Focus: Budget tax incentive for 'nationally significant' infrastructure
12 May 2011
In brief: Consistent with its broader policy of encouraging private investment in infrastructure, the Federal Government announced as part of the 2011-12 Budget that special treatment would be given to tax losses made by infrastructure projects designated as having 'national significance'. Partner Charles Armitage (view CV) and Senior Associate Rory O'Brien look at how this will work.
- What is the problem at which the proposed changes are directed?
- What is the concession?
- Relevance to lenders
- From when will the concession apply?
- What issues remain to be resolved?
How does it affect you?
- This concession is relevant to all private investors considering investment in infrastructure projects that may be of national significance. Where the concession applies, it would be expected to increase the value and liquidity of an investor's investment in a designated project.
Infrastructure projects are generally undertaken by a special purpose vehicle, either a company or a trust, in order to ensure that lenders to the project only have recourse to the assets of the infrastructure project. As infrastructure projects generally do not generate any income until the infrastructure is built, these special purpose vehicles will generally make substantial tax losses in the first several years of the infrastructure project. It can be many years before special purpose vehicles generate sufficient income to be able to use these losses.
Under current law, in order to be able to use tax losses, a company must satisfy either a 'continuity of ownership test' or 'same business test' from the time the tax losses are incurred until the time the losses are recouped (the rules are more complicated for trusts and, with the exception of listed trusts, trusts cannot rely on the same business test to carry forward tax losses). For infrastructure project special purpose vehicles, the difficulty is that this time gap can be very large, with the result that there is real doubt about whether these tests can be satisfied. Further, even where the tax losses are eventually able to be used, the long time gap between expenditure and the tax recognition of expenditure means that there would not be full tax recognition for expenditure in real terms. This is a significant disincentive to investors.
The Budget papers (and the Treasurer and the Minister for Infrastructure and Transport Joint Media Release No.054 of 2011) address both of these problems by stating that for privately financed infrastructure specifically designated to be of national significance:
- the continuity of ownership and same business tests will not apply to the infrastructure project tax losses; and
- the tax losses will be uplifted at the Government bond rate from the time the tax losses are incurred to the time the losses can be used.
The practical effect of making losses generated by the project immune from the continuity of ownership test is that the losses can 'stay with the project'. As a result:
- lenders to the project are better placed to realise value from enforcing their security over equity interests in the project vehicle; and
- under many typical financing arrangements, the project vehicle is potentially consolidatable for tax purposes with other entities. If the project vehicle becomes a subsidiary member of a tax consolidated group, its tax losses will belong to the head company, not to the project vehicle and thus the tax losses would not be available to a purchaser upon the enforcement by the lenders of their security over the project vehicle. As a result of the proposed concessions, lenders are likely to be more concerned to ensure that the tax losses remain in the particular entity over which they have security and thus be more reluctant to agree to a project vehicle becoming a member of a tax consolidated group. It will remain the case that tax funding and tax sharing agreements will not provide a complete solution to this issue of tax losses slipping out of the security net.
These measures will apply from the date of Royal Assent. From the date of Royal Assent until 30 June 2017, there is a global cap on the projects that can relevantly be determined to be of national significance of $25 billion in total capital expenditure.
There is no specific guidance on the timetable for enacting the relevant legislation, but the Budget papers indicate that there is expected to be a small and unquantifiable revenue impact in the 2013-14 and 2014-15 income years (the last years in the forward estimates period). The Budget papers note the long lead times in building and earning income from infrastructure and, since they are projecting some revenue impact already in 2013-14, this may indicate that the Government intends to progress the relevant legislation very quickly.
There is to be public consultation on the details of these measures. Some interesting issues that will need to be considered as part of this process are as follows:
- It is not clear what decision maker will be empowered to designate infrastructure projects as being eligible for the concession and nor is the criteria they would apply in making that decision.
- It is not clear at what point in time in the investment lifecycle it will be possible to have an infrastructure project designated as eligible for the concession. For example, if to take an extreme example, an application could only be made once funding was fully committed, this might defeat the purpose of encouraging private investment.
- It is not clear what will happen after 30 June 2017. Based on the wording of the Budget papers and the Press Release, it appears most likely that the $25 billion cap will no longer apply, and some new cap may be set. However, it is also possible that post-30 June 2017 investment would simply not be eligible for the concession.
- Private investment in infrastructure projects is often not made all upfront, but is rather tailored to match the capital expenditure program of the project. It appears most likely to us that the concession is intended to apply to investment committed after Royal Assent but before 30 June 2017. However, the position is not clear in relation to:
- investment committed before Royal Assent but actually made after Royal Assent; and
- investment committed before 30 June 2017 but actually made after 30 June 2017;
- If applications for the concession are received in respect of infrastructure projects with a combined value that exceeds the $25 billion cap, would the concession apply on an all-or-nothing basis, or might the cap be pro-rated between projects.
- In addition to the continuity of ownership test and same business tests, there may also be other loss integrity measures that it is appropriate to exclude from applying. For example, in some cases, if capital injections are made into an entity, this has the potential to restrict the use of tax losses; and
- As the loss integrity rules for trusts and companies are different, and both trust and companies are used as infrastructure project special purpose vehicles, it will be important to ensure that the relevant legislation appropriately deals with both types of entity. Sometimes there are also commercial reasons to use relatively complex structures and the relevant legislation should take this into account as well.
- Charles ArmitagePartner,
Ph: +61 2 9230 4756
- Martin FryPartner,
Ph: +61 3 9613 8610
- Katrina ParkynPartner,
Ph: +61 7 3334 3323
- Leighton O'BrienPartner,
Ph: +61 2 9230 4205