The Federal Government has released for consultation exposure draft legislation which proposes to introduce tax loss incentives for designated infrastructure projects.
The proposed changes will affect entities who undertake large scale infrastructure projects and investors and financiers of such projects.
This initiative builds on the government’s short-term commitment to support private investment in infrastructure projects which is considered to be a national priority.
The draft legislation, if enacted in its current form, will allow selected infrastructure project entities to:
- uplift their carry forward tax losses incurred during construction of the project by the 10 year Government Long Term Bond Rate;
- carry forward their tax losses for use in later income years without the need to satisfy the requirements for the use of such losses (such as the majority control tests and same business tests); and
- exempt these entities from the restrictions in deducting bad debts.
How is the change beneficial to the infrastructure sector?
There is often an extensive time lag between the construction phase of an infrastructure project (when tax losses may be incurred) and its operational phase where profits may be realised. This means that tax losses remain “trapped” for many years until much later when the project becomes profitable.
The ability to uplift these tax losses each year by the 10 year Government Long Term Bond Rate (currently at approximately 3.03%) allows the real value of these losses to be maintained whilst the entity remains designated.
The continuity of an infrastructure project is also often dependent on further investment by additional entities, which can impact the ability of the entity to utilise its tax losses under the current tax rules. The new rules propose to allow the entity to keep its losses through a change in its ownership.
Who can qualify for the benefit?
Only entities that are designated infrastructure project entities are able to qualify for the tax concessions. To qualify under the draft legislation at a particular time (referred to as the relevant time):
- the entity must be a company or fixed trust which is not a member of an income tax consolidated group at the relevant time;
- the entity must carry on a single investment in, or enhancement to, infrastructure at the relevant time or a later time (ie the Infrastructure Project);
- the only activities carried on by the entity at the relevant time, or before the relevant time, are for the purpose of the entity carrying on the Infrastructure Project (referred to as the Sole Purpose Test); and
- the infrastructure project must be, or must become, a designated infrastructure project (“DIP”).
We provide further detail on these requirements below.
What is a designated infrastructure project?
Infrastructure projects will only qualify for the tax loss concessions where they are approved as a DIP by the Infrastructure Coordinator under the Infrastructure Australia Act 2008 (Cth) (“IAA”).
The Infrastructure Coordinator may designate projects as provisional or final DIPs before 1 July 2017 unless a later date is prescribed. However, only projects which have reached financial close or where financial close is imminent may be designated as a final DIP.
More specifically, the draft legislation provides that an infrastructure project is eligible to be approved as a DIP by the Infrastructure Coordinator if the following conditions are satisfied:
Click here to view table.
What are the tax concessions?
The proposed measures are short-term in that the tax concessions discussed below are proposed to apply to designated infrastructure project entities from the 2012-2013 income year (and later income years), where the DIP has been designated before 1 July 2017 (unless a later date is prescribed).
Ability to utilise and carry forward losses
Generally, a company or fixed trust is prevented from carrying forward and utilising its losses from earlier years unless it satisfies the continuity of ownership test or same business test (in relation to a company and certain listed widely held trusts) or the 50% stake test (in relation to fixed trusts). The continuity of ownership test and 50% stake test generally require that the entity maintain a majority of the same members who control it (or are entitled to distributions) for a certain period of time. The same business test requires the entity to carry on the same business activities for a certain period of time. Those periods of time are referred to as the test time.
The Exposure Draft provisions seek to remove these limitations for designated infrastructure project entities to carry forward and utilise their losses. It generally does this by moving the test time forward to the time at which the designated infrastructure project entity stops being a designated infrastructure project entity. Fixed trusts that are designated infrastructure project entities are also specifically exempted from the trust loss limitations. The effect is that these rules can be disregarded whilst the entity is a designated infrastructure project entity.
As a result, if the entity is sold to another entity, the accumulated tax losses of the entity can continue to be utilised by the entity after the change in its majority control.
However, if the entity ceases to be a designated infrastructure project entity, the entity will need to satisfy the majority control (or same business) tests to carry forward its losses. An entity may cease to be a designated infrastructure project entity if it forms part of an income tax consolidated group or otherwise starts to carry on an activity which is not for the sole purpose of carrying on the infrastructure Project (that is, it breaches the Sole Purpose Test). Alternatively, if the entity is wound up, any undeducted tax losses will be lost.
Uplift of tax losses
An entity that satisfies the criteria to be a designated infrastructure project entity in an income year can (subject to other requirements in the Exposure Draft) uplift the balance of any tax losses it has not utilised in the previous year by the Australian Government Long Term Bond Rate. The uplift occurs at the end of an income year in which the loss is carried forward (or utilised), but before the loss is actually utilised. The uplift applies to revenue tax losses.
The losses can continue to be uplifted until the losses are utilised by the entity, or the entity stops being a designated infrastructure project entity. If the entity stops being a designated infrastructure project entity (as discussed above), the uplifted loss amount is retained but is not uplifted further.
It should be noted that, based on the current drafting of the eligibility criteria for a designated infrastructure project entity, and the comments in the Explanatory Memorandum to the Exposure Draft, an entity is able qualify as a designated infrastructure project entity (and therefore uplift its losses incurred in past years) in circumstances where the project is not yet a DPI, or the entity has not yet begun carrying on the project, as long as the project becomes a DPI or the entity begins carrying it on. These entities would not need to amend their past assessments (unless they have already utilised some of the losses), but are advised in the Explanatory Memorandum to the Exposure Draft to notify the Australian Taxation Office of the revised carry forward amounts. Note our comments below in respect of project entities that are currently in existence.
The Exposure Draft also contains similar proposed measures removing the limitations to deducting bad debts for designated infrastructure project entities. We expect these rules to be less relevant for an infrastructure project entity than the proposed tax loss rules.
Other key aspects of the draft legislation
Single investment in, or enhancement to, infrastructure
This requirement (which applies for an entity to be eligible for designated infrastructure project entity status) is unclear, and can be interpreted in a broad or narrow sense. The Explanatory Memorandum to the Exposure Draft provides no explanation as to the intention behind, or meaning of, this requirement.
As stated above, if the relevant entity which is to carry out the infrastructure project is (or is to be) a trust, it can only be eligible for the tax concessions under the proposed rules if it is a “fixed trust”. A trust will be a fixed trust where its beneficiaries have fixed entitlements to the income and capital of the trust. In practice, whether a trust qualifies to be a fixed trust is currently uncertain, and generally the only way to get certainty is to request the Commissioner of Taxation to exercise his discretion.
In this regard, on 30 July 2012, the Australian Government released a Discussion Paper dealing with this specific issue, entitled "A more workable approach for fixed trusts". It is, therefore, possible that once any reforms are enacted, there may be greater clarity on the meaning of "fixed trust". However, until that time, if the Exposure Draft legislation is passed in its current form, care should be taken in using a trust as the relevant entity which carries out the infrastructure project, as it is important to ensure that the trust is a fixed trust before the concessions will potentially apply.
Public Private Partnerships (PPPs)
Many infrastructure projects are conducted by PPPs with the relevant project vehicle being a partnership. Therefore, as the proposed rules do not apply at the partnership level, partners themselves will need to determine whether they satisfy the relevant conditions. Partners that are members of an income tax consolidated group will not be entitled to the tax concessions.
The Exposure Draft legislation provides that an entity that forms part of an income tax consolidated group is not eligible to access the tax concessions.
That is, if the entity becomes wholly owned by a member of an income tax consolidated group, it will cease to be entitled to the tax concessions under the proposed rules. However, certain measures have been proposed to ensure that the head company of the income tax consolidated group can utilise the (previously uplifted) losses of the infrastructure entity. That is, the measures seek to make it easier for an entity to transfer its losses to the head company on joining the income tax consolidated group.
The approach taken in the Exposure Draft differs to the initial approach taken in the Discussion Paper in relation to the interaction of these new rules with tax consolidation (see our alert on the Discussion Paper titled “Proposed new rules for tax losses for certain infrastructure projects” dated 26 October 2011). The approach in the Discussion Paper was to allow a wholly owned subsidiary member of a head company to be notionally kept outside the income tax consolidated group as a separate entity (although it would ordinarily be a member of the group) for the purposes of applying the proposed rules. That is, the rules were proposed to apply to those entities that were “kept outside” the income tax consolidated group. It is not clear why the Australian Government’s approach has changed. Possible reasons could include:
- the difficulty of separating losses within the consolidated group and applying those losses against different types of income (eg DIP losses and non-DIP losses); and/or
- the difficulty in determining the nature of the business activities of the entity (for the purpose of applying the Sole Purpose Test) because of the application of the ‘single entity rule’ which applies in an income tax consolidated group context.
Project entities that are currently in existence
The tax concessions will only apply to tax losses for the 2012-2013 income year and later income years. Therefore, an existing company or fixed trust that has incurred losses prior to the 2012-2013 income year will not obtain the benefits of the tax concessions for those losses (irrespective of whether the entity later becomes a designated infrastructure project entity under the rules). However, based on the Exposure Draft and draft IPDS, it may be possible for infrastructure projects that are already in existence to be designated under the rules, provided the relevant conditions are satisfied.
You may access the draft legislation here.
You may access the draft IPDR here.
Please contact us if you would like any further information in relation to the proposed new rules.
Requirements for designation as a DIP under the draft IPDR
Click here to view table.