By RICHARD TOOVEY, director, TaxTeam

The appropriate structuring of a PPP (including public/Iwi relationships) is complex. Success often turns on the clear harmonisation of commercial and cultural expectations. Taxation is an area where the parties’ expectations can be misaligned at an early stage. Unfortunately, the consequences of misalignment are often felt later. This article examines some of the interesting matters that often arise.

Tax awareness
Local authorities are largely exempt from income tax. This means that the level of in-house tax expertise is limited, and a high reliance is placed on external tax advisors. Also, by definition, local authorities are in New Zealand for the long haul. It cannot be ignored that the local authority will be the party left standing after the private partner has completed the arrangement.

In contrast, private-sector partners are often highly sophisticated in their tax management. Many private-sector partners will be undertaking PPPs all around the world. They will be highly focused on optimising tax-planning opportunities.

The private partner may well depart New Zealand once the arrangement is completed. Immediately, the expectations in terms of tax management/risk profiles can be different. Failure to address these differences can cause serious downstream problems for the local authority concerned.

Tax exemption
I mentioned earlier that local authorities are largely exempt from income tax. This is true, but exceptions apply. Most notably, local authorities are subject to income tax on amounts derived from council-controlled organisations (CCOs).

It is important to appreciate that a CCO in this context is specifically defined for tax purposes. It would be a mistake to rely solely on the definitions that exist in the Local Government Act 2002. With this warning in mind, most PPPs will involve one or more of the following:

· a special purpose company;

· a limited liability partnership;

· an unincorporated joint venture;

· a simple understanding to share profits.

The tax consequences arising for the local authority partner depend not only on which of the above apply, but also the amount of council control. How levels of control are determined and calculated can also vary across different scenarios.

It is vital that both parties in a PPP understand each other’s income tax drivers, as this inevitably informs commercial decision-making.

Income tax calculation
Local authorities now need to disclose the expected returns from commercial investments to ratepayers. Ratepayers will demand to know projected “after-tax” returns; particularly when tax represents a direct cost of the structure chosen for the PPP.

Determining the actual after-tax return requires appropriate reporting systems and, at a minimum, attention should be given to:

· using optimal funding structures

· owning assets tax-efficiently to optimise tax depreciation claims

· the methodology of cross-subsidisation from other council activities; and

· grouping tax losses to reduce the PPP tax liability.

These matters need to be considered in detail before agreement between the PPP parties. In the harsh world of commercial realities, changes can rarely be made later. A deal is a deal!

Gaining certainty
So, with the parties often seeking different results from a PPP (e.g. community outcomes vs. shareholder returns), having differing levels of commercial sophistication and, perhaps, differing attitudes to commercial risk, what tools are available to a local authority to manage its tax exposure? The answer can usually be found in the following:

· involving tax advisors at an early stage. It is a given that PPP negotiators should be highly engaged in achieving the desired outcomes. Often, using consultants (or, indeed, the finance department within a local authority!) can be seen as a potential derailment of the negotiation process. However, negotiating without full financial knowledge is dangerous and often costly.

· using tax indemnities and warranties. No party in a PPP likes to rely on indemnities and warranties. However, these are a vital protection under any contract of significance. Local authorities need to review contracts carefully and protect their tax positions appropriately.

· tax binding rulings. If tax certainty is required, a tax binding ruling can be the best solution. Usually both parties to the binding ruling are prepared to share the costs associated with this as both parties derive certainty from the outcome.

In short, a successful PPP relies on determining and managing expectations. Tax is an important area to get right.