Edited version of your written advice

Authorisation Number: 1051234458480

Date of advice: 7 June 2017

Ruling

Subject: Thin Capitalisation Exemption

Question 1

Will Entity A meet the conditions in section 820-39(3) of the Income Tax Assessment Act 1997 (Cth) for each income year during the term of the Project?

Answer

Yes

Relevant facts and circumstances

Entity A was established as a Special Purpose Vehicle (SPE) in order to manage the risk of recovery of certain receivables that were either assumed or created by Entity A. Entity A borrowed funds from Lenders pursuant to a Loan under the Loan Agreement and used the funds to purchase the right to the receivables from Entity C (the receivables originally being payable by Entity B to Entity C), as well as to make another loan.

Entity A was established solely for the purpose of purchasing the receivables and to facilitate the financing for a Project to be completed by Entity B.

The Loan is a debt interest for Australian income tax purposes. The value of the Loan is at least 50% of the receivables.

The Loan will have a Maturity Date which is less than 10 years.

Evidence in support of Entity A meeting the relevant criteria

Entity A was established to satisfy a particular, internationally renowned, ratings agency's criteria.

Entity A will be restricted through various representations, warranties and undertakings in the Loan Agreement to activities necessary to perform the role of facilitating finance, including that it is a single purpose entity with no other business and that it will not undertake or have an interest in any trading or other activity other than those contemplated by and permitted under the transaction documents. Entity A will be restricted from incurring any other financial indebtedness other than such financial indebtedness as permitted under the transaction documents.

Entity A will have at least one independent director on its Board who will not be inappropriately influenced by another transaction party.

Entity A is precluded from engaging in any dissolution, liquidation, consolidation, merger, or asset sale or the amendment of its constituent documents in accordance with its Project Agreement and Loan Agreement.

Entity A will ensure that it maintains its separateness from any other entity.

Entity A will display sound management by keeping proper books and records, conducting its business in Entity A's name only, carrying on and conducting its business in accordance with all applicable laws.

Any recourse will be limited to certain property specified in Entity A's finance documents and will be limited to transaction parties.

Entity A will be restricted from creating any security interest (other than that permitted under the transaction documents) over the secured property through an undertaking in the Loan Agreement.

Entity A will be restricted from disposing of any of its assets that are subject of the transaction, except in certain circumstances permitted in the transaction documents, by an undertaking in the Loan Agreement.

The Loan Agreement will provide insurance covenants which require project-specific insurance to be maintained to the extent commercially available and for the benefit of the project.

A cash flow waterfall will apply prioritising project cash flows to pay operating expenses as a first priority.

Entity A will have a debt service reserve account funded by Lenders.

The Loan Agreement will require that the proceeds of each insurance claim for loss or damage to project assets are to be applied to repair or reinstate the asset or to repay debt.

Entity A will not make any equity distributions during the term of the Project and Entity B is restricted from making distributions except in certain circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 820

Income Tax Assessment Act 1997 Section 820-39

Income Tax Assessment Act 1997 Subsection 820-39(3)

Income Tax Assessment Act 1997 Paragraph 820-39(3)(a)

Income Tax Assessment Act 1997 Paragraph 820-39(3)(b)

Income Tax Assessment Act 1997 Paragraph 820-39(3)(c)

Income Tax Assessment Act 1997 Subsection 820-39(4)

Income Tax Assessment Act 1997 Division 974,

Income Tax Assessment Act 1997 Subsection 974-15(1)

Income Tax Assessment Act 1997 Subsection 974-20(1)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

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

Detailed reasoning

The conditions in subsection 820-39(3) are:

(a) the entity is one established for the purposes of managing some or all of the economic risk associated with assets, liabilities or investments (whether the entity assumes the risk from another entity or creates the risk itself); and

(b) the total value of *debt interests in the entity is at least 50% of the total value of the entity's assets; and

(c) the entity is an special purpose entity according to the criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

Each of paragraphs 820-39(3)(a), (b) and (c) must be met for the requirements of subsection 820-39(3) to be satisfied.

Paragraph 820-39(3)(a) Managing economic risk

The Commissioner accepts that in Entity A’s circumstances, the requirement of paragraph 820-39(3)(a) is met as Entity A will be established for the purpose of managing some or all the risk associated with an asset that was either assumed or created by Entity A, being the recovery of the receivable payments.

As part of the arrangement, Entity A will assume some or all of the economic risks associated with the underlying receivables since Entity A's return is contingent on the recoverability of the receivables. That is, at least part of the credit risk of the receivables will pass from Entity C to Entity A.

Paragraph 820-39(3)(b) Value of debt interests

Paragraph 820-39(3)(b) requirement will be satisfied if the total value of the loans will be at least half the value of Entity A's assets.

The Loan will constitute a debt interest for the purposes of the ITAA 1997.

As such, this requirement is satisfied as the Loan is a debt interest and the value of Entity A's debt interests is at least 50% of Entity A's assets. Therefore Entity A will at all times be predominantly funded by debt.

Paragraph 820-39(3)(c) Entity A is a special purpose entity

Whether Entity A will satisfy the criteria of an internationally recognised rating agency is a question of fact, which includes a consideration of criteria published by internationally recognised ratings agencies.

Entity A was established to satisfy a particular, internationally renowned, ratings agency's criteria.

The requirement of meeting such Criteria can be met without a determination by a rating agency (subsection 820-39(4)).

In the criteria, the rating agency sets out that a SPE will achieve remoteness by adopting some form of the characteristics identified in the criteria. Therefore, Entity A does not need to satisfy each criterion in order to be assessed as remote.

In the Entity A’s circumstances, the relevant characteristics to assess the extent to which a project’s credit quality is linked to that of its parent(s) are:

● the presence of independent directors (or equivalent anti-filing mechanism)

● no cross-default provisions

● no ability to merge or reorganize

● limitations on amendments to organisational documents

● a project’s separateness from its parent(s)

● security interests over the project’s assets, and

● the existence of parent dependencies.

Further, the extent to which a transaction structure protects credit quality is assessed through two main sets of covenants:

● limited purpose entity covenants, which typically must include:

● limitations on additional debt

● limitations on additional security to third parties

● limitations on asset sales, and

● minimum insurance requirements.

● cash management covenants, which typically must include:

● cash flow protection and waterfall

● liquidity and reserves

● use of insurance proceeds, and

● distribution tests.

Based on the matters set out under the heading Evidence in support of Entity A meeting the relevant criteria set out in the Relevant facts and circumstances to which this ruling applies, the Commissioner accepts that Entity A will satisfy the requirements of the criteria of an internationally recognised rating agency, which are applicable to Entity A's circumstances, and the requirements of paragraph 820-39(3)(c) will in turn be satisfied.

Conclusion

As each of the requirements set out in paragraphs 820-39(3)(a), (b) and (c) will be met, Entity A will satisfy the requirements of subsection 820-39(3).

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