Edited version of private ruling

Authorisation Number: 1011850875230

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Ruling

Subject: Hire purchase arrangement

Issue 1

Will the terms of the hire purchase agreement be a 'hire purchase agreement' for the purposes of Subdivision 240 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answers

Yes

Issue 2

Where ABC Limited (as Head Company of a tax consolidated group) is taken to have acquired an asset pursuant to section 240-20 of the ITAA 1997, will the 'start of the arrangement' be when the time of acceptance is under the hire purchase agreement?

Answers

Yes

Issue 3

Will the direct costs be taken to be the consideration for the sale of the property by the notional seller for the purpose of the arrangement as contemplated by subsection 240-25(5) of the ITAA 1997?

Answers

Yes

Issue 4

Will ABC Limited (as Head Company of a tax consolidated group) be assessable under subsection 240-35(1) of the ITAA 1997, on the notional interest that it receives under the hire purchase agreement?

Answers

Yes

Issue 5

Will Division 250 of the ITAA 1997, apply to ABC Limited (as Head Company of a tax consolidated group) in relation to the hiring of the HP Equipment to the entity under the hire purchase agreement?

Answers No

Issue 6

Will the losses incurred by ABC Limited (as Head Company of a tax consolidated group) under the HP Loan, be deductible under section 230-15 (2) of the ITAA 1997 to ABC Limited on a compounding accruals basis?

Answers Yes

Relevant facts and circumstances

ABC Limited will establish a nominally capitalised wholly owned subsidiary Sub Pty Limited (Sub) that will provide hire purchase facilities in relation to HP Equipment. The Sub will be a member of the ABC Limited tax consolidated group, as all the shares in it will be held by another subsidiary member of that group. Reference to Sub in this ruling also refers to ABC Limited as Head Company of the tax consolidated group.

Sub will hire purchase the HP equipment to the Hirer.

Sub will contract with the Subcontractor for the installation of the hire purchase equipment that will require Sub to make scheduled progressive payments throughout the construction term (upon Sub being put into funds to make such payments). Sub will finance these payments through Loan drawings, (from third party loans and a loan from ABC Limited)

Sub will enter into arrangements under which:Sub will pay progress and completion payments to the Hirer and will progressively acquire legal title to hire purchase equipment that are not, or will not become fixtures.

Hire Purchase Agreement

The hire purchase agreement will have a specific term which will be aligned to the economic life of the hire purchase equipment. From the end of the construction period, Sub will hire the installed hire purchase equipment to the Hirer for the term and the Hirer will make quarterly hire purchase payments.

Although Sub will enter into the hire purchase agreement at the start of the construction period, the hiring of the equipment will only commence at the end of the construction period.

At the end of the construction period, Sub will hire the hire purchase equipment to the Hirer for periods less than or equal to the useful economic life of the hire purchase equipment.

Upon expiry of the term of the hire purchase agreement, the Hirer will not defer to exercise an option to acquire the HP equipment and the Hirer will pay the final hire purchase payment and legal title to the HP equipment will pass from Sub to the Hirer.

The Direct Cost is the cost that Sub is required to pay the Contractor to acquire the completed HP Equipment. Although Sub will be required to pay contracted progressive amounts for each HP Equipment, this Direct Cost itself comprises of various costs which have been incurred by the SubContractor in order to get the HP Equipment into a completed condition so that they can be installed (ie reflecting the cost of the materials, any construction/installation costs, costs of labour in construction /installation the HP Equipment, design costs, the Contractor's margin etc).

The quarterly payments under the Hire Purchase Agreement will be sufficient to service the debt repayment obligations under the loan agreements used to fund the purchase of the Hire purchase equipment.

The applicant states that the provision of asset finance is a significant part of ABC's Limited's business, and Sub agree to provide the hire purchase facilities to the transaction.

Loan agreements

Sub will finance the acquisition of the hire purchase equipment through loans.

The Loans will have a drawdown and amortisation profile to match the hire purchase agreement.

No payments will be made on the loans during the construction period. Quarterly payments on the loans, including payments of capitalised interest, will commence from the quarter end immediately following the end of the construction period.

The obligations of Sub to make payments under the loans will be limited to payments that Sub receives under the hire purchase agreement with the other Hirer.

For accounting purposes, AASB 123 Borrowing Costs provides for the capitalisation of borrowing costs, including interest on loans used for the purpose of the creation of a qualifying asset. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. In the present circumstances Sub's financial reports will reflect that the interest incurred in the construction period is capitalised, by increasing the value of the Hire purchase equipment.

Hire Purchase Payments

Under the hire purchase agreement, the Hirer will make quarterly fixed hire purchase instalment payments to Sub. Various factors will be taken into account in calculating the amount of the hire purchase payments including the direct costs of the hire purchase equipment that Sub has paid the Contractor, the dates on which Sub is required to make payments to the Contractor and the after tax cost of funds borrowed by Sub in order to fund the acquisition of the hire purchase equipment.

The hire purchase payments received from the Hirer will be sufficient to enable Sub to pay interest and repay the principal outstanding under the loan.

The obligation of Sub to make payments under the loan will be limited to payments that Sub receives under the hire purchase agreement with the Hirer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40;

Income Tax Assessment Act 1997 section 40-40;

Income Tax Assessment Act 1997 Division 43;

Income Tax Assessment Act 1997 subsection 43-10(1);

Income Tax Assessment Act 1997 subsection 43-10(2);

Income Tax Assessment Act 1997 subsection 43-70(1);

Income Tax Assessment Act 1997 Division 230;

Income Tax Assessment Act 1997 section 230-10.

Income Tax Assessment Act 1997 subsection 230-15(1).

Income Tax Assessment Act 1997 subsection 230-15(2).

Income Tax Assessment Act 1997 section 230-45.

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

Income Tax Assessment Act 1997 paragraph 230-45(2)(a).

Income Tax Assessment Act 1997 section 230-50.

Income Tax Assessment Act 1997 section 230-55.

Income Tax Assessment Act 1997 subsection 230-55(4).

Income Tax Assessment Act 1997 paragraph 230-55(4)(a).

Income Tax Assessment Act 1997 paragraph 230-55(4)(b).

Income Tax Assessment Act 1997 paragraph 230-55(4)(c).

Income Tax Assessment Act 1997 paragraph 230-55(4)(d).

Income Tax Assessment Act 1997 paragraph 230-55(4)(e).

Income Tax Assessment Act 1997 paragraph 230-55(4)(f).

Income Tax Assessment Act 1997 Subdivision 230-B

Income Tax Assessment Act 1997 subsection 230-115(1);

Income Tax Assessment Act 1997 subsection 230-115(2);

Income Tax Assessment Act 1997 subsection 230-100(3);

Income Tax Assessment Act 1997 subsection 230-130(3);

Income Tax Assessment Act 1997 subsection 230-135;

Income Tax Assessment Act 1997 Subdivisions 230-C,

Income Tax Assessment Act 1997 Subdivisions 230-D,

Income Tax Assessment Act 1997 Subdivisions 230-E,

Income Tax Assessment Act 1997 Subdivisions 230-F

Income Tax Assessment Act 1997 paragraph 230-410;

Income Tax Assessment Act 1997 paragraph 230-410(f);

Income Tax Assessment Act 1997 Subdivisions 230-G

Income Tax Assessment Act 1997 Subdivisions 230-H

Income Tax Assessment Act 1997 Subdivisions 240-A

Income Tax Assessment Act 1997 section 240-10;

Income Tax Assessment Act 1997 section 240-20;

Income Tax Assessment Act 1997 subsection 240-20(1);

Income Tax Assessment Act 1997 subsection 240-25(5);

Income Tax Assessment Act 1997 subparagraph 240-25(5)(a);

Income Tax Assessment Act 1997 subsection 240-35(1);

Income Tax Assessment Act 1997 subsection 240-60(1);

Income Tax Assessment Act 1997 subparagraph 250-25(5)(a);

Income Tax Assessment Act 1997 Division 250;

Income Tax Assessment Act 1997 section 250-10;

Income Tax Assessment Act 1997 section 250-15;

Income Tax Assessment Act 1997 subsection 974-75(1).

Income Tax Assessment Act 1997 subsection 995-1(1).

Income Tax Assessment Act 1936 subsection 47A(7);

Reasons for decision Issue 1

Summary

The terms of the hire purchase agreement is a 'hire purchase agreement' for the purposes of Subdivision 240 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

The broad scheme of Division 240 of the ITAA 1997 is to treat hire purchase agreement as a sale of the relevant goods to the hirer (notional buyer) combined with a loan from the supplier (notional seller) to the notional buyer.

The arrangement to which Division 240 of the ITAA 1997 applies is described in the table in section 240-10; they consist only of 'hire purchase agreements' that relate to any kind of property. The term 'hire purchase agreement 'in this context is defined in subsection 995-1(1) of the ITAA 1997 and includes either:

(a) Contracts for the hire of goods where

(i) the hirer has the right, obligation or contingent obligation to buy the goods; and

(ii) the charge that is or may be made for the hire, together with any other amount payable under the contract( including an amount to buy the goods or to exercise an option to do so), exceeds the price of the good; and

(iii) title in the goods does not pass to the hirer until the option referred to in subparagraph (a)(i) is exercised; or

(b) an agreement for the purchase of goods by instalments where title in the goods doe not pass until the final instalment is paid.

In this case, at the commencement of the construction period, ABC Limited will enter into a hire purchase agreement with the entity.

During the construction period, ABC Limited will progressively acquire title to the hire purchase equipment from the Contractor. It is intended that all the hire purchase equipment will be chattels and not fixtures.

At the end of the construction period, ABC Limited will hire the hire purchase equipment to the Hirer for periods less than or equal to the useful economic life of the hire purchase equipment.

The Hirer will make quarterly fixed hire purchase instalment payments to ABC Limited Various factors will be taken into account in calculating the amount of the hire purchase payments including the direct costs of the hire purchase equipment that ABC Limited is required to pay the Contractor, the dates on which ABC Limited is required to make payments to the Contractor and the after tax cost of funds borrowed by ABC Limited in order to fund the acquisition of the hire purchase equipment.

The hire purchase payments received from the Hirer will be sufficient to enable ABC Limited to pay interest and repay the principal outstanding under the Loans.

The Hirer will be granted a purchase option to acquire title to the hire purchase equipment. Upon exercise of the option, the Hirer will be obliged to pay the final hire purchase payment and legal title to the hire purchase equipment will pass from ABC Limited to the HIrer.

On these facts, the hire purchase agreement is a 'hire purchase agreement', as described in paragraph (a) of the definition in subsection 995-1(1) of the ITAA 1997.

Issue 2

Summary

Where ABC Limited (as Head Company of a tax consolidated group) is taken to have acquired an asset pursuant to section 240-20 of the ITAA 1997, the 'start of the arrangement' is the time of acceptance under the hire purchase agreement.

Detailed reasoning

Subsection 240-20(1) of the ITAA 1997 provides that the notional seller is taken to have dispose of the property by way of sale to the notional buyer, and the notional buyer is taken to have acquired it at the 'start of the arrangement'.

'Start of the arrangement' is not defined for the purposes of the ITAA 1997. In ATO Interpretative Decision ATO ID 2008/106 Income Tax Hire purchase agreement: notional sale - 'start of the arrangement' addresses the situation where a lease agreement was entered into 18 months prior to the time that the actual leasing commenced (with conversion works, installation and testing occurring in the initial 18 month period).

ATO ID 2008/106 concludes that where a taxpayer is taken to have acquired an asset pursuant to section 240-20 of the ITAA 1997, the 'start of the arrangement' is when the lease term commences.

In this case, at the commencement of the construction period, ABC Limited will enter into a hire purchase agreement with the Hirer.

Although ABC Limited will enter into the hire purchase agreement at the start of the construction period, the hiring of the hire purchase equipment will only commence at the end of the construction period when the project is completed and all the hire purchase equipment installed.

Therefore, the start of the arrangement for the hire purchase agreement will be when the hiring of the hire purchase equipment commences.

Issue 3

Summary

The direct costs are taken to be the consideration for the sale of the property by the notional seller for the purpose of the arrangement as contemplated by subsection 240-25(5) of the ITAA 1997.

Detailed reasoning

Paragraph 240-25(5)(a) of the ITAA 1997 provides that the consideration for the sale of the property by the notional seller is taken to have been the amount stated to be the cost or value of the property for the purpose of the arrangement (where the notional seller and the notional buyer were dealing with each other at arm's length in connection with the arrangement).

To determine whether paragraphs 240-25(5)(a) of the ITAA 1997 applies, there is a need to conclude whether the hire purchase arrangement between Sub and the Hirer is being conducted at an arm's length basis.

Taxation Ruling TR 2002/2 Income tax: meaning of "Arm's Length" for the purpose of subsection 47A(7) of the Income Tax Assessment Act 1936 (ITAA 1936) dividend deeming provisions provides commentary on the meaning of 'arms length' in the context of subsection 47A(7) of the ITAA 1936.

Meaning of 'arm's length' in subsection 47A(7)

16. The term 'arm's length' is used in both tax and non-tax legislation. However, variations exist in the way in which the term is used and judicial interpretations have varied accordingly. The case Pontifex Jewellers (Wholesale) Pty Ltd v FCT [1999] FCA 1822, 43 ATR 643 contains a useful summary of case law on the different meanings of the term 'arm's length'. Comments that follow are drawn from that summary.

17. The case law draws a distinction between two uses of the term 'arm's length'. One refers to the relationship of the parties to a transaction (i.e., whether the parties are related in some way) and the other refers to the terms of a transaction between the parties (i.e., whether they are those that could be expected to arise between independent parties).

18. The relevant judicial decisions turn on both the language used and the context in which the term 'arm's length' appears. When a statute refers to parties dealing at arm's length, or to a specific transaction being at arm's length, the arm's length test is generally taken to refer to the terms of the transactions such as would be entered into between independent parties.

In Granby Pty Ltd v FCT (1995) 30 ATR 400; 95 ATC 4240, where the expression 'dealing with each other at arm's length' in section 160ZH of the ITAA 1936 was in question, Lee J said (at ATR 403; ATC 4243):

The expression "dealing with each other at arm's length" involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs. Of course, it is relevant to that enquiry to determine the nature of the relationship between the parties, for if the parties are not parties at arm's length the inference may be drawn that they did not deal with each other at arm's length.

In Copperart Pty Ltd v FCT (1993) 26 ATR 327 at 349-50; 93 ATC 4779 at 4798-9, Hill J said:

However, it must be said that in a particular fact situation related parties may deal with each other at arm's length in relation to a transaction and unrelated parties may deal with each [other] not at arm's length in relation to a particular transaction. ...

In that case [the A W Furse case] I expressed the view that what was required was a determination whether, in respect of a particular dealing, the parties were dealing with each other as arm's length parties would normally do, so that the outcome of their dealing was a matter of real bargaining.

Hence, in determining whether ABC Limited and the Hirer were dealing at arm's length when they entered into the hire purchase agreement, the terms of the arrangement would need to be those such as would be entered into between independent parties.

ABC Limited will enter into the Hire Purchase Agreement under which the Hirer will hire and purchase the hire purchase equipment from ABC Limited. The Hirer will make quarterly hire purchase payments. The description of the scheme does not indicate that ABC Limited and the Hirer has acted severally and independently in forming the terms of the hire purchase agreement. Not acting severally and independently does not necessarily imply the parties acted in concert with an ulterior purpose.

Therefore, based on the facts, it is reasonable to conclude that ABC and the Hirer were not dealing with each other at arm's length in connection with the hire purchase arrangement as required under paragraph 240-25(a) of the ITAA 1997.

Further, we conclude that the consideration for the sale of property by the notional seller is otherwise determined under paragraph 240-25(b) of the ITAA 1997 as the amount that could have been expected to have been paid by a notional buyer to a notional seller should also reflect the Direct Costs of the Hire Purchase Equipment being, the amount paid by ABC to acquire the hire purchase equipment from the contractor.

Issue 4

Summary

ABC Limited (as Head Company of a tax consolidated group) will be assessable under section 240-35(1) of the ITAA 1997, on the notional interest that it receives under the hire purchase agreement.

Detailed reasoning

Subsection 240-35(1) of the ITAA 1997 provides that the notional seller's assessable income of any income year includes the *notional interest for arrangement payments periods, and part of arrangement payment periods, in the income year. The notional interest for an arrangement payment period is worked out under section 240-60(1) of the ITAA 1997.

If the property is not trading stock of the notional seller and the consideration of the notional sale of the property exceeds the cost of the acquisition of the property by the notional seller, the excess is included in the notional seller's assessable income of the income year of that notional sale.

In the facts of this case the hiring of the hire purchase equipment under the terms of the hire purchase agreement will commence at the end of the construction period and instalment payments under the hire purchase agreement will be payable quarterly throughout the period of the hire purchase agreement on a quarterly basis.

Part of each instalment paid to ABC Limited under the hire purchase agreement will comprise an amount of interest which will be included as the assessable income of ABC Limited. Over the period of the hire purchase agreement, the payments will be sufficient to reimburse ABC Limited of the Directs Cost of the hire purchase equipment together with the cost of finance and other ancillary costs incurred by ABC Limited.

Therefore the ABC Limited (as Head Company of a tax consolidated group) will be assessable under section 240-35(1) of the ITAA 1997, on the notional interest that it receives under the hire purchase agreement?

Issue 5

Summary

Division 250 of the ITAA 1997 will not apply to ABC Limited (as Head Company of a tax consolidated group) in relation to the hiring of the hire purchase equipment to the Hirer under the hire purchase agreement.

Detailed reasoning

In accordance with section 250-10 of the ITAA 1997, Division 250 can only apply to an asset if the general test in section 250-15 of the ITAA 1997 is first satisfied.

 Section 250-15 General test

This Division applies to you and an asset at a particular time if:

(a) the asset is being *put to a tax preferred use; and

(b) the *arrangement period for the *tax preferred use of the asset is greater than 12 months; and

(c) *financial benefits in relation to the tax preferred use of the asset have been, will be or can reasonably be expected to be,

*provided to you (or a *connected entity) by:

 (i) a *tax preferred end user (or a connected entity); or

(ii) any *tax preferred entity (or a connected entity); or

 (iii) any entity that is not an Australian resident; and

(d) disregarding this Division, you would be entitled to a *capital allowance in relation to:

(i) a decline in the value of the asset; or

(ii) expenditure in relation to the asset; and

 (e) you lack a *predominant economic interest in the asset at that time.

In respect of paragraph 250-15(d) of the ITAA 1997, capital allowances is defined in subsection 995-1(1) of the ITAA 1997 to include a deduction under Division 40 or Division 43 of the ITAA 1997 (further discussed below) in relation to the hire purchase equipment under the hire purchase agreement.

Division 40

In order to be entitled to capital allowance under Division 40 of the ITAA 1997, a taxpayer must 'hold' the relevant asset under an item in the table in section 40-40 of the ITAA 1997.

Although ABC Limited will be the legal owner of the hire purchase equipment, Division 240 of the ITAA 1997 will apply to the hire purchase agreement and the Hirer as the notional buyer is taken to own the hire purchase equipment and ABC Limited as the notional seller is taken to have disposed of the hire purchase equipment to Hirer.

Taxation Ruling TR 2005/20 explains the interaction of deemed ownership under Division 240 of the ITAA 1997 with the holding rules in Division 40 of the ITAA 1997. Paragraph 21 of that ruling states:

The Commissioner's view is that the notional buyer can be taken to be the holder of the goods under either item 6 or item 10. The requirements to 'hold' under item 6 and to own under Division 240 were intended by the drafters to achieve the same result namely to entitle the economic owner (as opposed to the legal owner) to any deductions for the decline in value of the goods. Although there are two mechanisms in the ITAA 1997 for ascertaining whether the notional buyer is the holder, in the great majority of cases, both mechanisms achieve precisely the same result, and so it does not really matter which item is taken to be satisfied

As stated at paragraph 23 of the Ruling, item 6 and Division 240 of the ITAA 1997 cumulatively express the circumstances in which a hirer of the asset is entitled to a decline in value deduction. Therefore, it is Hirer who is entitled to a decline in value deduction as the Hirer is the holder of the asset in accordance with item 6 in section 40-40 of the ITAA 1997.

As ABC Limited does not hold any depreciating assets, it will not be entitled to any decline in value deductions under Division 40 of the ITAA 1997.

Division 43

A deduction for capital works under Division 43 of the ITAA 1997 is based on the amount of construction expenditure, that is, capital expenditure incurred in respect of the construction of those capital works.

In paragraph 7 of Taxation Ruling TR 97/25 Income Tax : property development: deduction for capital expenditure on construction of income producing capital works, including building and structural improvements, recognises three categories of capital works:

· buildings or extensions, alternations or improvements to buildings;

· structural improvements or extensions, alternations or improvements to structural improvements; and

· environmental protection earthworks.

In this case, the expenditure incurred by ABC Limited is in respect of the construction of chattels/equipment that will not be or will not become fixtures. The expenditure incurred by ABC Limited is not capital expenditure incurred in respect of the construction of capital works outlined in section 43-20 of the ITAA 1997.

ABC Limited will therefore not be entitled to any capital works deductions under Division 43 of the ITAA 1997 as the expenditure incurred by ABC Limited in relation to the hire purchase equipment is not capital expenditure incurred in respect of the construction of those capital works under section 43-20 of the ITAA 1997.

Issue 6

Summary

The losses incurred by ABC Limited (as head company of a tax consolidated group) under the Loan, be deductible under section 230-15 (2) of the ITAA 1997 to ABC Limited on a compounding accruals basis.

Detailed Reasoning

Under subsection 230-15(2) of the ITAA 1997 losses from financial arrangements are deductible to the extent that they are made in gaining or producing your assessable income or are necessarily made in carrying on a business for the purposes of gaining or producing assessable income.

The definition of 'financial arrangement' determines the unit of taxation in respect of which gains and losses are recognised under Division 230. In order to determine whether gains and losses arise under a financial arrangement, it is first necessary to establish whether the rights and obligations under the Loan give rise to an 'arrangement' that in turn meets the definition of a financial arrangement.

Identification of the arrangement under subsection 230-55(4)

An 'arrangement' is defined in subsection 995-1(1) of the ITAA 1997 to include any arrangement, agreement, understanding, promise or undertaking. Section 230-55 of the ITAA 1997 modifies this broad notion of an arrangement by providing guidance as to which specific rights and obligations constitute the relevant arrangement for the purposes of Division 230 of the ITAA 1997.

Generally, under section 230-55 of the ITAA 1997, a contract will define the boundaries of an arrangement, especially where the form of the contract is consistent with its substance; refer to paragraphs 2.47 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (TOFA EM). That paragraph goes on to state:

…[T]he contract is typically viewed on a 'stand alone' basis. In this context, the contract is nether aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230.

Prima facie, the rights and obligations under the Loan will constitute one arrangement. However, section 230-55 of the ITAA 1997 is not limited by the form of a single contract in the identification of an arrangement. Specifically, under subsection 230-55(4) of the ITAA 1997 regard must be had to a range of factors in order to determine whether a number of rights and/or obligations arise under one or more financial arrangements. The way various rights and obligations are combined under subsection 230-55(4) of the ITAA 1997 is an objective enquiry, the purpose of which is to identify the correct 'unit of taxation' in the context of Division 230 of the ITAA 1997.

It is considered having regard to each of the factors listed in subsection 230-55(4) of the ITAA 1997, that the Loan is a single arrangement for the purposes Division 230 of the ITAA 1997.

Is the arrangement identified a financial arrangement under Division 230?

The identified arrangement (the Loan) must meet the definition of a 'financial arrangement' before it will be subject to Division 230 of the ITAA 1997. Subdivision 230-A of the ITAA 1997 provides the test for determining whether an arrangement is a 'financial arrangement'. An arrangement will be a financial arrangement if it satisfies the definition under section 230-45 of the ITAA 1997 (dealing with cash settlable rights and obligations to financial benefits) or the definition under section 230-50 of the ITAA 1997 (dealing with equity interest and rights and obligations to equity interests).

Broadly, an entity has a financial arrangement under subsection 230-45(1) of the ITAA 1997 if it has, under an arrangement a:

· cash settlable legal or equitable right to receive a financial benefit; or

· cash settlable legal or equitable obligation to provide a financial benefit; or

· combination of one or more such rights and/or one or more such obligations.

Under the Loan, ABC Limited will obtain funding for the purpose of acquiring the Hire purchase equipment. ABC Limited will repay the relevant Loan advances (which include interest). ABC Limited's right to receive amounts under the Loan, and its obligation to pay amounts of principal and interest under this loan are rights and obligations to things which are 'financial benefits' within the meaning of section 974-160 of the ITAA 1997; specifically as the Loan advances and the Loan itself has economic value. Therefore, the Loan on its terms will create legal rights and obligations to receive and provide financial benefits.

Under paragraph 230-45(2)(a) of the ITAA 1997 a right to receive or an obligation to provide a financial benefit is cash settlable if the benefit is money or money equivalent. As the Loan advances and Loan payments are monetary amounts, they will be financial benefits that are money. Therefore, ABC Limited's right to receive amounts under the Loan and its obligation to repay amounts of principal drawn down and interest will be cash settlable.

It follows that the Loan will satisfy the definition of a 'financial arrangement' under subsection 230-45(1) of the ITAA 1997.

Application of the tax-timing methods

The gain or loss from a financial arrangement is brought to account in the manner prescribed in Subdivisions 230-B and 230-G of the ITAA 1997, unless one of the elective tax timing methods in Subdivisions 230-C, 230-D, 230-E, or 230-F of the ITAA 1997 apply.

Financial reports tax timing method

It has been advised that ABC Limited is eligible and has made an election to rely on financial reports under Subdivision 230-F of the ITAA 1997.

Assuming ABC Limited satisfies the requirements of subsection 230-395(2) of the ITAA 1997, the question then turns to whether paragraphs 230-410(1)(e) and (f) of the ITAA 1997 in each of the relevant income years will be satisfied such that the gain or loss from the Loan is determined by the tax timing methods in Subdivision 230-F and the balancing adjustment in Subdivision 230-G.

A comparison of the amount of the gain or loss made from the Loan applying the financial reports tax timing method and the tax timing method that would be applied if financial reports tax timing method did not apply to the Loan must be performed both in relation to the gain or loss to be recognised overall (under paragraph 230-410(1)(e) of the ITAA 1997) and for the gain or loss recognised in each income year (under paragraph 230-410(1)(f) of the ITAA 1997).

In the current circumstances as the arrangement is one to which Subdivisions 230-C and 230-D of the ITAA 1997 could not apply, the tax timing method that would apply to gains and losses from the Loan if financial reports tax timing method did not apply is that in Subdivision 230-B of the ITAA 1997.

Treatment of the Loan in ABC Limited's financial reports

When an election to rely on financial reports applies to a financial arrangement, paragraph 230-420(1)(a) of the ITAA 1997 provides that the gain or loss that is made from the arrangement for an income year is the gain or loss that the standards referred to in paragraph 230-395(2)(a) of the ITAA 1997 (in the present circumstances - AASB Australian Accounting Standards) require to be recognised in profit and loss from that arrangement for that income year.

In accordance with AASB 123 Borrowing Costs, until the Hire purchase equipment which are funded by the Loan are created, borrowing costs including interest will be capitalised. This means that the borrowing costs relating to the Loan will not be recognised as a loss in ABC Limited's accounting profit or loss during the period during which they are created.

The accruals method under Subdivision 230-B

As mentioned above, the tax timing method that would apply to gains and losses from the Loan if financial reports tax timing method did not apply is that in Subdivision 230-B of the ITAA 1997.

The accruals method in Subdivision 230-B of the ITAA 1997, is the method that would apply to work out the overall gain and loss and gain or loss made in each income year in respect of the Loan if there is:

· a sufficiently certain overall gain or loss at the time ABC Limited starts to have the arrangement; or

· a sufficiently certain particular gain or loss.

In deciding whether ABC Limited has a sufficiently certain overall gain or loss or a sufficiently certain particular gain or loss, ABC Limited may only have regard to the financial benefits it is sufficiently certain to receive or provide (subsection 230-115(1) of the ITAA 1997).

Subsection 230-115(2) of the ITAA 1997 provides that a financial benefit to be received or provided will be sufficiently certain only if it is reasonably expected that ABC Limited will receive or provide the financial benefit and at least some of the amount or value of the financial benefit is, at that time, fixed or determinable with reasonable accuracy. In assessing whether this requirement is satisfied, it is assumed that ABC Limited will continue to have the financial arrangement for the remainder of its life.

Under the Loan, sufficiently certain losses will be made by ABC Limited as a consequence of the difference between the financial benefits received (amounts advanced under the loan) and the financial benefits provided (which includes repayment of principal advanced and interest) under the Loan.

These losses will arise each time an advance is made under the Loan.

In accordance with subsection 230-135(1) of the ITAA 1997, these losses will then be spread over income years. Such income years will include those when the advance is made under the Loan and subsequent income years (until the advance is repaid) (see section 230-130 of the ITAA 1997).

Substantial differences

In the present circumstances, due to the capitalisation of borrowing costs whilst the Hire purchase equipment are created, it is expected that there will be significant differences between the results of the method used in calculating the gain or loss in ABC Limited's financial reports, compared to the gain or loss calculated under the accruals method described in Subdivision 230-B of the ITAA 1997. The consequence of this is that the requirement in paragraph 230-410(1)(f) of the ITAA 1997 will not be satisfied and the election to rely on financial reports will not apply to the Loan.

Accordingly, ABC Limited will spread the losses under the Loan in accordance with the accruals method described in Subdivision 230-B of the ITAA 1997.

Deductibility of losses under the Loan

Under subsection 230-15(2) of the ITAA 1997, a loss that is made by ABC Limited by virtue of Subdivision 230-B of the ITAA 1997 is deductible if:

(a) it is made in gaining or producing your assessable income; or

(b) it is necessarily made in carrying on a business for the purpose of gaining or producing assessable income.

It is considered that the losses ABC Limited will make will have a sufficient nexus to the assessable income it will produce under the HP Agreement. This is because the funds from the Loan will be applied for the purposes of acquiring the Hire purchase equipment that are the subject of the other Agreement. These hire purchase equipment will then be hired out under the other Agreement - an agreement which will produce assessable income for ABC Limited.

It is also considered that the fact there will be a delay between when the Loan losses start to be made by ABC Limited and when ABC Limited will start deriving relevant assessable income does not preclude the deductibility of the losses made from the Loan. This is because the losses are made with one end in view - the gaining or producing of assessable income.

Therefore, the losses incurred by ABC Limited under the Loan, are deductible under section 230-15 (2) of the ITAA 1997 to ABC Limited on a compounding accruals basis.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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 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.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.