Edited version of your written advice

Authorisation Number: 1013059894815

Date of advice: 29 July 2016

Ruling

Subject: Thin Capitalisation - Securitised Licence Structure

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

Question 1

Will FinCo satisfy the insolvency-remote special purpose entity exemption in section 820-39?

Answer

Yes.

Question 2

Will the thin capitalisation rules in Division 820 apply to FinCo?

Answer

No.

This ruling applies for the following periods:

Year ending 31 March 2017

Year ending 31 March 2018

Year ending 31 March 2019

Year ending 31 March 2020

Year ending 31 March 2021

Year ending 31 March 2022

Year ending 31 March 2023

Year ending 31 March 2024

Year ending 31 March 2025

Year ending 31 March 2026

Year ending 31 March 2027

Year ending 31 March 2028

Year ending 31 March 2029

Year ending 31 March 2030

Year ending 31 March 2031

Year ending 31 March 2032

Year ending 31 March 2033

Year ending 31 March 2034

Year ending 31 March 2035

Year ending 31 March 2036

Year ending 31 March 2037

Year ending 31 March 2038

Year ending 31 March 2039

Year ending 31 March 2040

Year ending 31 March 2041

Year ending 31 March 2042

Year ending 31 March 2043

Year ending 31 March 2044

Year ending 31 March 2045

Year ending 31 March 2046

The scheme commences on:

The scheme has commenced

Relevant facts and circumstances

Transaction Overview

The large institution (Entity ABC) and Project Trust will enter into a 30 year agreement (Agreement), under which Project Trust will commit to pay an upfront payment, called the Upfront Concession Fee (UCF) and quarterly payments, called the Ongoing Concession Fees (OCFs) to Entity ABC. This will take place on Financial Close, and is solely in consideration for the right to the Monthly Net Revenue Amounts and other amounts to be provided by Entity ABC (Payments Swap).

The Agreement will also require Project Trust to deliver the Hard Facilities Management Services (Hard FM Services) in relation to the Infrastructure included in the Transaction and assuming Asset Risk for Hard Facilities Management Elements in consideration of payments (Hard FM Services Payments) (Hard FM Services arrangement).

Ownership structure

Holding Trust and Project Trust

Holding Trust is a unit trust established in an Australian state to act as the holding entity of Project Trust and its unit register will be kept in this Australian state.

Project Trust is a unit trust established in an Australian state and its unit register will be kept in this Australian state.

The trustees of Holding Trust and Project Trust are each companies incorporated in Australia.

Units in Project Trust are wholly owned by Holding Trust.

The terms of the trust deed for each of Holding Trust and Project Trust:

a. contain provisions which ensure their respective beneficiaries are presently entitled to all of the income of each trust as at the end of each income year;

b. contain provisions which restrict the transfer or registration of units in the trust where this would result in the trust becoming a "public unit trust" for the purposes of Division 6C of the Income Tax Assessment Act 1936 (ITAA 1936); and

c. have been drafted with the intention that Project Trust and Holding Trust will be fixed trusts for the purposes of section 272-65 in Schedule 2F to the ITAA 1936.

Charitable Trust, HoldCo and FinCo

A Charitable Trust has been established to act as the holding entity of HoldCo.

The beneficiaries of the Charitable Trust are charitable institutions in Australia.

HoldCo is a company incorporated in Australia for the sole purpose of acting as the holding entity of FinCo.

FinCo is a company incorporated in Australia for the sole purpose of raising senior debt from external financiers (Syndicated Facility), entering into the intercompany loan with Project Trust (Intercompany Loan), entering into related hedging arrangements and the agreement pursuant to which the Entity ABC will assign the right to receive the quarterly OCFs (Initial Receivables) to FinCo in exchange for the upfront Receivables Purchase Payment payable by FinCo (Receivables Purchase Agreement).

FinCo's and HoldCo's share capital comprise solely of ordinary shares that are wholly held by HoldCo and the trustee of the Charitable Trust respectively.

FinCo is contractually restricted by the transaction documents and/or its constituent documents to only undertake activities necessary for the above purpose.

A clause in FinCo's constitution provides that the board of FinCo must comprise of at least one independent non-executive director.

The directors of FinCo will at all times act independently of the Equity Investors, and pursuant to the FinCo constitution, questions arising at a meeting of directors are to be decided by a unanimous decision of the directors present and voting. Pursuant to the FinCo constitution, notwithstanding the initial directors of the company are the persons who have consented to act as directors, the company may by resolution passed in general meeting, remove any director and appoint another person in the director's place.

Funding

Prior to Financial Close, Holding Trust will call for committed equity from the Equity Investors pursuant to an equity subscription agreement (Shareholders and Unitholders Deed).

The Equity Investors will subscribe for all the units in Holding Trust pursuant to the Shareholders and Unitholders Deed.

Holding Trust will raise debt from Equity Investors (Unitholder Loan).

The Syndicated Facility, Unitholder Loan and Intercompany Loan will, at all times be debt interests for Australian income tax purposes and satisfy the definition of a debt interest as defined in subsection 974-15(1) .

The value of the Syndicated Facility will at all times be at least 50% of FinCo's assets.

The Syndicated Facility obtained by FinCo will bear interest at a variable rate.

The Intercompany Loan will represent a cash advance facility (herein referred to as the On-Loan) provided by FinCo to Project Trust at Financial Close. The Intercompany Loan also allows for a cash advance facility provided by Project Trust to FinCo where FinCo has a cash shortfall, in order for it to meet its debt service obligations under the Syndicated Facility (Liquidity Loan). It is expected the On-Loan will remain in place for the majority of the Project term.

The interest rate on the Intercompany Loan will be equal to the rate applicable to the Syndicated Facility from time to time and is expected to remain in place for the majority of the Project term.

Interest Rate Hedging Arrangements

On Financial Close, FinCo will enter into the External Swap. Under the External Swap, FinCo will be required to make regular fixed-rate payments based on an amortising notional principal to the swap providers, as specified in a schedule of payments. In return, the swap providers will be required to pay swap payments to FinCo referenced to a floating rate basis for each settlement period. Only the net amount payable for each period will be paid or received by FinCo under the External Swap.

On Financial Close, FinCo and Project Trust will also enter into the Equalisation Swap, under which:

a. If the actual financing costs on the Syndicated Facility and the Intercompany Loan are greater than the modelled financing costs in the Financial Model, Project Trust is required to pay the difference to FinCo; and

b. If the actual financing costs on which interest on the Syndicated Facility and the Intercompany Loan are less than the modelled financing amounts in the Financial Model, FinCo is required to pay the difference to Project Trust.

Key Project terms bid

The term of the Project will be the period beginning from satisfaction or waiver of the final condition precedent under the Agreement (Financial Close) and ending on 31 December 2046, unless terminated earlier.

Financial Close is expected to occur on dd/mm/yyyy.

On or before Financial Close, the Entity ABC will enter into the Agreement and the Receivables Purchase Agreement with Project Trust and FinCo respectively.

The Hard FM Services Arrangement

Hard FM Services

Project Trust will be the entity with the primary obligation of carrying out the Hard FM Services under the Agreement.

A KPI regime will apply to the performance of the Hard FM Services under the Agreement. If Project Trust fails to comply with those KPIs within agreed periods of time, the Entity ABC may notify Project Trust and require rectification. If Project Trust fails to rectify the non-compliance, pursuant to the Agreement, then Entity ABC may retain amounts worked out in accordance with the Agreement from the Hard FM Services Payments (Hard FM Retention Amounts). In the unlikely event that the Hard FM Retention Amounts exceed the amount of the monthly Hard FM Services Payments then Entity ABC would be able to retain the excess amount from other payments due and payable by it under the Transaction Documents.

The Hard FM Retention Amounts will be paid to Project Trust once it is again complying with the relevant KPI.

Step in Rights

In addition to the KPI regime and pursuant to the Agreement, Entity ABC will have step-in rights (Step-in Rights) if a Step in Event occurs. Which are broadly public safety incidents.

Compensation Events

Pursuant the Agreement, Project Trust will be entitled to apply for relief from its obligations and/or claim compensation to the extent that of an amount associated with that event (Compensation Event):

(a) affects the ability of the Transaction Company to comply with any of its obligations under a Transaction Document, including its ability to perform the Hard FM Services in accordance with the Hard FM Services Specification; and/or

(b) causes the Transaction Company to incur additional or increased costs or causes the Transaction Company to lose revenue in respect of the Transaction,

Asset Risk for Hard FM Elements

Pursuant to the Agreement, Project Trust acknowledges and agrees that it is wholly and solely responsible for all liability, loss and claims arising out of or in connection with all Asset Risk, however such Asset Risk arises or is caused from time to time during the term of the Project.

Project Trust may obtain insurance against certain insurable risks assumed or pass those risks to the Hard FM Service subcontractor under the subcontract (Hard FM Services Subcontract). Any other assumed risks will remain with Project Trust.

In this regard, we understand that Project Trust will engage an independent third party services contractor under the Hard FM Services Subcontract.

Hard FM Services Payments

As a scheduled payment the amount of the Hard FM Services Payments set out in the Financial Model Outputs Schedule will not be contingent upon the amount of funds received by the Entity ABC, the Monthly Net Revenue Amounts nor the Consortium Fees and Participation Fee Amounts.

Hard FM Sinking Fund

Project Trust will be required to maintain a Hard FM sinking fund account (Hard FM Sinking Fund Account).

The funds in the Hard FM Sinking Fund Account must be used for the purpose of undertaking certain lifecycle works forming part of the Hard FM Services in respect of the Infrastructure in accordance with an agreed lifecycle and maintenance plan.

Relevantly, the Agreement provides that, to the extent that there are any excess funds in the Hard FM Sinking Fund Account as against the balance that is required to be maintained at such time, such funds may be withdrawn by Project Trust from the Hard FM Sinking Fund Account.

Access during Project Term

At all relevant times during the Project term, Entity ABC will remain the legal owner of the Infrastructure.

Project Trust will not get any proprietary interests in the Infrastructure through the payment of the Concession Fees. Consistent with standard Hard FM Services arrangements, access will be provided under a non-exclusive licence (Hard FM Licence).

Under the Agreement, Entity ABC will grant the Hard FM Licence to Project Trust to access the area to which Project Trust will require access in order to carry out the Hard FM Services (Licensed Area).

Third-Party Hard FM Subcontract

Project Trust will subcontract responsibility for the delivery of the Hard FM Services to a Third-Party under the Hard FM Services Subcontract. The terms of the Hard FM Services Subcontract will be on broadly back to back terms with Project Trust's rights and obligations under the Hard FM Services arrangement.

In particular, the scheduled Hard FM Services Payments to be received by Project Trust under the Agreement will be broadly back to back with the scheduled payments to Third-Party under the Hard FM Services Subcontract, except for a profit margin that is intended to cover the cost of insurances to be taken out by Project Trust to cover risks that cannot be passed to the Third-Party under the Hard FM Services Subcontract.

Under the Agreement, Project Trust is liable to pay Entity ABC an amount of Liquidated Damages being an amount equivalent to the loss that Entity ABC in respect of the Infrastructure being unavailable.

Payments Swap

Concession Fees

Under the Agreement, Project Trust will pay the UCF and OCFs (Concession Fees) to Entity ABC solely in consideration of the Monthly Net Revenue Amounts and the Consortium and Participation Fee Amounts from Entity ABC. This will provide Entity ABC with a fixed, certain and assignable stream of payments that enhances the commercial ability of Entity ABC to effectively securitise its future cash flow by way of the Receivables Purchase Agreement.

Monthly Net Revenue Amounts

The Monthly Net Revenue Amount will comprise a monthly payment in arrears being an amount calculated in accordance with the Agreement.

For completeness, the Consortium and Participation Fee Amounts are amounts separate from the Monthly Net Revenue Amounts. The Consortium and Participation Fee Amounts will be paid to Project Trust on an annual basis.

In addition, Entity ABC must, in the case of decreased revenue being incurred or likely to be incurred by the Project Trust as a result of a Compensation Event, pay the Estimated Cost Effect in accordance with the Agreement via an adjustment to the Monthly Net Revenue Amounts.

Retention and Set off of Amounts

Under the Agreement, Entity ABC has a general right to retain and offset amounts due and payable under any Transaction Document. Also under that clause the amount of any liquidated damages payable or receivable by Project Trust and Entity ABC must be set off.

Under the Agreement it is intended that negative Monthly Net Revenue Amounts must be offset against the monthly Hard FM Services Payments (to the extent there is a monthly Hard FM Services Payment which exceeds the Hard FM Retention Amount for that period).

Receivables Purchase Agreement

FinCo will enter into the Receivable Purchase Agreement and pay an upfront Receivables Purchase Payment to Entity ABC in consideration for the Initial Receivables.

A Payment Directions Deed will be entered into between Entity ABC, FinCo and Project Trust. Under the Payment Direction Deed, the Entity ABC will direct the OCFs payable by Project Trust to Entity ABC to be paid directly to FinCo.

FinCo will apply the OCFs towards repayment of principal and payment of interest on the Syndicated Facility. OCFs (in excess of the amount required to repay principal and interest on the Syndicated Facility) will be lent to Project Trust under the Intercompany Loan.

Termination of the Project

The Agreement provide for termination of the agreement after Financial Close in certain circumstances (Termination Event).

Entity ABC is required to make a payment as specified under the Agreement, the amount of which will vary depending on the applicable Termination Event.

In each case, the component of the payment made by Entity ABC to FinCo and Project Trust in respect of a Termination Event will be a full or partial refund of the Receivables Purchase Payment (Receivables Refund Payment) and UCF (Termination Payment) respectively.

Other Information

The presence of independent directors (or equivalent anti-filing mechanism)

FinCo's constitution provides that the board of FinCo must comprise of at least one independent non-executive director.

FinCo will be owned by HoldCo.

No cross-default provisions

The Syndicated Facility that FinCo owes to the external finance providers will be guaranteed by Project Trust. A default by Project Trust to pay the OCFs is likely to result in a default under the finance documents in relation to the Syndicated Facility, referred to as the Debt Terms Sheet (DTS), subject to materiality thresholds. The DTS include the following features to mitigate, against the risks this criteria seeks to address:

(i) A Transaction Party must not, without the Facility Agent's prior written consent… incur any Finance Debt (including giving a guarantee or Indemnity) other than Permitted Finance Debt; and

(ii) No Transaction Party will apply to the court for its winding up or similar order.

Relevantly, amongst others Transaction Party is defined in the DTS as including each of FinCo and Project Trust.

No ability to merge or reorganize

The DTS contains the following representations, warranties and undertakings:

(i) In respect of the Transaction Parties… it is a single purpose entity no other business.

(ii) Each Transaction Party will do all things necessary to maintain its corporate existence.

(iii) Each Transaction Party will not, except with the prior written consent of the Facility Agent, make or threaten to make any material change in the nature of its business as conducted at the date of this Term Sheet.

(iv) Each Transaction Party will not, except with the prior written consent of the Facility Agent, enter into any merger or consolidation with any other person.

(v) No Transaction Party will enter into any trust arrangements, partnerships or joint ventures:.

(vi) No Transaction Party will apply to the court for its winding up or similar order.

(vii) A Transaction Party must not, without the Facility Agent's prior written consent…dispose of any of its assets the subject of the Transaction or attempt or agree to do so except:

(i) in the ordinary course of its ordinary business and on arms' length terms; or

(ii) to another Obligor where the asset will be the subject of a Security after the disposal; or

(iii) where the value of the asset is less than an amount to be agreed, both on an individual basis and in aggregate); or

(iv) where such disposal is expressly permitted or required under the Agreement; or

(v) under a Permitted Security Interest,

provided that Project Co shall not dispose of or exclude Infrastructure from the Transaction without the prior written consent of the Agent (acting on the instructions of all the Financiers) unless such disposal is expressly permitted or required under the Agreement.

Limitations on amendments to organizational documents

The DTS contains the following undertaking:

(i) Each Transaction Party will not amend its constitution in any way without prior notice to the Facility Agent, and never in a way which does or could adversely affect the interests of the Finance Parties under the Finance Documents.

A project's separateness from its parent(s)

FinCo should be considered a separate legal entity from HoldCo and the Charitable Trust.

Security interests over the project's assets

The provisions in relation to security over the Transaction are outlined in the DTS.

The rights of the hedge counterparties under the External Swap to terminate will be restricted to limited circumstances as outlined in the DTS.

The existence of parent dependencies (certain contracts with parents and affiliates, taxes, insurances)

The DTS contains the following undertaking:

(i) Each Transaction Party will not, except with the prior written consent of the Facility Agent, enter into any material transaction with any person otherwise than on arms' length terms that would be reasonable in the circumstances if the parties were dealing at arms' length.

It is not intended that FinCo will become a member of any tax consolidated group.

Limitations on additional debt

The DTS contains the following undertaking:

(i) A Transaction Party must not, without the Facility Agent's prior written consent… incur any Finance Debt (including giving a guarantee or Indemnity) other than Permitted Finance Debt.

Limitations on additional security to third parties

The DTS contains the following undertaking:

(i) A Transaction Party must not, without the Facility Agent's prior written consent…create or permit to exist a Security Interest, other than a Permitted Security Interest, over any of the Secured Property or attempt or agree to do so (except where the creation of the Security Interest cannot by law be restricted).

Pursuant to the DTS, it will be an event of default if a Transaction Party creates any Security Interest (other than a Permitted Security Interest) over the Secured Property.

Limitations on asset sales

The DTS contain the following undertaking:

(i) A Transaction Party must not, without the Facility Agent's prior written consent…dispose of any of its assets the subject of the Transaction or attempt or agree to do so except:

(i) in the ordinary course of its ordinary business and on arms' length terms; or

(ii) to another Obligor where the asset will be the subject of a Security after the disposal; or

(iii) where the value of the asset is less than an amount to be agreed, both on an individual basis and in aggregate); or

(iv) where such disposal is expressly permitted or required under the Agreement; or

(v) under a Permitted Security Interest,

provided that Project Co shall not dispose of or exclude Infrastructure from the Transaction without the prior written consent of the Agent (acting on the instructions of all the Financiers) unless such disposal is expressly permitted or required under the Agreement.

Minimum insurance requirements

The DTS provides the insurance covenants requiring insurance to be maintained to the extent commercially available and for the benefit of the Project.

Cash flow protection and waterfall

A cash flow waterfall will apply prioritising project cash flows to pay operating expenses as a first priority. The cash flow waterfall requirements are detailed in the DTS.

Liquidity and reserves

The requirement for debt service or capital expenditure reserves will depend on S&P's analysis of cash flow and any potential interruptions, as well as other sources of funding available to pay maintenance and other capital expenditure costs.

Use of insurance proceeds

Insurance proceeds are to be applied in accordance with the DTS.

Distribution test

Distributions will be subject to the conditions set out in the DTS. Accordingly, distributions of equity will be subject to an appropriate test of financial performance as well as no default.

Relevant clauses in FinCo constitution and Debt Term Sheet

There are additional extracts of the clauses from both FinCo's constitution and the DTS, which have not been included in this Edited Version for reasons of anonymity.

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 820-39

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 820-39(4)

Income Tax Assessment Act 1997 - Division 974

Income Tax Assessment Act 1997 - Subdivision 974-B

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

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

Reasons for decision

Question 1

Overview of Division 820

Division 820 contains the thin capitalisation regime. It applies to certain entities to disallow financing expenses that an entity could otherwise deduct from its assessable income where the entity's debt exceeds the prescribed level.

However, section 820-39 exempts certain special purpose entities from the thin capitalisation rules. Subsection 820-39(1) provides that the exemption applies for an income year if the entity satisfies all of the following conditions contained in subsection 820-39(3):

(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 criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

Pursuant to subsection 820-39(4), the condition in paragraph 820-39(3)(c) can be met without a rating agency determining that the entity meets those criteria.

In considering whether the conditions are satisfied, the Explanatory Memorandum to Taxation Laws Amendment Bill (No. 5) 2003 (Explanatory Memorandum) provides the following:

1.8 The first condition is a purpose test that seeks to exclude entities that are not specifically established for what might be commonly referred to as securitisation or origination activity. It also seeks to exclude entities that undertake any activities not related to the process of securitisation or origination. The first condition seeks to cover items and risks that could be securitised or originated. For example, it covers a straightforward arrangement where assets are purchased by a special purpose entity. It also covers more complex arrangements, for example, where the risk associated with the assets is acquired by a special purpose entity but the underlying assets remain on the balance sheet of the originating entity.

1.9 The second condition recognises that while the overall objective of a securitisation or origination program is to fund the assets of the special purpose entity entirely through the issue of debt interests, there is the possibility that this may take some time to achieve or that there may be some residual equity holding in the vehicle or some other form of credit enhancement.

1.10 The third condition seeks to ensure that the special purpose vehicle meets or would meet an internationally recognised rating agency's requirements for an insolvency remote special purpose entity. A rating agency would attempt to ensure that the entity is unlikely to be subject to voluntary or involuntary insolvency proceedings. A rating agency may be satisfied where the entity can demonstrate that it:

• is restricted to activities necessary to its role in the transaction;

• is restricted from incurring additional indebtedness;

• cannot be subject to reorganisation, merger or change of ownership; and

• holds itself out to the world as a separate entity.

In Taxation Determination TD 2014/18 Income tax: can the exemption in section 820-39 of the Income Tax Assessment Act 1997 apply to the special purpose finance entity established as part of the 'securitised licence structure' used in some social infrastructure Public Private Partnerships? (TD 2014/18); the Commissioner accepts that the exemption from the thin capitalisation rules may apply to a special purpose finance entity established as part of the 'securitised licence structure' used in a social infrastructure Public Private Partnership, provided that the special purpose finance entity meets the conditions in subsection 820-39(3).

ATO Interpretative Decision ATO ID 2005/357 Thin capitalisation: exemption - special purpose entities; further supports the Commissioner's view that an entity that is solely established for the purpose of borrowing funds for use in a debt securitisation arrangement will not be subject to the thin capitalisation rules in Division 820.

Consideration is therefore required to be given to each of the conditions in subsection 820-39(3).

Application of Division 820 to the facts

The application of the insolvency-remote special purpose entity exemption in section 820-39 to FinCo's circumstances:

First condition - managing economic risk

To meet this condition, the entity needs to be one established for the purposes of managing some or all of the economic risk associated with assets, liabilities or investments.

As stated above, paragraph 1.8 of the Explanatory Memorandum considers the purpose of the first condition.

To ascertain the purpose for which a company is established, it is necessary to look not only to the circumstances existing at the time of its incorporation, but also the activities carried on by the company at the time its status is to be determined (TD 2014/18, paragraphs 12 and 14).

The Constitution of FinCo does not set out the purposes for which the company was incorporated. However, in FinCo's constitution, it states that FinCo will not 'engage in any business or activity other than that, which is necessary for, or incidental to, its role in connection with the Transaction'.

'Transaction' is defined in FinCo's constitution to mean 'the Infrastructure Project, among other documents, which are embodied in the Agreement.

FinCo is the Finance Company in the Agreement. It is also the 'borrower' under the DTS as a 'special purpose company to be incorporated by the Sponsor in the Australian state'.

Its sole purpose is in:

1. raising senior debt from external financiers (Syndicated Facility),

2. entering into intercompany loan with Project Trust (Intercompany Loan),

3. entering into related hedging arrangements & agreement pursuant to which Entity ABC will assign right to receive quarterly Ongoing Concession Fees (Initial Receivable) to FinCo in exchange for upfront Receivables Purchase Payment payable by FinCo (Receivables Purchase Agreement).

FinCo is engaged in origination activity by virtue of it entering into the Syndicated Facility in order to fund the Receivables Purchase Payment payable to Entity ABC on Financial Close, under the Receivables Purchase Payment. The hedging activity that will be undertaken by FinCo will be directly connected with these origination activities. Accordingly, FinCo will only undertake activities related to the process of origination.

The Commissioner, at paragraph 17 of TD 2014/18, states that an entity will satisfy paragraph 820-39(3)(a) if it is established for the main or dominant purpose 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 created the risk itself).

Having regard to these requirements, the main or dominant purpose for the establishment of FinCo will be to manage the risks associated with financing the Transaction:

(i) FinCo will be exposed to the economic risk that it will be unable to repay the Syndicated Facility provided by the external finance providers (being a risk that FinCo created itself by entering into the Syndicated Facility);

(ii) The Syndicated Facility obtained by FinCo will bear interest at a variable rate. OCFs (in excess of the amount required to repay principal and interest on the Syndicated Facility) will be lent to Project Trust under the Intercompany Loan. The interest rate on the Intercompany Loan will be equal to the rate applicable to the Syndicated Facility from time to time and is expected to remain in place for the majority of the Project term; and

(iii) FinCo will manage the economic risk associated with the repayment of the Syndicated Facility by entering into interest rate hedging arrangements (i.e. the External Swap and Equalisation Swap).

Hence, FinCo is established for the purposes of managing the economic risk associated with the Transaction and paragraph 820-39(3)(a) is satisfied.

Second condition - value of debt interests is at least 50% of the value of FinCo's assets

Meaning of debt interest

Division 974 outlines what factors are used to determine whether an interest in a company constitutes 'equity' or 'debt'.

Subdivision 974-B deals with debt interests. Subsection 974-15(1), in relation to the meaning of a debt interest, provides:

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.

Subsection 974-20(1) provides the requirements of the debt test as follows:

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:

(i) 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.

The Syndicated Facility will be a debt interest pursuant to Division 974 and the value of the Syndicated Facility will at all times be at least 50% of FinCo's assets, being the On-Loan and OCFs Receivable under the Receivables Purchase Payment.

Accordingly, paragraph 820-39(3)(b) is satisfied.

Third condition - insolvency-remote special purpose entity

Paragraph 820-39(3)(c) states:

The entity is an insolvency-remote special purpose entity according to criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

Whether FinCo 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 rating agencies.

A number of rating agencies have published criteria that set out the characteristics required to be classified as an 'insolvency remote' entity. The criteria that is sought to be applied must be appropriate to the entity's circumstances.

In the present context, the most appropriate criteria for FinCo is S&P's Project Finance: Project Finance Transaction Structure Methodology (Criteria), issued on 16 September 2014 and republished on 16 September 2015 following a periodic review. The Criteria consider the following as key factors in assessing an entity's insolvency remoteness:

(i) the extent to which a project's credit quality is linked to that of its parent(s); and

(ii) the extent to which a transaction structure protects credit quality.

Relevantly in the present case, characteristics to assess the extent to which a project's credit quality is linked to that of its parent(s) (Parent Linkage Analysis) are:

(a) the presence of independent directors (or equivalent anti-filing mechanism);

(b) no cross-default provisions;

(c) no ability to merge or reorganize;

(d) limitations on amendments to organizational documents;

(e) a project's separateness from its parent(s);

(f) security interests over the project's assets; and

(g) the existence of parent dependencies (certain contracts with parents and affiliates, taxes, insurances).

The extent to which a transaction structure protects credit quality is assessed through two main sets of covenants (Structural Protection Analysis):

(a) Limited purpose entity covenants, which typically must include:

(i) limitations on additional debt;

(ii) limitations on additional security to third parties;

(iii) limitations on asset sales; and

(iv) minimum insurance requirements; and

(b) Cash management covenants, which typically must include:

(i) cash flow protection and waterfall;

(ii) liquidity and reserves;

(iii) use of insurance proceeds; and

(iv) distribution tests.

The following considers each criterion in turn.

Parent Linkage Analysis

The presence of independent directors (or equivalent anti-filing mechanism)

FinCo's constitution provides that the board of FinCo must comprise of at least one independent non-executive director.

FinCo's constitution further provides that an independent non-executive director is one who:

1. is independent of management; and

2. is free of any business or other relationship that could materially interfere with, or could reasonably be perceived to materially interfere with, the independent exercise of their unfettered and independent judgment.

FinCo will be owned by HoldCo.

The presence of independent director in FinCo's governing board may help to reduce the likelihood that FinCo would initiate insolvency proceedings merely for the benefit of its parent.

No cross-default provisions

The Syndicated Facility that FinCo owes to the external finance providers will be guaranteed by Project Trust.

A default by Project Trust to pay the OCFs is likely to result in a default under the DTS, subject to materiality thresholds. The DTS includes the following features to mitigate against the risks this criteria seeks to address:

(i) A Transaction Party must not, without the Facility Agent's prior written consent… incur any Finance Debt (including giving a guarantee or Indemnity) other than Permitted Finance Debt; and

(ii) No Transaction Party will apply to the court for its winding up or similar order.

Relevantly, amongst others Transaction Party is defined in the DTS to be FinCo, Project Trust, HoldCo and Charitable Trust.

No ability to merge or reorganize

FinCo's constitution states that FinCo will not amalgamate, merge or consolidate with or into any other person.

Further, the DTS contains the following representations, warranties and undertakings:

(i) In respect of the Transaction Parties… it is a single purpose entity no other business.

(ii) Each Transaction Party will do all things necessary to maintain its corporate existence.

(iii) Each Transaction Party will not, except with the prior written consent of the Facility Agent, make or threaten to make any material change in the nature of its business as conducted at the date of this Term Sheet.

(iv) Each Transaction Party will not, except with the prior written consent of the Facility Agent, enter into any merger or consolidation with any other person.

(v) No Transaction Party will enter into any trust arrangements, partnerships or joint ventures.

(vi) No Transaction Party will apply to the court for its winding up or similar order.

(vii) A Transaction Party must not, without the Facility Agent's prior written consent…dispose of any of its assets the subject of the Transaction or attempt or agree to do so except:

(i) in the ordinary course of its ordinary business and on arms' length terms; or

(ii) to another Obligor where the asset will be the subject of a Security after the disposal; or

(iii) where the value of the asset is less than an amount to be agreed, both on an individual basis and in aggregate); or

(iv) where such disposal is expressly permitted or required under the Agreement; or

(v) under a Permitted Security Interest,

provided that Project Co shall not dispose of or exclude Infrastructure from the Transaction without the prior written consent of the Agent (acting on the instructions of all the Financiers) unless such disposal is expressly permitted or required under the Agreement.

Limitations on amendments to organizational documents

The DTS contains the following undertaking:

(i) Each Transaction Party will not amend its constitution in any way without prior notice to the Facility Agent, and never in a way which does or could adversely affect the interests of the Finance Parties under the Finance Documents.

A project's separateness from its parent(s)

FinCo should be considered a separate legal entity from HoldCo and the Charitable Trust. As stated above, FinCo's constitution does not allow FinCo to amalgamate, merge or consolidate with or into any other person.

Further, FinCo's constitution requires FinCo to remain an independent entity by:

• Maintaining books and records separate from any other person or entity;

• Maintains accounts separate from any other person or entity;

• Does not commingle its assets with those of any other person or entity;

• Conducts its business in its own name;

• Maintains separate financial statements; and

• Uses separate stationary, invoices, and cheques.

Security interests over the Project's assets

The provisions in relation to security over the Transaction are outlined in the DTS.

The rights of the hedge counterparties under the External Swap to terminate are set out in the DTS.

The existence of parent dependencies (certain contracts with parents and affiliates, taxes, insurances)

The DTS contains the following undertaking:

(i) Each Transaction Party will not, except with the prior written consent of the Facility Agent, enter into any material transaction with any person otherwise than on arms' length terms that would be reasonable in the circumstances if the parties were dealing at arms' length.

It is not intended that FinCo will become a member of any tax consolidated group.

Structural Protection Analysis

Limitations on additional debt

The DTS contains the following undertaking:

A Transaction Party must not, without the Facility Agent's prior written consent… incur any Finance Debt (including giving a guarantee or Indemnity) other than Permitted Finance Debt.

Limitations on additional security to third parties

The DTS contains the following undertaking:

A Transaction Party must not, without the Facility Agent's prior written consent…create or permit to exist a Security Interest, other than a Permitted Security Interest, over any of the Secured Property or attempt or agree to do so (except where the creation of the Security Interest cannot by law be restricted).

Pursuant to the DTS, it will be an event of default if a Transaction Party creates any Security Interest (other than a Permitted Security Interest) over the Secured Property.

Limitations on asset sales

The DTS contains the following undertaking:

(i) A Transaction Party must not, without the Facility Agent's prior written consent…dispose of any of its assets the subject of the Transaction or attempt or agree to do so except:

(i) in the ordinary course of its ordinary business and on arms' length terms; or

(ii) to another Obligor where the asset will be the subject of a Security after the disposal; or

(iii) where the value of the asset is less than an amount to be agreed, both on an individual basis and in aggregate); or

(iv) where such disposal is expressly permitted or required under the Agreement; or

(v) under a Permitted Security Interest,

provided that Project Co shall not dispose of or exclude Infrastructure from the Transaction without the prior written consent of the Agent (acting on the instructions of all the Financiers) unless such disposal is expressly permitted or required under the Agreement.

Minimum insurance requirements

The DTS provides the insurance covenants requiring insurance to be maintained to the extent commercially available and for the benefit of the project.

Cash flow protection and waterfall

A cash flow waterfall will apply prioritising project cash flows to pay operating expenses as a first priority. The cash flow waterfall requirements are detailed in the DTS.

Liquidity and reserves

The requirement for debt service or capital expenditure reserves will depend on S&P's analysis of cash flow and any potential interruptions, as well as other sources of funding available to pay maintenance and other capital expenditure costs.

Use of insurance proceeds

Insurance proceeds are to be applied in accordance with the DTS. Proceeds of each insurance claim (other than for a claim under worker's compensation, public liability or professional indemnity insurance) will be deposited into the Insurance Proceeds Account to be applied, except to the extent inconsistent with the terms of the Agreement, in a manner to be agreed.

Distribution test

Distributions will be subject to the conditions set out in the DTS. Distributions of equity will be subject to an appropriate test of financial performance as well as no default.

On balance, the 'characteristics' of insolvency remoteness as set out by an internationally recognised rating agency are satisfied, and therefore the requirements of paragraph 820-39(3)(c) is satisfied.

As the three conditions set out in subsection 820-39(3) are met, FinCo will be entitled to an exemption under section 820-30 from any debt deduction being disallowed under Division 820.

Answer 1

Yes.

Question 2

Having regard to the reasons for question 1, and the determination that FinCo satisfies the insolvency remote exemption section 820-39, it is unnecessary to consider the application of the thin capitalisation rules in Division 820, as FinCo will in any event be exempted from their application.

Answer 2

No.