellation.

The leases satisfy the additional requirement, being that the xx leases, if non-cancellable, are not recorded as an asset or a liability in the balance sheet of the lessor, only the building is recorded as an asset not each lease. That is, the leases themselves are not recognised as finance leases (250-35(5)(a)).

Conclusion

Therefore, the exception at subsection 250-35(5) relating to non-cancellable leases will not apply. No other exceptions in 250-35 apply. Consequently, the third exclusion at section 250-30 will apply to all but 1 of the remaining leases entered into post 1 July 2007 or transitioned into Division 250 because these arrangements are short term or low value for the purposes of subparagraph 250-30(1)(c)(i).

Question 6

Summary

Yes, the Commissioner will exercise the discretion to make a determination pursuant to the fifth exclusion in section 250-45 that it is unreasonable for Division 250 to apply to the lease arrangements in respect of the capital works assets and depreciating assets to the extent that the second exclusion in section 250-25 or the third exclusion in section 250-30 is not applicable to these lease arrangements. This is on the basis of the consideration of the application of the safe harbour tests to the remaining No. 1 lease, and consideration of other matters.

Detailed Reasoning

Exercise of the Commissioners discretion not to apply Division 250

Background

The second and third exclusions (at subsections 250-25 and 250-30) will apply to all but 1 of the leases. There is 1 remaining lease that would be subject to Division 250 (the "No. 1 lease").

You have requested that, to the extent that Division 250 is applicable to the lease arrangements (i.e. the second or third exclusions are not applicable), the Commissioner make a determination under section 250-45 that Division 250 does not apply to the XYZ Limited Partnerships and the relevant capital works assets and depreciating assets leased to non-resident tenants on the basis that it is unreasonable for Division 250 to apply having regard to the circumstances because of which Division 250 prima facie applies and other relevant circumstances.

Exercise the discretion to make a determination in section 250-45

Section 250-45 contains the fifth exclusion for where Division 250 will not apply. It states that:

This Division does not apply to you and an asset at a particular time if:

(a) you request the Commissioner to make a determination under this subsection; and

(b) the Commissioner determines that it is unreasonable that the Division should apply to you and the asset at that time, having regard to:

(i) the circumstances because of which this Division would apply to you and the asset; and

(ii) any other relevant circumstances.

The EM provides the following guidance at paragraphs 1.136 and 1.137 on when the Commissioner may make a determination pursuant to section 250-45:

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

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".

In considering if a determination should be made the factors considered include whether a predominant economic interest is held in the asset, and any other relevant circumstances specific to the facts.

Considering whether a predominant economic interest is held

• limited recourse debt test section 250-115

Limited recourse debt has been used to acquire the asset and you will consequently lack a predominant economic interest in the asset under 250-115. This test is not satisfied.

• Right to acquire test section 250-120

The right to acquire test in section 250-120 is not satisfied for assets subject to the No. 1 lease.

• Effectively non-cancellable long term arrangement test section 250-125

The effectively non-cancellable long term arrangement test in section 250-125 would not be satisfied. This is on the basis that the arrangement term would only be the period commencing from the time the third party acquires Entity 2's interest (and remove the CED) to the end of the remaining No. 1 lease, as this is the period that Division 250 could apply. The period would be some 10 years and 4 months, and this period would ensure neither 250-125(1)(a) or (b) would be satisfied.

The Commissioner's view is that the arrangement is effectively non-cancellable for the purposes of 250-125(1)(a), as there would be a financial disincentive in the ongoing obligation pay rent arising if the lessee sought to terminate the lease prior to expiration.

Section 250-60 provides that an asset is put to a tax preferred use at a particular time if an end user holds at that time rights as lessee under a lease of the asset and the asset is used by or on behalf of an end user who is a tax preferred end user.

Section 250-65 then provides that the arrangement period for a particular tax preferred use of an asset starts when that tax preferred use starts. The arrangement period is taken to end on the day that is the date on which the tax preferred use of the asset may reasonably be expected or likely to end, or the arrangement period for a particular asset ends when this Division ceases to apply to you and the asset if that day is earlier.

The arrangement is with you the taxpayer, so the remaining lease commences for Division 250 when the taxpayer is subject to the lease, not when the lease was originally executed between the tax preferred end user and another lessor. The No. 1 lease term was 35 years commencing in 1989 and finishes in 2024. The assets were acquired by six limited partnerships on xx date. A Property Trusts was a Limited Partner with a percentage interest of 49.75%. Although the property was acquired with a lease in place, the first time the taxpayer was a party to the lease was upon acquisition of the property.

Division 250 applies to an asset at a particular time; subsection 250-125(1) provides you lack a predominant economic interest at a particular time if the arrangement is effectively non-cancellable and the period for the tax preferred use of the asset is greater than 30 years or where the arrangement period is less than or equal to 30 years - 75% or more of that part of the asset's effective life that remains when the tax preferred use of the asset starts.

You only lack a predominant economic interest in an asset at a particular time if the arrangement is effectively non-cancellable and the arrangement period for the tax preferred use of the asset is greater than 30 years or where the arrangement period is less than or equal to 30 years - 75% or more of that part of the asset's effective life that remains when the tax preferred use of the asset starts. The risk that is being measured is your risk in the asset arising from the agreement you have with the tax preferred end user.

The arrangement period the Limited Partnerships have with the No. 1 lessee is for a period of 17 and 9 months.

However, because there has been material change for the purposes of the transitional provisions of Division 250 as agreed at Question 2 above, paragraph 1.280 of the EM for Division 250 provides:

"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)]".

The arrangement period will therefore start from the time of the material alteration, being from when the CED no longer provides the additional assets for the purposes of section 51AD.

As 250-125(1)(b)(ii) will not be satisfied at the time that the third party acquires its interest, it follows that shortly after, 250-125(1)(b)(ii) will not be satisfied after the alteration actually occurs. This test is not satisfied.

• Level of expected financial benefits test section 250-135

You lack a predominant economic interest in an asset at a particular time if the asset has a *guaranteed residual value at that time.

Likely financial benefits exceeding 70% limit

Subsection 250-135(2) provides:

You also lack a predominant economic interest in an asset at a particular time if, at that time:

(a) 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

(b) the sum of the present values of the *expected financial benefits that *members of the tax preferred sector have provided, or are reasonably likely to provide, to you (or a *connected entity) in relation to the tax preferred use of the asset exceeds 70% of:

(i) the *market value of the asset if subparagraph 250-15(d)(i) applies; or

(ii) so much of the market value of the asset as is attributable to the expenditure referred to subparagraph 250-15(d)(ii) if that subparagraph applies.

The test is at a particular time under paragraph 250-135(2)(b). Subsection 250-140(2) provides if section 250-135 does not apply to you and the asset at the time when the tax preferred use starts, then subject to subsection (4) there is no need to retest.

Tax preferred use starts at the time of the material alteration. At this time you have advised that 250-135 is not satisfied. It follows that 250-135 is not satisfied for the assets subject to the No. 1 lease.

Considering Other Matters pursuant to 250-45(b)(ii)

In addition to not satisfying the safe harbour tests, the following factors have been considered in determining whether the Commissioner's determination at section 250-45 should be exercised:

• The asset subject to the No. 1 lease is xx sq ft. The total asset area is xx sq ft. The No. 1 lease accounts for xx % of the total asset that is leased.

• If the common areas are included this represents another xx% of additional xx sq ft. This adjusts the No. 1 lease tax preferred use of the asset (exclusive and not exclusive) to xx% of the total.

• The No. 1 lease provides income that is xx% of all lease income. The No. 1 lease does not provide sufficient income that it removes the economic risk held in either the portion of the asset, subject to the No. 1 lease or the risk held in the rest of the property.

• The taxpayer lacks a predominant economic risk in the asset subject to the No. 1 lease because of limited recourse debt under section 250-115, but the proportion of the asset subject to the No. 1 lease is considered to be relatively small.

• The capital allowances available on the assets subject to No. 1 lease to which Division 250 could apply is small as a proportion of the total capital allowances.

• The significant difference between both undeducted construction expenditure and written down value of depreciable assets, and the much larger cost of acquiring the property comprising capital works and depreciating assets; suggests that capital allowance deductions do not operate as a significant economic incentive in acquiring the asset, or provide a significant advantage in recovering as a deduction the cost of acquiring the building and plant.

Conclusion

On the basis of the application of the safe harbour tests to the No. 1 lease, as well as the consideration of the additional other matters above, the Commissioner will exercise his discretion to make a determination for the purposes of 250-45 that it is unreasonable that Division 250 should apply to the assets subject to the No. 1 lease. Therefore, the fifth exclusion at section 250-45 will apply to the 1 remaining lease and Division 250 will not apply.

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