House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 3 - Land transport facilities

Overview

3.1 Part 1 of Schedule 3 of the Bill will insert new Division 396 into the Income Tax Assessment Act 1997 to provide for a tax rebate at the general company tax rate on interest derived by lenders to approved public road and rail infrastructure projects. To the extent that a lender's interest is rebatable, the borrower will be denied a deduction on the interest.

3.2 Part A of this chapter summarises new Division 396.

Part B sets out the background to these provisions.

Part C explains the provisions of the new Division.

Part D explains transitional rules by which the new interest rebate provisions may apply to certain eligible projects under the previous Infrastructure Borrowings Tax Concession.

Part E is a Regulation Impact Statement.

A. Summary of the amendments

3.3 New Division 396 will provide for a tax rebate - called a tax offset - to be allowed to resident lenders to an approved land transport infrastructure project in the first 5 years of borrowings by the project borrower. The offset is calculated by applying the general company tax rate to the interest that a lender includes in assessable income. The amount of the tax offset may be subject to an upper limit set by the Minister for Transport and Regional Development (the Minister) in approving the particular infrastructure project. Where the lender's interest is subject to a tax offset, the project borrower is denied a deduction in respect of a comparable amount of interest.

3.4 The broad scheme of Division 396 is as follows:

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a tax offset calculated at the general company tax rate is allowable to a resident lender to an approved land transport project on the interest derived from the borrowing. The tax offset may be subject to an annual upper limit set by the Minister;

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deductions for a comparable amount of interest incurred by the borrower will be denied;

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to be approved, a project must be a publicly accessible road or rail infrastructure facility or a related facility in Australia. Broadly, that means a road or rail system open for use by the public at a charge;

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a project borrower is required to make written application to the Commissioner of Taxation so that the project can be approved and the borrower approved in relation to the project;

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the Minister will consider applications and decide whether to approve the borrower and the project, having regard to specified criteria including the commercial viability of the project, its economic or social benefits or costs etc, and advice from the Commissioner concerning aspects of the taxation law which may be relevant to the project, e.g. whether certain anti-avoidance provisions may apply;

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if a project is approved, it will be necessary for the project borrower and all of the lenders who are eligible for a tax offset on their interest to enter into an agreement with the Minister which specifies the conditions under which the offset will be allowed. A tax offset is not available to a lender unless the lender enters into an agreement;

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the agreement will specify details of the project, the lenders and the borrower, the income years covered, any maximum amount of tax offset determined by the Minister, and any other conditions set by the Minister;

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the agreement will also require the project borrower to apply the borrowed moneys by constructing the project facilities, or constructing or acquiring related facilities, and to control the use of the project facilities for income producing purposes for the income years covered by the agreement;

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provision is made to enable one lender to be replaced by another under the agreement. The new lender becomes eligible for a tax offset on interest derived for the balance of the period covered by the agreement.

B. Background to the legislation

3.5 The previous Infrastructure Borrowings Tax Concession which was introduced in 1992 to facilitate private sector investment in certain publicly accessible infrastructure projects was closed with effect from 14 February 1997. The provisions relating to the concession are contained in Division 16L of the Income Tax Assessment Act 1936 and Chapter 3 of the Development Allowance Authority Act 1992. The tax concession was, broadly, by way of exemption of the lender's interest on borrowings - or, as an option, a tax rebate of 36% of the interest - and non-deduction for the borrower's interest. In addition, any profit or loss on the disposal of an infrastructure borrowings instrument was non-assessable or non-deductible. Eligible infrastructure facilities included land transport, seaport, electricity generation, air transport, gas pipeline, water supply and sewerage or waste water facilities.

3.6 The replacement Land Transport Infrastructure Rebate contained in this Bill is a more restricted concession. Only road and rail infrastructure facilities may be approved infrastructure projects. (As a transitional measure, however, projects in respect of which an application had been made under the previous concession, extensions of projects certified under the previous concession, or projects certified after the cessation of the previous concession, may be approved.)

3.7 The concession is in the form of a tax offset on the taxable interest of a resident lender to an approved infrastructure project. The offset is calculated by applying the general company tax rate to the lender's assessable interest, but may be subject to an upper limit set by the Minister. Where the lender's interest is subject to a tax offset, the project borrower is denied a deduction in respect of a comparable amount of interest.

3.8 Offsets are allowable only in the first 5 income years after the first borrowing for the infrastructure project.

C. Explanation of the amendments

Tax offset for interest derived on land transport facilities borrowings

3.9 New section 396-15 authorises a tax rebate (called tax offset) to a lender who has entered into a land transport facilities borrowings agreement with the Minister. ( Section 396-80 describes such an agreement and section 396-85 the conditions it contains.) The allowable tax offset is the amount worked out by applying the general company tax rate (which is currently 36%) to the assessable interest derived by the lender in that year from a borrowing covered by the agreement. However, the amount must not exceed the maximum tax offset for the lender for the income year - as determined by the Minister and specified in the agreement.

3.10 For example, if a lender derived interest of $100,000 in a particular year, the allowable offset would be .36 x $100,000, i.e. $36,000, unless a lesser amount was specified by the Minister as the maximum offset for the lender for that year.

Maximum amount of tax offsets

3.11 The maximum revenue cost of tax offsets is governed by new section 396-20 which authorises the Treasurer to determine the maximum net cost to revenue for an income year of tax offsets being approved, having regard to any reduction to borrowers' interest deductions.

Deduction reduced for interest incurred on land transport facilities borrowings

3.12 New section 396-25 reduces the deduction for interest incurred in a year of income by an infrastructure project borrower if the lender is entitled to a tax offset under section 396-15. The deduction that would be allowable is reduced according to the formula:

1/ General company tax rate x Tax offset entitlement


That is, the borrower is denied a deduction on the equivalent amount of interest on which the lender's tax offset is calculated.

3.13 For the purpose of applying the formula, the lender must advise the borrower of the amount of offset to which it is entitled. It will be a condition of entering the agreement with the Minister (see section 396-85) that the lender undertakes to provide such information to the borrower.

3.14 If in any income year the amount of the reduction exceeds the borrower's deduction entitlements in respect of the interest, the deduction is reduced to nil and the excess must be carried forward and added to the reduction amount calculated for the subsequent year.

Land transport facilities interest

3.15 New sections 396-30 to 396-40 explain when interest will be eligible for a tax offset. Such eligible interest is called "LTF interest". Under section 396-30, LTF interest for a lender is defined broadly as being interest or in the nature of interest under a borrowing which is included in the lender's assessable income.

3.16 The converse applies for a borrower, i.e. the conditions are the same except that the interest would be deductible to the borrower.

3.17 Paragraphs 396-30(1)(b) and (2)(b) cover cases where the assessable or deductible amount is not, strictly speaking, interest but is assessable or deductible under the accrual rules contained in Division 16E of Part III of the Income Tax Assessment Act 1936 which deals with deferred income securities.

3.18 Section 396-35 explains when LTF interest is covered by a land transport facilities borrowings agreement to which section 396-80 applies. The lender must be a lender under the agreement and the interest must arise under a borrowing that is covered by the agreement when the lender derives the interest. The borrower must be a borrower under the agreement and the interest must arise under a borrowing that is covered by the agreement when the borrower incurs the interest.

3.19 Interest will cease to be covered by the agreement if the borrower or lender breaches the agreement and the Minister determines that the breach is a material breach and does not allow the breach by agreeing to vary the agreement under section 396-40.

Projects, borrowers and lenders

3.20 New sections 396-45 to 396-55 specify the infrastructure projects that can be approved by the Minister, and who can be approved as a project borrower or lender.

3.21 A project must be a land transport facility, that is a road or railway line in Australia that is for the transport of the public or their goods for a charge to them. Related facilities such as plant and equipment, buildings, stations and maintenance facilities which are reasonably necessary for the central facility to be able to operate also form part of the central facility for the purpose of the tax offset concession.

3.22 Roads and roadworks such as bridges or tunnels are not a related facility to a railway. Similarly, railways and railway works are not a related facility to a road.

3.23 Under section 396-50, an entity can be approved as a project borrower only if it is

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an incorporated body;

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a corporate limited partnership;

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a public trading trust; or

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a corporate unit trust,

and intends to retain its status as such an entity throughout the period covered by the land transport facilities agreement.

3.24 It is not permissible for a borrower to make the borrowing in partnership with another entity, nor to be a government body or government owned. Government bodies and government owned bodies may be borrowers, however, if they operate on a commercial basis under criteria published by the Treasurer in the Commonwealth Gazette. For that purpose, criteria are published in Gazette No S73 of 2 March 1995 under the authority of subsection 93I(4) of the Development Allowance Authority Act 1992.

3.25 Any person or entity that is an Australian resident may be approved as a lender to a project. To obtain a tax offset on interest income, the lender must be a resident for the whole of the relevant income year.

Application, approval and agreement process

3.26 New sections 396-60 to 396-90 contain rules relating to the process for making application for approval as a borrower to a land transport infrastructure project, approval by the Minister, and the entering into of a land transport facilities borrowings agreement.

3.27 An entity that seeks approval as a borrower must make written application to the Commissioner of Taxation in a form approved for that purpose, including all information required for proper completion. The Commissioner or the Minister may seek additional information if necessary in order to determine the application.

3.28 The person who approves the borrower and the project is the Minister. The Minister will make a decision in writing and will specify

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the borrower;

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the project;

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the income years covered; and

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if applicable, a maximum amount of tax offsets that lenders may obtain for each income year.

3.29 As mentioned, the approval must not apply to an income year that starts more than 5 years after the first borrowing is made for the project. The Minister is not authorised to approve a project if, having regard to the estimated revenue cost of allowing tax offsets to the project lenders etc., any maximum net revenue cost determined by the Treasurer in accordance with section 396-20 (the revenue cap) would be exceeded in any income year.

3.30 In deciding whether to approve a project, the Minister must weigh up the various criteria that are specified in new section 396-75:

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commercial viability;

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benefits to the borrower of lenders' tax offsets;

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estimated revenue foregone;

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economic or social benefits or costs;

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application of government planning rules;

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the degree of public consultation; and

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any other relevant matter

The Minister must also take into account any advice of the Commissioner relating to the application of the taxation law to the project e.g. the likely application of general or specific anti-avoidance rules, or whether lenders qualify as residents.

3.31 Some specific anti-avoidance rules are section 51AD and Division 16D of the Income Tax Assessment Act 1936. They prevent taxable financiers from obtaining tax benefits related to costs associated with property that is controlled, or the use of which is controlled, by tax exempt bodies. In the absence of section 51AD and Division 16D, financing arrangements could be structured so as to allow the tax exempt controller of the property to transfer these benefits to taxable financiers in return for cheaper finance.

3.32 The tax offset measure is intended to encourage genuine private investment in publicly accessible infrastructure, not to facilitate public sector involvement in the construction and financing of infrastructure projects. Section 51AD and Division 16D ensure that the tax benefits provided through the tax offset will only be available where the property is controlled by, and the benefits and burdens of control belong to, private investors.

3.33 If the Minister approves a project and a borrower, it is necessary to enter into a land transport facilities borrowings agreement with the borrower and each of the lenders that will be entitled to a tax offset on interest derived. The agreement will specify those matters specified in the Minister's written notice of approval, as well as each of the lenders and the borrowings that are covered by the agreement. The agreement may contain additional conditions.

3.34 New section 396-85 sets out certain conditions relating to the borrower's use of the approved infrastructure facilities, and the application of the borrowings, that must be included in the agreement. The two principal conditions are that:

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the borrower will own the facilities and use them principally for gaining or producing assessable income, and will effectively control their use until the end of the last income year covered by the agreement. (A borrower will be taken to own a facility if it holds a lease or other right over land on which the facility is situated and the lease or other right has been granted by a government or exempt government agency e.g. a Crown lease);

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the borrowings will be used only by spending them on the construction of the approved infrastructure facilities or the construction or acquisition of approved related facilities.

3.35 The agreement will also oblige the borrower and lenders to undertake to do all the things specified in the agreement, to keep proper records and to inform the Commissioner of any breach of the agreement. The borrower will be required to agree not to do anything that would trigger the application of section 51AD or Division 16D of the Income Tax Assessment Act 1936 to any part of the approved infrastructure facilities. Lenders will be obliged to inform the borrower of the amount of their tax offset entitlement as soon as practicable every year.

3.36 An agreement may be varied or revoked by the parties. In addition, the parties may enter into a new agreement for the purpose of replacing one lender with another.

Miscellaneous

3.37 The amendments being made by new section 396-95 will enable information to be passed, without breaching existing taxation secrecy rules, from the Commissioner of Taxation to the Minister or to other persons e.g. officers of the Minister's department, for the purpose of administering the land transport infrastructure tax offset scheme. Persons who receive such information, however, are bound by the secrecy rules not to divulge or make copies of it except for the specific purpose of that administration. The Minister will be authorised to publicly announce an approved project without breaching secrecy rules.

3.38 Under new section 396-105, the Minister may delegate his powers under Division 396 to the Secretary or other senior officers of his Department, but not the power to approve projects and borrowers stipulated in section 396-70.

3.39 The Minister's decisions under the Division are not reviewable by the Administrative Appeals Tribunal, except a decision under section 396-40 as to whether a breach of a land transport facilities agreement is a material breach.

Other Amendments

3.40 Part 2 of Schedule 3 contains various amendments to the 1997 Act consequential on the insertion of new Division 396. Section 13-1 - which lists the various offset provisions - is amended to include a reference to the land transport facilities borrowings offset rules being inserted by the Division. Section 995 -1(1) - containing the dictionary definitions - is amended to include definitions of "borrowing", "corporate limited partnership", "corporate unit trust", "general company tax rate", "land transport facility", "land transport facilities borrowings agreement", "LTF interest", "public trading trust" and "related facility".

D. Transitional provisions

3.41 Part 3 of Schedule 3 contains provisions which enable certain public infrastructure facilities which are not necessarily road or rail facilities to be treated as eligible facilities in respect of which lenders to the project borrower may become entitled to a tax offset under Division 396.

3.42 The first category is a facility (or a related facility) which qualified as an infrastructure facility under the previous Infrastructure Borrowings Tax Concession where either:

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an application had been made on or before 14 February 1997 to the Development Allowance Authority for a borrowings certificate under Part 3 of the Development Allowance Authority Act 1992 in respect of the borrowings for the facility; or

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facility is an extension of one for which a borrowings certificate under Part 3 is in force.

3.43 Borrowers may apply for such facilities to be approved by the Minister under section 396-70 subject to the same terms and conditions as apply to road and rail transport infrastructure.

3.44 The second category is a facility (or a related facility) which qualifies as an infrastructure facility under the previous Infrastructure Borrowings Tax Concession where:

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an application had been made on or before 14 February 1997 under Part 3 of the Development Allowance Authority Act 1992 in respect of borrowings for the facility; and

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ertificate was issued in respect of the borrowings but was rendered ineffective by the Taxation Laws Amendment (Infrastructure Borrowings) Act 1997, which terminated the previous Infrastructure Borrowings Tax Concession; and

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the Minister makes a written determination to approve the project and the borrower in the same manner as if the facilities were land transport facilities, i.e. by specifying all of the matters that would be set out in a written approval under section 396-70.

3.45 If the Minister makes such a determination, the Minister and the borrower and the project lenders will be able to enter into a land transport facilities borrowings agreement in accordance with section 396-80 so as to entitle lenders to a tax offset in respect of their assessable interest.

3.46 To facilitate the administration of the transitional rules contained in Part 3, the Development Allowance Authority will be required to advise the Commissioner of particulars relating to infrastructure facilities that may be approved under those rules.

E. Regulation impact statement

Policy Objective

3.47 To continue to encourage the provision of private sector investment in new public road and rail infrastructure through the Infrastructure Borrowings Tax Rebate scheme while also capping the potential cost to revenue of the tax concession. The Infrastructure Borrowings Tax Rebate replaces the Infrastructure Borrowings Tax Concession which was introduced in 1992 and was closed off to applications with effect from 14 February 1997.

Implementation options

Background

3.48 Certain aspects of the Infrastructure Borrowings Tax Rebate scheme are fixed.

3.49 Under the scheme, infrastructure providers forgo tax deductibility on interest paid on the infrastructure borrowings to resident infrastructure financiers. In return those financiers are given a tax rebate:

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on the amount of the interest on the borrowings in the year that interest is assessable as income of the financier;

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at a rate equal to the company tax rate;

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for a maximum of 5 years from the time of first borrowing for a project; and

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that is not tradeable or capable of being carried forward.

3.50 The cost to revenue of the rebate will be limited to $37.5 million for 1997-98 and $75 million per annum thereafter. The Australian Taxation Office (ATO), which will jointly administer the program, will call for applications for the rebate biannually. The closing date for the first round of applications is intended to be 31 December 1997.

3.51 As a transitional measure, the programme will also be open to infrastructure borrowers who:

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had applied by 14 February 1997 to the Development Allowance Authority for an Infrastructure Borrowings Certificate under the previous infrastructure borrowings tax concession; or

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had existing Infrastructure Borrowings Certificates from the Development Allowance Authority and propose to extend the certified project; or

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had applied by 14 February 1997 to the Development Allowance Authority for an Infrastructure Borrowings Certificate under the previous infrastructure borrowings tax concession and had received such a certificate, but the certificate was cancelled by operation of the Taxation Laws Amendment (Infrastructure Borrowings) Act 1997.

3.52 Applications seeking approval of a proposed infrastructure project as one to which tax rebatable loans can be made will be assessed against published selection criteria (such as commercial viability, transfer of tax benefits, cost to the revenue, economic and social benefits, and consistency with government policies). The decision in respect of each project and each lender will be made by the Minister for Transport and Regional Development (the Minister). The decisions of the Minister will not be subject to merits review.

3.53 Given the above restrictions there are two feasible implementation options.

Option 1

3.54 This option would have as little as possible contained in legislation. It would rely on the executive powers of Government being applied by the Minister to determine which projects have approval and the extent to which a financier could claim a rebate in any particular year.

3.55 The legislative scheme would simply require the Commissioner of Taxation to quantify the allowable rebate, or the deduction to be disallowed, in an assessment for a particular year, based on a decision of the Minister and/or on an agreement made between the Commonwealth and the relevant parties.

3.56 The only other legislation required would be machinery provisions to determine appeal rights and, because agencies other than the ATO will participate in assessment processes, provide relief from the secrecy provisions of the income tax laws.

3.57 Guidelines would have to be issued to assist applicants prepare their applications for the rebate. Applicants would be required to satisfy the criteria contained in the Budget announcement.

Option 2

3.58 This option is the same as Option 1 except that the selection criteria on which the Minister would base decisions are set out in legislation. Applicants would be required to provide the same information under either option, and the selection processes would be the same.

3.59 The selection criteria would be more fully described in guidelines.

Assessment of impacts (costs and benefits) of each implementation option

Impact group identification

3.60 Under either option, the scheme will affect developers of new road and rail public infrastructure and resident taxpayers who finance that development. Under transitional arrangements, however, the class of infrastructure development which may benefit under the scheme will be wider than road and rail.

3.61 The scheme will also affect various government agencies such as the ATO, the Department of Transport and Regional Development (DoTRD), the Treasury, the Department of Industry, Science and Tourism, the Department of Prime Minister and Cabinet, and the Department of Finance which will be asked to take part in the initial assessment of applications.

Identification of the costs and benefits

Costs under either Option

3.62 Under either option, there will be a cost for the developer and/or financier in providing sufficient information to support the application for the rebate. Under the taxation system as a whole this cost is considered to be small as few taxpayers will be affected. Once a rebate is granted, there will be a further cost for the developer and financier in negotiating an agreed contract with the Government. These costs are unquantifiable. Option 2 may be less costly overall because of the greater certainty for applicants in having selection criteria expressed in legislation.

3.63 There will be costs to the ATO and DoTRD in producing the forms and guidelines necessary for applications to be lodged. There are other significant government costs in administering the scheme taking into account the number of agencies involved in the process, the quantitative and qualitative assessments needed to be carried out before decisions are made (e.g., basic eligibility, anti-avoidance checks, revenue analysis, and compliance with selection criteria). These costs are estimated to be in the vicinity of $2m per annum.

Benefits of Option 1

3.64 Because there would be no legislative selection criteria on which to base his decisions, the Minister would have maximum flexibility in deciding which projects would receive the benefit of the tax rebate.

3.65 The absence of legislatively based criteria means that fewer legislative drafting resources would be required.

Benefits of Option 2

3.66 By expressing in legislation the criteria by which the Minister will make decisions, Option 2 is a more open and accountable process, and more likely to be an acceptable process to infrastructure project developers and financiers.

Consultation

3.67 Consultation in the form of discussions and seminars on administrative and legislative issues will be carried out with relevant industry and professional bodies and individuals in the early implementation stages of the rebate scheme.

3.68 The Treasury and the ATO will monitor this measure, as part of the whole taxation system, on an ongoing basis. In addition, the ATO has consultative arrangements in place to obtain feedback from professional and business associations and through other taxpayer forums.

Conclusion and preferred option

3.69 Given that the costs of Option 1 and 2 do not differ greatly, the benefits arising from the more open and accountable approach of Option 2 makes it the preferred option.