LAWFUEL – The Legal Newswire
Division 250 contains the long awaited amendments to the taxation treatment of asset financing arrangements between taxpayers and tax preferred end users. The new Division 250 is contained in the Tax Laws Amendment (2007 Measures No 5) Bill 2007. If enacted the amendments operate to replace section 51AD and Division 16D such that:
Transactions entered into on or after 1 July 2007 will not be subject to section 51AD or Division 16D;
Division 250 will treat certain transactions as loans for tax purposes and only include within assessable income a deemed interest component, and depreciation deductions on the asset will be denied;
Section 51AD will not apply in respect of certain transactions from 1 July 2003.
The proposed legislation will not become law until it has been passed by the House of Representatives and the Senate, and also received Royal Assent.
When does Division 250 apply?
Division 250 will apply to a taxpayer in respect of an asset if all of the following criteria are satisfied:
The asset is being put to a tax preferred use; and
The arrangement period is greater than 12 months; and
Financial benefits in relation to the tax preferred use of the asset have been, or can reasonably be expected to be, provided to the taxpayer by:
– a tax preferred end user;
– a connected entity of a tax preferred end user; or
– a non resident; and
Disregarding Division 250, the taxpayer would be entitled to claim depreciation in respect of the asset; and
The taxpayer does not have a “predominant economic interest” in the asset.
Looking at each of these requirements:
What is a tax preferred end use?
An asset will be put to a tax preferred end use if:
The asset is leased to a tax preferred end user (broadly a tax exempt entity or a non resident) and / or the asset is, or is to be, used wholly or principally outside Australia
If the asset is to be used wholly or partly in connection with the production, supply, carriage, transmission or delivery of goods or the provision of services or facilities then it will be out to a tax preferred end use if the end user of the goods, service or facilities is a tax preferred entity or the asset is to be used wholly or principally outside Australia by a non resident.
The 12 month arrangement period
The second requirement is that the arrangement period must be greater than 12 months. Generally the arrangement period commences when the asset is put to a tax preferred use. Where there are extension or renewal rights, the taxpayer is to assume that the extension or renewal will not be exercised unless the commercial consequences of not renewing or extending would be such that it is reasonable to assume that the extension or renewal would occur.
The financial benefits test
The financial benefits arising from the tax preferred use will include:
financial benefits relating to bringing the asset into a state, condition or location in which it can be put to the tax preferred use;
financial benefits relating to the end of the tax preferred use, such as any guaranteed residual value;
financial benefits provided in relation to the termination or expiration of the arrangement in relation to the asset;
financial benefits in relation to the purchase or acquisition of the asset;
financial benefits calculated by reference to receipts generated by the use of the asset.
Importantly for infrastructure projects, financial benefits will not include road tolls paid by road users collected by the tax preferred entity and passed on to the taxpayers; nor financial benefits provided under national marketing and distribution arrangements for electricity by a tax preferred authority to the electricity generator representing amounts payable by the electricity users.
Financial benefits are not limited to monetary amounts.
Entitlement to capital allowances
The next requirement is that the taxpayer would have otherwise been entitled to depreciate the relevant asset. Financing arrangements involving assets which do not entitle the relevant taxpayer to depreciation over the term of the arrangement will not be affected by Div 250 (for example a hire purchase agreement under Division 240).
The taxpayer lacks a “predominant economic interest” in the asset
This particular requirement is likely, in practice, to be the one that really determines the application of Div 250. A taxpayer will be taken as lacking the relevant interest if one or more of the following apply:
The limited recourse debt test.
If the asset has been put to a tax preferred use (for example is being leased to a non resident for use outside Australia) and more than 55% of the cost of acquisition or construction of the asset is financed by limited recourse debt (note that where the asset is being used by a tax exempt entity rather than a non resident the limited recourse debt percentage is 80% rather than 55%)
The Div 243 definition of “limited recourse debt” is to be applied here.
If the taxpayer is a corporate tax entity then this test will not apply if the tax preferred use of the asset is not a lease, or is a lease of real property but less than half the space within the property is occupied by members of the tax preferred sector (eg government entities and non residents); and the asset is used wholly or principally in Australia; and no tax exempt entity or non resident provides financing of the taxpayers interest in the asset. Similar rules apply to trusts.
The right to acquire the asset test. If a member of the tax preferred sector has a right to acquire the asset at the end of the arrangement period at less than market value.
The effective non cancellable long term arrangement test. This applies where the arrangement period is greater than either 30 years or 75% of the remaining effective life of the asset test.
The level of expected financial benefits test. This test applies if the asset has a guaranteed residual value, if the arrangement is a debt interest or if the total of the present value of the financial benefits is more than 70% of the adjustable value of the asset.
These tests essentially provide a safe harbour. Failure of one or more of the tests will mean that the taxpayer is taken to be lacking the relevant economic interest in the asset.
There are a number of specific exclusions from the operation of Div 250. These are:
Arrangements with an arrangement period not exceeding 12 months.
Arrangements involving taxpayers who are small business entities.
Arrangements where the financial benefits do not exceed $5million.
Arrangements where the tax preferred use of the asset does not exceed five years in the case of leases of real property or three years in any other case. Long term Government offices leases will continue to be an issue
Arrangements where the present value of the Div 250 assessable income is less than the amounts which would otherwise be assessable. In other words, where the notional interest is less than the net of the present value of, for example, the lease rentals minus capital allowance deductions. Variable rental arrangements may give rise to some difficult issues in this regard.
Arrangements excluded at the discretion of the Commissioner.
If the new rules apply…
Where Division 250 applies, then there are two potential effects:
Capital allowances /depreciation in respect of the asset will be denied.
The arrangement (ie the lease) will be treated as a deemed loan with the deemed interest being calculated using a compounding accrual method. Division 250 contains its own rules for calculating the deemed interest which is broadly based on the proposed TOFA (taxation of financial arrangements) measures.
At a practical level, applying a compounding accrual method to the deemed interest may mean that income is required to be recognised in advance of being received. This is a different result from that which would have been the case under Division 16D and may have cash flow implications for some arrangements.
Commencement date for Div 250
There are a number of commencement dates and transitional provisions which will be applied.
Where the tax preferred use of an asset starts on or after 1 July 2007 and under an arrangement entered into on or after that date then Division 250 will apply and, generally, section 51AD and Division 16D will not apply.
Taxpayers can elect to have Division 250 apply to relevant assets where the tax preferred use of the asset starts on or after 1 July 2007, if Div 16D or section 51AD would otherwise have applied.
Section 51AD will cease to apply to an asset with respect to income years beginning on or after 1 July 2007 if:
– The asset is put to a tax preferred use under an arrangement entered into before 1 July 2007; and
– The tax preferred use started on or after 1 July 2003 and before 1 July 2007.
These arrangements will become subject to Div 16D from 1 July 2007.
The tax preferred use started before 1 July 2007;
Immediately before 1 July 2007 neither section 51AD nor Division 16D applied to the asset;
The arrangement is materially altered on or after 1 July 2007; and
Section 51AD or Division 16D would otherwise apply.
This publication is only a general outline. It is not legal advice. You should seek professional advice before taking any action based on its contents.