Limited available to PPP receiving exempt income from government

court hood 1The DTLAB introduces section 12NA, which aims to regulate the tax treatment of allowances available to public private partnerships (PPP) receiving exempt contributions from the government in terms of section 10(1)(zI). The proposed section will limit the allowable deduction to the amount of expenditure actually incurred in effecting improvements to land or buildings owned by government, reduced by the aggregate exempt contributions received from government. This limit is intended to address an ostensible “double dipping” in the context of PPPs.

Currently, the Income Tax Act allows for a deduction of improvement expenditure actually incurred pursuant to an obligation to effect such improvements on land or to buildings, which was incurred under an agreement whereby the right to use or occupation is granted by the government to the PPP, and is used by the PPP in the production of income. The maximum period over which improvement expenditure can be deducted is limited to the lesser of the period over which the PPP will earn income from its operations or 25 years. The aggregate allowable deduction is also limited to the actual expenditure incurred.

The ostensible “double dipping” arises from the government guaranteed return to private shareholders, which aims to attract shareholder expertise and resources to a PPP project through profit subsidisation. In terms of these guarantees, the government subsidises any shortfall in the profit of the PPP, so that the investment yields the guaranteed return to shareholders. The subsidy is calculated as the difference between net profit or loss, as the case may be, and the requisite shareholder return on investment through dividends. The government is often not a shareholder.

During development, the PPP generally receives exempt contributions from the government to fund, in proportion to lenders and shareholders, the capital improvement expenditure. Once the development phase is concluded, and the PPP produces income from the improvements effected, which income is taxable. Section 12NA seeks to limit the allowable deduction of improvement expenditure by reducing the aggregate improvement expenditure by aggregate exempt contributions made by government used to fund the improvement expenditure.

The profit subsidisation by government is taxable in the hands of the PPP. This amount, together with income from the project, will erode the assessed loss tax shield created by exempting the contributions by government and the deductibility of the improvement expenditure.

The repercussions of section 12NA will result in the PPP having a higher tax cost. The tax cost will reduce the overall profitability of the PPP, which reduces the actual return available to shareholders. This may result in the government having to subsidise the increased shortfall based on its guaranteed return to private shareholders.

This will displace the actual tax cost from the PPP onto government through the increased burden of subsidisation of shareholder returns. The proposed section applies to expenditure incurred in years of assessment commencing on or after 1 April 2015 and will not apply to banking, financial or insurance business or services.