Edited version of administratively binding advice

Authorisation Number: 1012077754153

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Advice

Subject: Division 250 - put to a tax preferred use

Issue 1

Question 1:

Does the Commissioner of Taxation (the 'Commissioner') consider the Asset is not put to a 'tax preferred use' pursuant to section 250-15(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice

Yes

Period

Relevant facts and circumstances

The Company is an Australian propriety company.

The Company acquired the Asset through subsidiaries Company F and Company G.

Subsequent to the acquisition of the Asset, the Company formed a tax consolidated group of which Company F and Company G are subsidiary joining members.

The business of the Company, including the subsidiaries, is limited to owning, maintaining and operating the Asset.

The Entity is a service provider and facilities manager. It is exempt from Australian income tax and is therefore a tax exempt entity as defined in section 995-1 of the ITAA 1997.

The Company has entered into a services agreement with the Entity for the provision certain services.

The Board of Directors of the Company employs a general manager who has the delegation to manage the day to day operations of the business. The Company also employs other personnel who are experienced in operating the Asset. Employees of both the Company and the Entity will report to the General Manager.

The Company has also entered into a financial derivative arrangement with the Entity in order to manage particular risks.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 250-15;

Income Tax Assessment Act 1997 section 250-15(a);

Income Tax Assessment Act 1997 section 250-15(c);

Income Tax Assessment Act 1997 section 250-15(c)(i);

Income Tax Assessment Act 1997 section 250-50;

Income Tax Assessment Act 1997 section 250-50(1)(a);

Income Tax Assessment Act 1997 section 250-55(a);

Income Tax Assessment Act 1997 section 250-60(1);

Income Tax Assessment Act 1997 section 250-60(2);

Income Tax Assessment Act 1997 section 250-60(3);

Income Tax Assessment Act 1997 section 974-160;

Income Tax Assessment Act 1997 section 995-1.

Part IVA

Part IVA 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 provide advice on, or to an associated or wider arrangement of which the arrangement is part.

If you want us to provide advice 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.

Reasons for decision

Question 1

Does the Commissioner of Taxation (the 'Commissioner') consider the Asset is not put to a 'tax preferred use' pursuant to section 250-15(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice

Yes

Summary

The Commissioner of Taxation (the 'Commissioner') considers that the Asset acquired by the Company is not put to a 'tax preferred use' pursuant to section 250-15(a) of the ITAA 1997.

Detailed reasoning

Division 250 of the ITAA 1997 will deny capital allowances deductions where an arrangement effectively passes on the risks and benefits of ownership from a legal owner to an end user that is a tax exempt entity. Arrangements which come within the scope of Division 250 will be taxed as a financial arrangement on a compounding accruals basis.

Paragraph 1.14 of the Explanatory Memorandum to the Tax Laws Amendment (2007 Measure No. 5) Bill 2007 (Cth) (Explanatory Memorandum) states:

Division 250 will apply to a taxpayer if, broadly:

· An asset is put to a tax preferred use;

· The taxpayer is entitled to capital allowances in relation to the asset; and

· The taxpayer does not have the predominant economic interest in the asset.

In order for Division 250 of the ITAA 1997 to apply, all of the requirements set out in the general test under section 250-15 of the ITAA 1997 must be present. Section 250-15 states:

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

· the asset is *put to a tax preferred use; and

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

· *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:

o a *tax preferred user (or a connected entity); or

o any *tax preferred user (or a connected entity); or

o any entity that is a foreign resident; and

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

o a decline in value of the asset; or

o expenditure in relation to the asset; and

· you lack a *predominant economic interest in the asset at that time.

Paragraph 250-15(a) of the ITAA 1997 requires consideration of, whether the Asset is put to a tax preferred use. Whether an asset is put to tax preferred use is set out in section 250-60 of the ITAA 1997.

Subsection 250-60(1) of the ITAA 1997 provides that an asset is put to a tax preferred use at a particular time if an end user holds the rights to the asset under a lease. The Asset is not subject to a lease and therefore subsection 250-60(1) of the ITAA 1997 does not apply.

The alternative definition of 'put to a preferred use' is set out in subsection 250-60(2) of the ITAA 1997, which states:

An asset is also put to a tax preferred use at a particular time if:

(a) at that time the asset is, or is to be, used (whether or not by you) wholly or partly in connection with:

o the production, supply, carriage, transmission or delivery of goods; or

o the provision of services or facilities; and

(b) either or both of the following paragraphs is satisfied at that time:

o some or all of the goods, services, or facilities are, or are to be, produced for or supplied, carried, transmitted or delivered to or for an ^*end user who is a ^*tax preferred end user because of paragraph 250-55(a) (tax preferred entity) but is not an *exempt foreign government agency;

o the asset is, or is to be, used wholly or principally outside Australia and an end user of the asset is a tax preferred end user because of paragraph 250-55(b) (foreign resident).

In applying subsection 250-60(2) of the ITAA 1997 to the Asset, it is necessary to determine if there is a 'tax preferred end user'. Paragraph 250-55(a) of the ITAA 1997 defines a 'tax preferred end user' as an end user who is a tax preferred entity. 'Tax preferred entity' is defined under section 995-1 of the ITAA 1997 as:

(a) an *exempt entity; or

(b) an *exempt Australian government agency; or

(c) an *associated government entity of an exempt Australian government agency; or

(d) a *prescribed excluded STB; or

(e) an *exempt foreign government agency.

The Entity (or any entities associated with them) is a tax preferred entity for the purposes of section 995-1 of the ITAA 1997.

The Entity is therefore a potential 'tax preferred end user' if it is an end user of the Asset.

The term 'end user' is defined in subsection 250-50 (1) of the ITAA 1997 as:

An entity (other than you) is an end user of an asset if the entity (or a *connected entity):

(f) uses, or effectively controls the use of, the asset; or

(g) will use, or effectively control the use of, the asset; or

(h) is able to use, or effectively control the use of, the asset; or

(i) will be able to use, or effectively control the use of, the asset.

Subsection 250-50(2) stipulates that control can be either direct or indirect.

Therefore in order for the Entity to be an 'end user' of the Asset it has to either 'use ' or 'control the use' of the Asset.

The term 'use' is not a defined term in Australian income tax legislation. The Explanatory Memorandum to the Tax Laws Amendment (2007 Measures No.5) Bill 2007 ('the EM') states at paragraph 1.29 states that 'Division 250 of the ITAA 1997 will apply to a taxpayer in respect of an asset, only if, in a practical sense, a tax preferred end user has, or will have, the control or use of the asset during the arrangement period'. This would suggest, (without going into a full discussion on case law with such cases as Tourapark Pty Ltd v FCT (1982) 149 CLR176, Hamilton Island Pty Ltd v FCT (1982) 13 ATR 220, and Air Liquide Australia Ltd v FCT (1997) 32 ATR 510 that the use required is more than mere incidental use and is a real and requisite direct use of the asset itself by the end user.

Under certain contractual terms, the Entity acquires certain financial derivatives of the Company and therefore does not 'use' the Asset as a result. The derivatives do not create any rights for the Entity over the Company's Asset and is merely an agreement for it to purchase the derivatives at a predetermined price.

The Entity will also be providing services to the Company under certain contractual terms on a fee-for-service basis. The methodology used to calculate the fee is common to those used in many service industries. The Entity is providing the services for the benefit of the Company. The Entity's fees are solely obtained by the services it provides and are not a percentage of the income generated by the Asset. In this context, therefore, the Entity is not considered to be 'using' the Asset.

This then leads us to consider if the Entity 'effectively controls' the Asset.

'Taxation Ruling TR 96/22: Income tax: section 51AD - deductions not allowable if an asset financed by non-recourse debt is used by a tax exempt or other entity (As at 2 September 1998)' and 'Taxation Ruling No. IT 2602: Income tax: privately owned power stations: control by state electricity authorities' set out the Commissioner's interpretation of the meaning of 'effective control' for the purposes of subsection 250-50(1) of the ITAA 1997.

Paragraphs 1.30 to 1.33 of the EM further expand on the meaning of control. Generally, in determining whether an entity effectively controls the use of an asset, it is necessary to examine the whole commercial arrangement, including the financial arrangements, surrounding the ownership and operation of the asset.

TR 96/22 discusses the elements considered relevant to determining who has control of the use of the property at paragraphs 40 to 47. At paragraph 40, TR 96/22 states that control of use can include actual use of the property or can mean exerting control over the way in which another person uses the property.

IT 2602 specifically considers the issue of control in the context of privately owned power stations, but sets out indicia of effective control by an exempt entity that have a broader application to other facilities and assets.

These elements include:

· Day to day operation;

· Financial arrangements; and

· Reversion of the property to the exempt entity.

Day to day operation

Paragraph 8 of IT 2602 states:

In the context of the day-to-day operation of a power station, this Office sees effective control as meaning that a person, organisation or authority either operates the station on a day-to-day basis through its employees or agents or has such an immediate supervisory role… that enables it to direct others in that day-to-day operation. The staffing arrangements will be important in this regard, particularly where the legal owner has no previous experience or expertise in the management and operation of a power station.

The Company employs a small number of staff members, each of whom is experienced in the management of the Asset. The General Manager is the ultimate decision maker for the Company and reports directly to the Board. The staff members are responsible for the daily operation of the Asset, including coordination and management of any contractors and the surrounding infrastructure. The staff members are full time employees of the Company and report directly to the General Manager. The staffing arrangements of Company are consistent with paragraphs 10 and 11 of IT 2602 in establishing that the Company effectively controls the operation of the Asset.

Service Agreement

The Company has contracted services to the Entity for efficiency reasons. The contractual terms provide that the Entity will perform these functions at the request or direction of the General Manager of the Company, and under instructions provided by the Company. There is an operational protocol in place that contains specific guidelines for various operational procedures. This Operational Protocol has been reviewed by other regulatory bodies.

The Entity does does not have day to day control over the Assets.

Financial Arrangements

For financial arrangements and control, the EM states at paragraph 1.32:

A second key factor that is relevant in determining the question is the financial arrangements relating to the acquisition of the asset, the output generated by the asset and the purchase of inputs needed to operate the asset. In this regard, particular arrangements that may be encountered that might suggest that a tax preferred entity, rather than the taxpayer, effectively controls the use of an asset include:

· fixed return charges whereby the tax preferred entity agrees to buy the output of the taxpayer's asset on a fixed return basis;

· fixed fee arrangements whereby the tax preferred entity agrees to pay a minimum or maximum regular fixed amount to the taxpayer regardless of the amount of output actually supplied;

· an agreement to transfer ownership of the asset to the tax preferred entity after a specified number of years, or an option for the tax preferred entity to acquire the asset at a future time; and

· contracts for the supply of inputs by the tax preferred entity to the taxpayer that do not reflect arm's length prices and a relatively long supply period.

The service payments under the contractual terms have been calculated on a fee-for-service basis. The Entity will not be assuming any cost risk in the provision of services and will recoup all of its costs from the Company. The fees are therefore not considered to be a financial arrangement under which the Entity, rather than the taxpayer, effectively controls the use of the Asset.

Two other financial arrangements are in place between the Entity and the Company.

The first is an agreement for certain financial derivatives. The agreement does not create any rights, other than those between an issuer and a holder, and therefore does not provide the Entity with 'effective control' over the Asset of the Company.

The second agreement contains all the terms and conditions for certain transactions negotiated between the Company and the Entity.

The second agreement has been entered into in order to manage price volatility.

The second agreement does not allow the Entity to exert financial control over the Company as the financial benefits to be provided are not fixed return charges nor fixed fee agreements, but are purely derivative products being used to manage financial risk.

Reversion of the property to the exempt entity

The Company owns the Asset. The contractual terms between the Company and the Entity do not indicate that the Asset will 'revert' to the Entity in the future.