Contributed by Aldrin De Zilva, Director, Nicholas Rouse, Special Counsel, Naison Seery, Associate, Daniel Paolini, Senior Associate and Ryan Leslie, Senior Associate, Greenwoods & Herbert Smith Freehills
On 7 February 2019, Moshinsky J handed down his judgment in the Federal Court decision of Victoria Power Networks Pty Ltd v FC of T 2019 ATC ¶20-682 (the VPN decision). The case concerned the assessability of customer contributions “received” in cash or “gifted” assets by electricity distributors in the VPN group for “uneconomic” connections — being connections where the distributor’s “incremental revenue” would not exceed its “incremental cost” from the connection in present value terms. The “non-cash business benefit” rules in s 21A of the ITAA 1936 considered in this case are relevant in a broader range of scenarios.
This issue has vexed the electricity industry for some time, and there is no settled view between industry participants. The decision reinforces the ATO’s position as set out in its Infrastructure Framework document.
The VPN decision considered two alternatives for funding new “uneconomic” connections:
- the distributor carries out the construction works required to make the connection and the customer is required to make a cash contribution equal to the excess of the incremental costs (including estimated construction costs) over incremental revenue from the connection (net incremental costs) (Scenario 1), or
- the customer carries out the construction, the constructed asset is transferred to the distributor and the distributor pays the customer a rebate equal to the estimated costs of construction less the net incremental costs (ie estimated costs of construction less than what would have been the customer cash contribution in Scenario 1) (Scenario 2).
In both cases, the economic contribution from the customer is equal to the net incremental costs such that the pre-tax net cash position of each of the parties would be the same, assuming the actual construction costs equalled the estimate.
In summary, Moshinsky J found the distributor to be taxable on the customer contribution, whether paid in cash (Scenario 1) or provided in the form of a transferred asset (Scenario 2), and found that the same amount was taxable in each scenario.
Moshinsky J found that the cash contributions were ordinary income assessable under s 6-5 of the ITAA 1997, and not an assessable recoupment as claimed by the taxpayer, because they were gains (ie amounts derived) from a significant and ordinary part of the business of the distributor.
The recurrence and regularity of the new connections were an important factor in Moshinsky J’s consideration — VPN employed almost 100 staff to manage new connections.
Although the customer contribution component was calculated in the same way in both Scenarios, Moshinsky J acknowledged that the rights and obligations associated with Scenario 2 were quite different to Scenario 1 such that the customer contribution component was not ordinary income in Scenario 2.
The key issue then became the application of the non-cash business benefit rules in s 21A. Here, the parties accepted that the transferred asset was a “non-cash business benefit” that was “received on revenue account”. This seemingly was considered sufficient to satisfy the precondition to application of s 21A that the “non-cash business benefit” must be “income derived by the taxpayer” — a key issue in many circumstances in which s 21A arises.
The s 21A dispute therefore focused on the “arm’s length value” of the customer contribution; it was accepted that the rebate paid by VPN was a “recipient’s contribution” which would reduce the assessable amount under s 21A. Expert evidence calculating the net present value of cash flows from the transferred asset was ultimately held not to be relevant, with Moshinsky J ultimately deciding that the estimated cost of construction used to calculate the rebate in Scenario 2 (which would also be used to calculate the customer cash contribution in Scenario 1) was the “arm’s length value” of the transferred asset. The reasoning for this conclusion is not entirely clear, but the conclusion seems to be based on the use of estimated construction cost in the formula for calculating the customer cash contribution in Scenario 1 and rebate in Scenario 2 where those calculations were between parties acting at arm’s length, ie VPN and the customer.
The result means that in both Scenario 1 and Scenario 2, VPN is taxed upfront on the net customer contribution (whether or not paid in cash) while the constructed asset is depreciated over a longer term.
The purported acceptance by the parties that the transferred asset was a “non-cash business benefit” that was “received on revenue account” and the lack of commentary in the judgment as to why the transferred asset gives rise to “income derived by a taxpayer” (being a threshold requirement for s 21A to apply) is not helpful in considering the potential application of the case to other fact patterns. If the case is appealed it is hoped that the appeal may provide further clarity on these issues.
CCH note: The taxpayer in Victoria Power Networks Pty Ltd v FC of T 2019 ATC ¶20-682 has since appealed against the first instance decision to the Full Federal Court.
[This article was originally published in CCH Tax Week on 22 March 2019. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]