Edited version of private ruling

Authorisation Number: 1011472269692

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Ruling

Subject: Income Tax: Co-operative Companies

Question 1

Can X Co continue to satisfy the definition of a co-operative company under section 117 of the Income Tax Assessment Act 1936 (ITAA 1936) if it acquires a major percentage of a subsidiary entity?

Answer

Yes.

Question 2

If X Co continues to satisfy the definition of a co-operative company under section 117 of the ITAA 1936, would section 118 of the ITAA 1936 apply to deem X Co not to be a co-operative company?

Answer

No.

This ruling applies for the following period/s:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 2009

Relevant facts and circumstances

X Co is a co-operative enterprise resident of Australia for income tax purposes in New South Wales, Australia. It is registered under the Co-operatives Act 1992 (Co-operatives Act) as a trading co-operative within the meaning of section 14 of the Co-operatives Act. X Co's Rules satisfies the definition under section 117 and 118 of the ITAA 1936.

X Co is proposing to acquire a subsidiary (Sub Co), which business is almost similar to X Co's business. It is proposed that X Co will initially purchase a major percentage shareholding in Sub Co. The value of Sub Co is less than 5% of X Co's assets.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 117

Income Tax Assessment Act 1936 Section 118

Does Part IVA or any other anti-avoidance provision apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Summary

For subsection 117(1) of the ITAA 1936 to apply, the primary or dominant object of the business must be to serve the shareholders by acquiring their products or rendering some other of the specified services.

X Co is proposing to acquire a subsidiary (Sub Co), a meat trading company dealing in beef, pork, lamb and chicken. It is proposed that X Co will initially purchase a major percentage shareholding in Sub Co. The facts of this ruling indicate that the value of Sub Co is not expected to exceed 5% of the X Co's assets and the Sub Co also a meat trading company dealing in beef, pork, lamb and chicken

It is recognised that a business may have secondary objects in conjunction with its primary objects. Secondary objects are those activities that do not impact on the overriding character of the business. Sub Co broadly operates within the same industry as X Co and an investment in this entity is merely and extension of the existing business X Co is currently carrying on. The investment in Sub Co will allow X Co to further its core business, strengthen its financial position, improve its market penetration and maximise returns to its members.

Therefore, it is considered that the acquisition of shares in Sub Co does not affect the co-operative company status of X Co under subsection 117(1) of the ITAA 1936..

Detailed reasoning

Subsection 117(1) of the ITAA 1936 provides that, for a co-operative company to fall within the meaning of Division 9 of the ITAA 1936, it must comply with the following conditions:

· its rules must limit the number of shares which may be held by or on behalf of any one shareholder;

· its rules must prohibit the quotation of its shares for sale or purchase at any stock exchange, or in any other public manner whatever;

· it must be established for the purpose of carrying on any business having as its primary object or objects one or more of the following:-

· the acquisition of commodities or animals for disposal or distribution among its shareholders;

· the acquisition of commodities or animals from its shareholders for disposal or distribution;

· the storage, marketing, packing or processing of commodities of its shareholders;

· the rendering of services to its shareholders;

· the obtaining of funds from its shareholders for the purpose of making loans to its shareholders to enable them to acquire land or buildings to be used for the purpose of residence or of residence and business.

For subsection 117(1) of the ITAA 1936 to apply, the primary or dominant object of the business must be to serve the shareholders by acquiring their products or rendering some other of the specified services. If the dominant motive is merely to carry on a business for the purpose of making profits which are not divided on a recognised co-operative basis, the company would not be a co-operative company even though there is literal compliance with all the other conditions of Division 9 of the ITAA 1936.

In A & S Ruffy Pty Ltd v FCT (1958) 98 CLR 637; 7 AITR 238, the taxpayer company argued that it satisfied paragraph 117(1)(b) of the ITAA 1936, namely the acquisition of commodities or animals from its shareholders for disposal or distribution. The company, which manufactured sausage casings, purchased the raw material from its "C" class shareholders, who were wholesale butchers. The High Court held that the acquisition of the runners from shareholders was not a primary object and "to say what the primary purpose of a business is may not always be quite easy, but relatively speaking the test it provides may be considered practicable". On examination of the facts, particularly the rights and benefits of the "C" class shareholders, it was held that the primary object was the manufacture and sale of sausage casings for the purpose of earning profits for the benefit of "A" and "B" class shareholders.

The meaning of subsection 117(1) of the ITAA 1936 was considered by the High Court in Brookton Co-operative Society Ltd v FC of T 81 ATC 4346; (1981) 11ATR 880. In the appeal to the High Court it was held that the primary object of the company was to be established from year to year, and regard was to be had to the whole of the activities surrounding the business undertaken irrespective of the form in which that business undertaking was carried on. Gibbs CJ, Mason and Wilson JJ were of the view that the dominant purpose for which it was established was to hold shares in subsidiary companies which would engage in share trading and dividend stripping, so that the Co-operative and the subsidiaries would benefit, from the point of view of income tax, from the circumstance that the co-operative was a public company. In determining the primary object the real activities of the business must be examined and the primary object must be the sole or dominant purpose. Mason and Wilson JJ added that the intentions of the promoters might also be examined in determining the primary object.

Aickin J had a narrower interpretation. His Honour felt that there could be only one object. Thus, if a company was carrying on a business with an object as outlined in paragraphs 117(1)(a)-(e) of the ITAA 1936 and also for the purpose of carrying on some other business, then it would not gain co-operative status unless the secondary activity had a primary object as outlined in paragraphs 117(1)(a)-(e) of the ITAA 1936. The company was thereby disqualified from such status because the share trading and associated activities were not encompassed within paragraphs 117(1)(a)-(e). He also stated the intentions of the promoters were irrelevant in determination of the primary object.

In this case X Co's Rules satisfy the primary objects of its business. Therefore, X Co fall under the definition of paragraph 117(1)(b) of the ITAA 1936 and it is considered as a Co-operative for the purpose of Division 9 of the ITAA 1936.

Acquisition of Sub Co

X Co is proposing to acquire a major percentage shareholding of a subsidiary (Sub Co). The investment in Sub Co will allow X Co to further its core business, strengthen its financial position, improve its market penetration and maximise returns to its members.

Paragraphs 26 of the Taxation Ruling TR 1999/14 (TR 1999/14) states that:

It is recognised that a business may have secondary objects in conjunction with its primary objects. Secondary objects are those activities that do not impact on the overriding character of the business. They should be no more than occasional or incidental. Should any of the secondary objects of a business not conform with the objects set out in paragraphs (a) to (e) of subsection 117(1) that does not preclude the company from satisfying the requirements of the subsection.

This view is further supported by example 2 at paragraph 46 of the explanation to TR 1999/14. In this example, owner-occupied loans were regarded as a primary object for the current year and due to the relative size, all other types of loan were regarded as secondary objects as they are less than 5% of the total loans.

Applying the same approach, the small percentage of income derived from Sub Co represents a deminimus secondary object and should not cause contravention of subsection 117(1). In ordinary language it is clearly apt for description as incidental to the primary object of X Co's business activities.

Sub Co broadly operates within the same industry as X Co and an investment in this entity is merely and extension of the existing business that X Co is currently carrying on.

Therefore, it is considered that the acquisition of a major percentage of shares in Sub Co does not affect the co-operative company status of X Co under subsection 117(1) of the ITAA 1936.

Question 2

Section 118 of the ITAA 1936 provides that:

If, in the ordinary course of business of a company in the year of income, the value of commodities and animals disposed of to, or acquired from, its shareholders by the company, or the amounts of its receipts from the storage, marketing, packing and processing of commodities of its shareholders, or from the rendering of services to them, or the amount lent to it by them, is less than 90% of the total value of commodities and animals disposed of or acquired by the company, or of its receipts from the storage, marketing, packing and processing of commodities, or from the rendering of services, or of the total amount lent by it, that company shall in respect of that year be deemed not to be a co-operative company.

Thus in general terms, so long as 90% of the value of the company's total activity is with its shareholders, then the company can still be a co-operative company. There is no prohibition on activity being conducted with third parties so long as the value of that activity is less than 10% of the company's total activity.

In Renmark Fruitgrowers Co-operated Ltd v FC of T 69 ATC 4135 the company, a co-operative whose main business was always the processing and packing of its shareholders' fruit, also had from its inception purchased commodities for sale to its shareholders. By the year under review, the latter activity accounted for more than 60% of total receipts. The processing and packing was almost exclusively done for shareholders, but the sales to non-shareholders accounted for about 22% of all sales in the merchandising business. Held, the company was not a co-operative as it failed to meet the 90% test of section 118 of the ITAA 1936 in relation to its merchandising activities. The primary object or objects of a company's business are to be determined each year and merchandising was by the year under review a primary object of the company's business.

In this case Sub Co is projected to only add a diminimus amount to the consolidated revenue, well below the threshold of 10% provided for in section 118 of the ITAA 1936.

Paragraph 26 of TR 1999/14 states that:

Secondary objects are those activities that do not impact on the overriding character of the business. They should be no more than occasional or incidental.

Therefore, the reference to 'occasional or incidental' takes account of the usage of the word 'primary' in subsection 117(1) of the ITAA 1936 and inter alia the allowance for 10% of the company's activity to be with outsiders as contemplated by section 118 of the ITAA 1936.

Sub Co broadly operates within the same industry as X Co and an investment in this entity is merely and extension of the existing business X Co is currently carrying on. The investment in Sub Co will allow X Co to further its core business, strengthen its financial position, improve its market penetration and maximise returns to its members.

Accordingly, it is considered that acquisition of Sub Co will not affect the 90% requirement to X Co under section 118 of the ITAA 1936.

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