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Special Determination S41: Application of the financial arrangements rules to a public-private partnership agreement

This Determination may be cited as Special Determination S41: "Application of the financial arrangements rules to a public-private partnership agreement".

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 asset management and facilities maintenance services in respect of a prison (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.
  2. The sole limited partner in the Holding Partnership will be Investor Limited Partner, a limited partnership with multiple limited partners, some of whom are exempt from income tax. The limited partners of Investor Limited Partner that are not exempt from income tax are together referred to as the Taxable Limited Partners. This determination only applies to the Taxable Limited Partners and does not apply to those limited partners that are exempt from income tax.
  1. 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;
    • Leases of part of the Existing Facility and the New Facility by the Crown to the Partnership (together, the Facility Leases), under which the Partnership pays amounts representing the rental under the Facility Leases to the Crown (the Rental Prepayments); and
    • An asset management and facilities maintenance phase (the AM/FM Phase), under which the Partnership will provide asset management and facilities maintenance services to the Crown in consideration for monthly payments (the Unitary Charge). Asset management and facilities maintenance service will be provided from the Applicable Service Commencement Date until the Actual Termination Date (a date specified in the event that the Project Agreement is terminated) or the Expiry Date, being 25 years from the Full Service Commencement Date.
  1. The Partnership has entered into an Early Works Construction Subcontract with a contractor (the Contractor), under which the Contractor will provide earthworks and any associated works that are required to form the building platform for the Facility.
  1. The Partnership will enter into:
    • a D&C Subcontract with the Contractor, under which the Contractor will design and construct the Facility in consideration for monthly and milestone payments; and
    • an Asset Management and Facilities Maintenance Contract (the AM/FM Subcontract) with a service provider (the Service Provider), under which the Service Provider will provide the on-going asset management and facilities maintenance (and other) services in consideration for monthly payments.
  1. The Partnership will raise external debt from third party financiers (the Senior Debt). The Partnership will enter into Interest Rate Swaps in respect of the Senior Debt.
  2. The Investor Limited Partner will provide investment support during the D&C Phase in the form of a standby letter of credit (the Letters of Credit) to the external lenders.
  3. The Facility Leases, AM/FM Phase of the Project Agreement, Early Works Construction Subcontract, D&C Subcontract and AM/FM Subcontract are all excepted financial arrangements.
  4. The D&C Phase of the Project Agreement, Senior Debt, Interest Rate Swaps and Letters of Credit are financial arrangements to which the Partnership is a party.
  5. The Project, including all of these agreements, is a wider financial arrangement.
  1. This determination prescribes:
    • the amount of consideration that is solely attributable to the Facility Lease;
    • how the financial arrangements rules apply to the AM/FM Phase of the Project Agreement, the Early Works Construction Subcontract, the D&C Subcontract and the AM/FM Subcontract;
    •   the method for spreading the payments made under the Senior Debt, Interest Rate Swaps and Letters of Credit.

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 Ruling BR Prv 15/35 issued on 4 September 2015), 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 S42: Application of the financial arrangements rules to the D&C Phase of a public-private partnership).
    • The AM/FM Phase of the Project Agreement, under which the Partnership will provide on-going asset management and facilities maintenance services to the Crown in consideration for monthly payments. Asset management and facilities maintenance service will be provided from the Applicable Service Commencement Date until the Actual Termination Date (a date specified in the event that the Project Agreement is terminated) or the Expiry Date, being 25 years from the Full Service Commencement Date.
    • The Facility Leases, under which the Partnership will lease the complete Facility (the New Facility Lease) and part of the existing Facility (the Existing Facility Lease) from the Crown and make the Rental Prepayments to the Crown. The leases commence from the Applicable Service Commencement Date until the Actual Termination Date (a date specified in the event that the Project Agreement is terminated) or the Expiry Date, being 25 years from the Full Service Commencement Date. The Rental Prepayment for the New Facility Lease will be equal to and will offset the D&C Payment.
    • An Early Works Construction Subcontract and a D&C Subcontract with the Contractor, under which the Contractor will design and construct the Facility in consideration for payments under the D&C Subcontract.
    • An AM/FM Subcontract with the Service Provider, under which the Service Provider will provide the on-going asset management and facilities maintenance (and other) services in consideration for payments under the AM/FM Subcontract.
    • Senior 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 Senior Debt will include a capitalising, interest only senior debt facility that converts to an amortising senior tranche on the Conversion Date and a debt servicing facility. It is expected that the Senior 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 Senior Debt (and any subsequent re-financings) will initially be recognised at fair value plus integral fees, and subsequently measured at amortised cost using the effective interest method (regardless of whether hedge accounting is applied). The Senior Debt will not be treated as a hedge of another financial arrangement.
    • Letters of Credit, under which Investor Limited Partner will provide equity support in favour of the Holding Partnership and the Senior Lenders. The Holding Partnership will pay Investor Limited Partner an annual Investment Support Fee for the provision of the Letters of Credit. The Investment Support Fee will be an arm's length fee.
    • 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.
  1. This determination is made subject to the following conditions:
    • The Taxable Limited Partners use IFRS to prepare financial statements.
    • The Taxable Limited Partners will recognise income derived from the Crown during the D&C Phase of the Project Agreement and the AM/FM Phase of the Project Agreement, and will deduct expenditure incurred in relation to the Facility Leases, Early Works Construction Subcontract, D&C Subcontract and AM/FM Subcontract, in each case, under the relevant provisions of the Income Tax Act 2007 (outside of the financial arrangements rules).
    • The Taxable Limited Partners each do not use the Fair Value method for the Senior Debt if the Senior Debt 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.
    • The Letters of Credit are not treated as a hedge of another financial arrangement.
    • The Taxable Limited Partners will recognise income in respect of the D&C Payment in the manner prescribed by Special Determination S42: Application of the financial arrangements rules to the D&C Phase in a public-private partnership.
    • The continued application of Private Ruling BR Prv 15/35 issued on 4 September 2015.
    • The executed documentation not being materially different from the final documentation provided to Inland Revenue on 25 February 2015, 21 August 2015 and 28 August 2015 to the extent that it impacts on the scope of the determination or the application of the financial arrangements rules to the Applicants and the scope of the determination.

4. Principle

  1. The Facility Leases are excepted financial arrangements 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 arrangements rules (s EW 6(2)). This determination specifies the amounts that are solely attributable to the Facility Leases that are not taken into account under the financial arrangements rules.
  2. The AM/FM Phase, Early Works Construction Subcontract, D&C Subcontract and AM/FM Subcontract 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 AM/FM Phase, D&C Subcontract and AM/FM Subcontract are required to be spread under the financial arrangements rules.
  3. The D&C Phase, Senior Debt, Interest Rate Swaps and Letters of Credit are "financial arrangements" under s EW 3. This determination specifies that the payments made to or by the Taxable Limited Partners, in proportion to their share in Investor Limited Partner, under the Senior Debt, Interest Rate Swaps, and Letters of Credit 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, which is subject to a separate determination (Special Determination S42: Application of the financial arrangements rules to the D&C Phase in a public-private partnership).

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.
    • Capitalised terms have the same meaning as set out in the Project Agreement.
    • "Applicable Service Commencement Date" for the Existing Facility is the Existing Facility Service Commencement Date and for the New Facility is the Full Service Commencement Date.
    • "Existing Facility Lease" means the lease of part of the Existing Facility.
    • "Facility Leases" means the Existing Facility Lease and the New Facility Lease.
    • "IFRS" means International Financial Reporting Standards as defined in s YA 1.
    • "New Facility Lease" means the lease of the New Facility.
    • "Project Agreement" is a public-private partnership agreement between the Partnership and Her Majesty, the Queen in right of New Zealand acting by and through the Chief Executive of the Department of Corrections (the Crown).
    • "Rental Prepayments" mean the rent payable under the New Facility Lease and the Existing Facility Lease that is to be prepaid.
    • "Senior Debt" means the external debt financing arrangements including the Construction Facility, the Term Facility and the Debt Service Reserve Facility.

6. Method

  1. The Rental Prepayments paid in respect of the Facility Leases, and the property interest granted to the Partnership under the Facility Leases, are solely attributable to the Facility Leases and are not taken into account under the financial arrangements rules.
  1. The Taxable Limited Partners are not required to spread any amounts under the financial arrangements rules in respect of the:
    • AM/FM Phase of the Project Agreement;
    • Early Works Construction Subcontract;
    • D&C Subcontract; and
    • AM/FM Subcontract.
  1. 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 Senior Debt and none of the restrictions for application of the IFRS financial reporting method contained in s EW 15D(2B) apply.
  2. 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 Senior Debt over the term of the relevant refinancing, provided that the terms of any such refinancing are materially similar to the terms of the Senior Debt. This determination paragraph does not affect the Taxable Limited Partners' obligation to perform a base price adjustment under s EW 31 at the time of each refinancing.
  1. None of the mandatory spreading methods in ss EW 15H or EW 15I apply to the Interest Rate Swaps.  Over the term of the Interest Rate Swaps, income or expenditure may be allocated using either:
    • the expected value method in s EW 15F (other than "non-contingent fees" as defined in s YA 1) provided that the swaps are not treated as a hedge of other financial arrangements for which the "fair value method" is used, or
    • the IFRS financial reporting method in s EW 15D (other than "non- integral fees" as defined in s YA 1) provided that the swaps are not treated as a hedge of other financial arrangements for which a method other than the IFRS financial reporting method is used,
  2. provided that each Taxable Limited Partner uses the same method for the entire term of the Interest Rate Swaps.
  1. This determination does not affect the Taxable Limited Partners' obligation to perform base price adjustments under s EW 31 in respect of the Interest Rate Swaps.
  2. 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 Letters of Credit. None of the restrictions for the application of this reporting method in s EW 15D(2B) apply.

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 2015
Completion of D&C Phase
30 June 2020
Completion of O&M Phase
30 June 2045
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 Senior Debt
($85)
Annual net payments in respect of the Interest Rate Swaps
($7)
Annual Investment Commitment Fee for the Letters of Credit
($7)

The Taxable Limited Partners are not required to spread any amounts under the financial arrangements rules in respect of the Facility Leases, AM/FM Phase of the Project Agreement, Early Works Construction Subcontract, D&C Subcontract and AM/FM Subcontract.

The amounts that must be spread under the financial arrangements rules are:

  • Interest on the Senior Debt 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 or the IFRS financial reporting method in s EW 15D;
  • Payments in respect of the Letters of Credit calculated in accordance with the IFRS financial reporting method in s EW 15D; and
  • Amounts in respect of the D&C Payment as specified in Special Determination S42: Application of the financial arrangements rules to the D&C Phase in a public-private partnership.

This Determination is signed by Howard Davis the 4th day of September 2015

Howard Davis
Director (Taxpayer Rulings)