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Special Determination S27A: Convertible notes in respect of a limited partnership interest

This determination may be cited as Special Determination S27A: Convertible Notes in respect of a limited partnership interest.

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

  1. This determination varies and replaces Special Determination S27: Convertible Notes in respect of a limited partnership interest following a change of partners in the limited partnership.
  2. This determination relates to the subordinated convertible notes (Convertible Notes) issued by the Holding Partnership to Limited Partner A which will convert to a 45% partnership interest at a single or several nominated dates in the future to match the partnership contributions by Limited Partner B and some of the partnership contributions by Limited Partner C.  The Convertible Notes are being issued to provide equity funding to the Holding Partnership as part of an arrangement (the Project) involving the finance, design, construction and ongoing operation of the Facility by the Partnership under a public-private partnership agreement with the Crown. 
  1. Limited Partner C intends to transfer their interest in the Holding Partnership to Limited Partner C1 in late 2015.  This determination applies to:
    1. Limited Partner A and Limited Partner B from the date of signing;
    2. Limited Partner C from the date of signing until the date that they transfer their interest to Limited Partner C1; and
    3. Limited Partner C1 from the date that the interest is transferred to them.
  1. Limited Partner A and Limited Partner C1 have agreed that Limited Partner A will have the option to sell up to 9.9% of the equity interest in the Holding Partnership (along with up to 9.9% of the shareholding in General Partner 1, in equal proportions) to Limited Partner C1.  It is envisaged that if the option is exercised it will be exercised after the Convertible Note has converted to committed capital, noting that early exercise rights do exist in limited situations. 
  2. The Convertible Notes will earn a fixed rate of interest that is payable monthly (Coupon Interest Payments) until the Convertible Notes are converted. The Coupon Interest Payments will be capitalised on each interest payment date but will be paid to Limited Partner A on the first partnership distribution date, and therefore will not convert to a partnership interest.
  3. The conversion to a partnership interest will be effected by way of a mandatory set off.  Limited Partner A's obligation to make its capital contribution(s) will be satisfied by setting off that obligation against the Holding Partnership's obligation to repay that portion of the Convertible Notes equal to the capital contribution(s) required to be made on the relevant date.
  4. The rate of interest will be an arm's length rate determined under an agreed rate setting process.
  5. No commitment fees or upfront fees are payable on the Convertible Notes.
  6. In accordance with s EW 6(2) an amount (whether it is income, consideration, gain, loss or expenditure) that is solely attributable to an excepted financial arrangement is not taken into account under the financial arrangement rules.
  7. As an interest in a partnership is an excepted financial arrangement under s EW 5(11), only the Coupon Interest Payments are regarded as income or expenditure for the purposes of calculating accrual income or expenditure.
  8. This Determination prescribes a method for determining the part of the consideration receivable by the parties to the arrangement that is solely attributable to the excepted financial arrangement as well as the method for spreading the accrual income, gain or loss, or expenditure under the financial arrangement rules.

2. Reference

This determination is made under ss 90AC(1)(bb) and 90AC(1)(h) of the Tax Administration Act 1994. This determination varies and replaces Special Determination S27A: Convertible Notes in respect of a limited partnership interest and applies to:

  1. Limited Partner A and Limited Partner B from the date of signing;
  2. Limited Partner C from the date of signing until the date that they transfer their interest to Limited Partner C1; and
  3. Limited Partner C1 from the date that the interest is transferred to them.

3. Scope of determination

  1. This determination applies to the Convertible Notes issued by the Holding Partnership to Limited Partner A as part of the Project (which is set out in detail in Private Rulings BR Prv 15/38 and BR Prv 15/39 issued on 8 September 2015). The terms of the Convertible Notes are as follows:
    1. Limited Partner A will loan an amount to the Holding Partnership (subject to the prevailing market rates at Financial Close) with repayment being set off against the  obligation to make capital contribution(s) in respect of a 45% interest in the Holding Partnership at a single or several nominated dates in the future.  The Convertible Notes will have a face value equal to 45% of the total equity requirement (being all of Limited Partner A's 45% interest in the Holding Partnership). 
    2. The Convertible Notes will earn a fixed rate of interest that is payable monthly until conversion, defined as the construction swap rate exclusive of charges, plus a margin.  For Financial Close, the construction swap rate will be calculated based on the prevailing swap rates as determined by standard market methodology. 
    3. The Coupon Interest Payments will be capitalised on each interest payment date, and paid out to Limited Partner A on the first partnership distribution date, that is, the Coupon Interest Payments will not convert to a partnership interest.
    4. The rate of interest will be an arm's length rate determined under an agreed rate set process.
    5. No commitment fees or upfront fees are payable on the Convertible Notes.
    6. The Convertible Notes (and any interest payable on the Convertible Note) are subordinated to senior debt.  After conversion of the Convertible Notes, Limited Partner A will rank equally with Holding Partnership contributions made by the other limited partners. 
  1. This determination is made subject to the condition that the executed documentation is not 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 Convertible Notes have both debt and partnership interest components. They can be regarded alternatively as:
    1. a loan to a partnership with repayment by way of an interest in a partnership (debt component); or
    2. a forward purchase of a partnership interest (in which case the holder of the Convertible Notes is buying an interest in the partnership).
  2. The financial arrangement rules in the Act classify an interest in a partnership as an excepted financial arrangement under s EW 5(11).
  1. As the Convertible Notes have this dual character, when calculating income derived or expenditure incurred in relation to the Convertible Notes it is first necessary to separate the debt and partnership interest components of the Convertible Notes.
  2. This determination specifies that, apart from the Coupon Interest Payments, all amounts relate to the underlying interest in a partnership, and will not be dealt with under the financial arrangement rules (subpart EW) when calculating income derived or expenditure incurred.
  3. Income and expenditure in respect of the Convertible Notes is calculated by daily apportionment of the Coupon Interest Payment to income years in accordance with Determination G1A: Apportionment of Daily Income and Expenditure.
  4. For the purposes of this determination it is assumed that any change in the market value of the interest in the partnership between the issue date of the Convertible Notes and the conversion into the partnership interest relates to the partnership interest component and therefore can be ignored when calculating income derived or expenditure incurred under the financial arrangements rules.

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.
    • Coupon Interest Payment means any amount payable on the Convertible Notes by the Convertible Note issuer (borrower) to the Convertible Note holder (lender) other than payments relating to the redemption or conversion of the Convertible Notes.
    • Financial Close has the same meaning as set out in the Project Agreement referred to in Private Rulings BR Prv 15/38 and BR Prv 15/39. 
    • Limited Partner A is the holder of the Convertible Notes
    • the Holding Partnership is the issuer of the Convertible Notes
    • Subordinated Convertible Notes or Convertible Notes means the arrangement described in clause 3(1) of this determination.
  1. For convenience, words and phrases defined in this determination are indicated by initial capital letters, but the absence of a capital letter shall not alone imply that the word or phrase is used with a meaning different from that given by its definition.

6. Method

  1. Amounts to be included when calculating income or expenditure under the financial arrangements rules with regard to the Convertible Notes in respect of income, gain or loss, or expenditure, and also of any other consideration receivable by the holder or payable by the issuer, consist of the Coupon Interest Payments.
  2. The income derived or expenditure incurred in respect of the Convertible Notes shall be calculated by daily apportionment of the Coupon Interest Payments to income years. The required method is outlined in Determination G1A: Apportionment of Daily Income and Expenditure.
  3. All other income, gain, loss, expenditure or consideration paid under or with respect to the wider financial arrangement is solely attributable to the excepted financial arrangement component of the wider financial arrangement.

7. Example

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

The example assumes the following:

  • On 1 April 2014 a Convertible Note is issued to the holder for $1,000 with an interest coupon set at the arm's length interest rate of 8.5%. The Convertible Note will convert to a 45% interest in a partnership on 31 March 2019.
  • The conversion to a partnership interest will be effected by way of a mandatory set off.  The holder's obligation to make its capital contribution will be satisfied by setting off that obligation against the issuer's obligation to repay the Convertible Note.
  • Coupon payments accrue monthly, in arrears and are compounding. Interest will be paid to the holder on the first partnership distribution date.
  • On the date of issue, the limited partners have agreed that the market value of a 45% partnership interest on 31 March 2019 is $1,000.00.
  • The parties use a 31 March balance date and apply Determination G1A on a 365 day basis when apportioning daily income and expenditure.
  • The annual sum of Coupon Interest Payments is as follows:

  • 31 March 2015 88.39
    31 March 2016 96.20
    31 March 2017 104.71
    31 March 2018 113.96
    31 March 2019 124.04
      527.30
    The amounts that must be spread under the financial arrangements rules are the Coupon Interest Payments which shall be apportioned using the method outlined in Determination G1A: Apportionment of Daily Income and Expenditure.

This Determination is signed by Howard Davis on the 8th day September 2015.

Howard Davis
Director (Taxpayer Rulings)