ATO Interpretative Decision
ATO ID 2011/11
Income Tax
Trading trust: meaning of 'control' and 'affairs or operations' of another personFOI status: may be released
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Issue
Is a unit trust a 'trading trust' under paragraph 102N(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) where the trustee of the unit trust holds a veto power over matters that go to the structure, scope and management of X Co's business?
Decision
Yes. The trustee's power of veto over matters that go to the structure, scope and management of X Co's business constitutes control, or the ability to control, directly or indirectly, the affairs or operations of X Co in respect of the carrying on by X Co of its trading business for the purposes of paragraph 102N(1)(b) of the ITAA 1936.
Facts
The trustee of a public unit trust (the 'PUT') and three co-investors (collectively 'the members') incorporated a private company, X Co. Each member, including the trustee, held 25% of the shares, and thereby voting rights, in X Co.
X Co carried on a trading business for the relevant year of income. Pursuant to an agreement between the members, the Board of Directors of X Co cannot undertake any action specified in the agreement as a 'Shareholder Matter' without approval by at least 80% of the members.
The Shareholder Matters go to the structure, scope and management of X Co's business and encompass matters which pertain to X Co's capital structure, shareholders' rights, corporate governance as well as business scope and strategic direction.
As a consequence of the trustee's holding 25% of the voting rights in X Co, the trustee can effectively block the 80% approval threshold being met in respect of any of the Shareholder Matters.
Reasons for Decision
Division 6C of the ITAA 1936 governs the way the income of certain unit trusts is treated for tax purposes and applies to a unit trust that is 'public trading trust'. Paragraph 102N(1)(b) of the ITAA 1936 provides that a unit trust will be a "trading trust" if, at any time during the year of income, the trustee:
... controlled, or was able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that other person of a trading business.
The word 'control' or 'controlled' is not defined for the purposes of Division 6C of the ITAA 1936 and accordingly must be construed by reference to its natural meaning refined by the context within which the provision is intended to operate. In that regard, it is helpful to revisit Parliament's intention in enacting paragraph 102N(1)(b), discerned from the Explanatory Memorandum ('EM') to Taxation Laws Amendment Bill (No. 4) 1985 which comments as follows:
Paragraph (b) of section 102N is a safeguarding provision against arrangements to circumvent the operation of Division 6C by having activities that would constitute a trading business of a public unit trust carried on by an associated entity. By taking income from the associate in the form of eligible investment income, the trust could otherwise ensure that the relevant trust did not qualify as a trading business and so avoid the operation of Division 6C.
Given that paragraph 102N(1)(b) of the ITAA 1936 is a safeguarding provision, the concept of 'control' and its variants which determine the provision's application should be given the wide meaning which accords with its intention and not be constrained by conventional notions of corporate control.
The Australian Oxford Dictionary (1999), Oxford University Press, Melbourne defines the word 'control' as (i) the power of directing, command; (ii) the power of restraining, especially self-restraint; and (iii) a means of restraint; a check. Plainly, the concept of exercising control includes both the positive aspect of directing or commanding and the negative aspect of restraining.
Whereas one might ordinarily reflect on control of a company in terms of its Board of Directors ultimately answerable to a majority vote by shareholders, it is a perspective which does not accommodate the notion of negative control and, in turn, would narrow the scope intended by Parliament for the operation of paragraph 102N(1)(b) of the ITAA 1936. In Re The News Corporation Ltd and Others (1987) 70 ALR 419, Bowen CJ held that a 'power of veto is a power to restrain, and hence to control.' The statement by Bowen CJ, was made and meant, on its face and in its context, as a statement of general principle.
Arguably, a view could be taken that no one shareholder, in effect, controls the Shareholder Matters because the ability to block a resolution is available to each of the other shareholders with 20% or more of the voting power in X Co. However, this view focuses on the positive aspect of control and disregards the negative aspect. The distinction between the two was highlighted by Mahoney JA in North Sydney Brick & Tile v. Darval & Anor (1986) 10 ACLR 837 at 844, where he said:
The part that a shareholder plays in the restrictions imposed by these articles is, in a sense, negative rather than positive: they empower him to prevent ... but do not authorise him to permit...
But a power to prevent, in this sense, may constitute a power to control
within the section. [Emphasis added]
Under the agreement, the trustee holds the power, presently exercisable, to restrain the Board of Directors from undertaking an action listed as a Shareholder Matter. That power is a form of 'control' in the negative sense. In other words, irrespective of the status of any other shareholder, any matter listed as a Shareholder Matter is blocked if the trustee exercises its power of veto, that is, negative 'control'. Therefore the trustee effectively controls or is effectively able to control the matters comprising the Shareholder Matters.
Paragraph 102N(1)(b) of the ITAA 1936 requires that the trustee of the PUT controlled, or was able to control, directly or indirectly, the 'affairs' or 'operations' of X Co in respect of the carrying on by X Co of a trading business.
The terms 'affairs' and 'operations' are not defined in the Tax Act. On ordinary concepts, the 'affairs' of a person includes their business and internal affairs: Re National Foods Ltd (Nos 1 and 2) (2005) 54 ACSR 80 at 55. In the context of a company, Winn J in R v. Board of Trade, ex parte St Martin Preserving Co Ltd [1964] 2 All ER 561 at 568, said:
... the phrase "affairs of the company" comprises all its business affairs, interests or transactions, all its investment or other property interests, all its profits and losses, and its goodwill.
The term 'operations', on the other hand, is explained in the singular in the Australian Oxford Dictionary (1999), Oxford University Press, Melbourne as (i) an action, or process or method of working or operating; (ii) an active process, a discharge of a function; and (iii) a piece of work, especially one in series. Thus, the word 'operations' has a narrower meaning than 'affairs' and would sit more comfortably as a reference to the day-to-day business of the company rather than its business structure. However, the concept of 'affairs' may include 'operations'.
Pursuant to the agreement between the members (referred to above), the trustee controls or is able to control the matters comprising the Shareholder Matters. The breadth of the Shareholder Matters effectively delivers pervasive control of the affairs and operations of X Co to the trustee via its negative 'control'.
In addition, the Shareholder Matters concern matters that ordinarily fall within the responsibility of the Board of Directors independent of shareholder involvement and as such would be readily acknowledged as being 'in respect of' and indeed integral to X Co's carrying on of its trading business.
Under these circumstances, the trustee, as a practical matter of fact, has by its power of veto, the ability to control, directly or indirectly, the affairs or operations of X Co in respect of the carrying on by X Co of its trading business. Accordingly, the PUT will be a trading trust under paragraph 102N(1)(b) of the ITAA 1936.
Date of decision: 4 August 2010Year of income: Year ended 30 June 2011
Legislative References:
Income Tax Assessment Act 1936
Division 6C
paragraph 102N(1)(b)
Case References:
Re The News Corporation Ltd and Others
(1987) 70 ALR 419
(1986) 10 ACLR 837 Re National Foods Ltd (Nos 1 and 2)
54 ACSR 80 R v Board of Trade, ex parte St Martin Preserving Co Ltd
[1964] 2 All ER 561
(1965) 1 QB 603 Related ATO Interpretative Decisions
ATO ID 2003/162
Other References:
Australian Oxford Dictionary (1999), Oxford University Press, Melbourne
Keywords
Trading trusts
Trusts
Unit trusts
Public trading trusts
ISSN: 1445-2782
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