Leveraged Leasing and Leasing to Government and other Tax Preferred Entities
The general structure of leveraged leasing in Australia is also determined within the Commonwealth taxation framework.
The July 1983 Tax Ruling IT2051 set down the guidelines for ‘acceptable’ leveraged leases. Where the transaction is structured according to this Ruling and does not have any other unusual feature, it is not necessary to seek Tax Office approval. The Ruling covers debt/equity ratio (20 percent), capitalisation of charges (not allowed) and residual values (fair estimate of market value at lease end).
Subsequently in June 1985 a further Ruling (IT2169) extended a number of these requirements to equity or partnership leases.
Another area where leasing structures have been affected by tax laws is leasing to tax exempt public and semi-government authorities. Following the announcement of restrictions in December 1981 (denying the Investment Allowance in leveraged arrangements where a tax exempt was the real end-user), and June 1982 (denying all ownership deductions (depreciation, interest and Investment Allowance) in leveraged or similar arrangements where overseas plant or sale-and-leasebacks to tax exempts was involved), in May 1984 Division16D of Part III of the Act was added (Sns 159GE-GO) which effectively required that traditional finance leases to these bodies be tax accounted by lessors only using the ‘finance’ method (i.e. the interest earned from the transaction). The rationale behind this was to deny the depreciation claim (among other deductions) for (especially State and Territory) public sector and overseas (‘cross border’) equipment investment against Commonwealth Revenue caused by the lessor using the ‘asset’ method (i.e. rentals less depreciation).
Unfortunately aspects of the Division 16D definitions as to what constituted a finance (as distinct from operating) lease differed from the accounting standard with the result that many operating leases could not be offered to government authorities. Of particular concern was the requirement that where the total repayments under the arrangement exceeded 90 percent of the cost price of the property, the arrangement was a finance lease – in the accounting standard this 90 percent test relates to the present value of the repayments. Over the years AELA has made several submissions seeking that present value be taken into account.
Following from the RBT recommendations, the Government proposed a new legislative framework to replace Division 16D (and section 51AD), which govern the tax treatment of leasing and similar arrangements with tax preferred entities
In August 2007 the government introduced the long-awaited tax-exempt asset financing reforms, Division 250, which replaced Division 16D and Section 51AD. Division 250 applies to leasing and similar arrangements between taxpayers (e.g. lessors) and the tax preferred sector. Arrangements coming within Division 250 are denied capital allowances, and taxed as a financial arrangement on a compounding accrual basis.
The Division broadly applies where the taxpayer does not have the ‘predominant economic interest’ in the asset. Short-term and relatively lower value arrangements are excluded, ie where the arrangement does not exceed 12 months or where the ‘financial benefits’ are less than $5 million. The Division does not apply to hire purchase arrangements with a tax preferred entity, and these are treated as ‘notional loans’ under Division 240 of the ITAA.
Finance leases to tax-exempt bodies prima facie come within Division 250 because they contain a guaranteed residual value, and operating leases are prima facie within this Division if they are ‘effectively non-cancellable’ or the present value of the expected financial benefits under the lease exceed 70% of the market value of the asset. However, both finance and operating leases are excluded if any of the following applies: the lease does not exceed 12 months; or the taxpayer (ie lessor) is a small business entity; or the financial benefits under the lease do not exceed $5 million. There is a further exclusion for leases of non-real property, where certain criteria are met.
In relation to public sector leasing, from the 1993-94 year, the previous Loan Council Global Limits for borrowing were replaced by Loan Council Allocations which include operating leases as a memo item where payments under such leases have a net present value of more than $5 million. In March 1994, Guidelines for Loan Council Coverage of Infrastructure Projects with Private Sector Involvement were issued. The risk-weighting approach involves estimating the degree of public sector risk exposure in an infrastructure project and including that exposure in the particular State or Territory’s Loan Council Allocation.
With a range of privatisations involving assets of previously exempt entities entering the private sector, in 1998 the Government introduced a number of technical amendments (effective from 4 August 1997) to limit the depreciation deductions that can be claimed by purchasers of tax exempt entities, to the higher of the asset’s notional written down value or its undeducted pre-existing audited book value.
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