Edited version of private advice

Authorisation Number: 1012653893359

Ruling

Subject: Application of thin capitalisation exemption under subsection 820-39(3)

Question 1

Does Entity D meet the conditions in subsection 820-39(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Relevant facts and circumstances

Entity D was established as a Special Purpose Vehicle (SPE) in order to manage the risk of recovery of certain receivables that were either assumed or created by it. Entity D borrowed funds from Lenders pursuant to a Loan and used the funds to purchase the receivables from Entity F that are payable by Entity G as well as to make another loan.

Entity D was established solely for the purpose of purchasing the receivables and to facilitate the financing for a Project to be completed by Entity G.

The Loan is a debt interest for Australian income tax purposes. The value of the Loan is at least 50% of the receivables.

Entity D is restricted through various contractual requirements to activities necessary to perform the role of facilitating finance. Entity D may not engage in any business or activity other than that, which is necessary for, or incidental to, its role. Entity D is restricted from issuing other debt.

At least one Director appointed to the Board of Entity D will be an 'Independent Director

The Constitution of Entity D and the contractual requirements prohibit Entity D from:

• Merging or consolidating with another entity;

• Issuing any shares, units or grant any rights to acquire shares or units;

• Selling, disposing of an interest in its property other than that permitted within the transaction documents; and

• Amending its Constitution and the relevant transaction documents.

Entity D will ensure that it maintains its separateness from any other entity

Entity D will display sound Management by keeping proper books and records, conducting its business in Entity D's name only, carrying on and conducting its business in accordance with all applicable laws

Any recourse will be limited to the certain property specified in the finance documents and will be limited to transaction parties.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 820

Income Tax Assessment Act 1997 Section 820-39

Income Tax Assessment Act 1997 Sub section 820-39(3)

Income Tax Assessment Act 1997 Paragraph 820-39(3)(a)

Income Tax Assessment Act 1997 Paragraph 820-39(3)(b)

Income Tax Assessment Act 1997 Paragraph 820-39(3)(c)

Income Tax Assessment Act 1997 Subsection 974-15(1)

Income Tax Assessment Act 1997 Subsection 974-20(1)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Detailed Reasoning

The conditions in subsection 820-39(3) 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 the criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

Each of these must be met for the requirements of subsection 820-39(3) to be satisfied.

Paragraph 820-39(3)(a) Managing economic risk

The Commissioner accepts that in the circumstances of Entity D, the requirement of paragraph 820-39(3)(a) is met as Entity D was established for the purpose of managing some or all the risk associated with an asset that was either assumed or created by Entity D, being the recovery of the receivable payments. As part of the arrangement, Entity D will assume some or all of the economic risks associated with the underlying receivables since Entity D's return is contingent on the recoverability of the receivables. That is at least part of the credit risk of the receivables will pass from Entity F to Entity D.

Paragraph 820-39(3)(b) Value of debt interests

As set out in the Relevant facts and circumstances, the Loan is a debt interest for Australian income tax purposes. The value of the Loan is at least 50% of the receivables.

Entity D meets the paragraph 820-39(3)(b) requirement.

Paragraph 820-39(3)(c) Entity Dis an insolvency-remote special purpose entity

Whether Entity D will satisfy the criteria of an internationally recognised rating agency is a question of fact, which includes a consideration of criteria published by internationally recognised ratings agencies. Entity D was created to satisfy Standard & Poor's Criteria for Special-Purpose Entities in Project Finance Transactions, issued 20 November 2000 and revised 4 March 2011 (Criteria).

The requirement of meeting such Criteria can be met without a determination by a rating agency; subsection 820-39(4).

In the Criteria document, set out that a Special Purpose Entity (SPE) will achieve insolvency remoteness by adopting some form of the characteristics identified in the Criteria. Therefore, Entity D does not need to satisfy each criterion in in order to be assessed as insolvency remote. The characteristics set out in the Criteria to assess insolvency remoteness are:

• Restrictions on objects and powers;

• Debt Limitations;

• Independent director;

• No merger or reorganisation;

• Non-petition language in contracts to which the SPE is a party; and

• Separateness

The Constitution of Entity D provides that Entity D has the sole purpose of conducting the activities necessary to effect the transaction. The Constitution restricts Entity D from undertaking any activity other than the sole purpose.

Entity D is prohibited from incurring additional debt.

Entity D will have at least one Director appointed to the Board that is an Independent Director.

Entity D is prohibited from selling or otherwise disposing of any relevant property. Entity D is also prohibited from merging or consolidating with any other entity.

The Criteria set out that every agreement between the SPE and a creditor is required to include non-petition language pursuant to which the creditor will agree not to initiate insolvency proceedings against the SPE and not to join any such proceedings. Every agreement between Entity D and a creditor includes non-petition language in which the creditor agrees not to initiate insolvency proceedings against Entity D and not to join any such proceedings.

The Constitution of Entity D also contains 'separateness covenants' which are similar to those in the Criteria, that is: '… maintaining separate records, books, accounts, assets, financial statements, stationary, etc. as well as holding itself out to be a separate entity.'

The Commissioner accepts that in the circumstances of Entity D, the 'characteristics' of bankruptcy remoteness in the Criteria are satisfied, and therefore the requirements of paragraph 820-39(3)(c) will in turn be satisfied.

Conclusion

As each of the requirements set out in paragraphs 820-39(3)(a), (b) and (c) are present in the circumstances of Entity D, the conditions in subsection 820-39(3) are satisfied.