Edited version of your written advice

Authorisation Number: 1012724263427

Date of advice: 10 November 2014

Ruling

Subject: Private binding ruling application: Division 250

Question 1

Will Division 250 apply to the taxpayer company in respect of the facility?

Answer

No.

This ruling applies for the following periods:

This ruling applies for the duration of the agreement.

Relevant facts and circumstances

The taxpayer company (the company) submitted an application for a private binding ruling in relation to the application of Division 250 of the ITAA 1997 to a facility.

The company’s parent corporation operates similar facilities internationally.

Copies of the relevant deeds, agreements and licences were provided with the application.

The facility will be configured to allow expansion to supply other commercial users.

The foundation customers executed their independently negotiated agreements.

The company has fielded supply queries from other customers in its area.

The grant of the licence will not give rise to capital allowance deductions as contemplated by section 250-15(d).

Some key details and provisions from documents and legal agreements were summarised and provided in the application and are as follows:

The company will have sufficient access and rights over the leased area for the construction, commissioning, operation, maintenance and remediation of the facility.

The terms of the lease include provision for the company to have management and control of the leased area for the duration of the agreement.

The company has title and ownership in the facility and all materials, equipment and machinery to be supplied by it. In essence, the company obtains title and ownership and bears all risk of loss.

The project is uneconomic without both foundation customers as payment from just one of the foundation customers would not be sufficient to recover the anticipated debt and interest costs whilst still providing a commercial return on the assets.

The company can potentially make additional returns from the facility’s assets used by it in meeting the demand requirements of its foundation customers, as there is flexibility for the company to supply other customers in the region, although another major customer would require some augmentation of the existing facility.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 51AD

Income Tax Assessment Act 1936 subsection 51AD(1)

Income Tax Assessment Act 1997 Division 250

Income Tax Assessment Act 1997 section 250-15

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

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

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

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

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

Income Tax Assessment Act 1997 section 250-20

Income Tax Assessment Act 1997 section 250-25

Income Tax Assessment Act 1997 section 250-30

Income Tax Assessment Act 1997 section 250-40

Income Tax Assessment Act 1997 section 250-50

Income Tax Assessment Act 1997 subsection 250-50(1)

Income Tax Assessment Act 1997 subsection 250-50(2)

Income Tax Assessment Act 1997 section 250-60

Income Tax Assessment Act 1997 subsection 250-60(2)

Reasons for decision

Summary

None of the foundation customers uses or has de facto control of the facility and thus, Division 250 of the ITAA 1997 does not apply to the company in respect of the facility.

Detailed reasoning

Division 250 of the ITAA 1997 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 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 company

The company is the preferred proponent to build, maintain, operate and own a facility, for which agreements have been executed with foundation customers.

The facility will be configured to allow expansion enabling supply to other commercial users.

Accordingly, the provisions of section 250-15 which are satisfied are:

subsection 250-15(b) – the arrangement period for the tax preferred use of the asset is greater than 12 months;

subsection 250-15(c) – financial benefits in relation to the tax preferred use of the asset will be provided to the company by one of the customers;

subsection 250-15(d) – disregarding Division 250, the company as economic owner and holder of the assets will be entitled to a capital allowance in relation to the decline in value and expenses incurred in holding the assets;

subsection 250-15(e) – the company currently lacks a predominant economic interest in the assets.

Also, none of the following exclusions apply:

● small business entities (section 250-20);

● financial benefits under a minimum value (section 250-25);

● short term or low value arrangements (section 250-30); or

● section 250-40.

Whether the facility is ‘put to a tax preferred use’ by an ‘end user’

Given the above, consideration moves to subsection 250-15(a), and the matter as to whether the facility is ‘put to a tax preferred use’ by an entity that is an ‘end user’.

Subsection 250-15(a) ‘put to a tax preferred use’

Paragraph 250-15(a) requires that an asset be put to a tax preferred use. The term ‘put to a tax preferred use’ is a defined term, the meaning of which is explained by section 250-60. So far as is relevant, subsection 250-60(2) provides that an asset is put to a tax preferred use at a particular time if:

(a) at that time the asset is, or is to be, used (whether or not by you) wholly or partly in connection with:

(i) …

(ii) the provision of services or facilities; and

(b) … the following subparagraph(s) is satisfied at that time:

(i) some or all of the goods, services or facilities are, or are to be, produced for or supplied, carried, transmitted or delivered to or for an *end user who is a *tax preferred end user because of paragraph 250-55(a) (tax preferred entity) but is not an *exempt foreign government agency;

Assets leased or acquired by the company will be used by it to build, maintain, operate and own the facility. Agreements have only been executed with the foundation customers, one of whom is a tax preferred entity; however the facility will be configured to allow expansion enabling it to supply other commercial users.

Control of use

The question is then whether there is an end user under 250-50(1) controlling the company's use of the property:

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

(a) uses, or effectively controls the use of, the asset; or

(b) will use, or effectively control the use of, the asset; or

(c) is able to use, or effectively control the use of, the asset; or

(d) will be able to use, or effectively control the use of, the asset.

The control referred to in subsection (1) may be direct or indirect.

As provided in Taxation Ruling No. IT 2602 Income tax: privately owned power stations: control by state electricity authorities (IT 2602) control of use is determined by day to day operations, including financial matters, which can be indicative of control by an end user.

IT 2602 provides the following in relation to control and staffing:

6. Subsection 51AD(1) defines "control" as meaning effectively control. The relevant Explanatory Memorandum points out that to control effectively is to control in a practical sense, whether or not, in a more formal sense, there would be control. So far as is relevant, a number of dictionaries and texts of judicially defined words and phrases indicate that "effectively" means productive of or capable of producing a result, having effect, operative, actual rather than theoretical; "control" means to command, direct, check, limit, curb, regulate, restrain, operate or the power to direct or determine. Those definitions and certain judicial pronouncements suggest that "effectively" means that which actually causes something to happen, and "control" is the power to decide what is to be done, how it will be done, when it will be done and where.

Day-to-Day Operations

7. It is accepted that where a taxpayer's power station is to supply power as part of the State grid, the State authority will need to coordinate the activities of the private station with other stations on the grid. In particular, the State authority may need to vary outputs or institute shutdowns. Where the State authority has such a coordinating or supervisory role which is limited only to such matters as are necessary to ensure a reliable and continuous supply of electricity on the grid, economy of operation of the grid, or public health and safety in emergency conditions, the State authority will not, on that basis alone, be regarded as controlling the use of the power station.

8. In the context of the day-to-day operation of a power station, this Office sees effective control as meaning that a person, organisation or authority either operates the station on a day-to-day basis through its employees or agents or has such an immediate supervisory role (not in the sense explained in the previous paragraph) that enables it to direct others in that day-to-day operation. The staffing arrangements will be important in this regard, particularly where the legal owner has no previous experience or expertise in the management and operation of a power station.

9. If staff operating the station are employees of the State authority, it would be difficult to escape the conclusion that the authority had effective control of its operation, despite the existence, perhaps, of a management agreement under which the authority purports to act as service provider or agent for the owner. A similar conclusion might be drawn if, for example, the employees are employees of the State authority but have been seconded to the staff of the power station owner. The existence of a station management agreement under which key management or technical staff are employees of the State authority or State authority employees seconded to the power station owner, or where the composition of the management board is such that present or seconded employees of the State authority dominate station management, would also suggest effective control of the power station is with the State authority. Arrangements like those are suggestive of the power station owner having only a passive role in station management, being content to let the State authority take charge on a day-to-day basis.

Control of use looks to de facto control rather than legal control (see discussion of section 51AD of the ITAA 1936 in paragraphs 5 and 6 of IT 2602). The Explanatory Memorandum to Income Tax Assessment Amendment Bill (No. 5) 1983 (EM), which introduced section 51AD, points out that to control effectively is to control in a practical sense, regardless of formalities.

Taxation Ruling TR 96/22 states that the following factors are relevant in determining de facto control:

● Staffing arrangements;

● Who bears the financial risk of the project;

● Where the taxpayer receives a guaranteed rate of return from an agreement so that the return is the same whether the property or service is used or not used, may indicate that control lies with someone else;

● Reversion of the property to the government authority;

● Broad step-in rights beyond emergency intervention or the rights to dictate issues such as occupation of the property, what activities take place there, and on what terms; and

● Any right to dictate issues such as who will occupy the property, what activities will take place there, and on what terms.

These factors are considered below.

Staffing

Nothing in a customer’s agreement can be construed as granting a customer any title, right or interest over the facility. The company owns the facility and accepts all risks and costs associated with:

● the engineering, designing, procuring, constructing, erecting, installing, financing, testing, commissioning and ownership of the facility;

● the operation and maintenance of the facility;

● the adequacy and suitability of the site; and

● the operation and maintenance of the assets.

The company operates similar plants to the facility at a range of international sites. It uses its own staff and in regard to staffing is in no way reliant on government personnel and has stated in its application that none will be involved in the day to day management or operation of the facility.

Furthermore, from the handover date, customers and their personnel will have limited access to the facility and must comply with all work health and safety requirements (and other requirements) of the company.

Paragraph 43 of TR 96/22 Income tax: section 51AD – deductions not allowable if an asset financed by non-recourse debt is used by a tax exempt or other entity (TR 96/22) under the sub-heading, Control of use:

staffing arrangements – if staff operating the property are employees of the government authority, this is a strong indication that the government authority has effective control. Alternately, if the staff are answerable to the taxpayer and sufficiently experienced to be capable of operating the property without such supervision, the inference may arise that the taxpayer has control ...

In respect to staffing arrangements, it is apparent from the details provided above that the company has control of use.

Furthermore, the terms of the lease formally include provision for the company to have management and control of the leased area for the duration of the agreement, during which it must perform all relevant functions and fulfil all relevant duties of an employer and occupier and all other obligations of a duty holder under workplace health and safety laws.

Any rights a customer has under the various agreements are those that are limited only to such matters as are necessary to ensure a reliable and continuous supply. It is notable that the tax preferred entity’s rights do not include step-in rights.

Financial risk

Operation and maintenance of the facility is contracted to the company. Under the lease, provision is made for the company to have sufficient access and rights over the leased area for the permitted use, being the constructing, commissioning, operation, maintenance and remediation of the facility in accordance with the development deed.

The construction of the facility will be undertaken by an independent contractor and the company will carry the risk for any issues with this phase as well as capacity constraints that may result from the completed plant. The terms of the development deed require the company to engineer, procure, erect, construct, test and commission the facility and otherwise perform the works in accordance with (amongst other things) the design and equipment parameters set out in the specifications. These requirements are aimed at ensuring the company will meet its relevant obligations pursuant to the project documents and agreements.

The company has title and ownership in the facility and all materials, equipment and machinery are to be supplied by it. If there is any loss or damage to these assets including the construction works, then the company must rectify it at its own cost, unless it was caused by another party. In essence, the company obtains title and ownership and bears all risk of loss on assets, as from the agreement’s commencement date.

Paragraph 43 of TR 96/22 under the sub-heading, Control of use, considers the following:

who bears the financial risks of the project. This is not a separate test of control of use of the property, but may provide an indication of effective day-to-day control. However, if the end-user has no lease or right to use, but rather an agreement only to provide services for the operation of a facility, and that operation involves no significant day to day functions, the financial arrangement, may be a determinative factor …

As the foregoing discussion indicates, the financial risk of the construction and operation of the facility is borne by the company.

Monthly fixed and variable charges

The agreement sets out the company’s obligations in supplying the tax preferred entity from the facility, which include those cited above under the sub-heading, Staffing.

The agreements with customers have clauses whereby charges can be reduced where service provision is found to be inefficient; however, the company has incentives to seek efficiencies in the operation of the facility because it will benefit financially from them. Inefficiencies will, in turn, incur financial penalties against the company.

Furthermore, as the company has stated in its response to specific enquiries regarding its reliance or otherwise on the tax preferred entity, the project is uneconomic without both foundation customers, as payment from just one of the foundation customers would not be sufficient to recover the anticipated debt and interests costs whilst still providing a commercial return on the assets.

The company can potentially make additional returns from the facility’s assets used by it in meeting the demand requirements of its foundation customers, as there is flexibility for the company to supply other customers in the region, although another major customer would require some augmentation of the existing facility.

These circumstances provide further evidence that the arrangement between the company and the tax preferred entity is not a fixed maximum fee arrangement for the purposes of paragraph 19 of IT 2602; the company requires the other foundation customer for project viability. Furthermore, the company will have scope to garner commercial benefits from third parties by utilising the same assets supplying its foundation customers, all of which supports the company’s contention of control of use.

Guaranteed rate of return

Given the foregoing, it is apparent that the company bears considerable project risk from the date of agreement. Also, given the penalties and incentives provided in the agreements it is apparent that there is no guaranteed rate of return, as identified in paragraph 43 of TR 96/22, in fact in the wider view of the risk assumed by the company there would be a significant reduction in the rate of return.

In this respect, paragraph 43 of TR 96/22 under the sub-heading, Control of use, states the following:

where the taxpayer receives a guaranteed rate of return from an agreement, so that the return is the same whether the property or service is used or not used, this may indicate that control lies with someone else. Receipt of guaranteed income from an exempt entity for the provision of a service to that exempt entity, where the taxpayer uses the property and where the income is just sufficient to cover expected outgoings and to provide a return to the taxpayer, would make it evident that the exempt entity has de facto control of the property …

As stated above, given the operation of the agreements it is apparent that there is no guaranteed rate of return for the company, as described in paragraph 43 of TR 96/22. In fact, some clauses can invoke significant penalties against the rates of return, all of which indicates that control lies with the company.

Reversion of the property

As set out in paragraph 20 of IT 2602 an agreement to transfer ownership to the ‘State authority after a specified number of years’ or another option for acquisition could be construed as an indicator of real control residing in such an authority.

In this matter, the tax preferred entity will not acquire the facility on expiry of the term. Furthermore, the company is required to decommission the facility and remove from the site all plant, materials, consumables, fixtures and fittings owned by it. Therefore, reversion of the property is not a factor indicating de facto control on behalf of the tax preferred entity.

Broad step-in rights

As has been stated previously, under the sub-heading, Staffing, any rights the tax preferred entity has under the various agreements are those that are ‘limited only to such matters as are necessary to ensure a reliable and continuous supply’ (paragraph 7, IT 2602). The tax preferred entity does not have documented step-in rights. The entry rights it does have under the lease require the provision of reasonable written prior notice (two business days), or as much notice as is practicable in the case of emergency: in this respect it follows that the tax preferred entity will not, on that basis, ‘be regarded as controlling the use of the power station’ (paragraph 7 of IT 2602).

Any right to dictate issues

Paragraph 22 of IT 2602 addresses fuel supply and states in part:

On the basis that an appropriate supply of fuel is crucial to the ongoing, efficient operation of a power station, contracts for fuel supply by the State authority to the taxpayer that do not reflect arm’s length prices and a relatively long term supply period would call into question the issue of control. That would be the case, for example, where the supply contract enabled the State authority to withhold fuel on the basis of its judgment of the overall needs of the State grid.

The company’s customer supply arrangements are standard commercial arrangements, from which control of use cannot be construed.

Conclusion

Based on the facts provided, it is concluded that the tax preferred entity does not use or have de facto control of the use of the facility. Thus, Division 250 of the ITAA 1997 does not apply to the company in respect of the facility.

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