Application of the financial arrangements rules to the D&C Phase of a public-private partnership agreement
Determination S37 (28 Apr 2015) relates to payments received by a limited partnership for the design and construction of facilities under a PPP agreement.
This Determination may be cited as Special Determination S37: "Application of the financial arrangements rules to the D&C Phase of a public-private partnership agreement".
1. Explanation (which does not form part of the determination)
- 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.
- 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.
- 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.
- 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) in respect of each Facility, under which the Service Provider will provide the on-going operation and maintenance (and other) services in consideration for monthly payments.
- The Partnership will raise external debt from a range of third party financiers (the Senior Debt).
- 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).
- The Partnership will enter into Interest Rate Swaps in respect of the Senior Debt.
- 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.
- Special Determination S36: Application of the financial arrangements rules to a public-private partnership applies to arrangements in the wider financial arrangement, excluding the D&C Payments.
- This determination prescribes the portion of each D&C Payment treated as income under the financial arrangement rules (the Interest Component) and the method for spreading that income.
- This determination is made under ss 90AC(1)(bb)and 91AC(1)(i) of the Tax Administration Act 1994.
3. Scope of determination
- 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 D&C Phase of the Project Agreement for each Facility, under which the Partnership agrees to design and construct the Facility for the Crown and will receive a fixed lump-sum payment (the D&C Payment) once the Facility is ready for operation.
- This determination is made subject to the following conditions:
- The design and construction costs of each Facility are agreed between the Partnership and the Crown on an arm's length basis and set out in the Base Case for the relevant Facility under the Project Agreement as referenced in the definition of "Design and Construction Payment" in clause 1.1 of the Project Agreement.
- The Taxable Limited Partners each use IFRSs to prepare financial statements and to report for financial arrangements.
- 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.
- During the D&C Phase of the Project Agreement, the Partnership will receive consideration from the Crown (in the form of the D&C Payment) for each Facility and will in turn provide consideration to the Crown (in the form of the completion of each Facility that is part of the Project and the transfer of its rights, set out in clause 12.2(c) of the Project Agreement, in each Facility). The D&C Phase of the Project Agreement for each facility is a "financial arrangement" under s EW 3 and an "agreement for the sale and purchase of property or services" under s YA 1.
- The Partnership and the Crown have agreed that each D&C Payment includes capitalised interest (clause 13.6(c) of the Project Agreement). The Interest Component of each D&C Payment will be income under the financial arrangements rules under subpart EW.
- During the D&C Phase for each Facility the Partnership has variable expenditure commitments that will accrue. The capitalised interest component of each D&C Payment is intended to offset the expected funding costs incurred on these commitments.
- The Interest Component is calculated with reference to expected funding costs. No adjustment is made for variances between actual and expected costs as the D&C Payment for each Facility, including capitalised interest, is agreed in advance.
- The Interest Component of each D&C Payment needs to be spread over the term of the D&C Phase for the Facility to which it relates.
- 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 s YA 1.
Calculation of Interest Component
- The value of the completion of a Facility and transfer of the Partnership's rights to the Crown, set out in clause 12.2(c) of the Project Agreement, is the agreed design and construction costs of the relevant Facility (excluding Fitout) set out in the Base Case for the relevant Facility under the Project Agreement.
- The D&C Payment less the agreed design and construction costs of the Facility (excluding Fitout) set out in the Base Case for the relevant Facility under the Project Agreement is the Interest Component that is income under the financial arrangements rules.
- BR Prv 15/11 rules on the portion of the D&C Payment that is not income under the financial arrangements rules, and that portion is not considered in this determination.
Spreading of Interest Component
- The method for determining the amount of income that is to be allocated to each income year is as follows:
- The expected design and construction costs of the Facility (excluding Fitout) as set out in the Base Case for the relevant Facility are treated as having been incurred at the beginning of each of the income years that make up the D&C Phase for each Facility (the Annual Expenditure). No adjustment will be made to the Annual Expenditure in any income year to reflect actual expenditure in that year.
- The interest allocated to each income year is then calculated in accordance with the following formula:
Interest = OB x R
OB is the sum of the Annual Expenditure for that income year, plus the Annual Expenditure and interest attributable to any previous income year.
R is the internal rate of return (based on annual rests) calculated using the notional cash flows in paragraph (a) above at the beginning of each income year as outflows, and the D&C Payment at the end of the D&C Phase as the only inflow.
This example illustrates the application of the method set out in this determination.
The Partnership and the Crown agree to the D&C Payment under the Base Case sheet that the D&C Payment equals $60,000.
The Base Case sets out that the agreed design and construction costs of the Facility (excluding Fitout) are to be $55,500.
The value of the "completion of the relevant Facility and the transfer of the rights set out in clause 12.2(c)" of the Project Agreement, as set out in clause 13.4(a) of the Project Agreement, is equal to $55,500.
The Interest Component of the D&C Payment is $4,500 by implication of the valuation under this determination.
The Taxable Limited Partners will each spread the Interest Component over the term of the D&C Phase of the Project Agreement, as follows.
The Annual Expenditure incurred and treated as having been incurred at the beginning of the relevant income year is as follows:
|Year||Actual D&C Costs|
Based on receipt of the $60,000 D&C Payment in Year 3, the Project has an internal rate of return of 4.62%.
The Interest Component is therefore spread as follows:
|Year||Actual D&C costs||Cumulative||Interest income|
This Determination is signed by Howard Davis on the 28th day of April 2015.
Director (Taxpayer Rulings)