The ATO’s overall position on a number of infrastructure related tax issues are set out in a draft ‘Privatisation and Infrastructure – Australian Federal Tax Framework’ (the Framework), released in January 2017 for consultation. The Framework is non-binding and is described as a ‘living document’ that the ATO intends to update as new transactions, issues and/or tax laws impact the analysis.

Adopting a modern Promethean approach, the ATO has given life to the Framework by moulding together some of its existing views, modifying some previously expressed views and guidance and adding some new content.

The remaining three chapters are new and address certain privatisations of government businesses to stapled structures, infrastructure related issues and ‘red flag’ areas for ATO compliance.

Public Private Partnerships (PPPs)

Chapter 1 of the Framework sets out the ATO view on the typical structure used to deliver PPPs.

The ATO specifically restricts the views in the Framework to ‘social’ PPPs, that is where the consortium will finance, construct and maintain the infrastructure and the Government will obtain title to and repay the consortium for the infrastructure over time (e.g. schools, hospitals, prisons).

The ATO views do not apply to ‘economic’ PPPs, which the ATO identifies as PPPs involving user fees being used to repay the consortium’s cost of construction and financing, rather than payments from the government.

Typical structure

The structure discussed in the Framework reflects the following typical PPP structure:

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The ATO is comfortable with the exact structure set out in Chapter 1. The key positions of the ATO in relation to this structure are:

  • Thin capitalisation will not apply to the finance company, even where the consortium members are non-residents;
  • TOFA will apply to the securitisation of the licence payments such that finance company will be assessed on the net gain on the arrangement on an accruals basis; and
  • Part IVA will not apply to the structure.

These positions are consistent with the earlier draft version of this chapter released in December 2015.

ATO view of compliance risks

According to the ATO, variations on the ‘vanilla’ securitised licence structure have begun to emerge over the last few years. The ATO has identified variations on the typical structure that it regards as representing a high compliance risk. These are discussed in Chapter 4 and include:

  • Arrangements where the term or profile of the licence payments is such that deductions are spread over a period of less than 20 years (see our comments below).
  • Arrangements where availability payments are back-ended resulting in the deferral of taxable income.
  • Fabricated PPPs – which the ATO identifies as ‘economic’ PPPs where the securitisation of the licence fees is used as a substitute to paying an amount to the government to run a monopoly business. A key aspect of this structure is that the Government retains a portion of the receivables purchase price in effect as an upfront payment for the rights to run the business.
  • Fabricated PPPs and withholding tax – another concern that the ATO has in respect of ‘fabricated PPPs’ is the use of stapled or common ownership structures to convert ‘active income’ from the underlying business to ‘passive income’ resulting in distributions to non-residents being subject to a withholding tax rate of between nil and 15%.
  • Capital stripping PPPs – which the ATO identifies as a variation on the typical structure that uses nominal equity in the Project Trust with almost all of the income from the Project Trust being used to pay licence fees to the government (which are securitised), potentially resulting in what would otherwise be a capital loss at the end of the project being converted into deductible licence payments.
  • MIT – use of a MIT interposed between certain types of non-resident investors and a consortium PPP holding trust, which does not control the consortium PPP and does not cause the consortium PPP holding trust to be a public unit trust, in order to access the concessional 15% withholding tax rate for fund payments to non-resident investors in information exchange countries (this is also relevant for non-PPP structures). The ATO has particular concern in relation to:
    • arrangements to ‘fracture’ control (e.g., where an interposed MIT does not control the consortium PPP holding trust but its unitholders do have effective control of that trust);
    • MITs that are wholly owned by one beneficiary and may not satisfy the requirement to be a managed investment scheme or the requirement that investment management activities take place in Australia.
  • Arrangements where it is argued that the section 128F withholding tax exemption applies and where the interposition of a Finance Company that is owned by a charitable trust obscures the connection between the lender and borrower for the purposes of the section 318 associate test.

Privatisation of Government businesses into stapled structures

In keeping with the ATO’s purported approach of providing guidance for taxpayers to ‘swim between the flags’, Chapter 2 sets out guidance on the permitted structure for particular types of privatisations.

Taxpayers who adopt certain positions in relation to the specific privatisations identified in Chapter 2 can bathe in the ‘comparative safety’ of the ATO not applying compliance resources. For taxpayers considered not to be ‘swimming between the flags’, the ATO repeatedly states that it will apply compliance resources, and that taxpayers cannot rely on Chapter 2 for a privatisation into a stapled structure that is not identical to the type described, and cannot rely on Chapter 2 if there is any departure from the structure or tax treatments outlined by the ATO.

Privatisations to which Chapter 2 applies

Chapter 2 is essentially the ‘separate general guidance’ on privatisations of businesses which are effectively land (and land improvement) based, which are expressly carved out of Taxpayer Alert 2017/1. It only applies to privatisations with the following characteristics:

  • The government business being privatised must be ‘land rich’.
  • The means of ‘asset transfer’ is by way of:
    • the consortium paying consideration by way of a lease premium for the grant of a long-term lease of the Land Assets; and
    • the ‘transfer’ of the other government business assets (i.e. non-Land Assets such as intangibles) to the consortium for consideration.
  • The consortium uses the Land Assets together with the other assets to run the privatised Government Business for the period of the long-term lease (for which there may be a renewal at the end of the term).
  • In some cases, the consortium agreeing to operate, maintain and sometimes upgrade or expand, the assets of the business over the term of the long-term lease.

There are generally only a handful of privatisations of government businesses that are ‘land rich’ each year. Given the high dollar values and public profile of these privatisations, the ATO will typically engage with taxpayers in any event. The recent trend is for this engagement with the ATO to culminate in a Tax Deed whereby certain tax positions in respect of the downstream structure and the tax consequences for investors upon exit are agreed upfront based on the principles contained in Chapter 2.

The ATO will apply compliance resources, and consider the application of Part IVA to the stapled structure itself, to a privatisation of a ‘land rich‘ government business where a taxpayer does not adopt the structure and/or tax treatment outlined in Chapter 2 – effectively the ‘stick’ to pressure taxpayers into entering into a Tax Deed or otherwise engaging with the ATO.

Tax treatment of the down-stream structure

The guidance provided by the ATO in Chapter 2 is in keeping with the ATO approach that the assets of the Asset Trust and Operating Entity form part of a single unified business.

Purchase price allocation

The ATO acknowledges that the allocation of the total ‘purchase price’ between the lease premium and the price for the other assets is likely to be a difficult process and will materially impact the tax implications of the structure. The ATO identifies the following factors as being relevant in determining whether a given ‘purchase price’ allocation is a low compliance risk:

  • The nature of the business being privatised.
  • If the business income is subject to Government regulation or supervision, the way in which the revenue amounts are determined / applied.
  • The pre-privatisation financial statements and/or (if relevant) the value of assets used by the regulator in determining the maximum allowable revenue amount.
  • The manner in which the value of tangible assets are determined as distinct from intangible assets.
  • Previous and comparable privatisation transactions.

The ATO sets out the flags in discussing Part IVA in Chapter 2 and states that it ‘will typically provide to bidders for a potential privatisation what it considers to be a low risk purchase price allocation.’

Approach to pricing the sub-lease

The ATO makes its view clear that pricing a sub-lease in a manner that is inconsistent with the Framework will be considered high risk. ATO compliance resources are likely to be applied to consider a raft of measures, including the deductibility of rental payments under section 8-1, whether the Asset Trust’s activities constitute an investment in land for the purpose of deriving ‘rent’ as relevant for the purposes of Division 6C and the MIT rules, the application of the non-arm’s length rule for MITs and the application of Part IVA.

In Chapter 4, the ATO indicates that sub-leases that have been entered into between stapled entities on non-arm’s length terms is an area of compliance focus. The ATO’s comments in paragraph 4.2 on the ‘illegitimate use of stapled structures’ suggest that the ATO may view the entire rental amount payable under such a sub-lease as being non-arm’s length income on the basis that arm’s length parties would not have entered into the lease in the first place.

In pricing the periodic rentals under the sub-lease on arm’s length terms, the ATO notes that each of the Asset Trust and the Operating Entity must make an appropriate return on their capital assets. The ATO expects that the pricing of the periodic rent would result in the market value of each entity being in the same proportion as the allocation of purchase price (assuming the same portion of gearing).

In the context of what constitutes an investment in land for the purpose of deriving rent, the ATO identifies features of a sub-lease rental arrangement that it considers may indicate that the Asset Trust is a trading trust. These features include where rental payments are a substantial component of the profits of the Operating Entity, result in minimal taxable income in the Operating Entity or do not represent an appropriate return to the Asset Trust having regard to the purchase price allocation.

The ATO cannot make specific comments about whether a trust would be regarded as investing in land as this is obviously a product of particular facts (and even then the law is uncertain). However, given that the ATO includes port assets, and electricity distribution and transmission assets, as examples in the Framework it can be implied that the ATO considers that these asset can potentially satisfy the definition.


The ATO expects that the gearing of each entity will be broadly the same (notwithstanding that the nature of their underlying assets are different, on the basis that the ATO views the assets as being part of one overall businesses). The ATO regards unequal levels of gearing as being primarily tax motivated and would regard this feature as high risk from a compliance perspective.

Cross-staple loans

The ATO flags that it will consider the debt/equity integrity rules together with section 8-1 and Division 230 in determining whether interest on loans from the Asset Trust to the Operating Entity is deductible. For on-lent amounts that ATO would expect a small, if any, margin over the price of external debt incurred by the structure.

Consistent with its views expressed in TA 2017/1, the ATO notes that an example of the Asset Trust controlling, or being able to control, the trading business conducted by the Operating Entity would arise where the cross-staple loan results in the Operating Entity’s continuation as a going concern being contingent on the Asset Trust deciding not to exercise its right to trigger the Operating Entity's insolvency.

The ATO is concerned that there may be tax leakage where deductions of the Asset Trust are not properly allocated against interest income, in determining the net interest distributed by the Asset Trust which is then subject to the interest withholding tax rules (as compared to being taxed on an assessment basis or at MIT withholding rates for other income).

Part IVA

The ATO makes the bold assertion that where a transaction displays any of the following features, this would lead to a conclusion that Part IVA would apply to the entire transaction (and not simply to the particular offending feature):

  • rental payments under the sub-lease (or any other instrument) are calculated to capture profits of the Operating Entity;
  • the Asset Trust and the Operating Entity having unequal levels of gearing – referring to an example where the Asset Trust is 40% geared and the Operating Entity 99% geared; and/or
  • the purchase price allocation does not have a reasonable basis, having regard to the factors described above under the heading Purchase price allocation.

Other items in Chapter 2

The ATO makes a number of non-controversial observations about the application of Division 40, Division 58, Division 250, Division 43 and Division 57 as well as comments on the character of a lease premium. The ATO has helpfully confirmed that a Government entity can make an election under the tax law to treat an appropriate long term lease as a sale (and therefore transfer the entitlement to capital allowances under Division 43 to the lessee) despite being exempt from tax itself.

Chapter 2 also flags that where the bid is made on a stamp duty inclusive basis, and the stamp duty payable appears disproportionately high, that the ATO may review the allocation of the bid price.

A number of items are identified as being beyond the scope of the Framework, including what constitutes land and what constitutes rent (despite the ATO’s comments in paragraph 2.3.5 of the Framework), the tracing rules in Division 6C, the meaning of ‘right to remove’ in the context of section 40-40 and the types of lease that create the ability to make elections under CGT event F2.

Tax treatment of upstream / feeder-level structure

In Chapter 2, the ATO makes a number of non-controversial observations and/or restates the law in relation to the tax treatment of certain features of a privatisation, including the cost base of equity interests in the Asset Trust and Operating Entity, the Division 6 net income of a trust, tax deferred distributions, MIT status and fund payment withholding.

Unitholder debt

The ATO acknowledges that in addition to debt borrowed by the Asset Trust and the Operating Entity, investors may also seek to gear their equity investment into the Asset Trust and the Operating Entity. The ATO flags that where the unitholder debt is related party debt, this could potentially be considered high risk if deductible against Australian income.

The ATO does not mention whether it would make any difference if the related party debt could be traced back to external debt, but notes that the transfer pricing rules in Division 815 and the thin capitalisation rules in Division 820 and Part IVA should be carefully considered by taxpayers. The ATO flags that in addition to providing case by case guidance, it will be issuing general guidance in the future in relation to these aspects.

Control for the purpose of the MIT rules and Division 6C

The ATO identifies that there may be compliance risk where particular investors control the Operating Entity (addressed in more detail in our Chapter 3 comments) and goes on to say that the ATO will likely allocate compliance resources to test whether there is control through conduct and/or formal understandings where an investor holds 20% or more, and will allocate compliance resources in this regard where an investor has a 30% stake or more.

Capital gains tax and Division 855 – restructuring and exiting

The ATO makes some general non-controversial observations about the likely capital gains tax consequences for a non-resident investor under Division 855. Features of an exit that are identified as a concern to the ATO, and which the ATO flags as potential Part IVA risks, include:

  • taxpayers treating an asset as ‘land’ for Division 6C purposes and not treating the same asset as ‘real property’ for Division 855 purposes;
  • inappropriate allocation of sale proceeds (similar concepts to the factors that the ATO identifies as being relevant for allocating the purpose price); and/or
  • pre-sale restructuring to create more value in the Operating Entity and less value in the Asset Trust.

Potential revenue account treatment on sale

The ATO acknowledges that any profit on sale could give rise to ordinary income. The Framework does not provide guidance on this point but other ATO publications do. The Australian tax treatment will depend on whether the income is from an Australian source, whether the investor is resident in a treaty country and how the particular tax treaty operates.

The ATO states that if SPV trusts which hold the units in the holding trust have an Australian permanent establishment, the enterprise carried on by the trustee of the SPV trusts is deemed to be a business carried on by the foreign investors with the result being that investors would generally be subject to tax on any profit or gain made by the trustee of the SPV trusts on a sale of the holding trusts.

Infrastructure related issues

Chapter 3 of the Framework sets out the ATO’s views on a number of infrastructure-related issues that are not addressed elsewhere in the Framework.

Customer cash contributions or reimbursements

The ATO considers that where a customer pays an amount to an infrastructure network owner for adding to, extending or modifying their network (for example, adding an electricity connection to a new property, or relocating network assets to allow construction of a mine), the payment will always be assessable income to the network owner, even if it is applied to construct or improve a capital asset, because receipt of such payments is an ordinary incident of the business of the network owner.

While the ATO analysis might hold where receiving such payments is in fact an ordinary incident of the business, in our experience that may not always be the case.

Government grants

The Framework states that government grants in relation to infrastructure assets will be assessable income in essentially all circumstances under section 6-5 or section 15-10, regardless of whether it is received by a holding company before construction commences or during construction.

This is an interesting view (to say the least) given that the ATO has issued a number of rulings confirming that ARENA grants received before construction of a project commences are neither assessable under section 6-5 (the grant cannot be a product of income-producing activity before such activity commences), nor assessable under section 15-20 (the funds are not received in relation to carrying on a business if a business has not commenced) but are instead taxed under the assessable recoupment rules.

Gifted assets

Lessee constructs the asset

The first ‘gifted asset’ example addressed in the Framework is where a lessee constructs a fixture (the example is a wharf), legal ownership of which vests in the lessor and use of which will pass to the lessor on expiration of the lease at a time when the fixture is still valuable.

The Framework states that at the expiration of the lease the lessor will derive an amount of assessable income equal to the value of the asset at that time (less any recipient’s contribution) under sections 21A and 6-5. While that conclusion appears reasonable (subject to our comments below in relation to market values), the Framework does not state that the lessee will be entitled to a balancing adjustment deduction equal to the adjustable value of the asset (i.e. assuming it is a depreciating asset) on the basis that the terminating value is nil.

Expanded network

The second scenario is where an electricity network is expanded (for example, an estate developer constructing poles and wires) and the expansion is transferred to the network owner for no consideration.

The Framework states that the network owner will derive an amount of assessable income equal to the value of the asset at that time (less any recipient’s contribution) under sections 21A and 6-5. This scenario is essentially the same as the customer cash contribution with the contribution being provided in kind. As set out above, assessability in this scenario would depend on whether receiving the network expansion is in fact an ordinary incident of the business of the network owner. The Framework also recognises that the construction costs may be non-capital and therefore deductible to the transferee in some circumstances.

Market value of ‘gifted asset’

The Framework also states that the market value of an asset in a gifted asset scenario is to be calculated using construction costs if the gifting occurs shortly after construction, or replacement cost otherwise.

Given that market value is a question of fact, this is unlikely to be correct in every case. For example, in the electricity network expansion example, the treatment of the asset for regulatory asset base calculation purposes may also be highly relevant to the market value of such an asset (i.e. an asset that is gifted but not included in the RAB may effectively be worthless to the taxpayer).

Capitalised labour

The ATO maintains its view that:

  • employment costs for employees engaged in the design, construction or upgrade of depreciating assets are capital costs which will form part of the Division 40 cost of the asset, rather than being immediately deductible;
  • costs of an employee engaged in a mixture of, for example, repair and construction, need to be allocated accordingly; and
  • employment expenditure which is capitalised under the accounting standards should be capitalised for tax purposes.

The ATO notes that it will apply compliance resources to test positions taken by taxpayers that are contrary to its view on capitalised labour. This issue is not a new one and there is significant doubt as to whether the ATO’s position is correct, particularly where an employee is engaged in a mix of work.

Undergrounding power lines

The ATO states that undergrounding power lines is not a repair, but rather is an outgoing of capital because it is not undertaken for the purposes of remedying defects from wear and tear, damage, etc.

This conclusion seems non-controversial, however the ATO has issued conflicting private rulings on this point in the past (copies of which are publicly available, see also Example 5 in TR 97/23).

Control for the purposes of Division 6C

Given the importance of Division 6C in both the infrastructure and property sectors, and the ‘trading trust’ requirement for MIT qualification, this issue has implications beyond the infrastructure sector and will be particularly relevant to the funds management sector. The ATO’s views are also relevant to the ‘associate entity’ test for thin capitalisation purposes.

The ATO has reiterated its previous views (widely disputed by taxpayers and advisers alike) that an entity will ‘control’ a trading business for Division 6C purposes if it has the power to veto (but not pass) a decision that goes towards the carrying on of a trading business. In this regard, the Framework sets out a list of decisions which are considered to go to the carrying on of a trading business, including approval or amendment of strategic budgets or entry into additional debt. Conversely, issuing shares, varying share rights, amending distribution policies and material changes in business are matters which are considered not to go to the carrying on of a trading business.

While the purpose of this Tax Brief is not to provide a detailed response to the ATO’s views on negative control, it is important to note that the ATO’s view is based on decisions about the meaning of control for the purposes of the Broadcasting and Television Act 1942, which involved a very different statutory context to Division 6C. In particular, provisions in the Broadcasting and Television Act deemed an entity who held 15% of the voting rights attached to shares in a company to be in a position to control the company. It is therefore not surprising that the Court found that ‘control’ had a broad meaning for the purposes of that Act, and held that a person in a position to appoint 50% of a company’s board of directors (and therefore veto every decision of the company) was in a position to control the company for Broadcasting and Television Act purposes.

The Framework includes a number of examples about circumstances in which entities will, and will not, control a trading business carried on by another entity. The examples are reflective of the ATO’s position that ‘control’ for Division 6C purposes includes negative control (or veto rights).

Fracturing of control interests

In Chapter 4, the ATO identifies a variety of ways in which an ultimate investor may seek to fracture its control interest to:

  • ensure that interposed entities are not subject to Division 6C and remain eligible as a MIT; and/or
  • achieve higher gearing levels under the thin capitalisation rules.

The ATO considers that fracturing control interests gives rise to a high compliance risk where an ultimate investor’s stake is held through multiple interposed trusts instead of one (the example is a 40% stake split into two separate 20% stakes). The ATO is also concerned with structures that include different types of control and/or veto rights held by certain entities which don’t reflect the economic substance of an investment, and governance arrangements that the ATO views as being put in place to enable non-eligible investment business income producing assets to be held by the flow through asset trust.

Although the ATO’s comments around ‘fracturing of control interests’ seem non-controversial, the interesting part of this issue is the ATO’s view on what constitutes control of a trading business, and what constitutes control generally.