S36
Issued
28 Apr 2015

Application of the financial arrangements rules to a public-private partnership agreement

Determination S36 (28 Apr 2015) relates to operation and maintenance services of a facility by a limited partnership under a PPP. Replaced by S36A (26 Jan 2018).

This Determination may be cited as Special Determination S36: "Application of the financial arrangements rules to a public-private partnership agreement".

1. Explanation (which does not form part of the determination)

  1. This determination relates to an arrangement (the Project) involving the finance, design, construction and on-going provision of operation and maintenance services in respect of the Facilities by a limited partnership (the Partnership) under a public-private partnership agreement (the Project Agreement) with the Crown. The Holding Partnership will be the sole limited partner in the Partnership, holding 100% of the Partnership.
  2. The limited partners in the Holding Partnership are Limited Partner A and Limited Partner B. Limited Partner A is a limited partnership. Limited Partner B is a limited liability company. Limited Partner B and each taxable limited partner of Limited Partner A are together referred to as the Taxable Limited Partners.
  3. The Project Agreement comprises three basic components for each Facility:
    • A design and construction phase (the D&C Phase) under which the Partnership agrees to design and construct the Facility for the Crown in consideration for a fixed lump-sum payment (the D&C Payment), payable on completion of the D&C Phase;
    • A Facility Lease entered into by the Partnership and the Crown, under which the Partnership pays an amount representing the rental under the Facility Lease to the Crown (the Rental Prepayment); and
    • An operations and maintenance phase (the O&M Phase) under which, in consideration for quarterly payments (the Unitary Charge), the Partnership will provide operation and maintenance services to the Crown over a term beginning once the Facility is ready for operation and ending 25 years after completion of the last-completed Facility.
  4. The Partnership will enter into:
    • A Construction Agreement with a contractor (the Contractor), under which the Contractor will design and construct each Facility in consideration for monthly and milestone payments; and
    • An Operation and Maintenance Contract (the O&M Contract) with a service provider (the Service Provider), under which the Service Provider will provide the on-going operation and maintenance (and other) services in consideration for monthly payments.
  5. The Partnership will raise external debt from a range of third party financiers (the Senior Debt).
  6. The Partnership may raise subordinated debt from the Holding Partnership, which may in turn raise subordinated debt from Limited Partner A and Limited Partner B (Subordinated Debt).
  7. The Partnership will enter into Interest Rate Swaps in respect of the Senior Debt.
  8. The Facility Lease, O&M Phase of the Project Agreement, Construction Agreement and O&M Contract are all excepted financial arrangements. The D&C Phase of the Project Agreement, Senior Debt, Subordinated Debt and Interest Rate Swaps are financial arrangements to which the Partnership is a party. The Project, including all of these agreements, is a wider financial arrangement.
  9. Special Determination S37: Application of the financial arrangements rules to the D&C Phase in a public-private partnership applies to the D&C Payment under the D&C Phase.
  10. This determination prescribes:
    • the amount of consideration that is solely attributable to each Facility Lease;
    • how the financial arrangements rules apply to the O&M Phase of the Project Agreement, the Construction Agreement and the O&M Contract for each Facility; and
    • the method for spreading the payments made under the Senior Debt, Subordinated Debt and Interest Rate Swaps.

2. Reference

  1. This determination is made under ss 90AC(1)(bb)and 91AC(1)(h) of the Tax Administration Act 1994.

3. Scope of determination

  1. This determination applies to the Partnership in respect of the Project (which is set out in detail in Private Ruling BR Prv 15/11 issued on 28 April 2015), including the following arrangements:
    • The D&C Phase of the Project Agreement, under which the Partnership agrees to design and construct each Facility for the Crown and will receive a fixed lump-sum payment (the D&C Payment) for each Facility once the Facility is ready for operation (which is the subject of Special Determination S37: Application of the financial arrangements rules to the D&C Phase of a public-private partnership).
    • The O&M Phase of the Project Agreement, under which the Partnership will provide on-going operation and maintenance services to the Crown for 25 years following completion of the last-completed Facility to the Crown in consideration for quarterly payments.
    • The Facility Lease for each Facility, under which the Partnership will lease the Facility from the Crown for a period ending 25 years following completion of the last-completed Facility and will make the Rental Prepayment to the Crown. The Rental Prepayment will be equal to and will offset the D&C Payment.
    • A Construction Agreement with the Contractor, under which the Contractor will design and construct the Facility in consideration for payments under the Construction Agreement.
    • An O&M Contract with the Service Provider following completion of the last-completed Facility, under which the Service Provider will provide the on-going operation and maintenance (and other) services in consideration for payments under the O&M Contract.
    • Senior Debt, under which the Partnership will borrow an agreed sum from external lenders for a term of 5 years from financial close of the Project (Financial Close). The Senior Debt will be a capitalising, interest only senior debt facility that converts to an amortising senior tranche on the Conversion Date. It is expected that the Senior Debt will be refinanced within 5 years of Financial Close and every 5 years thereafter over the term of the Project. Under IFRS (as the standards apply at the date of this Determination), the Senior Debt (and any subsequent re-financings) will initially be recognised at fair value plus integral fees, and subsequently measured using the amortised cost using the effective interest method (regardless of whether hedge accounting is applied). The Senior Debt will not be treated as a hedge of another financial arrangement.
    • Subordinated Debt, under which Limited Partner A and Limited Partner B may lend to the Holding Partnership and the Holding Partnership may lend to the Partnership.
    • Interest Rate Swaps, under which the Partnership will pay a fixed rate of interest to the swap counterparties, and receive a floating rate in return.
  2. This determination is made subject to the following conditions:
    • The Taxable Limited Partners each use IFRSs to prepare financial statements.
    • The Taxable Limited Partners will each recognise income derived from the Crown during the D&C Phase and the O&M Phase of the Project Agreement, and will deduct expenditure incurred in relation to the Facility Lease, Construction Agreement and O&M Contract, in each case, under the relevant provisions of the Income Tax Act 2007 (outside of the financial arrangements rules).
    • The Taxable Limited Partners each do not use the fair value method for the Senior Debt if the Senior Debt is treated as a hedge of another financial arrangement under IFRS and uses for the other financial arrangement a method that is neither the IFRS financial reporting method nor the method required under Determination G29: Agreements for Sale and Purchase of Property Denominated in Foreign Currency: Exchange Rate to Determine the Acquisition Price and method for spreading income and expenditure.
    • The Taxable Limited Partners will each recognise income in respect of the D&C Payment in the manner prescribed by Special Determination S37: Application of the financial arrangements rules to the D&C Phase in a public-private partnership.
    • The continued application of Private Ruling BR Prv 15/11 issued on 28 April 2015.
    • The final executed documentation is not materially different from the draft documentation that Inland Revenue received on 24 October 2014, 16 January 2015, 12 April 2015 and 23 April 2015.

4. Principle

  1. Each Facility Lease is an excepted financial arrangement under s EW 5(9). Any amount that is solely attributable to an excepted financial arrangement described in ss EW 5(2) to (16) is not an amount that is taken into account under the financial arrangements rules (s EW 6(2)). This determination specifies the amounts that are solely attributable to a Facility Lease that are not taken into account under the financial arrangements rules.
  2. The O&M Phase, Construction Agreements and O&M Contracts are "short-term agreements for sale and purchase" as defined in s YA 1, and are excepted financial arrangements under s EW 5(22), provided that payment under the Construction Agreements and O&M Contracts is required within 93 days of an invoice being rendered. Any amount that is solely attributable to an excepted financial arrangement described in ss EW 5(17) to (25) that is part of a financial arrangement is an amount that is taken into account under the financial arrangements rules (s EW 6(3)). This determination specifies that no amounts payable to or by the Partnership in respect of the O&M Phase, Construction Agreements and O&M Contracts are required to be spread under the financial arrangements rules.
  3. The D&C Phase, Senior Debt, Subordinated Debt and Interest Rate Swaps are "financial arrangements" under s EW 3. This determination specifies that the payments made to or by Limited Partner A and Limited Partner B, in proportion to their share in Holding Partnership, under the Senior Debt, Subordinated Debt and Interest Rate Swaps must be spread under the financial arrangements rules in accordance with this determination.
  4. This determination does not deal with the treatment of the D&C Payment which is subject to a separate determination (Special Determination S37: Application of the financial arrangements rules to the D&C Phase in a public-private partnership).

5. Interpretation

  1. In this determination, unless the context otherwise requires:
    • All legislative references in this determination are to the Income Tax Act 2007, unless otherwise stated.
    • Capitalised terms have the same meaning as set out in the Project Agreement.
    • "IFRS" means International Financial Reporting Standards as defined in sYA1.

6. Method

  1. The Rental Prepayment paid in respect of a Facility Lease, and the property interest granted to the Partnership under a Facility Lease, are solely attributable to the Facility Lease and are not taken into account under the financial arrangements rules.
  2. The Taxable Limited Partners are not required to spread any amounts under the financial arrangements rules in respect of the:
    • O&M Phase of the Project Agreement;
    • Construction Agreement;
    • O&M Contract.
  3. The IFRS financial reporting method in s EW 15D may be used to allocate income and expenditure (other than "non-integral fees" as defined in s YA 1) over the term of the Senior Debt and none of the restrictions for application of the IFRS financial reporting method contained in s EW 15D(2B) apply.
  4. The IFRS financial reporting method in s EW 15D may be used to allocate income and expenditure (other than "non-integral fees" as defined in s YA 1) in respect of any subsequent refinancing of the Senior Debt over the term of the relevant refinancing, provided that the terms of any such refinancing are materially similar to the terms of the Senior Debt. This determination paragraph does not affect each Taxable Limited Partner's obligation to perform a base price adjustment under s EW 31 at the time of each refinancing.
  5. The IFRS financial reporting method in s EW 15D may be used to allocate income and expenditure (other than "non-integral fees" as defined in s YA 1) over the term of the Subordinated Debt provided that none of the restrictions for the application of this reporting method in s EW 15D(2B) apply and Taxable Limited Partner uses the same IFRS method to allocate both income and expenditure under the Subordinated Debt for financial reporting purposes.
  6. None of the mandatory spreading methods in ss EW 15H or EW 15I apply to the Interest Rate Swaps. Over the term of the Interest Rate Swaps, income or expenditure may be allocated using either:
    • the expected value method in s EW 15F (other than for "non-contingent fees" as defined in s YA 1) provided that the swaps are not treated as a hedge of other financial arrangements for which the "fair value method" is used; or
    • the IFRS financial reporting method in s EW 15D (other than for "non-integral fees" as defined in s YA 1) provided that the swaps are not treated as a hedge of other financial arrangements for which a method other than the IFRS financial reporting method is used;

    provided that each Taxable Limited Partner uses the same method for the entire term of the Interest Rate Swaps.
  7. This determination does not affect each Taxable Limited Partner's obligation to perform base price adjustments under sEW 31 in respect of the Interest Rate Swaps.

7. Example

This example illustrates the application of the method set out in this determination.

This example is based on the following parameters:

Commencement of D&C Phase 1 May 2015
Completion of D&C Phase 16 September 2017
Completion of O&M Phase 21 December 2041
D&C Payment from the Crown $1,000
Aggregate payments to the Contractor ($850)
Facility Lease prepayment ($1,000)
Quarterly payments from the Crown during the O&M Phase $30
Quarterly payments to the Service Provider ($15)
Annual interest on the Senior Debt ($85)
Annual net payments in respect of the Interest Rate Swaps ($7)

The Taxable Limited Partners are not required to spread any amounts under the financial arrangements rules in respect of the Facility Lease, O&M Phase of the Project Agreement, Construction Agreement and O&M Contract.

The amounts that must be spread under the financial arrangement rules are:

  • Interest on the Senior Debt calculated in accordance with the IFRS financial reporting method in s EW 15D;
  • Interest on the Subordinated Debt calculated in accordance with the IFRS financial reporting method in s EW 15D;
  • Payments in respect of the Interest Rate Swaps calculated in accordance with the expected value method in s EW 15F or the IFRS financial reporting method in sEW 15D; and
  • Amounts in respect of the D&C Payment as specified in Special Determination S37: Application of the financial arrangements rules to the D&C Phase in a public-private partnership.

This Determination is signed by Howard Davis on the 28th day of April 2015.

Howard Davis
Director (Taxpayer Rulings)