Edited version of your written advice

Authorisation Number: 1012919380351

Date of advice: 7 December 2015

Ruling

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

Question 1

Will 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 Entity (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.

The Loan will have a Maturity Date which is less than 10 years.

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 those 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 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, and

• Selling, disposing of, or create an interest in its assets other than permitted disposals and permitted security interest.

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 subsection 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 provisions of 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 conditions 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 paragraph 820-39(3)(a) requirement 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

If the loans held in Entity D constitutes a debt interest for the purposes of the ITAA 1997, the paragraph 820-39(3)(b) requirement will be satisfied as the total value of the loans will be at least half the value of Entity D's assets.

Debt Interest

Subsection 995-1(1) of the states that:

debt interest in an entity has the meaning given by Subdivision 974-B.

Subsection 974-15(1) states:

A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity.

The relevant scheme for subsection 974-15(1) is each draw-down made pursuant to the Loan and not the Loan itself that is the debt interest: ATO Interpretive Decision ATO ID 2006/230.

Subsection 974-20(1) states:

A scheme satisfies the debt test in this subsection in relation to an entity if:

(a) the scheme is a financing arrangement for the entity; and

(b) the entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; and

(c) the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when:

(ii) the financial benefit referred to in paragraph (b) is received if there is only one; or

(ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and

(d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and

(e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil.

For a scheme to constitute a debt interest, each of the conjunctive requirements in paragraphs 974-20(1)(a)-(e) must be present.

Paragraph 974-20(1) (a): Financing arrangement

Entity D enters into each draw-down to the Loan mainly for the purpose of obtaining sufficient funds to purchase an asset. Therefore, each draw-down is a scheme that raises finance for Entity D.

Paragraph 974-20(1) (b): Receipt of financial benefits

A 'financial benefit' is defined in paragraph 974-160(1)(a) to mean '… anything of economic value …' even where obligations are imposed on the entity under the transaction under which the benefit is conferred on the entity.

Entity D will obtain funds by way of successive draw-downs. Each draw-down that Entity D makes will result in Entity D receiving a financial benefit for the purposes of paragraph 974-20(1)(b).

Paragraph 974-20(1) (c): Effectively non-contingent obligation to provide financial benefits to one or more entities

Entity D has obligations to repay the amounts advanced by the lenders as well as pay the interest for each applicable period. Therefore Entity D is under an effectively non-contingent obligation to provide financial benefits in respect of the loan to other entities in the form of repayments of principal and payments of interest for each period, as well as other amounts such as certain fees and charges.

Paragraph 974-20(1) (d): Substantially more likely the value provided will at least be equal to the value received

The paragraph 974-20(1)(d) requirement is to be satisfied in nominal terms if there is an effectively non-contingent obligation to repay all principal outstanding (as well as any Interest and fees such as the commitment fee) in 10 years or less; subparagraph 974-35(1)(a)(i).

Where greater than 10 years, the paragraph 974-20(1)(d) requirement is to be satisfied in present value terms pursuant to the formula set out in section 974-50; subparagraph 974-35(1)(a)(ii).

As the maturity date is less than 10 years the paragraph 974-20(1)(d) requirement is satisfied on nominal terms pursuant to subparagraph 974-35(1)(a)(i).

Paragraph 974-20(1) (e): The values provided and received are not both nil

Entity D will receive funds by way of successive draw-downs pursuant to the Loan, the value of which is not nil. Therefore Entity D will be required to provide financial benefits in the repayment of the loan which is also not nil.

The paragraph 974-20(1)(e) requirement that the value provided, and the value received, by Entity D are not both nil is satisfied.

As each of the requirements in paragraphs 974-20(1)(a)-(e) are met, the draw-downs will constitute debt interests for income tax purposes.

Paragraph 820-39(3)(b)Conclusion

This requirement is satisfied as the draw-downs will constitute debt interests and the value of Entity D's debt interests is at least 50% of Entity D's assets. Therefore Entity D will at all times be predominantly funded by debt.

Paragraph 820-39(3)(c) Entity D is 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.

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

The applicable criteria in Entity D's circumstances are Standard & Poor's (S&P) 'Structured Finance - Guide to Legal Issues in Rating Australian Securitization', originally published March 1, 2005 and reviewed on May 10, 2012 ('S&P Guide' or Criteria).

In the Criteria, S&P set out that each characteristic is 'important to the overall determination of an entity's insolvency remoteness'. The characteristics set out in the Criteria to assess insolvency remoteness are:

• contractual restrictions on activities

• debt limitations

• no reorganization, merger or change of ownership

• separateness covenants

• appropriateness of charges

• independence of directors, and

• tax neutrality and tax consolidation.

Under the Entity D Agreements, Entity D is restricted from engaging in any business other than that contemplated by the Entity D Agreements, being those that are necessary for it to participate in the Project.

The Entity D Agreements also requires that Borrower must not incur any other financial indebtedness. Further, Entity D must not waive or amend the Agreements in a manner that would affect the Lenders.

Under the Agreements, Entity D provides undertakings that will prevent it from reorganising, merging or having a change of ownership without the consent of the Lenders.

Entity D's Agreements also require that Entity D maintains its separate identity by entering into agreements in its own name, maintaining its existence, maintaining accounting records and observing all its obligations.

All of the assets of Entity D will be charged in favour of the Lenders under the Entity D Agreements.

Entity D's Constitution also requires that at least one independent director is appointed to the Board of Borrower.

Entity D will not have an obligation to pay tax over the term of the Project. Further Entity D will undertake not to join a tax consolidated group.

The Commissioner accepts that the 'characteristics' of bankruptcy remoteness in the S&P 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.