TAX CORRS DECEMBER Insights and trends in Australian taxation. SPI POWERNET PTY LTD v COMMISSIONER OF TAXATION

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1 CORRS TAX DECEMBER 2013 Insights and trends in Australian taxation Welcome to the December 2013 edition of the Corrs Tax newsletter. We bring you brief summaries of topical taxation issues, as well as their implications for your business. IN THIS ISSUE: SPI POWERNET PTY LTD v COMMISSIONER OF TAXATION We examine the recent Federal Court deductibility of outgoings case and consider the lessons for taxpayers arising from the decision. AUSTRALIAN INTEREST WITHHOLDING TAX In this article we consider the conditions necessary to satisfy the public offer withholding tax exemption. OUR EDITORS: JONATHON LEEK Partner, Perth Tel jonathon.leek@corrs.com.au THE CROSS CITY TUNNEL CASE We look at the stamp duty, taxation and broader commercial implications arising out of a NSW Supreme Court decision that a tolling right was not an asset separate from a lease of land. GOVERNMENT ANNOUNCEMENT ON UNLEGISLATED TAX CHANGES We summarise the Government s response to 96 unlegislated tax changes. SIMON MIFSUD Senior Associate, Sydney Tel simon.mifsud@corrs.com.au KATHRYN BERTRAM Senior Associate, Melbourne Tel kathryn.bertram@corrs.com.au How can we improve? We are always striving to improve our newsletters to make them more relevant. We welcome your feedback on suggested themes/topics and any questions or general comments. Every person whose suggestion is implemented will receive a small gift from us. Contact the editors with feedback.

2 SPI POWERNET PTY LTD v COMMISSIONER OF TAXATION [2013] FCA 924 The most recent Federal Court case on deductibility of outgoings, SPI PowerNet Pty Ltd v Commissioner of Taxation (SPI), highlights the difficulties for taxpayers, the Australian Taxation Office (ATO) and the courts in applying the taxation law in this area. The facts and decision in SPI The taxpayer in SPI derives assessable income from providing its customers access to the electricity transmission network in Victoria. Under the Electricity Industry Act 1993 (Vic), the taxpayer is required to hold a licence to transmit electricity. In the years in question in the case, apart from licence fees, the taxpayer was also required to pay certain additional amounts to the State Treasurer (referred to as the s 163AA imposts ). The s 163AA imposts were calculated as the difference between the taxpayer s gross revenue and its maximum allowable revenue under a tariff order regulating the revenue that the taxpayer could derive from the transmission services. In the financial years 1999 to 2001, the taxpayer paid s 163AA imposts totalling $177.5 million. It claimed deductions for these payments under s 8-1 of the ITAA The deductions were subsequently disallowed by the ATO and became the subject matter of the Federal Court case. The first question that the court looked at was whether the taxpayer incurred the s 163AA imposts in gaining or producing its assessable income or otherwise necessarily incurred them in carrying on its business for that purpose (the first or positive limb of s 8-1). The court decided that the taxpayer failed the positive limb. The court identified that deductibility of an outlay is determined by reference to the business purpose for which it was incurred from the payer s (not the recipient s) point of view. Despite finding that the s 163AA imposts were inseparably connected with the transmission licence which [the taxpayer] used for business purposes, the court concluded that the imposts were not incurred in the course of the taxpayer carrying on its business for the purpose of gaining or producing its assessable income. It did so, adopting a line of reasoning of Justice Lockhart in United Energy v Federal Commissioner of Taxation (1997) 78 FCR 169. In that case, Lockhart J characterised franchise fees paid by United Energy as akin to the state taking a share of United Energy s profits, leaving it with what the state considered was a reasonable return on the capital that United Energy used in deriving its income. The court in SPI appeared content to proceed on the same basis as Lockhart J, saying that the s 163AA impost was, in substance and effect, a share of profits, leaving the licence holder with an amount determined to be a reasonable return on its capital. Although not strictly necessary, the court also considered the second or negative limb of s 8-1; in particular, whether the s 163AA imposts were capital or revenue in nature. The court identified the relevant tests to be applied, the most important being the character of the advantage sought by the payer in making the payment. Despite the taxpayer s submissions that the character of the advantage from its perspective related to its use of the transmission licence, the court again appeared more focussed on the design of the s 163AA imposts as Page 2

3 a means of the state extracting excess profits from the electricity transmission services. As such, the court held that the s 163AA imposts were capital in nature. Lessons for taxpayers The most obvious lesson from SPI is that, despite the question of deductibility of losses and outgoings being the subject of jurisprudence dating back over a century, we are no closer today to having tests, the application of which produce predictable outcomes to the question asked. A second lesson (or perhaps curiosity) from the case relates to the fact that the court was prepared to find that the s 163AA imposts failed both limbs of s 8-1. For each limb, the court appeared to rely upon much the same broad proposition, being that the s 163AA imposts were in the nature of payments out of profit already derived. This leads on to a third lesson. There are many well worn formulations of words that the courts cite and describe as tests or indicia of deductibility which are uncontroversial. The controversy arises when courts attempt to apply the general words of these tests or indicia to the facts at hand. So, for instance, where taxpayers looking at SPI may be perplexed is how you reconcile the tests so clearly articulated by the court, with the court s apparent reliance in reaching its decision on what appeared to motivate the state when imposing the s 163AA imposts and that they constituted an extraction by the state of excess profits. The taxpayer has appealed the decision of the Federal Court in SPI to the Full Federal Court. This is an edited version of an article that originally appeared in the International Tax Review. STEWART GRIEVE Partner Tel stewart.grieve@corrs.com.au Page 3

4 AUSTRALIAN INTEREST WITHHOLDING TAX THE PUBLIC OFFER EXEMPTION Interest withholding tax is an issue that appears on the radar of many non-australian lenders to Australian borrowers. One of the first questions that is often asked is whether there are any exemptions. In this article, we provide an overview of the exemption that is most often applicable but which invariably raises queries from foreign parties as a result of its unique and prescriptive conditions for eligibility. That is, the public offer exemption under section 128F of the Income Tax Assessment Act Background The general rate of Australian withholding on interest payments to foreign lenders is 10%, however the rate may be reduced under the terms of a double tax agreement (DTA) between Australia and the lender s country of residence. While there are some specific exemptions in a number of DTAs for payments made to foreign financial institutions 1, the public offer exemption can apply to arrangements involving a broad range of lenders in any foreign country. However, there are a number of strict requirements that must be met, and it is necessary for all parties to focus on these requirements at the time that the loan is established if it is intended that the exemption will be applied in future. Categories of eligible borrowers The exemption applies in relation to Australian borrowers that are companies (or Australian branches of foreign companies). Trusts may also be eligible for the public offer exemption if the beneficiary is a company that is not a trustee. Certain widely-held unit trusts are also eligible for a comparable exemption under section 128FA of the Income Tax Assessment Act Categories of eligible loans The purpose of the public offer exemption is to reduce barriers for Australian borrowers raising finance in international markets, rather than providing a concession for bilateral or intra-group financing. In this regard, the public offer exemption can apply in relation to two broad categories of loans, being structures commonly used for raising multi-lender finance: (a) debentures (including debenture stock, bonds, promissory notes and bills of exchange) and non-equity shares; and (b) syndicated loan facilities (a defined concept discussed below). However, in either case, the parties must satisfy a public offer test. The public offer test For the exemption to apply, it is necessary for the debentures or shares to be offered, or an invitation to participate in the syndicated loan facility to be made, in accordance with one of the following alternatives: (a) to at least 10 non-associated persons carrying on a business of providing finance, or investing or dealing in securities, in the course of operating in financial markets (eg 10 banks); (b) publicly in an electronic form that is used by financial markets for dealing in such loans (such as a listing on a Bloomberg or Reuters screen); (c) in relation to debentures or non-equity shares only, to at least 100 persons that have previously acquired such interests or whom it is reasonable for the borrower to assume as being likely to be interested in acquiring such interests; (d) in relation to debentures or nonequity shares only, as a result of 1 Currently, the countries with which Australia has a DTA in which there is an IWT exemption for payments to financial institutions are: UK, USA, Japan, South Africa, Norway, New Zealand, France and Finland. Page 4

5 being accepted for listing on a stock exchange, where the company had previously entered into an agreement with a dealer, manager or underwriter, in relation to the placement of debentures or nonequity shares, requiring the company to seek such listing; (e) to a dealer, manager or underwriter, in relation to the placement of debentures or debt interests, who, under an agreement with the company, offered the debenture or debt interest for sale within 30 days in a way covered by any of the above. The most common method used is paragraph (a) above, typically involving an offer to 10 separate banks. The offer may be by letter or , setting out the terms of the proposed loan. It is not necessary that all (or even most) of the banks accept the offer. However, the Australian Taxation Office has emphasised that the relevant offers or invitations must be genuine. In this regard, parties should approach this exemption with caution in circumstances where one or more lenders have already been identified and it is intended that an offer to other lenders will be made purely for the purpose of making up numbers without any real prospect of acceptance. If the exemption is to be sought, the parties must be genuinely open to having the offerees participate in the lending arrangement. In all cases, the exemption is only available if the borrower has no reasonable grounds to suspect that one of the lenders will be an offshore associate of the borrower. An associate would include related entities of the borrower however the associates test is broad and should be reviewed prior to making any offers under the proposed arrangement. Syndicated loan facilities If the loan is not in the form of a debenture or non-equity share, then it will be necessary for the loan to be structured as a syndicated loan facility, being a loan meeting all of the following criteria: (a) the agreement must describe itself as a syndicated loan facility or a syndicated facility agreement ; (b) there must be at least two lenders participating in the arrangement at the time that interest is paid (this is a distinct and additional requirement from the public offer test described above); (c) each lender must severally, but not jointly, agree to lend money to the borrower; and (d) the amount of the loan to which the borrower is entitled at first drawdown must be at least AUD 100,000,000. Paragraph (d) above is a key limitation. Where the exemption is sought, the only alternative for smaller loans would be to structure the relevant loan as an issue of debentures or non-equity shares. Navigating the exemption The extent and specificity of the above requirements will often mean that compliance with the exemption can be an ongoing consideration for parties in structuring cross-border loans. In our experience, the requirements are more prescriptive and extensive than foreign parties may be used to in relation to tax compliance measures for loans and this can occasionally be a source of confusion for foreign clients wishing to lend into Australia. Loan documentation will frequently contain detailed representations and undertakings regarding compliance with the requirements of the public offer test, and it is not uncommon for lenders to seek a tax gross-up in their favour in circumstances where there has been a failure by the borrower to satisfy the requirements. SIMON MIFSUD Senior Associate Tel simon.mifsud@corrs.com.au Page 5

6 THE CROSS CITY TUNNEL CASE Major road infrastructure projects involve the design, construction, operation and maintenance of a toll road. The private operator takes a lease of the road from the government for a set period. The key income stream from the project is derived from the right to levy and keep tolls. Accordingly, the tolling right is of critical importance to the viability of the project. The nature and value of a tolling right has recently been considered by the Supreme Court of New South Wales in CCM Holdings Trust Pty Ltd v Chief Commissioner of State Revenue; CCT Motorway Company Nominees Pty Ltd v Chief Commissioner of State Revenue [2013] NSWSC The case involved a change in ownership of a motorway in Sydney funded by the private sector. The CCM group used a classic stapled trust/ company structure for the road. The structure was multi-tiered with a unit trust as the asset owning entity and a company as the operator of the toll road. In particular, the unit trust acquired a lease and the tolling right from the Roads and Traffic Authority and subleased them to the company. The CCM group had been placed into receivership and the relevant transaction essentially involved an acquisition by the taxpayer of the unit trust and company from the receivers. At the time of the relevant transaction, stamp duty at approximately 5.5% was payable on the acquisition of a 50% or more interest in a land rich company or unit trust. A company or unit trust was land rich if it held land or interests in land with an unencumbered market value of 60% or more of the unencumbered market value of all of its property (subject to exclusion of certain property). A key issue in the case was whether the unit trust acquired by the taxpayer satisfied the 60% threshold. If it did then duty was prima facie payable on 100% of the unencumbered value of the lease of the motorway land. The lease held by the trust was clearly an interest in land. A key question was whether the tolling right could be severed from the land lease and, if so whether it was an interest in land and had any substantial value. The taxpayer argued that the tolling right was property in its own right separate from the lease, did not amount to an interest in land and had a significant market value. The court held that the tolling right and land lease were inseparable parts of the composite whole and the tolling right was not therefore a separate item of property. It could not be acquired separately from the lease. All of the value was therefore attributable to the lease and to land. The 60% threshold test was satisfied. Despite this finding, the court was asked to address the other issues raised. The court therefore provided additional insight. It commented that, if the tolling right was separate from the land it would not be an interest in land and it was not unreasonable for it to have a value at least equal to the value of the land lease. In other words, if the tolling right was a separate asset, then the trust would not have been land rich. Implications for other projects The court found that the tolling right was not severable because of, amongst other things, the wording of the relevant statute in New South Wales and the drafting of the suite of documents between the parties. It also held that the relevant tolling right was statutory and not a common law right. So while the decision Page 6

7 is instructive as to the approach of the court, as the only jurisdiction considered in the case is New South Wales, the position could potentially be different for projects in other jurisdictions. In this regard, it can be observed that: The regimes for tolling rights in Australia are not uniform. Should the same issue arise in jurisdictions other than New South Wales the result will depend on the statutory scheme for levying tolls (if any) or if the right to toll arises under the common law rather than under statute. The outcome may be different depending on the drafting of the documents. The concepts of land for stamp duty purposes vary in some respects between the different jurisdictions. Relevance for present stamp duty regimes Australia-wide, there is no longer a 60% threshold test for land rich duty (now called landholder duty) except in Tasmania. Instead, the thresholds range from any land to $2 million land in the jurisdiction. However, certain kinds of intangible property may not be included in the duty base for landholder duty if they are not land or an interest in land as a matter of law. Accordingly, the issue raised in the Cross City Tunnel case is still very relevant. The Commissioner has lodged a notice of intention to appeal the decision because the taxpayer ultimately won the case on another point. The court s finding on the tolling right may therefore be considered afresh. Given that the project is again in receivership it is unknown whether the appeal will proceed because, even if he wins the appeal, the Commissioner will stand as an unsecured creditor. Tax implications Although the case was confined to the stamp duty issues, it is also relevant from an income tax perspective. First, capital gains tax applies to a nonresident that disposes of an interest in a unit trust if the non-resident holds (or has for 12 months in the preceding 2 years held) 10% or more of the units in the trust (the portfolio test), and more than 50% of the assets of the trust are Australian real property (the principal asset test). For these purposes, Australian real property includes a lease of land. Accordingly, the finding that the tolling rights were inseparable from the lease means that the principal asset test would be satisfied and CGT may therefore apply to any non-resident non-portfolio investor in the trust. Second, it raises questions about the application of Division 6C which operates to tax public trading trusts as if they are companies. As indicated above, the CCM group used a classic stapled trust/ company structure for the road. Under Division 6C, a public trading trust is a public unit trust that does not limit itself to eligible investment business, relevantly including investing in land for the purpose or principal purpose of deriving rent. If the trust had been successful in arguing that the tolling rights were a separate asset from the lease, would that have meant it was no longer carrying on an eligible investment business? It seems not, as the structure of the arrangements was that the company mainly paid rent to trust, with the licence fee for the tolling rights being a nominal amount each year. Division 6C specifically provides that a trust will not be a trading trust if not more than 2% of its gross income is from activities other than eligible investment business (provided that the other activities are incidental and related to the eligible investment business). Broader commercial implications The case may have broader commercial implications. For example, if a tolling right is not separate from a lease of land then it cannot be separately assigned to a third party and it may not be possible to provide specific security to a financier over a tolling right. The Cross City Tunnel case is therefore of significance to stamp duty going forward, tax and also from a commercial perspective and may present opportunities and pitfalls that need to be carefully considered in other infrastructure projects. GARY CHIERT Partner Tel gary.chiert@corrs.com.au Page 7

8 GOVERNMENT ANNOUNCEMENT ON UNLEGISLATED TAX CHANGES The Coalition Government inherited 96 announced but unlegislated tax and superannuation measures. It has now decided which of those measures will proceed (some with amendment). Of the 96 measures, 4 have been dealt with as part of the Government s carbon tax and mining tax repeal packages. The summary below identifies the 18 announcements that will be enacted, 3 announcements that will be amended and 7 announcements that have been abandoned altogether by the Coalition. The remaining 64 announcements may not proceed but the Government will undertake consultation before making a final decision 1. Initiatives to proceed as announced 1. Staged increase in excise on tobacco and tobacco-related products. 12.5% increases in tobacco excise on 1 December 2013 and 1 September 2014, 2015 and Restricting the immediate deduction for the cost of acquiring mining rights so that it is only available for genuine exploration activities. 3. Denying access to the R&D tax incentive for large companies with income of $20b or more. 4. Phasing out the net medical expenses tax offset. 5. Indexing tobacco excise to Average Weekly Ordinary Time Earnings (AWOTE) instead of CPI, from March Closing loopholes in the consolidation regime and preventing entities claiming double deductions. 7. Improving compliance through third party reporting and data matching. 8. Increasing the threshold below which lost member superannuation accounts are required to be transferred to the ATO from $2,000 to $4,000 and then to $6, Addressing issues associated with administering Australia s foreign capital gains tax regime and clarifying the operation of Australia s taxing rights over indirect Australian real property interests. 10. Introducing a new tax regime for managed investment trusts which increases certainty and reduces compliance costs. 11. Closing a dividend washing loophole to prevent sophisticated investors double dipping on franking credits. 12. Increasing the off-farm income exclusion threshold for farmers involved in the farm management deposits scheme. 13. Updating the list of specifically listed deductible gift recipients to include Bali Peace Park. 14. Updating the list of specifically listed deductible gift recipients to include the National Arboretum Canberra. 15. Working towards signing and enacting a treaty status inter-governmental agreement with the US to enable the 1 This article does not deal with the 64 announcements, the outcome of which is yet to be determined. Page 8

9 financial sector to comply with US Foreign Account Tax Compliance Act (FATCA) reporting rules. 16. Giving force of law to the revised Australia-Switzerland tax treaty. 17. Allowing foreign pension funds access to the managed investment trust withholding regime. 18. Extending the conduit income measure to exempt foreign managed funds from tax on gains from the disposal of foreign non-portfolio investments. It also exempts those funds from tax on gains from the disposal of certain portfolio Australian financial arrangements. Initiatives to proceed with amendment 1. Tightening and improving the thin capitalisation rules and changing the exemption for foreign non-portfolio dividends will proceed as previously announced. Abolishing the s deduction will not proceed. The government will consult on a targeted integrity rule to address certain conduit arrangements. 2. Closing loopholes in the Offshore Banking Unit regime. The Government is not proceeding with the part of the measure that excludes all related party transactions. It will instead develop targeted rules to address integrity concerns. 3. Restricting refunds of overpaid GST. Amendments address a recent AAT finding it doesn t have jurisdiction to consider refund matters. Initiatives not proceeding 1. Amending the fringe benefits tax regime in relation to cars which made it harder for people to have a company or salary sacrificed vehicle. 2. Imposing a tax on superannuation pension earnings above $100,000 on assets supporting retirement income streams in the draw-down phase. 3. Imposing a $2,000 annual cap on the amount deductible for work-related self-education expenses. 4. The creation of the Super Council or the Charter of Superannuation Adequacy and Sustainability. 5. Introducing amendments to allow public museums and other eligible entities to import cars free of the luxury car tax. 6. Updating the specifically listed deductible gift recipients to include the Tasmanian Centre for Global Learning. 7. Separating the low value import threshold for customs duty and GST purposes. KATHRYN BERTRAM Senior Associate Tel kathryn.bertram@corrs.com.au Corrs Chambers Westgarth, 2013 This publication does not constitute legal advice and should not be relied on as such. You should seek individualised advice about your specific circumstances. We have sent this publication to you because you have requested to receive these publications from us. If you do not wish to receive such publications, please send an with Unsubscribe in the subject heading and containing your name and contact details to privacy@corrs.com.au Page 9