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Focus: Tax – 16 August 2007

Bill introduced to repeal section 51AD and Division 16D of the Income Tax Assessment Act 1936 (Cth) and introduce Division 250

In brief: The Tax Laws Amendment (2007 Measures No 5) Bill 2007 (Cth) was tabled in Federal Parliament today. Partner Charles Armitage (view CV) outlines the significance of the Bill. 

How does it affect you?

  • If the Bill is ultimately enacted in its current form:
    • transactions entered into on, or after, 1 July 2007 will not be subject to 51AD or Division 16D;
    • instead, Division 250 will tax certain transactions as loans: depreciation will be denied and only a deemed interest amount will be included in assessable income;
    • section 51AD will be 'switched off' from 1 July 2003 in respect of certain existing transactions.
  • AAR will hold a series of public seminars in Brisbane, Melbourne and Sydney over the next few weeks to discuss this Bill.

Background

Schedule 1 to the Tax Laws Amendment (2007 Measures No 5) Bill 2007 (Cth) (the Bill) contains the long-awaited measures to repeal section 51AD and Division 16D of the Income Tax Assessment Act 1936 (Cth) and replace them with a new Division 250 of the Income Tax Assessment Act 1997 (Cth).

These provisions are the result of a lengthy process of drafting, consultation and redrafting of the rules and the Bill has undergone considerable refinement since the exposure draft Bill released publicly in June 2003.

Contrary to the recommendations of the Review of Business Taxation chaired by John Ralph and the exposure draft Bill in 2003, the concept of use/control of use upon which s51AD and Division 16D are based, has been retained albeit in a more refined and better targeted form known as a 'tax preferred use'.

The legislation covers 70 pages and is supported by 100 pages of Explanatory Memorandum. Therefore, any summary must necessarily be in very broad terms and the following preliminary observations should be read accordingly. 

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Scope of Division 250

The structure of the new Division 250 involves the so called 'General Test' subject to a number of specific exclusions.

The General Test

The General Test provides that Division 250 will apply if all of the following five conditions are satisfied:

  • the asset is being put to a 'tax preferred use';
  • the arrangement period for tax preferred use of the asset is greater than 12 months;
  • financial benefits in relation to the tax preferred use of the asset have been, will be or can reasonably be expected to be, provided to the taxpayer by a tax preferred entity or a non-resident of Australia;
  • disregarding Division 250, the taxpayer would be entitled to capital allowances in respect of the asset; and
  • the taxpayer lacks a 'predominant economic interest' in the asset.


Some key points to note in relation to this General Test are:

  • tax preferred use means that the asset is used or its use is controlled by a tax preferred entity or a non-resident of Australia. A tax preferred entity essentially means a government entity or an entity the income of which is specifically exempt from tax. This is a narrower concept than that used for the application of s51AD, but a much broader concept than that adopted for the application of Division 16D. The concept of lease is very wide;
  • the fact that financial benefits in relation to the tax preferred use must be provided by a tax preferred entity or a non-resident of Australia should ensure that projects in which all remuneration is received from the public will not be brought within the scope of Division 250, simply because a government might be seen as having some degree of control over the use of the asset; and
  • the 'predominant economic interest' test is really the heart of Division 250 because once it is determined that there is tax preferred use of the asset and none of the specific exclusions applies, it is likely that the question of whether Division 250 actually operates or not will depend upon whether the predominant economic interest test is satisfied. This test is discussed below.

Specific exclusions

The specific exclusions are:

  • the new Division 250 will not apply to 'small business entities' (an existing concept in the 1997 Act);
  • the Division will not apply where the nominal value of all financial benefits to be provided by members of the tax preferred sector over the arrangement period does not exceed $5 million (to be indexed annually); and
  • the Division will not apply if either:
    • the arrangement period does not exceed five years in the case of real property leases and three years in any other case; or
    • it is reasonably expected that the financial benefits to be provided by the tax preferred sector will not exceed $50 million in the case of a real property lease and $30 million in any other case; or
    • the total value of assets put to a tax preferred use under the arrangement does not exceed $40 million in the case of a real property lease and $20 million in any other case.

There are a number of qualifications and restrictions on the operation of these exclusions from Division 250, such as the exclusion that:

  • the Division does not apply if, broadly, the present value of all the amounts that would be assessable pursuant to Division 250 is less than the present value of the net amounts that would be assessable (ie assessable receipts less capital allowance deductions) if Division 250 did not apply.

In addition, the Commissioner of Taxation has a reasonably broad discretion not to apply Division 250 where to do so would be unreasonable. This is similar to the approach adopted in Division 16D, but a marked departure from the approach adopted in s51AD, which did not confer any general discretion on the Commissioner not to apply the provision.

Predominant economic interest test

The predominant economic interest test has undergone considerable refinement since the exposure draft Bill was released in 2003 and, while the provisions are somewhat complicated and will require careful analysis, can be broadly summarised in the following manner.

The taxpayer will be regarded as lacking a predominant economic interest in an asset if any one or more of the following tests is satisfied:

  • in excess of 80 per cent (55 per cent in the case of a non-resident) of the cost of acquiring or constructing the asset is financed by limited recourse debt. The definition of limited recourse debt used for Division 243 (which itself was based upon an enhanced version of the definition of non-recourse debt in section 51AD) has been adopted. There is an exclusion for real property leases where members of the tax preferred sector occupy less than half of the space available for tenants;
  • a member of the tax preferred sector has, or will have, a right to acquire the asset at the end of the arrangement period otherwise than at the market value of the asset at the time of the purchase, acquisition or transfer. However, if the taxpayer's interest in the asset simply ceases to exist at the end of a particular period of time, this test will not be satisfied. For example, if the expiry of a site lease results in a taxpayer ceasing to hold a fixture to land owned by a tax exempt entity then that, of itself, would not cause this test to be satisfied;
  • the arrangement is effectively non-cancellable and the arrangement period is greater than the lesser of 30 years and 75 per cent of the remaining effective life of the asset;
  • the asset has a guaranteed residual value;
  • the arrangement is a debt interest; or
  • the sum of the present value of the financial benefits to be provided in relation to the tax preferred use of the asset is in excess of 70 per cent of the 'adjustable value' of the asset.

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Effect of Division 250

If Division 250 applies, the intention is that the taxpayer will be denied capital allowance deductions but, unlike s51AD, will not be assessed on the full amount of the payments received. Instead, the arrangement will be taxed as if it were a loan on a compounding accruals basis.

Unlike s51AD, the entitlement of the taxpayer to interest deductions and other costs associated with the ownership of the asset (other than capital allowances) is not affected by Division 250.

The approach of treating the arrangement as a loan is similar to the approach adopted in Division 16D, but whereas Division 16D taxes a deemed interest component of payments actually received, Division 250 will apply a compounding accruals basis for bringing amounts to account for tax purposes and therefore the timing of recognition may be different under Division 250 than under Division 16D.

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Commencement date and transitional provisions

The basic rule is that Division 250 will apply to all arrangements under which the tax preferred use starts on, or after, 1 July 2007 if the use occurs pursuant to an enforceable arrangement entered into on, or after, that date. Correspondingly, s51AD and Division 16D will not apply to such an asset.

Where the tax preferred use commences on, or after, 1 July 2007, but pursuant to an arrangement entered into before 1 July 2007, a taxpayer can elect to apply Division 250 if s51AD or Division 16D would otherwise have applied to the asset.

If an arrangement entered into before 1 July 2007 to which s51AD or Division 16D does not apply, is materially altered after 1 July 2007 in such a way that s51AD or Division 16D would commence to apply, Division 250 will apply to that asset from the time of the material alteration.

Finally, and of particular interest to parties involved in transactions entered into in recent years, is the 'switching off' of section 51AD. Where the tax preferred use of an asset commences on, or after, 1 July 2003 pursuant to a legally enforceable arrangement entered into before 1 July 2007, s51AD will not apply to the arrangement. Instead, Division 16D will apply. If there is a material alteration to the arrangement on or after 1 July 2007, the provisions mentioned above may result in Division 250 applying.

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What happens now?

Today is the last sitting day of the House of Representatives in the current session. The next sitting day scheduled is 11 September 2007. Debate on the Bill has been adjourned until the House of Representatives sits again. The Bill will not become law until it has been passed by both the House of Representatives and the Senate and has received Royal Assent. It will then take effect in accordance with the commencement and transitional provisions mentioned above. If an election is called before the Bill is passed by Parliament, Parliament will be prorogued and the Bill will lapse. This means that the Bill would need to be reintroduced into Parliament by the relevant government following the election. In the meantime, affected parties have an opportunity to approach politicians to lobby for changes to the Bill, if that were considered appropriate.

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What is AAR doing?

To help you understand the consequences of the proposed changes, Allens Arthur Robinson will be holding a series of public seminars in Brisbane, Melbourne and Sydney. The presenters, who will include our senior tax, project finance and infrastructure experts, will discuss the relevance of the new rules to your particular types of deals.

  • Brisbane, Thursday 6 September, 7.30am – 9.00am (Peter Allen and Alan Millhouse)
  • Melbourne, Thursday 30 August July, 5.30pm – 7.30 pm (Grant Cathro, Emma Warren and Stephen Spargo)
  • Sydney, Tuesday 28 August, 5.30pm -7.30 pm (Charles Armitage, Phillip Cornwell, Leighton O'Brien)

To register your attendance:

For Brisbane: rsvpbrisbane@aar.com.au

For Melbourne: rsvpmelbourne@aar.com.au

For Sydney: rsvpsydney@aar.com.au

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For further information, please contact:

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