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Technical tax area Ngā tūmomo whakataunga me ngā aratohu

Special Determination S29: Application of the financial arrangements rules to a public-private partnership

This determination may be cited as Special Determination S29: Application of the financial arrangements rules to a public-private partnership.

Note  
This determination was varied and replaced by Special Determination s29A on 8 September 2015. It therefore applies for the period from 25 July 2014 to 8 September 2015.

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 Facility 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, Limited Partner B and Limited Partner C.  This determination does not apply to Limited Partner C.
  2. The Project Agreement comprises three basic components:
    • 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 in which the Partnership and the Crown enter and 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 the Partnership will provide operation and maintenance services to the Crown over a 25 year term in consideration for monthly payments (the Unitary Charge).
  3. The Partnership will enter into:
    • A Construction Agreement with a contractor (the Contractor), under which the Contractor will design and construct the 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.
  4. The Partnership will raise external debt from a range of third party financiers (the Bank Debt).  Limited Partner C will provide a term debt facility (the Term Debt Facility) to the Partnership to supplement the Bank Debt.
  5. The Holding Partnership will receive funding from Limited Partner C during the D&C Phase in the form of a convertible debt instrument (the Convertible Note). 
  6. The Partnership will enter into Interest Rate Swaps in respect of the Bank Debt.
  7. 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, Bank Debt, Term Debt Facility 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. 
  8. Special Determination S27: Convertible Note in respect of a limited partnership interest applies to the Convertible Notes.  Special Determination S28: Application of the financial arrangement rules to the D&C Phase in a public-private partnership applies to the D&C Payment under the D&C Phase.
  9. This determination prescribes:
    • The amount of consideration that is solely attributable to the 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;
    • The method for spreading the payments made under the Bank Debt, Term Debt Facility and Interest Rate Swaps.

2. Reference

  1. This determination is made under ss 90AC(1)(bb) and 90AC(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 Rulings BR Prv 14/31 and BR Prv 14/32 issued on 25 July 2014), including the following arrangements:
    • The D&C Phase of the Project Agreement, 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 (which is the subject of Special Determination S28: Application of the financial arrangement 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 for 25 years to the Crown in consideration for monthly payments;
    • The Facility Lease, under which the Partnership will lease the Facility from the Crown for 25 years and 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, 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;
    • Bank Debt, under which the Partnership will borrow an agreed sum from external lenders for a term of 7 years from financial close of the Project (Financial Close). The Bank 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 Bank Debt will be refinanced within 7 years of Financial Close, and every 7 years thereafter over the term of the Project. Under IFRS (as the standards apply at the date of this Determination), the Bank 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 or not hedge accounting is applied), and will not be treated as a hedge of another financial arrangement;
    • 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;
    • Term Debt Facility under which the Partnership will borrow an agreed sum from Limited Partner C during the D&C Phase for a market rate of interest that converts to an amortising senior tranche on the Conversion Date.  The Term Debt Facility will be recognised under IFRS as a financial liability and initially recorded at fair value plus integral fees. Subsequent measurement will be at amortised cost using the effective interest method;
    • Convertible Note issued by Holding Partnership to Limited Partner C for the duration of the D&C Phase.  On a single or several nominated dates during the D&C Phase, the Convertible Note will convert (by way of mandatory set off) into a partnership interest in Holding Partnership for Limited Partner C (which is the subject of Special Determination S27: Convertible Note in respect of a limited partnership interest).
  2. This determination is made subject to the following conditions:
    • Limited Partner A and Limited Partner B use IFRS to prepare financial statements.
    • Limited Partner A and Limited Partner B will recognise income derived from the Crown during the D&C Phase of the Project Agreement 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 arrangement rules).
    • Limited Partner A and Limited Partner B do not use the fair value method for the Bank Debt or Term Debt Facility if the Bank Debt or Term Debt Facility 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.
    • Limited Partner A and Limited Partner B will recognise income and expenditure in respect of the Convertible Note in the manner prescribed by Special Determination S27: Convertible Note in respect of a limited partnership interest.
    • Limited Partner A and Limited Partner B will recognise income in respect of the D&C Payment in the manner prescribed by Special Determination S28: Application of the financial arrangement rules to the D&C Phase in a public-private partnership.
    • The continued application of Private Rulings BR Prv 14/31 and BR Prv 14/32 issued on 25 July 2014.
    • The executed documentation not being materially different from the final documentation that was provided to Inland Revenue on 23 July 2014 to the extent that it impacts on the scope of the determination or the application of the financial arrangement rules to the Applicants and the scope of the determination.

4. Principle

  1. The 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 arrangement rules (s EW 6(2)). This determination specifies the amounts that are solely attributable to the Facility Lease that are not taken into account under the financial arrangement rules.
  2. The O&M Phase, Construction Agreement and O&M Contract are "short-term agreements for sale and purchase" as defined in s YA 1, and are excepted financial arrangements under s EW 5(22). 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 Agreement and O&M Contract are required to be spread under the financial arrangements rules.
  3. The D&C Phase, Bank Debt, Interest Rate Swaps and Term Debt Facility 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 Bank Debt, Interest Rate Swaps, and Term Debt Facility 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 or the Convertible Note which are subject to separate determinations (Special Determination S27: Convertible Note in respect of a limited partnership interest and Special Determination S28: Application of the financial arrangement rules to the D&C Phase in a public-private partnership).

5. Interpretation

  1. In this determination, unless the context otherwise requires-
    • "IFRS" means International Financial Reporting Standards as defined in s YA 1.
    • All legislative references in this determination are to the Income Tax Act 2007, unless otherwise stated.

6. Method

  1. The Rental Prepayment paid in respect of the Facility Lease, and the property interest granted to the Partnership under the Facility Lease, are solely attributable to the Facility Lease and are not taken into account under the financial arrangement rules.
  2. Limited Partner A and Limited Partner B 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 Bank 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 Bank Debt over the term of the relevant refinancing, provided that the terms of any such refinancing are materially similar to the terms of the Bank Debt. This determination paragraph does not affect Partner A or Partner B'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 Term Debt Facility. None of the restrictions for the application of this reporting method in s EW 15D(2B) apply.
  6. The expected value method in s EW 15F may be used to allocate income and expenditure (other than "non-contingent fees" as defined in s YA 1) over the term of the Interest Rate Swaps provided that the swaps are not treated as a hedge of other financial arrangements for which the "fair value method" is used.  None of the mandatory spreading methods in s EW 15H or s EW 15I apply to the Interest Rate Swaps.
  7. This determination does not affect Limited Partner A or Limited Partner B's obligation to perform base price adjustments under s EW 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 July 2014
Completion of D&C Phase                                                                   30 June 2019
Completion of O&M Phase                                                                  30 June 2044
D&C Payment from the Crown                                                                     $1,000
Aggregate payments to the Contractor                                                          ($850)
Facility Lease prepayment                                                                        ($1,000)
Monthly payments from the Crown during the O&M Phase                                    $30
Monthly payments to the Service Provider                                                       ($15)
Annual interest on the Bank Debt ($85)
Annual interest on the Term Debt Facility                                                          ($7)
Annual interest (and inflation adjustment) on the Convertible Note                       ($15)
Annual net payments in respect of the Interest Rate Swaps                                  ($7)

The Partnership is 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 Bank Debt calculated in accordance with the IFRS financial reporting method in s EW 15D;
  • Interest on the Term Debt Facility 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;
  • Amounts in respect of the Convertible Note as specified in Special Determination S27: Convertible Note in respect of a limited partnership interest;
  • Amounts in respect of the D&C Payment as specified in Special Determination S28: Application of the financial arrangement rules to the D&C Phase in a public-private partnership.

This Determination is signed by me on the 25th day of July 2014.

Howard Davis
Director (Taxpayer Rulings)