Edited version of private advice

Authorisation Number: 1052362558690

Date of advice: 21 February 2025

Ruling

Subject:Power purchase agreement

Question

Does the Power Purchase Agreement satisfy the definition of 'financial arrangement' pursuant to section 230-45 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

1 July 20XX - 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Seller is an Australian XXXX company, whose principal activity is generating renewable electricity and the creation of Large-Scale Generation Certificates (LGCs) in Australia.

The Seller has entered into a long-term Power Purchase Agreement (PPA) with the Buyer to fix the electricity price for a period of time.

Power Purchase Agreements

A PPA is an agreement between an independent power generator (or vendor) and a purchaser for the sale and supply of energy. They can be used for the supply of any type of energy, however are often used for the supply of renewable energy. Corporates typically enter PPAs with generators to obtain LGCs which they may use to offset emissions associated with their power consumption, to assist it meet their sustainability targets.

In a virtual PPA, the energy is not physically supplied and sold directly from the generator to the purchaser. Instead, the generator supplies energy to the National Energy Market (NEM) in exchange for a fluctuating payment (known as the spot price). The purchaser enters a separate agreement with an energy retailer to supply their energy needs at an arm's length price. At the same time a separate agreement (the PPA) often taking the form of a 'contract-for-differences', is agreed between the generator and the purchaser to guard against fluctuations in the spot price for electricity which will be reflected in the retail contract. This means that, in effect, energy and relevant renewable energy certificates are provided to the purchaser at a 'fixed price'.

A PPA allows the purchaser to lock in a price for electricity over an extended period, benefiting from not being subject to wholesale energy market price fluctuations. However, it can also lock the purchaser into a higher price than it would otherwise pay.

Large-Scale Generation Certificates

LGCs are issued under the Renewable Energy (Electricity) Act 2000 to encourage electricity generation from renewable sources and reduce greenhouse gas emissions. LGCs are created and issued through the Renewable Energy Certificate Registry (REC Registry), which is an online trading platform managed by the Clean Energy Regulator (CER).

The PPA the subject of the Private Ruling

In 20XX, the Buyer and the Seller executed the PPA. Broadly:

•                     The Seller will own and operate the renewable energy generator for the purposes of generating electricity and creating Green Products, and

•                     The Seller will sell and the Buyer will buy a percentage of Green Products and enter into power purchase arrangements for a percentage of electricity generated from the Project.

'Green Products' includes RECs, GPRs and other rights, entitlements, credits, offsets, allowances, benefits or certificates of any kind, whether present or future and whether tradeable or otherwise can be created or obtained in connection with the Project.

Under the PPA, the Seller agrees to sell and the Buyer agrees to buy the Buyer's Percentage of all the Green Products capable of being created by the Project; and the Buyer and the Seller agree to pay the net monthly amounts.

The net monthly amounts are determined by a formula based on, amongst other things, the spot price as defined in the NEM Rules, and the fixed MWh price set out for each calendar year under the PPA. While this price difference is calculated every five minutes during each day, the net settlement is calculated at the end of each month. Broadly, if the spot price is less than the price agreed under the PPA each month, then an amount is payable by the Buyer to the Seller, being an amount equal to the difference. If the spot price is more than the price agreed under the PPA for the month, an amount is payable by the Seller to the Buyer. The difference between the spot price and the agreed price is the net monthly amounts.

The PPA provides:

•                     that the Seller must create and register all Green Products that can be created in respect of the project during each month, and transfer title of the relevant amount to the Buyer within XX days;

•                     if at any time the Seller or the Buyer become entitled to, or is eligible to create, registers or otherwise receives Green Products (other than RECs or GPRs), the Buyer is entitled to the agreed percentage of those additional Green Products in consideration for the payment of the agreed price;

Under the PPA, it is expected that the Seller would be able to transfer to the Buyer a yearly minimum of XX LGCs when the Buyer's Percentage is set at XX%.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 230-45

Income Tax Assessment Act 1997 subsection 230-45(1)

Income Tax Assessment Act 1997 subsection 230-45(2)

Income Tax Assessment Act 1997 subsection 230-45(3)

Income Tax Assessment Act 1997 subsection 230-45(4)

Income Tax Assessment Act 1997 subsection 230-50

Income Tax Assessment Act 1997 subsection 230-55

Income Tax Assessment Act 1997 subsection 230-55(2)

Income Tax Assessment Act 1997 subsection 230-55(4)

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 section 974-160

Reasons for decision

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

Application of Division 230

1)  Division 230 provides a regime for calculating the gains and losses arising on financial arrangements and for determining when these gains and losses should be brought to account. For Division 230 to apply to the PPA, it must meet the definition of 'financial arrangement'.

2)  'Financial arrangement' is defined in subsection 995-1(1) as having the meaning given by sections 230-45 to 230-55. Section 230-45 and subsection 230-50(2) provide tests which determine whether you have a 'financial arrangement', however those tests apply on the basis of whether you have a specified kind of right and/or obligation under an 'arrangement,' where the 'arrangement' is determined pursuant to subsection 230-55(4). Accordingly, it is necessary to determine what constitutes the 'arrangement' before analysing whether that arrangement is a 'financial arrangement' under sections 230-45 and 230-50.

What is the arrangement? Subsection 230-55(4)

3)  The word 'arrangement' is defined in subsection 955-1(1) as:

any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

4)  Subsection 230-55(4) provides that whether a number of rights and /or obligations are themselves an arrangement or are two or more separate arrangements is a question of fact and degree to be determined having regard to the following:

(a)          the nature of the rights and/or obligations;

(b)          their terms and conditions (including those relating to any payment or other consideration for them);

(c)          the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved);

(d)          whether they can be dealt with separately or must be dealt with together;

(e)          normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole);

(f)          the objects of this Division.

In applying this subsection, have regard to the matters referred to in paragraphs (a) to (f) both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other.

Example 1:

Your rights and obligations under a typical convertible note, including the right to convert the note into a share or shares, would constitute one arrangement.

Example 2:

Your rights and obligations under a typical price-linked or index-linked bond would constitute one arrangement.

5)  Relevant guidance on how to apply subsection 230-55(4) is available in Taxation Ruling 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 of the ITAA 1997 (TR 2012/4). Paragraph 13 states that regard must be had to all of the matters referred to in paragraphs (a) to (f), although in a particular case, it may be that one matter is more influential than others.

The six matters in paragraphs 230-55(4)(a) to (f)

6)  Broadly, the Seller will operate the renewable energy generator, generate electricity and provide it to the national grid, for which it will receive the spot price from the market operator and an allocation of LGCs commensurate to the amount of electricity generated.

7)  The Seller and the Buyer have executed a PPA governing a bundle of rights and obligations between them.

Paragraph 230-55(4)(a)

8)  The nature or substance of the rights and/or obligations under the PPA can be summarised as follows;

•                     The Seller has an obligation to supply electricity to the grid;

•                     The Seller has the obligation to pay the net monthly amount to the Buyer if the spot price is more than the fixed price;

•                     The Seller has the right to receive the net monthly amount from Buyer if the spot price is less than the fixed price;

•                     The Buyer has the obligation to pay the net monthly amount to the Seller if the spot price is less than the fixed price;

•                     The Buyer has the right to receive the net monthly amount from the Seller if the spot price is more than the fixed price;

•                     The Buyer has the right to receive LGCs from the Seller; and

•                     The Seller has the obligation to provide LGCs to the Buyer.

9)  Paragraph 155 of TR 2012/4 provides that where a number of rights and/or obligations arise from the same contract, it would typically be the case that considering the rights and/or obligations in combination would tend to suggest that there is one arrangement (although not necessarily so).

10)  The above rights and obligations arise under a single contract between the Buyer and the Seller, except for the obligation to supply electricity to the national grid. Although that obligation enables the other obligations and rights under the PPA to occur, providing electricity to the grid falls under a separate contract between the Seller and a third party.

11)  In considering the nature and substance of the rights and obligations under the PPA, the Buyer's stated reasoning for entering the PPA, the fact that the rights and obligations arise under one contract, and the way the PPA has been negotiated, suggests that the right to receive the LGCs is intrinsically linked to the other rights and obligations under the PPA.

12)  This factor tends towards aggregation.

Paragraph 230-55(4)(b)

13)  The consideration required by paragraph 230-55(4)(b) includes the terms and conditions in which the rights and obligations are expressed, including those relating to payment. Paragraph 16 of TR 2012/4 provides that where one amount is calculated and paid as consideration for a number of rights, it will tend to suggest aggregation of such rights.

14)  Under the PPA, the consideration provided for the obligations and rights under the PPA is combined. As the price negotiated for all rights and obligations under the PPA is calculated as one amount, this factor tends towards aggregation.

Paragraph 230-55(4)(c)

15)  The consideration required by paragraph 230-55(4)(c) includes the circumstances surrounding the creation of the rights and obligations under the PPA, and their proposed exercise (including what can reasonably be seen as the purposes of one or more of the entities involved). Paragraph 169 of TR 2012/4 provides that regard should be had to matters beyond, for example, the boundaries of the contract itself. In this regard the high importance placed on the LGCs generated through this program, as opposed to signing a contract solely to lock in future electricity prices evidences that this factor tends towards aggregation.

Paragraph 230-55(4)(d)

16)  Paragraph 230-55(4)(d) requires an assessment of whether the rights/obligations can be dealt with separately or must be dealt with together. Paragraph 174 of TR 2012/4 provides that where rights and/or obligations can be dealt with separately, but there are contractual rights that practically inhibit such separate dealing, it will tend to suggest aggregation.

17)  The PPA has been constructed such that the rights and obligations must be dealt with together - it is not possible to excise one of the rights/obligations and deal with it outside of the PPA, as the monthly consideration is for a bundle of rights/obligations. Further, the terms of the PPA provide that the Seller cannot dispose of its interests in the generator unless it also disposes of its rights, title and obligations under the PPA to that same entity, ensuring practically that the rights and obligations will continue to be bundled rather than separated.

18)  This factor tends towards aggregation.

Paragraph 230-55(4)(e)

19)  Paragraph 230-55(4)(e) requires an assessment of what are the normal commercial understandings and practices in relation to the relevant rights/obligations, noting that TR 2012/4 provides that accounting treatment is relevant but not determinative.

20)  Entities must generally enter into a PPA with an accredited generator to acquire LGCs directly, rather than through a secondary market. The structure chosen is therefore in line with industry norms.

21)  This factor tends toward aggregation.

Paragraph 230-55(4)(f)

22)  Paragraph 230-55(4)(f) requires an assessment of the objects of Division 230, which are set out in section 230-10 as follows:

a)          to minimise the extent to which the tax treatment of gains and losses from your *financial arrangements distorts, by providing inappropriate impediments and stimulation, your trading, financing and investment decisions and your risk taking and risk management; and

b)          to do so by aligning more closely the tax and commercial recognition of gains and losses from your financial arrangements in the following ways:

(i)           by allocating the gains and losses to income years throughout the life of your financial arrangements on a reasonable basis;

(ii)           by generally recognising gains and losses on revenue rather than capital account; and

c)          to appropriately take account of, and minimise, your compliance costs.

23)  Overall, it is considered that the objects of Division 230 are supported by treating the PPA as a single arrangement, because:

•                     the embedded derivative is recognised on a fair value basis in the financial statements in accordance with accounting standards;

•                     the embedded derivative is valued independently at year end before being included in 'other comprehensive income';

•                     the actual receipts and payments are recognised for accounting purposes when the performance obligations under the PPA are satisfied;

•                     the tax and commercial recognition of payments and receipts under the PPA are aligned with the accounting treatment of such gains and losses, and

•                     if they were treated separately, it would involve additional compliance costs to dissect the net monthly amount into components.

24)  This factor tends towards aggregation.

Conclusion regarding 'what is the arrangement' under subsection 230-55(4)

25)  On balance, having regard to the factors in subsection 230-55(4), the Seller's rights and obligations under the PPA should be considered a single arrangement, in line with its legal form, excluding the sale of electricity to the grid. This is a separate arrangement between the Seller and a third party, and its supply is not inextricably linked to other rights and obligations under the PPA.

Financial Arrangement

26)  As it has been determined that the PPA constitutes the 'arrangement', it is now necessary to determine whether the arrangement is a 'financial arrangement' according to sections 230-45 and 230-50.

27)  Section 230-50 relates to financial arrangements that are equity interests, or a legal or equitable right/obligation in relation to an equity interest. As the PPA does not meet any of the tests to be an equity interest, this provision is not considered further.

28)  Subsection 230-45(1) provides that you have a financial arrangement if you have, under an arrangement:

(a)          a *cash settlable legal or equitable right to receive a *financial benefit; or

(b)          a cash settlable legal or equitable obligation to provide a financial benefit; or

(c)          a combination of one or more such rights and/or one or more such obligations;

unless:

(d)          you also have under the arrangement one or more legal equitable rights to receive something and/or one or more legal or equitable obligations to provide something: and

(e)          for one or more of the rights and/or obligations covered by paragraph (d):

(i)           the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or

(ii)           the right or obligation is not cash settable; and

(f)          the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).

The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.

29)  Central to the definition of 'financial arrangement' is the term 'cash settlable'. It is defined in subsection 995-1(1) as having the meaning in subsection 230-45(2), which provides that:

A right you have to receive, or an obligation you have to provide, a *financial benefit is cash settlable if, and only if:

(a)          the benefit is money or a *money equivalent; or

(b)          in the case of a right - you intend to satisfy or settle it by receiving money or a money equivalent or by starting to have, or ceasing to have, another *financial arrangement; or

(c)          in the case of an obligation - you intend to satisfy or settle it by providing money or a money equivalent or by starting to have, or ceasing to have, another financial arrangement; or

(d)          you have a practice of satisfying or settling similar rights or obligations as mentioned in paragraph (b) or (c) (whether or not you intend to satisfy or settle the right or obligation in that way); or

(e)          you deal with the right or obligation, or with similar rights or obligations, in order to generate a profit from short-term fluctuations in price, from a dealer's margin, or from both; or

(f)          none of paragraphs (a) to (e) applies but you satisfy subsection (3); or

(g)          you are able to settle the right or obligation as mentioned in paragraph (b) or (c) (whether or not you intend to satisfy or settle the right or obligation in that way) and you do not have, as your sole or dominant purpose for entering into the arrangement under which you are to receive or provide the financial benefit, the purpose of receiving or delivering the financial benefit as part of your expected purchase, sale or usage requirements.

A reference in paragraph (b) or (c) to a financial arrangement does not include a reference to something that is a financial arrangement under section 230-50.

Note:

Examples of dealing of the kind covered by paragraph (e) are:

(a)          dealing with the right or obligation, or similar rights or obligations, on a frequent basis, a short-term basis or on a frequent and short-term basis; and

(b)          acquiring the right or obligation, or similar rights or obligations, and managing the resulting risk by entering into offsetting arrangements that provide a profit margin.

30)  Paragraph 230-45(2)(f) refers the reader to subsection 230-45(3), which in turn refers to subsections 230-45(4) and (5). Relevantly, they state:

230-45(3)

You satisfy this subsection if:

(a)          the *financial benefit is readily convertible into money or a *money equivalent; and

(b)          there is a market for the financial benefit that has a high degree of liquidity; and

(c)          subsection (4) or (5) is satisfied.

230-45(4)

This subsection is satisfied if, for the recipient of the *financial benefit, the amount of the money or *money equivalent referred to in paragraph (3)(a) is not subject to a substantial risk of substantial decrease in value.

230-45(5)

This subsection is satisfied if your purpose, or one of your purposes, for entering into the arrangement under which you are to receive or provide the *financial benefit, is to receive or deliver the financial benefit:

(a)          to raise or provide finance; or

(b)          if paragraph (a) does not apply - so that it may be converted or liquidated into money or a money equivalent (other than as part of your expected purchase, sale or usage requirements).

Application of section 230-45

31)  The PPA will be a 'financial arrangement' if it satisfies any of the requirements of paragraphs 230-45(1) (a) to (c), unless it also satisfies paragraphs 230-45(d) to (f). This requires an assessment of whether the rights and obligations under the PPA are cash settlable.

32)  It is not in contention that the net monthly amounts are settled as a cash payment under the PPA, and is therefore a cash settlable right or obligation for the purposes of subsection 230-45(2).

33)  In relation to the LGCs, it is accepted that they are a 'financial benefit' as they have economic value. It is also accepted that:

•                     the LGCs are not money or money equivalent (paragraph 230-45(2)(a))

•                     the right to receive or the obligation to provide LGCs will not be satisfied or settled by providing money or money equivalent, or by starting to have or ceasing to have another financial arrangement (paragraphs 230-45(2)(b) and (c))

•                     The Buyer and the Seller have no practice of satisfying or settling similar rights or obligations through the ways mentioned in paragraphs (b) and (c), (paragraph 230-45(2)(d)) and

•                     neither party deals with the right or obligation in order to generate a profit from short term fluctuations in price (paragraph 230-45(2)(e)).

34)  As none of paragraphs (a) to (e) applies, paragraph (f) provides it is necessary to determine whether the obligation to provide LGCs or the right to receive LGCs, satisfies subsection 230-45(3). Paragraphs 230-45(3)(a) and (b) are satisfied if the LGCs are readily convertible into money or a money equivalent, and there is a market for the financial benefit that has a high degree of liquidity. Guidance as to the meaning of these terms is provided in the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2009 (the EM), at paragraph 2.84:

A financial benefit will be readily convertible into money or a money equivalent and be subject to a highly liquid market if, for example, the financial benefit is a security or commodity traded in an active market or if it is an amount of foreign currency that is readily convertible into the functional currency of the taxpayer. A right to receive, or an obligation to provide, a financial benefit that is a publicly traded security for which the market is not very active will still be readily convertible to cash and subject to a highly liquid market if the number of shares or other units of the security the right or obligation is for, is small relative to the daily transaction volume for that security. A right to receive, or an obligation to provide, that same security would not be so readily convertible if the number of shares or units the right or obligation is for is large relative to the daily transaction volume for that security. [Schedule 1, item 1, paragraphs 230-45(3)(a) and (b)]

35)  The LGCs are a commodity that is traded in an active market. The EM suggests that relative trading volumes in a market are an indication of liquidity, and therefore that the LGC market would be highly liquid if LGCs were being traded in sufficiently large volumes each day compared to the amount of LGCs covered by the right or obligation. On the facts provided, the minimum amount of LGCs that the Seller is obligated to provide and the Buyer is to receive monthly, is relatively small compared to the daily trading volume of LGCs, indicating a highly liquid market. We consider that the obligation to provide and the right to receive LGCs meet the requirements of paragraphs 230-45(3)(a) and (b).

36)  The final requirement of subsection 230-45(3) is that subsection (4) or (5) is satisfied.

37)  Subsection 230-45(4) is satisfied if, for the Buyer, the amount of money or money equivalent referred to in paragraph (3)(a) is not subject to a substantial risk of substantial decrease in value.

38)  The facts provided demonstrate that the value of LGCs fluctuates substantially (noting that within 24 months, they have traded across a band of approximately $XX to $XX). The value of LGCs has also had a downward trend over that time. This, coupled with the fact there is inevitably some time lag between acquiring the right to the LGCs (on signing the PPA), and the receipt of the LGCs (which occurs over the life of the PPA), we consider that the Buyer is subject to a substantial risk of substantial decrease in the value of LGCs. Accordingly, we consider that subsection 230-45(4) is not satisfied.

39)  Subsection 230-45(5) is satisfied if, one of the purposes for entering the arrangement is to receive or deliver the LGCs to raise or provide finance, or so that it may be converted or liquidated into money or money equivalent.

40)  The Seller does not deliver the LGCs to raise or provide finance, and they are not delivered for the purposes of conversion or liquidation into money or money equivalent. The Buyer's purpose in sourcing the LGCs is in relation to meeting renewable energy targets and surrendering them to the CER via the REC Registry. While the Buyer could sell surplus LGCs on the market, there is no evidence to suggest that this is a purpose for their acquisition. The Seller's purpose in supplying the LGCs was an inducement to a PPA partner which required LGCs for such purposes. Accordingly, we consider that paragraph 230-45(5) is not satisfied.

41)  As neither paragraph 230-45(4) or (5) is satisfied, paragraph 230-45(3) is not satisfied. Accordingly, we do not consider the right to receive or the obligation to provide the LGCs is a cash settlable obligation.

42)  The PPA may still be a financial arrangement however, if the exclusion provided by paragraphs 230-45(1)(d) to (f) do not apply to the LGCs.

43)  Relevantly, those paragraphs provide that if under the arrangement you have a legal equitable right to receive something and/or a legal equitable obligation to provide something that is not cash settlable, and the right or obligation is not insignificant in comparison with the cash settlable rights already covered above, then the financial arrangement may be constituted by those rights and obligations that are cash settlable (covered by paragraphs 230-45(1)(a)(b) or (c)).

44)  We consider that the obligation to provide and the right to receive the LGCs is not insignificant when compared to the cash settlable rights and obligations under the PPA because:

their provision is a primary obligation under the PPA, and

the market value of the LGC is significant, even when based on the notional price allocated under the PPA compared to the total fixed price under the contract and payment of the net monthly amounts.

45)  As the LGCs are not insignificant compared to the cash settlable rights under paragraph 230-45(1)(f), the obligation to provide and the right to receive LGCs under the PPA will cause the arrangement to fail the definition of 'financial arrangement' in subsection 230-45(1) of the ITAA 1997.

46)  Accordingly, the PPA is not subject to the Taxation of Financial Arrangements (TOFA) rules under Division 230.