S40
Issued
10 Aug 2015

Spreading method to be used by Infrastructure Provider in respect of the Provision of Services Agreement and valuation of shares issued under that Agreement

Determination S40 (10 Aug 2015) relates to a company share incentive scheme where a customer commits to increase the volume of throughput processed by the company.

This determination may be cited as Special Determination S40: "Spreading method to be used by Infrastructure Provider Ltd in respect of the Provision of Services Agreement and valuation of shares issued under that Agreement".

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

  1. This determination relates to the Provision of Services Agreement (the Agreement) established between Infrastructure Provider Limited (IPL) and Provider Logistics (Provider).
  2. Under the Agreement, Provider commits to delivering a specified volume of freight to IPL each year for the duration of the Agreement, and to increasing the volume of freight over the duration of the Agreement (the Commitment).
  3. In consideration for the Commitment:
    • IPL will issue shares to Provider, and
    • Provider will grant IPL a call option.
  1. If Provider does not meet the Commitment over the term of the Agreement, IPL can exercise the call option to require Provider to sell shares back to IPL for nil consideration.  The combination of the share issue and the call option leave Provider in the net position that the number of shares it will retain in IPL is determined by the extent to which Provider meets the Commitment.
  2. For any of Provider's freight that is sent via IPL, IPL will provide freight services to Provider's freight handlers and will receive payment in return (the Freight Services Agreement).
  3. The Arrangement is the subject of private ruling BR Prv 15/29 issued on 10 August 2015, and is fully described in that ruling.
  4. The Agreement is a financial arrangement under s EW 3 and an agreement for the sale and purchase of property or services as defined in s YA 1.  The Freight Services Agreements are short-term agreements for sale and purchase as defined in s YA 1.  Together, the Agreement and the Freight Services Agreement are a wider financial arrangement. 

2. Reference

This determination is made under s 90AC(1)(bb) of the Tax Administration Act 1994.

3. Scope of determination

  1. This determination applies to the Agreement between IPL and Provider.
  2. Under the Agreement, Provider commits to sending freight to IPL's facilities as set out in the Commitment.  In consideration, IPL will issue shares to Provider and Provider will grant a call option over those shares to IPL.
  3. This determination applies to determine the spreading method to be used by IPL for the Arrangement. 
  4. This determination also applies when:
    • Freight Services are provided by IPL to Provider's freight handlers, to determine the value of the services provided by IPL for the financial arrangements rules;
    • Shares are issued by IPL to Provider, to determine the value of the shares issued by IPL for the financial arrangements rules.
  1. This determination is made subject to the following condition:
    1. IPL will continue to recognise income derived from the Freight Services Agreement and deduct expenditure incurred in relation to the Freight Services Agreement under the Income Tax Act 2007 (primarily Parts C and D) (other than amounts dealt with under this determination).

4. Principle

  1. The Agreement is a financial arrangement under s EW 3 and an agreement for the sale and purchase of property or services as defined in s YA 1.  Together, the Agreement and the Freight Services Agreement are a financial arrangement as defined in s EW 3.
  2. The Freight Services Agreements are excepted financial arrangements (a short-term agreement for sale and purchase) under s EW 5(22).  Under s EW 6(3), all amounts solely attributable to that excepted financial arrangement are taken into account under the financial arrangements rules. 
  3. Under s EW 15I, because the financial arrangement includes in part an excepted financial arrangement, s EW 15C(1) does not apply and one of the methods in s EW 15I(2) must be used to allocate an amount of income or expenditure to an income year.
  4. One of the methods available under s EW 15I(2)(c) is a determination made by the Commissioner.
  5. To determine the consideration paid or payable under the financial arrangements rules, the value of the freight services provided by IPL and the IPL shares issued by IPL to Provider must be established under s EW 32.
  6. Under s EW 32(6), the Commissioner must determine the value of the services and shares. Both IPL and Provider must use this amount. 
  7. The only amounts payable under the Arrangement that must be spread under the financial arrangements rules are the amounts allocated to the issue of the IPL shares to Provider. 

5. Interpretation

In this determination (and the Explanation), unless the context otherwise requires-

Words and expressions used (which have not been defined elsewhere within the determination) have the same meaning as in s YA 1 of the Income Tax Act 2007.

"Agreement" means the Provision of Services Agreement between IPL and Provider.

"IPL" means Infrastructure Provider Limited.

"Provider" means Infrastructure Provider Limited.

"Provider's freight handlers" means the freight handlers that are engaged by Provider to provide freight services for Provider's customers.

"Freight Services Agreement" means the agreements between IPL and Provider's freight handlers under which IPL agrees to provide freight services to Provider's freight handlers for consideration.

6. Method

  1. The amount to be spread will not exceed the market value of the shares issued on the commencement date.  The market price will be determined by reference to the volume weighted average sale price of the shares on the NZX Main Board over the 20 business days prior to the date the shares were issued (subject to adjustment by the Board of IPL).
  2. The amounts to be spread in relation to the shares issued by IPL must be allocated to an income year by applying a method that treats the market value of the shares issued to Provider as, in substance, a volume rebate.  The amount of the rebate will be reported as a reduction in revenue to be recognised in each year that the rebate is earned (ie at the time it becomes reasonably clear that Provider's Commitment will be met).
  3. The amounts spread each year will be spread on a pro-rata basis based on the number of shares in each tranche that have been estimated each year will be eventually released from the call option.
  4. For s EW 32(6), the value of the shares issued by IPL is equal to the market price of the shares as at the issue date.  The market price will be determined by reference to the volume weighted average sale price of the shares on the NZX Main Board over the 20 business days prior to the date the shares were issued (subject to adjustment by the Board.  The same value will be used for any shares that are acquired pursuant to the exercise of the call option.
  5. For s EW 32(6), the value of the freight services provided by IPL under the Freight Services Agreement is equal to the price paid for the services by Provider's freight handlers.
  6. On termination of the Arrangement, a base price adjustment (BPA) will be calculated under s EW 31.  The BPA will take into account all consideration received by IPL (being the fees received by IPL for facilities services provided to Provider freight handlers and any amount paid by Provider on exercise of the call option calculated by reference to dividends received on those shares plus interest), and all consideration provided by IPL (being the facilities  services and the shares issued to Provider at the commencement of the Arrangement net of any shares (if any) that were acquired pursuant to the exercise of the call option).

7. Example

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

Under the Agreement, IPL has issued 1m in Tranche 1 shares (value approximately $100m ) and a further 1m in Tranche 2 shares (value approximately $100m to Provider).    

Provider's commitment to IPL under the Agreement consists of an initial volume commitment of freight and an increase in the volume of freight for each year the Agreement is in force.  Provided the Provider has satisfied the applicable freight commitment for each vesting period, the Agreement provides for a percentage of the Tranche 1 and Tranche 2 shares to be released from the call option every 3 years, and at year 10.  The percentage of shares available for release under the Agreement in each vesting period is set out below:

Vesting Period Years 1-3 Years 4-6 Years 7-9 Year 10
% of Tranche 1 shares available for release
30.00
30.00
30.00
10.00
% of Tranche 2 shares available for release
20.00
30.00
40.00
10.00

Further, assume that in year 1 IPL provides Provider's freight handlers with facilities services costing $ 30 m in return for fees of $100m.

At the end of every year, IPL will assess whether Provider has satisfied the Commitment for that year.  Where it appears likely that the Commitment will be satisfied, IPL will recognise a reduction to Revenue in the Income Statement for an amount equal to the value of the shares that are likely to vest in Provider as a result of satisfying its Commitment, and an increase to Equity will be recognised in the Balance Sheet. 

For example, in year 1, if Provider was considered likely to satisfy its Commitment, IPL would recognise a reduction in revenue in its P&L of $10m for the Tranche 1 shares and $6.66m for the Tranche 2 shares. 

The reduction in revenue recognised by Provider in each subsequent year (assuming that its Commitment is satisfied) is set out below:

Deduction available to Provider if Commitment is
satisfied:
Years 1-3 Years 4-6 Years 7-9 Year 10
In relation to Tranche 1 shares/ year ($m)
10
10
10
 
10
In relation to Tranche 2 shares/ year ($m)
6.66
10
13.33
10
Total deduction available/ year ($m)
16.66
20
23.33
20

The value of the shares for s EW 32 is $200m. 

The value of the services for s EW 32 is $100m. 

This Determination is signed by Dinesh Gupta on the 10th day of August 2015.

Dinesh Gupta
Manager Taxpayer Rulings