Chapter 2 - Schedule 1-Tax preferred entities (Asset financing)
2.1
Schedule 1 to the bill amends the income tax law to modify the taxation
treatment of financing arrangements between public private partnerships (PPPs).
The changes are intended to simplify the tax treatment of leasing and similar
arrangements between taxpayers and the tax exempt sector for financing and
providing infrastructure and other assets.[1]
They ‘will effectively remove a complex aspect of the current arrangements, and
bring two different provisions of the 1936 Tax Act into one consolidated
provision in the new law.’[2]
2.2
The policy objective of the provisions in the income tax law affecting
tax-exempt asset financing arrangements is to restrict the transfer of tax
preferences between taxable entities and tax-exempt entities (including
non-residents).[3]
The objective of the measure in Schedule 1 is to provide a more coherent and
neutral tax treatment that reflects the economic substance of the arrangement.
2.3
Schedule 1 adds Division 250 to the Income Tax Assessment Act 1997
(ITAA 1997). The aim of Division 250 is to encourage private sector investment
in pubic–private partnerships (PPPs) by reducing compliance costs, providing
tax benefits and giving greater certainty to private builders of major infrastructure.
The legislation can therefore be viewed as a stimulus to PPP activity in
Australia. The measure will apply if, broadly:
- the tax exempt entity (the public agency)[4]
directly or indirectly uses, or effectively controls the use of the asset; and
- the taxpayer (the private investor) does not have the predominant
economic interest in the asset.[5]
2.4
The Division will deny or reduce capital allowance deductions if the
asset is put to a tax preferred use and the taxpayer has insufficient economic
interest in the asset. (Schedule 1 of the bill defines and introduces into the
ITAA 1997 various terms relating to tax preferred use of an asset.[6])
Where deductions are denied or reduced, Division 250 treats the arrangement as
a deemed loan that is taxed as a financial arrangement on a compounding
accruals basis. The effect of such treatment is to allow deductions for
interest payments which are spread over the period of the arrangement rather
than over the period of the effective life of the asset.[7]
Depending on the particular arrangement, this can spread deductions over a
longer period.[8]
This differs from existing treatment under the Income Tax Assessment Act
1936 (ITAA 1936) where deductions are denied and all the proceeds from the
arrangement are assessable (section 51AD) or capital allowance deductions are
denied and the arrangement is treated as a deemed loan that is taxed on a cash
receivables basis (Division 16D).[9]
2.5
Division 250 also contains various exclusions such as certain short-term
and low value arrangements. Additionally, it does not apply to arrangements
that operate for less than 12 months, where the taxpayer is a small business
entity or where the financial benefits provided by the tax preferred sector do
not exceed $5 million.[10]
2.6
The provisions of Schedule 1 offer more flexibility and incentives for
public-private investment than current arrangements.
Background and existing arrangements[11]
2.7
A general principle of the income tax law is that, in order to claim
deductions for expenditure relating to ownership of an asset (such as capital
allowances), the owner must show that the asset is used for the purpose of
producing assessable income or in carrying on a business for that purpose.
2.8
Stakeholders in public private partnerships developed arrangements to
circumvent this principle[12]
and so section 51AD and Division 16D of Part III of the ITAA 1936 were enacted
in the 1984-85 income year to prevent the mischief. Section 51AD was designed
to operate as an ‘anti-avoidance’ provision against this background because the
large scale nature of the arrangements posed a significant threat to the
revenue base.
2.9
Currently, section 51AD prevents a tax-exempt body—typically a
government agency—from accessing tax benefits from an asset that is financed by
highly leveraged non-recourse debt. Where this section applies, the taxpayer is
assessed on all the proceeds derived from the arrangement but is denied access
to all deductions in respect of the asset (such as capital allowances and
interest deductions).
2.10
Division 16D denies capital allowance deductions for the cost of, or
capital expenditure on, property which a tax-exempt body uses under a finance
lease or similar arrangement.[13]
This division does not apply where section 51AD applies. If Division 16D
applies, the arrangement is treated as a loan and payments made under that
arrangement are treated as having an interest and principal component.
2.11
The amendments in Schedule 1 of the bill will replace section 51AD and
Division 16D with Division 250 of the ITAA 1997. Division 250 will improve the
taxation regime for asset financing arrangements between taxpayers and the
tax-exempt sector as:
- the harsh impact of section 51AD will be removed;
- certain relatively short-term and lower value arrangements will
be specifically excluded from the scope of the regime; and
- arrangements which come within the scope of the regime will be
taxed as a financial arrangement on a compounding accruals basis.
2.12
Because of the specific exclusions in Division 250 and its more generous
safe harbour tests, it will likely have a narrower scope than section 51AD and
Division 16D.[14]
2.13
On 13 September 2005, the Minister for Revenue, the Hon. Mal Brough,
announced the amendments to the law 'to give greater certainty for parties
involved in major infrastructure projects'. He foreshadowed that the proposed
amendments will insert a ‘lease, use or control of use of the asset’ test into
the Income Tax Assessment Act 1997. He added:
Stakeholders are familiar with the operation of the ‘lease, use
or control of use of the asset’ test in the existing law. This is an important
consideration in enhancing continued investment in Australia’s infrastructure.
Stakeholder concerns about the scope of arrangements affected by the reforms
being broadened by the use of new risk based tests will be alleviated by this
change.[15]
2.14
On 16 August 2007, the Minister for Revenue, the Hon. Peter Dutton,
announced the introduction of the legislation. He noted that the measure will
apply to arrangements entered into on or after 1 July 2007, while the denial of all tax deductions in certain circumstances under section 51AD will cease
to apply to arrangements entered into on or after 1 July 2003.[16]
Evidence received by the committee
2.15
The committee received seven submissions that commented on Schedule 1,
one of which was confidential. Overall, submissions were supportive of the
Schedule which is the outcome of an extensive consultation process between
stakeholders and the Treasury.[17]
Although there are some areas of concerns with the legislation,[18]
submitters did not wish to see the passage of the bill delayed.
2.16
Broadly, submissions can be divided into three categories, as follows:
- those that welcome the amendments as a means of encouraging
investment in infrastructure (Property Council of Australia, CPA Australia,
Infrastructure Partnerships Australia, and Australian Chamber of Commerce and
Industry);
- those that consider the amendments unfairly discriminate against
Australian investors in foreign real estate – for example property trusts
(Property Council of Australia); and
- the Minerals Council of Australia submission that points out that
although the Australian minerals industry supplies commodity to tax exempt
state owned corporations, Division 250 provisions will not apply in this
context, a point of view it contends is supported by some of the examples in
the Explanatory Memorandum (Examples 1.3 and 1.4).[19]
Therefore the Council supports Schedule 1 of the bill on the proviso that
these examples remain in their current form.
The ‘limited recourse debt test’
2.17
One of the tests for applying Division 250 to a taxpayer in respect of
an asset is that the taxpayer lacks a predominant economic interest in the
asset. There are several tests in the division to determine whether this is the
case and one of these is the ‘limited recourse debt test’. Under this test the
taxpayer lacks a predominant economic interest in an asset at a particular time
if:
- where the asset is put to tax preferred use by a tax preferred
end user, more than 80 per cent of the cost of acquiring or constructing
the asset is financed (directly or indirectly) by limited recourse debt;[20]
or
- where the asset is put to tax preferred use by an end user that
is a non-resident, more than 55 per cent of the cost of acquiring or
constructing the asset is financed (directly or indirectly) by limited recourse
debt.
2.18
As well as applying in relation to public private partnership
arrangements in Australia, the Division can also apply where Australian
taxpayers invest overseas and the tax preferred end user in such an instance is
a non-resident. The Property Council of Australia submitted that there is no
sound public policy ground for the distinction between residents and
non-residents in relation to their levels of limited recourse debt.[21]
Mr Trevor Cooke, Executive Director, International and Capital Markets
Division, Property Council of Australia told the committee that ‘the 55 per
cent test is too low and...it should be harmonised with that applying to
domestic, which is 80 per cent.’[22]
The Property Council submission argues that as it stands, the provision will:[23]
- generate additional foreign taxes payable by Australian investors
in overseas real estate;
- put Australian investors at a disadvantage when bidding for
foreign real estate assets;
- mean that Australian investors will take more risk and pay more
to foreign banks for that risk; and
- penalise Australian investment.
2.19
Further, the submission suggests that foreign investors are not
interested in tax benefit transfers and equalising the threshold will not give
an advantage to foreigners.
2.20
Mr Tony Regan, Manager, Company Tax Unit, Business Tax Division,
Department of the Treasury, told the committee that the fundamental policy
question is that capital allowance deductions are intended to encourage
investment in Australia rather than investment offshore.[24]
Under the current law, an asset that is predominantly financed by non-recourse
debt triggers section 51AD. When that occurs all capital allowance and interest
deductions are denied.
2.21
However, Division 250 will relax the 50 per cent test for non-residents.
Mr Regan stated that this will:
...build some tolerance into [the test]. It will relax it to a
greater extent where the asset is in Australia. But it also does not deny
deductions as such. Strictly speaking, it denies capital allowance deductions
but keeps the arrangement as a loan.[25]
2.22
Currently, the position is that a 50 per cent test exists for both
residents and non-residents. As a result of representations received during the
consultation process, the Government decided to increase those thresholds to 80
per cent for residents and 55 per cent for non-residents. Essentially, the
increase to 55 per cent for non-residents was to build some tolerance into the
test so that it would not be triggered it by a marginal breach of the 50 per
cent test.[26]
Committee comment
2.23
The committee understands that the primary aim of the legislation is to
encourage investment in Australia rather than investment offshore, so it is not
persuaded about the need to equalise the proportion of non-recourse debt
between residents and non-residents in this particular legislation.
2.24
The committee notes the evidence of Mr Regan that the Board of Taxation
is currently reviewing the foreign income attribution rules (as part of the
Board's Review of the Anti-Tax-Deferral Regimes) and depending on its findings,
some future modification of the limited recourse debt test may be possible.[27]
Other issues
2.25
The Committee also received a submission from Deloitte Touche Tohmatsu
Ltd which supported the bill for its removal of the 'draconian' impacts of
section 51AD and the inclusion of 'many of the significant issues raised during
the earlier consultation process'.[28]
However, it raised some technical issues that it believed need to be corrected
in three areas of the bill.
2.26
First, Deloitte expressed concern that the wording of Division 250-50
may define an 'end-user' in terms of the use or control of the property by the
tax-exempt entity post transfer. This is inconsistent with the 'end user' test
in section 51AD, which did not examine the use of control of the asset post the
transfer. Accordingly, Deloitte recommends changing the definition of 'user
end' in Division 250–50(1) to insert the words during the arrangement period.
2.27
Second, Deloitte argued that Division 250 may apply inappropriately to
the controlled foreign companies (CFC) regime in cases where a CFC leases
property located outside Australia to another non-resident entity. Section 383
of the ITAA 1997 does not assume that the other non-resident entity is to be
treated as a resident for the purpose of Division 250. Deloitte therefore
suggested that Division 250 be excluded:
...until such time that proper consultation has occurred in
respect of this interaction provision. We believe that a technical correction
should be made to section 389 and 557A to achieve this result.[29]
2.28
Third, Deloitte noted that the transition rule in Schedule 1, Part 3,
subitem 71(11) only has application from 1 July 2007, whereas the EM (paragraph
1.287) states that the legislation will be backdated to 1 July 2003. It argued that a technical amendment was required to change the reference from 1 July 2007 to 1 July 2003 to ensure that those affected by section 51AD since July 2003
are not adversely affected.
2.29
The committee did not canvass these issues during its public hearing and
can therefore make no comment on them.
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