Edited version of your written advice

Authorisation Number: 1012756872398

Ruling

Subject: Application of Division 250 of the ITAA 1997

Question 1

Will the Asset be put to a tax preferred use for the purposes of paragraph 250-15(a) of the ITAA 1997?

Answer

No.

Question 2

Will the Commissioner make a determination under section 250-45 of the ITAA 1997 that Division 250 ITAA 1997 does not apply?

Answer

No.

This ruling applies for the following periods:

The years ended 30 June 2015 until the end of the Term.

The scheme commences on:

1 July 2014

Relevant facts and circumstances

The Taxpayer will enter a loan agreement with the Tax Preferred Entity to provide to the Taxpayer a limited recourse loan, which will be used to design, construct, operate and maintain the Asset.

At the end of the term of the loan agreement (the Term), the Taxpayer, at its sole discretion, has the option to:

a) retain the Asset and repay the loan amount in full; or

b) return the Asset and terminate any loan obligations under the loan agreement.

The Tax Preferred Entity has no right to anything supplied or produced from the use of the Asset. All production or supply vests in the Taxpayer and the Tax Preferred Entity does not acquire any title or interest in it. There are no contractual obligations imposed to supply or produce anything from the Asset to the Tax Preferred Entity. The pricing of anything produced or supplied to the Tax Preferred Entity, if any, is consistent with the pricing that would be applied for the supply or production to any other third party that wishes to purchase from the Taxpayer.

In relation to the operations of the Asset:

1) The Taxpayer will operate the Asset day-to-day with its own staff.

2) The Taxpayer will bear some of the financial risks through a partly secured loan under a guarantee, and bear the operating risks and costs of the Asset.

3) No guaranteed rate of return or fee will be received by the Taxpayer.

The loan agreement contemplates the Tax Preferred Entity having the right to enter the land on which the Asset is located and take such action as is required to deal with the Asset during an emergency.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 250-5

Income Tax Assessment Act 1997 section 250-15

Income Tax Assessment Act 1997 section 250-45

Income Tax Assessment Act 1997 section 250-50

Income Tax Assessment Act 1997 section 250-60

Reasons for decision

Question 1

Will the Asset be put to a tax preferred use for the purposes of paragraph 250-15(a) of the ITAA 1997?

Reasoning

Section 250-5 provides that the main objects of Division 250 are to deny or reduce capital allowance deductions for an asset that is put to a tax preferred use if the taxpayer has an insufficient economic interest in the asset.

The Explanatory Memorandum to the Taxation Laws Amendment Bill 2007 (No.5) (the EM) explains that Division 250 of the ITAA 1997 applies to a taxpayer if the general test in section 250-15 is met and none of the exclusions apply.

The first condition of the general test, pursuant to paragraph 250-15(a) is that the asset is put to a tax preferred use at a particular time.

An asset is relevantly put to a tax preferred use at a particular time, pursuant to paragraph 250-60(2) of the ITAA 1997, if it is used in connection with the supply of water and the goods, services or facilities are to be produced or delivered to or for an end user who is a tax preferred end user.

Section 250-50 of the ITAA 1997 defines an end user as:

(1) 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.

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

(3) For the purposes of subsection (1), disregard any temporary control of the asset that is for the purpose of ensuring public health or safety, protecting the environment or continuing the supply of an essential service.

(4) To avoid doubt, an entity is taken to be an end user of an asset if the entity (or a *connected entity) holds rights as a lessee under a lease of the asset.

Note: For particular arrangements that are treated as leases, see section 250-80.

For Division 250 of the ITAA 1997 to apply, the Tax Preferred Entity, as an end user, must either use the Asset in the requisite sense or control the use of the Asset during the agreed Term.

Use of the asset

The term 'use' is not defined within either of the Income Tax Assessment Acts.

The Explanatory Memorandum to Tax Laws Amendment (2007 Measures No.5) Bill 2007 (the EM) at paragraph 1.29, states that Division 250 of the ITAA 1997 will apply to a taxpayer in respect of an asset only if, in a practical sense, a tax preferred end user has, or will have, the control or use of the asset during the arrangement period. This would suggest, (without going into a full discussion on case law - for example, Tourapark Pty Ltd v FCT, Hamilton Island Pty Ltd v FCT and Air Liquide Australia Ltd v. FCT) that the use required would be more than mere incidental use and would require a real and requisite direct use of the asset itself by the end user.

During the Term, the Taxpayer will own, operate and use the Asset. The Tax Preferred Entity will not actually use the asset and will not be able to use the Asset until the end of the Term. At the end of the Term, the Taxpayer has the option to either keep the Asset or repay the loan or transfer title and control of the Asset to the Tax Preferred Entity in satisfaction of the loan. If the Asset is transferred to the Tax Preferred Entity, it is only from this point that the Tax Preferred Entity may be able to use the Asset.

Therefore, from the facts presented, the Tax Preferred Entity will not have use of the Asset in a way required by subsection 250-50(1) during the agreed Term.

Effectively controls the use of the asset

Like the term 'use', the term 'effectively controls the use', is not defined in either of the Income Tax Assessment Acts.

Paragraph 1.34 of the EM states:

'Division 250 applies a test of effective control that is consistent with the test in section 51AD and Division 16D.'

The Commissioner has expressed the view of what 'effective control' means for these purposes in Taxation Ruling 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 (As at 2 September 1998) (TR 96/22) and Taxation Ruling No. IT 2602 Income tax: privately owned power stations: control by state electricity authorities (IT 2602).

These rulings continue to be relevant in determining what is meant by 'effectively controls the use', for the purposes of subsection 250-50(1) of the ITAA 1997.

Paragraph 9 of TR 96/22 states:

'Control of use is effective control of the property. Effective control means day-to-day or de facto control.'

Paragraph 42 of TR 96/22 states:

'Effective control is a broad test that is not limited to the strict legal rights resulting from agreements or arrangements but includes any other arrangements, including financial ones, that could affect the question of who controls the use of the property for the production of goods or provision of services.'

Paragraph 43 of TR 96/22 reiterates the elements previously discussed in IT 2602 as relevant to considering who has effective control of the use of the asset.

The relevant indicia include:

• Who controls the day-to-day operations of the assets;

• The relevant financial arrangements relating to the assets (and who bears the financial risks in relation to the assets operations); and

• Whether there is reversion of ownership of the assets to an exempt entity after current arrangements expire.

Day to Day operations

Paragraph 7 of IT 2602 states:

"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 that 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." (Emphasis added)

Paragraph 8 of IT 2602 goes on to state:

"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 an immediate supervisory role (not in the sense explained in the previous paragraph) that enables it to direct other in that day-to-day operation. The staffing arrangements will be important in this regard …"

From the facts given it is apparent that the Taxpayer controls the day to day operations of the Asset during the Term.

The only time the Tax Preferred Entity can take control of the day to day operations of the Asset is during an emergency. The Tax Preferred Entity may only take control for the duration of the emergency and the Taxpayer must cover the costs associated with overcoming the cause and consequences of the emergency. Temporary control in certain emergency situations will not result in the user being an end user of an asset pursuant to paragraph 250-50(3). Paragraph 44 of TR 96/22 states that an indicia of control would be where the Tax Preferred Entity has very broad step-in rights, beyond an emergency situation. The Tax Preferred Entity does not have such rights and will not be considered to control the Asset on these grounds.

Financial Arrangements

Paragraph 13 of IT 2602 states:

'While economic relationships will not generally be determinative of the question of control of a power station, examination of the whole commercial arrangement surrounding the ownership and operation of the station may point to a situation where the taxpayer's interest is largely of a financing kind…..'

IT 2602 further stipulates that the presence of fixed return charges or a fixed fee arrangement would be indicative of this type of relationship.

The Tax Preferred Entity provides the Taxpayer with the funding it needs to design, construct and maintain the Asset. Relevant factors concerning the Tax Preferred Entity's financial control during the Term include that the financial benefits provided by the Tax Preferred Entity to the Taxpayer are:

• not fixed return charges; and

• not a fixed fee agreement.

At the end of the Term the Taxpayer has the option to repay this loan and keep the Asset or transfer the Asset and terminate its loan obligations. The risks and costs associated with the Asset rest with the owner of the Asset. Thus, during the Term, the risks and costs remain with the Taxpayer and not the Tax Preferred Entity. Although the costs of operations will be funded through the loan, it is still the Taxpayer who bears the operating risks and costs of the Asset during the Term.

Reversion of property to the exempt entity

Upon expiry of the Term, the Asset may be transferred to the Tax Preferred Entity at the Taxpayer's sole discretion. During the Term, the Tax Preferred Entity does not have any way of taking control of the Asset other than in an emergency.

Based on the above factors, the Tax Preferred Entity will not have effective control of the Asset in a way required by subsection 250-50(1)of the ITAA 1997.

As the Tax Preferred Entity does not meet the requirements of section 250-50, it will not be an end user of the Asset for the purposes of Division 250 of the ITAA.

Furthermore, for the Asset to be put to a tax preferred use at a particular time, in addition to the Tax Preferred Entity being an end user, some or all of the goods, services or facilities must be produced for or supplied, carried, transmitted or delivered to or for the Tax Preferred Entity. From the facts given, there is no evidence of this. There are no contractual obligations for the Taxpayer to produce, supply, carry, transmit or deliver any goods, services or facilities to or for the Tax Preferred Entity. Thus, even where the Tax Preferred Entity is an end user, the asset would not be considered to be put to a tax preferred use pursuant to section 250-60 of the ITAA 1997.

Question 2

Will the Commissioner make a determination under section 250-45 of the ITAA 1997 that Division 250 ITAA 1997 does not apply?

Reasoning

As the general test in section 250-15 of the ITAA 1997 for the application of Division 250 is not met, Division 250 does not apply and, thus, section 250-45 cannot apply.

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