Edited version of administratively binding advice

Authorisation Number: 1011719453470

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Subject: Construction of a new facility

Issue 1

Question 1

Is a lump sum payment deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice

Yes.

Year(s) of income or period(s) to which this ruling applies:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

Commencement date of scheme:

Contractual close

Question 2

Should the answer to Question 1 be positive, is the proportion of the lump sum that is deductible in a relevant year of income determined in accordance with the formula in section 82KZMD of the Income Tax Assessment Act 1936 (ITAA 1936)?

Advice

Yes.

Year(s) of income or period(s) to which this ruling applies:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

Commencement date of scheme:

Contractual close

Issue 2

Question 1

Will Division 250 of the ITAA 1997 apply to the construction of the new facility?

Advice

No.

Year(s) of income or period(s) to which this ruling applies:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

Commencement date of scheme:

Contractual close

The scheme that is the subject of the ruling:

Coy A proposes to construct and operate a new facility for the facility owner. Under the relevant agreement Coy A is required to pay the facility owner an annual fee for the right to operate the facility for a number of years. Alternatively Coy A may discharge its obligations by paying a single lump sum up front. Coy A will borrow the funds to pay the lump sum.

Relevant provisions:

Income Tax Assessment Act 1936 Section 82KZL.

Income Tax Assessment Act 1936 Subsection 82KZL(1).

Income Tax Assessment Act 1936 Paragraph 82KZL(2)(b).

Income Tax Assessment Act 1936 Paragraph 82KZMA(1).

Income Tax Assessment Act 1936 Paragraph 82KZMA(1)(a).

Income Tax Assessment Act 1936 Paragraph 82KZMA(1)(b).

Income Tax Assessment Act 1936 Paragraph 82KZMA(2)(a).

Income Tax Assessment Act 1936 Paragraph 82KZMA(2)(b).

Income Tax Assessment Act 1936 Subsection 82KZMA(3).

Income Tax Assessment Act 1936 Subsection 82KZMA(4).

Income Tax Assessment Act 1936 Subsection 82KZMA(5).

Income Tax Assessment Act 1936 Section 82KZMD.

Income Tax Assessment Act 1936 Subsection 82KZMD(2).

Income Tax Assessment Act 1936 Section 82KZO.

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Subsection 8-1(1).

Income Tax Assessment Act 1997 Subsection 8-1(2).

Income Tax Assessment Act 1997 Division 40.

Income Tax Assessment Act 1997 Division 43.

Income Tax Assessment Act 1997 Section 40-30.

Income Tax Assessment Act 1997 Section 40-40.

Income Tax Assessment Act 1997 Section 43-75.

Income Tax Assessment Act 1997 Division 230.

Income Tax Assessment Act 1997 Subsection 230-45(1).

Income Tax Assessment Act 1997 Subsection 230-460(1).

Income Tax Assessment Act 1997 Paragraph 230-460(2)(e).

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).

Reasons for Decision

Issue 1

Question 1

In the present case, Coy A is required, to pay an annual fee in equal monthly instalments in advance. The agreement allows for prepayment of the annual fee. Significantly where the agreement is terminated prior to the expiration date, the facility owner will refund the unexpired portion of the prepayment calculated on a NPV basis. The lump sum was determined by reference to the revenue and expenses predicted for the facility over the period of the agreement.

Having regard to 'the whole picture' the payment of the lump sum would not appear to detract from the fact that the agreement contemplates an annual payment of the annual fee over the period of the agreement and had they been made annually would likely be on revenue account. By making the lump sum payment, Coy A will simply be relieved from the responsibility to make regular (likely increasing due to CPI adjustments) annual fee payments. However, it is conceded this of itself is not conclusive as a lump sum prepayment does not necessarily have the same character as a series of annual payments would have had.

Coy A is part of a syndicate engaged in a competitive tender process which if successful will result in Coy A being granted the right to operate the facility. It is anticipated that the facility owner will look favourably upon the prepayment of the annual fee in its evaluation of the syndicates tender given that it will provide an upfront cash amount free from any credit risk concerns that would typically accompany a long-term right to receive future income.

Payment of the lump sum will allow Coy A to further profit from the aggregate revenue received from activities conducted at the facility where the prepayment is discounted at a rate in excess of the weighted average cost of capital of Coy A.

Payment of the lump sum will not enlarge Coy A's framework. The payment was not made to acquire any asset and, in fact, there was no requirement for it to be made under the agreement (it could be made where notice is given by Coy A). Coy A will be subject to payment of the annual fee if successful in being granted the right, as opposed to a payment for the acquisition of that right, to operate the facility by virtue of the agreement signed. This is an expense to be incurred as part of the process by which coy A operates to obtain regular returns. It is not an outgoing made to bring into existence an asset from which those regular returns could be made. The payment will be for the right to operate the facility for a specified period. Ownership of the facility rests with the facility owner at all times.

Coy A will be granted the right to operate the facilities should the syndicate with whom they are associated be successful in entering the agreement with the facility owner. The lump sum is not required to be paid as a condition of Coy A being granted that right. It only becomes payable subject to entering into the agreement where Coy A provides notice of its intent to pay the lump sum. Failing that notice the annual fee remains payable.

Conclusion

Having regard to the whole set of circumstances, it is considered that the outgoing is not capital or of a capital nature. The lump sum will not form part of the purchase price of an asset forming part of the fixed capital of Coy A. The agreement makes clear that at all times ownership of the facility is vested in the facility owner. The clause in the agreement which provides for a proportional refund of the lump sum should the agreement be terminated prior to the expiry of the term is also supportive of the conclusion that no capital asset has been acquired. As such, it needs to be considered whether the outgoing satisfies the positive limbs of section 8-1 of the ITAA 1997.

The use of the facility by Coy A pursuant to the agreement will give rise to assessable income of Coy A. The payment of the lump sum will be incurred for the purposes of gaining assessable income. Absent the rights granted to coy A under the agreement to occupy the facility, it would not be able to gain or produce that income. Further, the lump sum will be necessarily incurred in the course of coy A's business. The payment of the lump sum therefore satisfies both positive limbs of subsection 8-1(1) of the ITAA 1997.

It is clear from Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; (1999) ATC 4242; (1999) 41 ATR 139 at CLR pp 470-471; ATC pp 4248; ATR p 148, that contemporaneity between the incurring of a loss or outgoing and the derivation of assessable income is not essential to deductibility. The expression 'the assessable income', which was explained for the purposes of interpreting the predecessor to section 8-1 of the ITAA 1997, subsection 51(1) of the ITAA 1936 is not to be read as confined to assessable income actually derived in a particular tax year, but was also to refer to assessable income which the relevant outgoing 'would be expected to produce' in future years (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236, repeated in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 at CLR pp 16-17; ATC 4957; ATR pp 621-622.

Division 230

For completeness, it is considered that Division 230 will not apply to the Prepayment made under the Sublease. The arrangement under which the Prepayment will be made will include not insignificant non-cash settlable rights, being the right to occupy under the lease agreement itself. Hence, the arrangement will not constitute a financial arrangement due the application of the negative limb of subsection 230-45(1) of the ITAA 1997.

Indeed, even if a Division 230 financial arrangement were some how constituted, any gain or loss from the arrangement to the extent it arises from a right arising under an agreement that is a licence to use real property will not have Division 230 apply to it: subsection 230-460(1) and paragraph 230-460(2)(e) of the ITAA 1997.

Question 2

Where expenditure qualifies for deduction under section 8-1 of the ITAA 1997, the deduction is generally allowable in full in the year the expenditure is incurred. However the timing of deductions for certain types of expenditure is subject to the advance payment rules in sections 82KZL to 82KZO of the ITAA 1936.

Paragraph 82KZMA(1)(a) of the ITAA 1936 is satisfied, being an expenditure that could otherwise be deducted in the relevant expenditure year under section 8-1 of the ITAA 1997

The conditions in paragraph 82KZMA(1)(b) of the ITAA 1936 are also satisfied.

Coy A carries on a business and is not an STS taxpayer for the year of income (paragraphs 82KZMA(2)(a) and 82KZMA(2)(b) of the ITAA 1936).

The lump sum will be incurred in carrying on a business and incurred under an agreement (subparagraph 82 KZMA(3)(a)(i) and paragraph 82KZMA(3)(b) of the ITAA 1936).

The lump sum will be incurred in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year (paragraph 82KZMA(3)(c) of the ITAA 1936). The rights granted under the agreement will continue to be granted to coy A over more than one income year, and beyond the income year in which the lump sum is paid.

Paragraph 82KZL(2)(b) of the ITAA 1936 provides that where expenditure incurred under an agreement consists of rent, a lease payment or a 'payment of a similar kind' the expenditure shall be taken to be incurred in return for the making available, or continued making available of the thing rented, leased or otherwise of a similar kind under the agreement during the period to which the payment relates. The agreement does not create a lease of the facility, however an analogy may be drawn in that the expenditure incurred under the agreement is in relation to the continued making available of the rights of use of the facility.

The lump sum will not be 'excluded expenditure' (subsection 82KZMA(4) of the ITAA 1936) as that term is defined in subsection 82KZL(1) of the ITAA 1936 as the amount of the payment will not be less than $1000, it is not required to be paid by law, or by an order of a court, of the Commonwealth, a State or a Territory. It will not be a payment under a contract of service, it is not a payment of a capital, private or domestic nature and nor does it come within paragraphs (e) or (f) of 'excluded expenditure' as defined in subsection 82KZL(1).

The lump sum will not be to meet a 'pre-RBT obligation' (subsection 82KZMA(5) of the ITAA 1936) as that term is defined in subsection 82KZL(1) of the ITAA 1936.

As a result the portion of the lump sum that is deductible in each year of income that contains all or part of the 'eligible service period' (as defined in subsection 82KZL(1) of the ITAA 1936) is calculated using the formula contained in subsection 82KZMD(2) of the ITAA 1936.

The eligible service period will commence on the later of the commencement date under the agreement or the date on which the lump sum is incurred. It will end on the earlier of the tenth anniversary of this date or the end of the term under the agreement.

Issue 2

Question 1

The business of Coy A involves responsibility for the design, construction, leasing, operation, provision and maintenance of the new facility and specified facilities during a period beginning from Financial Close and ending on the Expiry Date.

The State will pay Coy A a series of payments on progressive completion. Coy A will return the progressive payments as assessable income in accordance with Taxation Ruling IT 2450. Expenditure incurred in the construction of the Project is taken into account in the estimation of profit for construction.

ATO ID 2005/277 provides that a taxpayer that carries on a construction business and that determines its taxable income from a long term construction contract on an estimated profits basis as described in IT 2450 taxation will not have a construction expenditure area of capital works as provided in section 43-75 of the ITAA 1997.

ATO ID 2005/278 provides that a taxpayer that carries on a construction business and that has entered into an arrangement for the construction of a facility for which a progressive payment is received will not hold the depreciating assets it has constructed for the purposes of section 40-30 of the ITAA 1997.

As the expenditure incurred on the construction of the new facility is included in the calculation of the estimated profit from the progressive payment that is assessable income under section 8-1 of the ITAA 1997 in accordance with IT 2450, the expenditure will not constitute capital expenditure for the purposes of section 43-75 or section 40-25 of the ITAA 1997.

Part IVA

Part IVA of the ITAA 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.