Taxation of financial arrangements: identification of arrangement - facility agreement

Will the rights and obligations under a facility agreement form a single arrangement under subsection 230-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The rights and obligations under a facility agreement will form a single arrangement under subsection 230-55(4) of the ITAA 1997. The rights and obligations in respect of each draw down under the facility agreement will not constitute separate arrangements.

A company (the borrower) enters into a syndicated loan facility agreement with an arms length party (the lender). The borrower is a special purpose vehicle created to finance a specific project.

The lender will commit to advance funds up to an agreed credit limit provided certain pre-requisites are met. These include the completion and service by the borrower to the lender of a valid notice of draw down stating, amongst other things, the amount to be drawn down and the term required. The timing and the amount of each draw down is set out in, and occurs under, a pre-determined draw down schedule. The borrower intends to draw down the full amount available under the facility for the specific purpose of funding the project.

The first draw down will occur shortly after the facility becomes available. The borrower will pay a commercial rate of interest which is applied to the balance of the funds drawn down that remain outstanding from time to time under the facility.

The loan facility agreement itself will terminate in five years and each draw down will be required to be repaid on the basis of a common amortisation schedule and must be fully repaid within five years. Each successful notice of draw down imports the terms and conditions contained in the facility agreement.

In order to determine whether Division 230 of the ITAA 1997 applies to certain rights and obligations, those rights and obligations need to be tested to see if they meet the definition of a financial arrangement in subsection 230-45(1) of the ITAA 1997. The identification of a financial arrangement is in turn dependent on the identification of the parameters of the arrangement as determined by subsection 230-55(4) of the ITAA 1997.

Whether a number of rights and/or obligations form an arrangement or are two or more separate arrangements is a question of fact and degree. Division 230 of the ITAA 1997 relies on the broad definition of an arrangement under subsection 995-1(1) of the ITAA 1997. Division 230 also provides additional guidance as to which specific rights and obligations should be combined to form the relevant arrangement to be tested for the purposes of the Division. A contract will often define the boundaries of an arrangement, especially where the form of the contract is consistent with its substance. Relevantly, paragraph 2.47 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 states: "The various rights and obligations subsisting under a contract will typically constitute the relevant arrangement for the purposes of Division 230. That is, the contract is typically viewed on a 'stand alone' basis. In this context, the contract is neither aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230."

However, section 230-55 of the ITAA 1997 is not limited by the form of a single contract in the identification of an arrangement. Specifically, under subsection 230-55(4) of the ITAA 1997 regard is to be had to a range of factors in order to determine whether the arrangement comprises other additional rights and obligations or is limited to only some of those rights and obligations. The combination of various rights and obligations under subsection 230-55(4) is an objective enquiry, the purpose of which is to identify the correct 'unit of taxation' in the context of Division 230 of the ITAA 1997.

The issue that arises in respect of a facility agreement is how the various rights and obligations are combined under subsection 230-55(4) of the ITAA 1997 to form an arrangement and whether or not the draw downs made under the facility agreement form individual arrangements in their own right.

Subsection 230-55(4) of the ITAA 1997 states that whether a number of rights and/or obligations form an arrangement or are two or more separate arrangements is a question of fact and degree that you determine having regard to the following: (a) the nature of the rights and/or obligations; (b) their terms and conditions (including those relating to any payment or other consideration for them); (c) the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved); (d) whether they can be dealt with separately or must be dealt with together; (e) normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole); (f) the objects of Division 230.

The facility agreement creates contingent rights to receive and obligations to provide financial benefits for the lender and the borrower. Under section 230-85 of the ITAA 1997, rights and obligations subject to a contingency are treated as rights and obligations for the purposes of Division 230 of the ITAA 1997.

When each drawn down is made, rights and obligations that are not subject to a contingency exist between the lender and the borrower. These include, for the lender, an obligation to provide financial benefits (advances of funds) and rights to receive financial benefits (repayment of principal and interest). For the borrower it has, in respect of each draw down, a right to receive financial benefits (the right to receive the principal amount under the draw down request) and obligations to provide financial benefits (the obligations to make principal and interest payments).

Having regard to the factors in subsection 230-55(4) of the ITAA 1997, it is appropriate to consider the rights and obligations comprising the facility agreement as constituting a single arrangement. Therefore, the rights and obligations in respect of each individual draw down are not considered to constitute separate arrangements in their own right.

Specifically, the facility agreement is entered into to finance a project and the parties intend that all of the funds available under the facility agreement will be utilised. The first draw down will occur within a short timeframe after the facility becomes available and subsequent draw downs will occur under a pre-determined draw down schedule which directly relates to the borrower's financial obligations under the project.

The amounts drawn down under the facility are repaid on the basis of a common amortisation schedule, that is, amounts drawn down form an overall outstanding balance owing by the borrower and interest is calculated on that overall outstanding balance. Commercially this indicates that the facility agreement and the draw downs made under it are regarded as a series of rights and obligations that form a whole.

These circumstances, together with the purpose and intention of the parties, indicate that the rights and obligations under the facility agreement comprise a single arrangement. The rights and obligations in respect of each draw down should not be considered as individual arrangements.

Whether or not the facility agreement is a financial arrangement will depend upon whether it satisfies the definition of 'financial arrangement' in subsection 230-45(1) of the ITAA 1997.