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Special Determination S59: Equity Subordinated Notes in respect of a Limited Partnership Interest in a Public–Private Partnership

This Determination may be cited as Special Determination S59: Equity Subordinated Notes in respect of a Limited Partnership Interest in a Public–Private Partnership.

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

  1. This determination relates to the issue of equity subordinated notes (ESNs) by a limited partnership (Holdings LP) to two of its limited partners (the Subscribers). The ESNs will be deemed to be repaid at a single, or several, nominated date(s) in the future, with the proceeds used to satisfy the Subscribers’ obligation to contribute a total of 60% of the required capital of Holdings LP. The timing of the partnership contributions will match those made by the other limited partner in Holdings LP (Limited Partner C, a limited liability company).
  2. The Subscribers are both limited partnerships. The first (Limited Partner A) has two limited partners, one of which is a limited liability company (Limited Partner A1) and the other of which is itself a limited partnership (Limited Partner A2) with multiple limited partners, some of whom are exempt from income tax. The second (Limited Partner B) is a limited partnership with multiple limited partners, some of whom are exempt from income tax.
  3. Limited Partner C, Limited Partner A1, and each limited partner of Limited Partner A2 and Limited Partner B that is 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.
  4. The ESNs will earn a fixed rate of interest that is payable monthly (Coupon Interest Payments) until the ESNs are repaid or deemed to have been repaid. The Coupon Interest Payments will be capitalised on each interest payment date, with additional ESNs issued in satisfaction of the interest payments.
  5. The interest rate on the ESNs will be approximately 6.22% per annum. No fees are payable by Holdings LP or the Subscribers in relation to the ESNs.
  6. This Determination prescribes the method for determining the amounts that are solely attributable to the excepted financial arrangement, as well as the method for spreading the income and expenditure under the financial arrangements rules.

2. Reference

This determination is made under ss 90AC(1)(bb), 90AC(1)(d) and 90AC(1)(h) of the Tax Administration Act 1994.

3. Scope of determination

  1. This determination applies to the ESNs issued by Holdings LP to the Subscribers as part of a wider transaction entered into by the parties. That wider transaction is the subject of the Private Rulings.
  2. The terms of the ESNs are as follows:
    1. The ESNs will be drawn in full at Financial Close and will have a face value equal to 60% of the total capital requirement of Holdings LP.
    2. The ESNs will earn a fixed rate of interest that is capitalised monthly until the ESNs are repaid or deemed to be repaid (the Coupon Interest Payments).
    3. Additional ESNs will be issued in satisfaction of the Coupon Interest Payments.
    4. The interest rate payable under the ESNs will not exceed the arm’s length rates that would have been agreed between wholly unrelated parties having regard to the terms of the convertible notes and applying orthodox pricing methodologies.
    5. No fees are payable by Holdings LP or the Subscribers in relation to the ESNs.
    6. On issue of a Call Notice from Holdings LP for the contribution of partnership capital, the requisite number of ESNs will be deemed to be repaid to meet the Subscribers’ funding obligation under the Call Notice. The amount payable on repayment of the ESNs will be offset against the obligation to contribute capital to Holdings LP.

4. Principle

  1. The ESNs are a financial arrangement (as defined in section EW 3). An interest in a partnership is an excepted financial arrangement (section EW 5(11)). Therefore, the ESNs are a financial arrangement that includes an excepted financial arrangement.
  2. Under section EW 6(2), an amount that is solely attributable to an excepted financial arrangement is not taken into account under the financial arrangements rules.
  3. Any amount that is not solely attributable to an excepted financial arrangement is required to be taken into account under the financial arrangements rules and spread in accordance with those rules.
  4. Under section EW 14(3), an amount calculated for, and allocated to, an income year under a spreading method will either be expenditure incurred or income derived by the person.
  5. Determination G1A: Apportionment of Income and Expenditure on a Daily Basis sets out a method for calculating and allocating income and expenditure on the basis of daily apportionment.

5. Interpretation

In this determination, unless the context otherwise requires:

  • All legislative references in this determination are to the Income Tax Act 2007, unless otherwise stated.
  • ESNs means the unsecured equity subordinated notes, in a denomination of $1.00 issued by the Holdings LP to the Subscriber.
  • Private Rulings means Private Rulings BR Prv 18/45 and BR Prv 18/46, issued on 3 April 2018, and includes any Rulings issued to replace those Rulings, provided that the change to the relevant Ruling does not affect the application of this determination.
  • Taxable Limited Partners has the same meaning as in the Private Rulings.

6. Method

  1. Any change in the market value of the interest in Holdings LP (between the issue date of the ESNs and any deemed repayment of those ESNs and associated capital contribution to Holdings LP) will be solely attributable to the excepted financial arrangement.
  2. The Coupon Interest Payments are not solely attributable to an excepted financial arrangement, and therefore must be spread under the financial arrangements rules. There will be no other amounts of income or expenditure under the financial arrangements rules in relation to the ESNs.
  3. Under section EW 14(3), the Coupon Interest Payments will be:
    1. expenditure incurred by the Taxable Limited Partners; and
    2. income derived by Limited Partner A1 and the limited partners of Limited Partner A2 and Limited Partner B that are not exempt from income tax.
  4. Income and expenditure in respect of the ESNs will be calculated by daily apportionment of the Coupon Interest Payment to income years in accordance with Determination G1A: Apportionment of Income and Expenditure on a Daily Basis.

7. Example

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

On 1 April 2018, ESNs are issued to the Subscribers for $1,000. The ESNs will be deemed to have been repaid when a call is made by Holdings LP for partnership capital (on 31 March 2023).

The Coupon Interest Payments will be set at a market interest rate of approximately 6.22% and will be capitalised on each monthly interest payment date, with additional ESNs issued.

The annual sum of Coupon Interest Payments as at 31 March, from 2019 to 2023, is:

Date Amount
31 March 2019 $64.00
31 March 2020 $68.10
31 March 2021 $72.46
31 March 2022 $77.10
31 March 2023 $82.03
  $363.69

On the date of issue, the market value of a 60% partnership interest in the Partnership is $1,000. Any change in the market value between the date of issue and 31 March 2023 will be solely attributable to an excepted financial arrangement.

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 Income and Expenditure on a Daily Basis.

This Determination is signed by me on the 3rd day of April 2018.

Howard Davis
Manager (Taxpayer Rulings)