Edited version of administratively binding advice

Authorisation Number: 1011493321924

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Administratively binding advice - Investment trust

What this advice is about.

The applicant requested administratively binding advice on the application of paragraph 102N(1)(b) and Part IVA of the Income Tax Assessment Act 1936 ("ITAA 1936") to a proposed property investment by a unit trust (the "MIT").

The subject of the advice

The applicant sought the Commissioner's advice in respect of a proposed investment by the MIT. The applicant submitted that the MIT, once settled, is intended to satisfy the definition of a "managed investment trust" in section 12-400 of the Subdivision 12-H of Schedule 1 of the Tax Administration Act 1953 ("TAA 1953").

It is intended that the proposed unit trust, the MIT, together with other investors will invest in a property asset via the bidding vehicle comprising a unit trust, the Property Trust, and a company, the OpCo. The plan is for the Property Trust to hold investments in the property asset and OpCo to conduct all the operations related to the property asset. OpCo will lease part or all of the property asset from the Property Trust in return for rent and the Property Trust will not conduct any other activities apart from deriving rent under that lease. It is proposed that OpCo will carry on a "trading business" for the purposes of Div 6C of the ITAA 1936.

The rights and obligations of each investor, including the MIT, in respect of the proposed investment of the property asset are to be set out in the Investment Agreement. Each investor holds an interest of less than 40% in the proposed investment. In accordance with the Investment Agreement, each investor (including the trustee of the MIT) can effectively block the approval threshold being met with respect to all matters listed in the Shareholder Reserved Matters. The question is whether this veto right held by the trustee would satisfy paragraph 102N(1)(b) of the ITAA 1936. That is, whether the power would result in the trustee having control, or the ability to control, directly or indirectly, the affairs or operations of OpCo in respect of OpCo's carrying of its trading business.

Advice:

The trustee of the MIT has by its power of veto the ability to control the affairs or operations of OpCo to the extent that they are reflected in the Shareholder Reserved Matters. They are matters that go to the structure, scope and management of OpCo's business and effectively usurp the discretion of the Board of Directors in relation thereto. In these circumstances the MIT would qualify as a "trading trust" for the purposes of section 102N in Division 6C of the ITAA 1936.

You also sought the Commissioner's view on the application of Part IVA of the ITAA 1936. Before the Commissioner can apply Part IVA to a scheme, the requirements of Part IVA must be satisfied. These requirements are that:

· a 'tax benefit' as identified in section 177C of the ITAA 1936, was or would, but for subsection 177F(1) of the ITAA 1936, have been obtained;

· the tax benefit was or would have been obtained in connection with a 'scheme' as defined in section 177A of the ITAA 1936; and

· having regard to section 177D of the ITAA 1936, the scheme is one that was entered into for the sole or dominant purpose of enabling a taxpayer to obtain the tax benefit.

Whilst some factual information in relation to the proposed structure of the MIT's investment has been provided, the arrangement is too preliminary for the Commissioner to identify a precise scheme and tax benefit to which the matters in paragraph 177D(b) of the ITAA 1936 can be considered. Furthermore, the involvement of the other investors is pertinent to any consideration of Part IVA in relation to the formation and utilisation of the Property Trust and OpCo. In these circumstances the Commissioner is unable to provide advice to you in relation to Part IVA.

This advice applies for the following period:

Year ending 30 June 2011

The arrangement commences during:

Year ending 30 June 2011

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6C.

Income Tax Assessment Act 1936 section 102M.

Income Tax Assessment Act 1936 section 102N.

Income Tax Assessment Act 1936 subsection 102N(1).

Income Tax Assessment Act 1936 paragraph 102N(1)(b).

Income Tax Assessment Act 1936 paragraph 102R(1)(b).

Income Tax Assessment Act 1936 section 102T.

Income Tax Assessment Act 1936 Part IVA.

Income Tax Assessment Act 1936 section 177A.

Income Tax Assessment Act 1936 section 177C.

Income Tax Assessment Act 1936 section 177D.

Income Tax Assessment Act 1936 section 177F.

Tax Administration Act 1953 subdivision 12-H.

Tax Administration Act 1953 section 12-400 of Schedule 1.

Tax Administration Act 1953 paragraph 12-400(1)(b) of Schedule 1.

Tax Administration Act 1953 paragraph 12-400(2)(a) of Schedule 1

Tax Administration Act 1953 section 12-405 of Schedule 1.

Tax Laws Amendment (2010 Measures No. 3) Act 2010

EXPLANATION: (This does not form part of the Notice of Administratively Binding Advice)

Division 6C of the ITAA 1936

Historically under the classical system of taxation business activities were tax advantaged by utilising trusts in preference to companies, as tax was levied on both companies and company distributions to shareholders. Trust arrangements, on the other hand, were not subject to the same dual layer of taxation. The introduction of dividend imputation removed some, but not all, of the tax advantages arising through the use of trusts.

Division 6C, introduced into Part III of the ITAA 1936 in 1985, governs the way the income of certain unit trusts is treated under the Tax Act and was intended to stem the increasing use of trusts to avoid the company tax arrangements

Specifically, the intention was to ensure that trusts were not used to conduct trading business normally undertaken by companies, thereby escaping company tax by exploiting the flow-through character of a trust arrangement. However, provided trusts limited their investment(s) to essentially passive investment(s), defined as "eligible investment business" in section 102M of Division 6C, they could preserve that flow-through characteristic, undisturbed by the application of Division 6C.

In 2008 the Government introduced measures that were intended to attract and retain foreign investment through "managed investment trusts". Among the new measures was a reduction in the withholding tax rate on fund payments to foreign investors from 30% to 7.5% by 1 July 2010. However, these measures were intended to preserve the restrictions on trusts as discussed in the Draft White Paper 1985 and Discussion Paper 2008 namely, that the managed investment trusts be widely-held, flow-through vehicles that undertake predominantly passive investment in Australia. Division 6C, by confining trustees to carrying on only "eligible investment business", would continue to ensure that Australian active businesses conducted through companies are not at a competitive disadvantage. Limiting the managed investment trust's business in this way ensures a level playing field tax-wise where active "trading business" is involved.

On 7 May 2010, the Assistant Treasurer announced that a new tax system for managed investment trusts will commence on 1 July 2010. The proposed changes to the managed investment trust rules, with effect from 1 July 2010, did not vary the existing "trading trust" test in Division 6C. However, they did introduce a new restriction to the effect that the trust must not be a "trading trust" under Division 6C in order to qualify as a managed investment trust under section 12-400 of Subdivision 12-H of Schedule 1 of the TAA 1953.

Discussion

Subsection 102N(1) 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:

(a) carried on a trading business; or

(b) 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 applicant has sought specifically the Commissioner's views on whether a veto power held by the trustee over the matters listed as a Shareholder Reserved Matter would satisfy paragraph 102N(1)(b) of the ITAA 1936. That is, whether the power would result in the trustee having control, or the ability to control, directly or indirectly, the affairs or operations of OpCo in respect of OpCo's carrying on of its trading business.

In examining the position of the trustee of the MIT in relation to paragraph 102N(1)(b) of the ITAA 1936 it is appropriate to consider the terms used in the provision and 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) of the ITAA 1936, 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.

Under paragraph 102N(1)(b) of the ITAA 1936, Division 6C of the ITAA 1936 is mobilised if the trustee of the MIT either "controlled", or is "able to control", the affairs or operations of another person; in this instance, OpCo. The word "control" is not defined for the purposes of Division 6C and accordingly, as acknowledged by the High Court, must be construed by reference to its natural meaning refined by its context

The Courts have held that the word "control" is a "slippery concept and has a number of possible meanings. The Australian Oxford Dictionary 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. The language of the provision and its supporting materials make clear that the legislative intention did not proceed on the myopic footing that control can be exercised only through a majority vote of shareholders

In Re The News Corporation Ltd and Others, the concept of control in the context of the Broadcasting and Television Act 1942 was given wide import. In that case, 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.

In the present case, the trustee of the MIT (through its voting power) can block a resolution put to the shareholders by the Board of Directors. In other words, irrespective of the status of any other shareholder in OpCo, any matter listed as a Shareholder Reserved Matter is blocked if the trustee of the MIT exercises its power of veto, i.e. negative "control".

Paragraph 102N(1)(b) of the ITAA 1936 requires that the trustee of the trust controlled, or was able to control, directly or indirectly, the "affairs" or "operations" of another person. The term "affairs" is not defined in the Tax Act. On ordinary concepts, the "affairs" of a person includes their business and internal affairs and in the context of a company, Winn J in R v. Board of Trade, ex parte St Martin Preserving Co Ltd 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 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. It would seem then that 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.

The concept of "affairs" may include "operations", however it may be that the latter has been singled out in the provision in acknowledgement that the business operations of a company could be susceptible to control by agreements entered into outside of the protocols normally associated with corporate decision making.

The items listed in the Shareholder Reserved Matters are not a mere subset of the "affairs" of OpCo that are limited in scope and akin to protection rights enjoyed by minority shareholders. Rather, the items listed there are extensive and significant and they encompass matters which pertain to OpCo's corporate business structure, future direction and ongoing corporate governance and management. In addition, they are 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 OpCo's carrying on of its trading business.

From the analysis above, the MIT has by its power of veto the ability to control the affairs or operations of OpCo to the extent that they are reflected in the Shareholder Reserved Matters. They are matters that go to the structure, scope and management of OpCo's business and effectively usurp the discretion of the Board of Directors in relation thereto. In these circumstances the MIT would qualify as a "trading trust" for the purposes of section 102N in Division 6C of the ITAA 1936.

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