Edited version of private ruling

Authorisation Number: 1011732183293

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Ruling

Subject: Thin capitalisation

Question 1

Does the exemption for special purpose entities under section 820-39 of the ITAA 1997 apply to Finance Co?

Answer

Yes.

This ruling applies for the following period:

1 July 2010 to 30 June 2046

Relevant facts and circumstances

The scheme is as identified in the request for a ruling and in the documents provided in support of the request.

This ruling is provided on the understanding that the scheme will be undertaken in accordance with the scheme as identified in the request for a ruling, the draft documentation and the additional information provided pursuant to that request.

Assumption

Finance Co will at all times during the course of the Project be an insolvency-remote special purpose entity according to criteria of an internationally recognised rating agency that are applicable to Finance Co's circumstances.

Reasons for decision

Section 820-39 of the ITAA 1997 provides an exemption from the thin capitalisation provisions, for special purpose entities that satisfy the conditions set out in that section. Section 820-39 of the ITAA 1997 reads as follows:

SECTION 820-39 Exemption of certain special purpose entities

820-39(1)

Subdivision 820-B, 820-C, 820-D or 820-E does not apply to disallow any debt deduction of an entity for an income year if the entity meets the conditions in subsection (3) throughout the income year.

820-39(2)

Subdivision 820-B, 820-C, 820-D or 820-E does not apply to disallow any debt deduction of an entity for an income year that is an amount incurred by the entity during a part of that year, if the entity meets the conditions in subsection (3) throughout that part.

820-39(3)

The conditions 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 insolvency-remote special purpose entity according to criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

820-39(4)

The condition in paragraph (3)(c) can be met without the rating agency determining that the entity meets those criteria.

Finance Co is a specific purpose vehicle incorporated solely for the purpose of securitising assets and providing finance for the Project. Finance Co will be funded by borrowing from the senior debt providers. This debt will be secured by the cash flows from the licence fee receivables and the repayments on the loan.

The three conditions for the exemption set out in subsection 820-39(3) of the ITAA 1997 are considered in turn against the facts as set out in the ruling application:

Condition (a)

The Explanatory Memorandum to Taxation Laws Amendment Bill (No. 5) 2003 (the EM) that introduced section 820-39 to the ITAA 1997 states at paragraph 1.8 that the first condition provides a purpose test that seeks to exclude entities that are not specifically established for securitisation or origination activities, as commonly understood. It also seeks to exclude entities that undertake any activities unrelated to the process of securitisation or origination.

This condition is considered to be satisfied in this case as Finance Co has been specifically established to borrow funds to buy receivables as part of a securitisation arrangement as well as provide the loan. Both these activities form part of the financial structure of the Project. Finance Co will assume some of the economic risks associated with the licence fee receivables, since its return is contingent on the recoverability of the receivables. In the event of a default by Project Trust, Finance Co has no recourse against the grantor of the licence.

Both Finance Co's return on investment and return of investment are contingent on the recoverability of the receivables. In addition, on the liabilities side, Finance Co manages the risk on its borrowings from the senior debt providers to fund the securitisation.

In addition Finance Co manages the economic risk associated with the intercompany loan.

This condition is therefore satisfied.

Condition (b)

This condition requires that 'the total value of debt interests in the entity is at least 50% of the total value of the entity's assets'.

The expression 'debt interests' is defined in section 995-1 and Division 974 of the ITAA 1997 and includes financing and other interests of a similar nature.

This condition recognises that while the overall objective of a securitisation or origination programme is to fund the assets of the specific purpose entity entirely through the issue of debt interests, in some cases this objective may take some time to achieve or there may be some residual equity holding in the vehicle.

The equity contribution to Finance Co will be $2 or a similar nominal amount while its debt drawdown will be such that Finance Co will, at all times during the Project, be more than 50% funded by debt.

On this basis the condition is considered to be satisfied.

Condition (c)

This condition requires that the entity is an insolvency-remote special purpose entity according to the criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

The section does not require that the entity must have been actually rated as such by a ratings agency. The condition just requires that an internationally recognised ratings agency would be satisfied that the entity is unlikely to be subject to voluntary or involuntary insolvency proceedings.

Paragraph 1.10 of the EM states that a ratings agency may be satisfied where the entity can demonstrate that it:

· is restricted to activities necessary to its role in the transaction;

· is restricted from incurring additional indebtedness;

· cannot be subject to reorganisation, merger or change of ownership; and

· holds itself out to the world as a separate entity.

Some ratings agencies publish general criteria whereas others have specific criteria for particular types of specific purpose entities. An example of the latter is Standard and Poors' Structured Finance Criteria for Australian and New Zealand Special Purpose Entities, which is mentioned in the EM.

Finance Co has been created to satisfy Standard & Poor's insolvency remote criteria which are:

· Contractual restrictions;

· Debt limitations;

· Prohibitions of mergers, reorganisations and changes in ownership;

· Separateness of covenants;

· Fixed and floating security over assets;

· Independence of directors; and

· Tax neutrality and tax consolidation.

As it is not possible for the ATO to assess whether the ratings agency criteria of insolvency remoteness are satisfied by a particular entity over the course of a project and given the fact that ratings agency criteria may change from time to time, it has been decided to deal with the satisfying of this condition by way of an assumption (See under 'Assumption' above).

In conclusion, as the three conditions in subsection 820-39(3) of the ITAA 1997 are satisfied, Division 820 of the ITAA 1997 does not apply to Finance Co by virtue of the fact that it is exempt as a special purpose entity within the meaning of section 820-39 of the ITAA 1997.