Edited version of your private ruling

Authorisation Number: 1012519603011

Ruling

Subject: Lease

Question 1

Will the Lessee make a capital loss pursuant to section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) on assignment of the contractual rights to acquire the commercial equipment?

Answer

Yes.

Question 2

Should the Lessee include the Cash Payment in its assessable income under section 6-5 of the ITAA 1997 in the year the amount is derived?

Answer

Yes.

Question 3

Should the Lessee include the Cash Payment as capital proceeds from the assignment of the contractual rights to acquire the commercial equipment pursuant to section 116-20 of the ITAA 1997?

Answer

No.

Question 4

Will the Lessee be entitled to a deduction pursuant to section 240-50 of the ITAA 1997 for the 'notional interest' calculated under Subdivision 240-E of the ITAA 1997?

Answer

Yes.

Question 5

Will the Lessee be entitled to claim a deduction under section 40-25 of the ITAA 1997 for the decline in value of the commercial equipment?

Answer

Yes.

Question 6

Will the Lessee have an obligation to withhold an amount from the notional interest in respect to the lease rentals it pays to the Lessor under section 12-245 of Schedule 1 to the Taxation Administration Act 1953 (TAA )?

Answer

No.

Question 7

Will the Lessee have an obligation to withhold an amount from a royalty in respect to the lease rentals it pays to the Lessor under section 12-280 of Schedule 1 to the TAA ?

Answer

No.

This ruling applies for the following periods:

Income year ending 30 June 2014 until completion of the lease arrangement.

The scheme commences on:

Income year ending 30 June 2014.

Relevant facts and circumstances

1. Entity (the Lessee) has entered into an agreement with an unrelated entity, Vendor, to purchase commercial equipment.

2. The Lessee will assign the contractual rights to purchase the commercial equipment (the Rights) to an unrelated entity (the Lessor).

3. Under the assignment agreement, the Lessor is required to pay the full purchase price of the commercial equipment to the Vendor.

4. Pursuant to the purchase agreement, the Lessee is required to make prepayments. These prepayments will be refunded by the Vendor upon the Vendor's receipt of the full payment of the purchase price from the Lessor.

5. The Lessee will incur incidental costs associated with the assignment of the Rights. The Lessee will not receive any money or property in respect of the assignment of the Rights. The market value of the commercial equipment at the time of the assignment is the same as the purchase price of the Rights.

6. On delivery of the commercial equipment, the Vendor will provide a Cash Payment to the Lessee in respect of the Lessee's order of the commercial equipment. The Cash Payment does not relate to the assignment of the Rights.

7. The Lessor will finance the acquisition of the commercial equipment through a combination of debt finance and equity. The majority of the funding will be obtained through a traditional loan from the Lenders, who are a syndicate of banks (Loan). Under the Loan, the Lessor has an effectively non-contingent obligation to repay the debt with interest.

8. Once the Lessor has acquired the commercial equipment, it will lease the equipment to the Lessee (the Lease) under a Lease Agreement for the Lease term. The Lease Agreement is entered into on commercially agreed terms and negotiated on an arm's length basis.

9. The Lease Agreement contains an option for the Lessee to purchase the commercial equipment. The Lessee intends to exercise the option to purchase the commercial equipment. It is the common practice of the Lessee to exercise the purchase option under similar arrangements.

10. During the term of the Lease, the Lessee is required to make periodic rental payments in arrears to the Lessor. The sum of the total rental payments and amounts payable on exercise of the option to purchase the equipment (Option Amount) exceed the purchase price of the commercial equipment.

11. During the term of the Lease, the Lessee will have exclusive possession of the commercial equipment. Title to the commercial equipment will remain with the Lessor until the option to purchase is exercised by the Lessee.

12. The Lessee is a resident of Australia for income tax purposes. The Lessee will use the commercial equipment for the purpose of producing its assessable income.

13. There is and will not be any direct or indirect common ownership between the Lessor and Lessee. The Lessor, its associated companies or their directors, does not have any control of or ability to sufficiently influence the Lessee, and vice versa.

14. The Lessor and the Lessee both own shares in another company, Company A.

15. The Lessor is a company incorporated under the laws of a foreign country (the Foreign Country). The Lessor is a resident of, and liable to tax in, the Foreign Country.

16. The Lessor is a wholly owned subsidiary of a non-resident company. Its central management and control and voting power is exercised by non-residents who reside outside Australia.

17. The Lessor carries on business in the Foreign Country. The Lessor's business is limited to the Lease and other activities related to the Lease. The Lessor merely leases the commercial equipment and there is no active use of the commercial equipment.

18. For the purposes of the applicable tax treaty between Australia and the Foreign Country (the Convention):

· the Lessor is a financial institution;

· the Lessor beneficially owns the rental payments;

· the Lessor is unrelated to and dealing wholly independently with the Lessee;

· the rental payments paid by the Lessee to the Lessor are not paid as part of an arrangement involving back-to-back loans;

· The Lessor does not have a permanent establishment in Australia; and

· The Lessor is a qualified person.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 128AC

Income Tax Assessment Act 1936 subsection 128B(5A)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 Subdivision 240-E

Income Tax Assessment Act 1997 section 240-50

Income Tax Assessment Act 1997 section 995-1

Taxation Administration Act 1953 section 12-245 of Schedule 1

Taxation Administration Act 1953 section 12-280 of Schedule 1

Taxation Administration Act 1953 section 12-300 of Schedule 1

International Tax Agreements Act 1953 subsection 4(2)

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 on which the ruling is made, or to an associated or wider arrangement of which that arrangement is part.

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'.

Reasons for decision

Question 1

CGT event A1 in section 104-10 of the ITAA 1997 happens if a CGT asset is disposed of, that is, a change of ownership occurs from one entity to another entity. The assignment of the Rights by the Lessee to the Lessor constitutes a disposal of a CGT asset under section 104-10 of the ITAA 1997.

Subsection 108-5(1) of the ITAA 1997 provides that a CGT asset is any kind of property or a legal or equitable right that is not property. Pursuant to subsection 108-5(1) of the ITAA 1997, the Rights is a CGT asset for the purposes of Part 3-1 of the ITAA 1997.

The Lessee will make a capital loss in accordance with subsection 104-10(4) of the ITAA 1997 if the capital proceeds from the disposal of the Right are less than the reduced cost base of the Rights.

Reduced cost base of the Rights

In accordance with section 110-55 of the ITAA 1997, the reduced cost base of a CGT asset consists of five elements and all of the elements (except the third element) of the reduced cost base of the CGT asset are the same as those for the cost base.

Subsection 110-25(2) of the ITAA 1997 defines the first element of cost base and reduced cost base as the total of the money paid, or required to be paid, and the market value of property given, or required to be given, in respect of the acquisition of the asset.

Subsections 110-25(3) and 110-35(1) of the ITAA 1997 defines the second element of cost base and reduced cost base as the incidental costs incurred in acquiring the CGT asset or which relate to a CGT event that happens in relation to the CGT asset.

The prepayments paid by the Lessee to the vendor would, prima facie, be included in the first element of the cost base or reduced cost base of the Rights if they were not refunded to the Lessee by the Vendor.

Subsection 110-55(6) of the ITAA 1997 provides that expenditure does not form part of the reduced cost base to the extent of any amounts you have received as recoupment of it except where the recouped amounts are included in your assessable income.

The term 'recoupment' is defined in subsection 20-25(1) of the ITAA 1997 to include any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described. The prepayments to be refunded will not be included in the Lessee's assessable income. Pursuant to subsection 110-55(6), the prepayments do not form part of the reduced case base of the Rights. The market value substitution rule in section 110-20 of the ITAA 1997 does not apply in this case.

The Lessee will incur incidental costs associated with the assignment of the Rights. These incidental costs form part of the reduced cost base of the Rights pursuant to subsections 110-55(2) and 110-25(3) of the ITAA 1997.

Therefore, at the time of the disposal of the Rights, the reduced cost base of the Rights is equal to the incidental costs incurred by the Lessee.

Capital proceeds

Subsection 116-20(1) of the ITAA 1997 states the amount of the capital proceeds from a CGT event is the sum of the money received or receivable and the market value of any other property received or receivable in respect of the CGT event happening.

If an entity receives no capital proceeds from a CGT event, generally, in accordance with subsection 116-30(1) of the ITAA 1997, the entity is taken to have received the market value (worked out as at the time of the event) of the CGT asset that is the subject of the event.

Based on the facts, the more proper characterisation of the receipt of the refund of the prepayments is a recoupment of the acquisition costs, rather than capital proceeds from the disposal of the Rights. As such, the Lessee will be taken to have received the market value of the Rights in respect of the assignment of the Rights.

Consistent with Taxation Ruling TR 1999/19, it is considered that the market value of the Rights at the time of the CGT event is nil because the Lessor is required to pay the full purchase price of the commercial equipment under the assignment agreement.

As the Lessee will not receive any money or property from the assignment of the Rights and the market value of the Rights at the time of the CGT event happening is nil, the Lessee will make a capital loss to the extent of the reduced cost base of the Rights, being the amount of the incidental costs.

Question 2

It is considered that the Cash Payment will give rise to assessable income under section 6-5 of the ITAA 1997. Consequently, the Lessee is required to include this amount in its assessable income in the income year in which the amount is derived by the Lessee.

Question 3

Under subsection 116-20(1) of the ITAA 1997 the capital proceeds from a CGT event include the money you receive or are entitled to receive in respect of the event happening.

The Cash Payment is not consideration for the assignment of the Rights and accordingly, should not be included as capital proceeds from the assignment of the Rights.

Question 4

Division 240 of the ITAA 1997 applies to hire purchase agreements (as defined in subsection 995-1(1) of the ITAA 1997). The broad scheme of the Division is to treat such hire purchase agreements 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.

Among other things, the Division treats the notional buyer as the owner of the goods for certain purposes and treats as interest the payments made by the notional buyer (including amounts payable on termination of the arrangement) to the extent they exceed the notional loan principal.

The term 'hire purchase agreement' is defined in subsection 995-1(1) of the ITAA 1997 to relevantly mean:

(a) a contract for the hire of goods where:

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

(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 goods; and

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

(a) …

On the facts, the Lease Agreement between the Lessor and Lessee is a hire purchase agreement as defined in subsection 995-1(1) of the ITAA 1997 for the purposes of Division 240 of the ITAA 1997. Accordingly, the Lease will be treated as a notional sale of commercial equipment to the Lessee (notional buyer under subsection 240-17(2) of the ITAA 1997) with a notional loan from the Lessor (notional seller under subsection 240-17(1) of the ITAA 1997) to the Lessee.

Section 240-50 of the ITAA 1997 provides that a notional buyer is entitled to periodic deductions for notional interest on the notional loan taken to have been made to the notional buyer under the arrangement. However, subsection 240-50(1) of the ITAA 1997 limits the extent to which a notional buyer can deduct notional interest for an income year. Subsection 240-50(1) of the ITAA 1997 provides that a notional buyer is only entitled to deduct notional interest (as calculated under section 240-60 of the ITAA 1997) for an income year to the extent that the notional buyer would, apart from Division 240 of the ITAA 1997, have been entitled to deduct arrangement payments for that income year if no part of those payments were capital in nature.

An arrangement payment is defined in section 240-65 of the ITAA 1997 to be an amount that the notional buyer is required to pay under the arrangement but does not include:

· a penalty payable for failure to pay on time; or

· a termination amount.

On the facts, the Lessee would, apart from Division 240 of the ITAA 1997, have been entitled to deduct arrangement payments if no part of those payments were capital in nature. Accordingly, the Lessee, as the notional buyer under the hire purchase agreement to which Division 240 applies, will be entitled to a deduction pursuant to section 240-50 of the ITAA 1997 for the notional interest, calculated in accordance with section 240-60 of the ITAA 1997.

Question 5

Broadly, section 40-25 of the ITAA 1997 provides a deduction for the decline in value of a depreciating asset a taxpayer holds to the extent the asset is used for a taxable purpose.

On the facts, the commercial equipment is a depreciating asset (as defined in subsection 40-30(1) of the ITAA 1997) and will be used for a taxable purpose.

The table in section 40-40 of the ITAA 1997 identifies who holds a depreciating asset in any particular circumstance. Item 10 of the table in section 40-40 of the ITAA 1997 (which applies as a default rule) provides that a taxpayer holds a depreciating asset if they are the owner of the asset, or the legal owner, if there is both a legal and equitable owner.

However, there are other items in the table that identify a holder in various other circumstances even though they are not the asset's owner. One of these circumstances is contained in item 6 of the table in section 40-40 (item 6). Broadly, item 6 applies where:

· a taxpayer has possession, or an immediate right to possession, of the asset combined with a right, the exercise of which would make it the holder (e.g. an option to acquire); and

· it is 'reasonable to expect' that the taxpayer will become the holder by exercising that right or that the asset will be disposed of at their direction and for their benefit.

As determined in Question 4 (above), the Lease Agreement between the Lessor and the Lessee is a hire purchase agreement to which Division 240 of the ITAA 1997 applies and the Lessor will be the notional seller and the Lessee will be the notional buyer.

Taxation Ruling TR 2005/20 (TR 2005/20) sets out the Commissioner's view as to when a taxpayer who is taken to own goods under Division 240 of the ITAA 1997 will be taken to 'hold' a depreciating asset for the purpose of Division 40 of the ITAA 1997.

Paragraphs 6 and 7 of TR 2005/20 states that the notional buyer who is taken to be the owner of goods under subsection 240-20(2) of the ITAA 1997 will not be the holder of the goods for the purposes of Division 40 of the ITAA 1997, unless it is reasonable to conclude that the notional buyer will acquire the asset, or that the asset will be disposed of at the direction, and for the benefit of, the notional buyer. Where this requirement is satisfied, the notional buyer will be the holder of the asset under section 40-40 of the ITAA 1997.

Based on the facts and in accordance with TR 2005/20, the Lessee will hold the commercial equipment under either item 6 or item 10 of the table in section 40-40 of the ITAA 1997.

As the Lessee holds the commercial equipment, which is a depreciating asset, and uses the commercial equipment for a taxable purpose, the Lessee can deduct an amount equal to the decline in value of the commercial equipment under section 40-25 of the ITAA 1997.

Question 6

Section 12-245 of Schedule 1 to the TAA imposes an obligation to withhold tax on interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)) that an entity pays to a recipient who has an address outside Australia. However, section 12-300 of Schedule 1 to the TAA provides that an entity is not required to withhold an amount if no withholding tax is payable in respect of the interest.

Taxation Ruling TR 98/21 (TR 98/21) states at paragraph 7 that where it is clear from the outset that the purchase or repurchase of the equipment is paramount, payments made under a cross border equipment leasing transaction are not subject to equipment royalty withholding tax under subsection 128B(5A) of the ITAA 1936.

Further, where instalment payments under a hire-purchase agreement contain an implicit interest component, that interest component is subject to interest withholding tax in accordance with section 128AC of the ITAA 1997.

Under section 128AC of the ITAA 1936, interest withholding tax is payable on the interest component calculated according to the requirements of the section, paid by a resident to a non-resident entity pursuant to a relevant agreement. The definition of relevant agreement includes a hire-purchase agreement and certain leases.

Hire-purchase agreement for the purposes of section 128AC of the ITAA 1936 is undefined even though it is a defined term in subsection 995-1(1) of the ITAA 1997, in accordance with subsection 995-1(2) of the ITAA 1997. Paragraph 72 of TR 98/21 provides guidance as to the definition of hire-purchase agreement for the purposes of section 128AC of the ITAA 1936. It states that a hire-purchase agreement has two basic ingredients; the paramount purpose of purchasing, and, the financing element of hire-purchase (purchasing by deferred payments).

Having regard to the facts and the ten factors listed in TR 98/21, it is considered that the paramount purpose of the Lease is the purchase of the commercial equipment by the Lessee and the Lease has a financing element. Thus, the interest component of the hire-purchase agreement is prima facie subject to interest withholding tax.

In determining liability to Australian tax on income from Australian sources derived by a non-resident, it is necessary to also consider the applicable tax treaty or other agreement defined in sections 3AAA or 3AAB of the International Tax Agreements Act 1953 (Agreements Act). Pursuant to subsection 4(2) of the Agreements Act, where inconsistency exists the provisions of the Agreements Act override the provisions contained in the ITAA 1936 and ITAA 1997 (other than Part IVA of the ITAA 1936).

The Lessor, a resident of Foreign Country, will receive periodic lease rentals from the Lessee, an Australian resident. Part of the lease rentals will be deemed to be income that consists of interest pursuant to section 128AC of the ITAA 1936. The implicit interest component of the lease rental payments, which is beneficially owned by the Lessor, is interest for the purpose of the Interest Article of the Convention.

Under the Interest Article of the Convention, Australia has a taxing right in respect of interest payments arising in Australia which the non-resident beneficially owns. However, such interest payments will not be taxed in Australia if:

· the non-resident is a financial institution as defined in the Interest Article;

· the non-resident is unrelated to and dealing wholly independently with the interest payer;

· the interest arising in Australia is not paid as part of an arrangement involving 'back to back' loans or other arrangement to that effect;

· the interest is not effectively connected with a permanent establishment in Australia of the non-resident; and

· the non-resident is a qualified person as defined; or

· the non-resident is carrying on a business in the Foreign Country and the interest derived in Australia is derived in connection with, or is incidental to, that business.

Taxation Ruling TR 2005/5 provides guidance on the interpretation of these conditions.

On the facts, the Lessor satisfies all of the above requirements. Therefore, the Lessor will not be liable to interest withholding tax in respect of the interest component of the rental payments. Accordingly, the Lessee will not be required to withhold an amount from the rental payments under section 12-245 of Schedule 1 to the TAA , pursuant to section 12-300 of Schedule 1 to the TAA .

Question 7

Section 12-280 of Schedule 1 to the TAA requires an entity to withhold an amount from a royalty it pays to a non-resident. In accordance with section 12-300 of Schedule 1 to the TAA , no withholding is required from a royalty payment where no withholding tax is payable pursuant to Division 11A of Part III of the ITAA 1936.

A 'royalty' is defined in subsection 6(1) of the ITAA 1936 to relevantly include any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for the use of, or right to use, any industrial, commercial or scientific equipment.

Subsections 128B(2B) and 128B(5A) of the ITAA 1936 impose a withholding tax liability on a non-resident who derives royalty income which is paid by a person who is a resident of Australia.

Taxation Ruling TR 98/21 sets out the Commissioner's view on the withholding tax issues that arise in cross border leasing arrangements in respect of payments made by an Australian resident to a non-resident lessor. Paragraph 7 of TR 98/21 states:

Where it is clear from the outset that the purchase or repurchase of the equipment is paramount, payments made under a cross border equipment leasing transaction are not subject to equipment royalty withholding tax under subsection 128B(5A) of the Act. …

It has been established in Question 6 that the paramount purpose of the Lease is the purchase of commercial equipment by the Lessee. Therefore, the rental payments made under the Lease Agreement will not be subject to royalty withholding tax under subsection 128B(5A) of the ITAA 1936. Consequently, the Lessee will not be required to withhold an amount from the lease rentals payable to the Lessor under section 12-280 of Schedule 1 to the TAA , pursuant to section 12-300 of Schedule 1 to the TAA .