Edited version of private ruling

Authorisation Number: 1011599943600

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Ruling

Subject: Private Binding Ruling

Question 1

Is the Entity exempt from income tax pursuant to s50-1 of the Income Tax Assessment Act 1997 (ITAA 1997) on the basis that it is a society, association or club established for the encouragement of a game or sport under item 9.1(c) of s50-45 if:

(a) it amends its Constitution in accordance with the proposed amendments outlined; and

(b) it applies its income in accordance with the terms of the amended constitution?

Answer:

The Entity is not exempt from income tax pursuant to s50-1 of the Income Tax Assessment Act 1997 (ITAA 1997) as a society, association or club established for the encouragement of a game or sport under item 9.1(c) of s50-45, despite proposed amendments to its constitution.

This ruling applies for the following period:

Year ending 30 June 2011

Relevant facts and circumstances:

The Entity is a private company limited by shares. The shares are owned by the Sports Club. The Sports Club is a company limited by guarantee incorporated in 2004.

There are sporting bodies (affiliated clubs) associated with the Sports Club. Each of the affiliated clubs is a separate body and is recognised by their own affiliated bodies. Each of the affiliated clubs is recognised by the directors of the Sports Club as the principal affiliated bodies.

There currently are approximately 800 individual members of the Sports Club. Most members are from a variety of backgrounds with the affiliated sports clubs as their focal interest.

The Sports Club is exempt from income tax under section 50-45 of the 1997 Tax Act as a society, association or club established for the encouragement of a game or sport.

The Sports Club operates a club from premises owned by Council.

The Entity owns 2 parcels of land adjoining the land where the club is located.

One parcel of land contains a Hotel. The other parcel of land is vacant land with a shed on it used by the Club.

Currently the income of the entity is distributed to Sports Club. The Sports Club applies that income to its purposes.

The Sports Club is the sole shareholder of the Entity. Therefore, under the terms of the Constitution of the Entity, the Sports Club has the sole right to appoint directors of the Entity. The Sports Club exercises that right.

The members of the Sports Club do not have any direct power to appoint directors of the Entity or to interfere in the management and control of the Entity. The members of the Sports Club have indirect power to control and manage the Entity through their capacity to elect the Board of the Sports Club.

The Directors of the Sports Club represent a mix of the affiliated Clubs. The directors of the Entity are normally the same persons who comprise the executive committee of the Sports Club.

The Entity proposes to amend its constitutions objects, as follows:

(1) By inserting a new clause 1A as follows:

The objects of the Company are to encourage and promote sporting activities through:

(a) the ownership of land to be used for such activities; and

(b) the application of the income of the Company towards sporting clubs, the provision of sporting facilities for the use and benefit of the community, and the promotion of sport as a medium for the improvement of health, social interaction and the general well-being of the community; and

(c) doing all things as may be appropriate and necessary to promote those objects, including carrying out other functions compatible with those objects (including generating income to promote those objects)

and the Company shall be organised and operated exclusively for the attainment of, and will hold its assets and any income derived from those assets to be used for the furtherance of, these objects.

(2) By deleting the … existing clause 113 … 114 to 121 and replacing them a new heading Dealings with Income and Property" and the following clauses:

113. The Company must apply its income and property solely towards the promotion of the objects described in clause 1A and none of it may be paid or transferred, directly or indirectly, to members, either by dividend, bonus or otherwise.

114. No director shall be paid any salary or fees or receive any remuneration or other benefit in money or money's worth from the Company unless the amount of that salary, fee or remuneration be determined at an Annual General Meeting and provided there shall be no legal impediment to such payment.

Clauses 119 to 121 have been deleted.

(3) By deleting the existing clause 134 and replacing it with the following:

If on the dissolution or winding up of the Company there remains, after the satisfaction of all its debts and liabilities, any property whatever, the same shall not be paid or distributed among the members, but shall be given or transferred to some other fund, authority or institution:

(1) having objects similar to the objects of the Company;

(2) which prohibits the distribution of its income and property to a similar extent to that imposed on the Company under clause 113; and

(3) which is approved by the Commissioner of Taxation of the Commonwealth of Australia as a fund, authority or institution covered by Item 9.1(c) of section 50-45 of the Income Tax Assessment Act 1997 (as amended).

If just before the time of its dissolution or winding up the Company is an entity to which income tax deductible gifts can be made, then the other fund, authority or institution must also be a fund, authority or institution to which income tax deductible gifts can be made.

The fund, authority or institution may be determined by the members at or before the time of dissolution, and insofar as effect cannot be given to such provision, then to some other charitable object which satisfies the criteria prescribed by this clause.

After the Entity has amended its constitution, it will be prohibited from making any distributions to its members. Therefore, the Entity will not be able to distribute any of its assets to the Sports Club. The Entity intends to apply its income directly in furtherance of the amended objects by paying amounts directly to sporting clubs and organisations. The Entity may elect to not pay out all amounts of income in a particular year, but may choose to retain some profits for re-investment.

The Entity does not have any proposed rules regarding the distribution of its profits beyond the general limitations contained in its constitution - namely, that the income and property must be applied solely towards the promotion of the object of encouraging and promoting sporting activities.

The Entity will only distribute funds to the affiliated clubs if the clubs are able to demonstrate the need for funds related to the promotion of that club (in particular the promotion of junior sport) and the provision of facilities, and in respect of the general running costs of the sporting facility or club.

Reasons for decision

Summary

The Entity is not a 'society, association or club' and therefore is not exempt from income tax pursuant to s50-1 of the Income Tax Assessment Act 1997 (ITAA 1997) as a society, association or club established for the encouragement of a game or sport under item 9.1(c) of s50-45, despite proposed amendments to its constitution.

Detailed reasoning

To be exempt from income tax under s50-1 of ITAA 1997, the Entity must meet the relevant conditions of Item 9.1(c) of the table in s50-45, as discussed below:

1. it must be a society, association or club;

The term society, association or club is not defined in the ITAA 1997. The term is therefore construed according to the ordinary meaning of the words.

In Theosophical Foundation Pty Ltd v. Commr of Land Tax (NSW) [1966] 67 SR (NSW) Sugerman JA stated at 82:

A society, in the relevant sense, is a number of persons associated together by some common interest or purpose, united by a common vow, holding the same belief or opinion, following the same trade or profession, etc; an association.

The meaning of "society" as the Oxford English Dictionary definition shows can be the equivalent of "association" and I do not think that any relevant distinction in nature exists between the two. It merely seems to have happened that some organisations are called "associations", others are called "societies" but no meaningful difference can be detected between the two.

Paragraph 2 of Taxation Determination TD 95/56 considers the definition of 'association' as follows:

The Shorter Oxford English Dictionary defines the term 'association' to be 'a body of persons associated for a common purpose; the organisation formed to effect their purpose'.

The Macquarie Dictionary defines 'association' as being 'an organisation of people with a common purpose and having a formal structure'. Olsson J, in Quinton v. South Australian Psychological Board (1985) 38 SASR 523, also stated that the term 'association' has come to be regarded as attaching to a body of persons associated for a common purpose.

The Macquarie Dictionary 2001, 5th edition (The Macquarie Library Pty Ltd, Macquarie University) defines 'club' as a group of persons organised for a social, literary, sporting, political, or other purpose, regulated by rules agreed by its members.

In this case, the Entity is a proprietary limited company with a number of directors however it only has one member, the Sports Club. This member is also a corporation (a company limited by guarantee). The Sports Club has directors and voting members. The directors of the Sports Club have various rights in relation to the entity (eg. appointment of directors, decisions on how profits generated will be distributed etc.).

The interpretations of society, association or club as described above, emphasise a 'body of persons' and 'an organisation of people'. There is the forming of a purpose of various people; for there to be a 'common purpose' there needs to be more than one person. Accordingly, a single entity, without more, would not constitute an association, society or club as there isn't a group or body or the forming of any common intention. Associations can comprise only corporations (Theosophical Foundation v. Commr of Land Tax (1966) 67 SR (NSW) 70 at 82), but the associating which is essential to an association is not present with a corporation that has only one member.

Furthermore, voting members of the Sports Club do not have any direct power to appoint directors of the Entity or to interfere in the management and control of the Entity. The members of the Sports Club only have indirect power to control and manage the Entity through their capacity to elect the Board of the Sports Club. Therefore, in this instance it does not seem appropriate to 'look through' the Sports Club to treat its members as de facto members of the Entity.

On this basis the Entity is not considered to be a society, association or club.

A further issue is that the Constitution allows for only one director at Clauses 1(b) and 72.

2. it must be established for the encouragement of a game or sport;

Encouragement

As per paragraph 11 of Taxation Ruling TR 97/22 Income tax: exempt sporting clubs 'encouragement' means 'stimulation by assistance', according to the Macquarie Dictionary. It is essential that the encouragement of a game or sport is the main or dominant purpose of a club.

Encouragement can occur directly by:

· forming, preparing and entering team and competitors in competitions in the game of sport;

· co-ordinating activities;

· organising and conducting tournaments and the like;

· improving the abilities of participants;

· improving the standard of training and coaches;

· providing purchased or leased facilities for the activities of the game or sport for the use of club members and visitors; or

· encouraging increased and wider participation and improved performance;

and can occur indirectly:

· through marketing; or

· by initiating or facilitating research and development

The proposed objects of the Entity are to encourage and promote sporting activities through:

(a) the ownership of land to be used for such activities; and

(b) the application of the income of the Company towards sporting clubs, the provision of sporting facilities for the use and benefit of the community, and the promotion of sport as a medium for the improvement of health, social interaction and the general well-being of the community; and

(c) doing all things as may be appropriate and necessary to promote those objects, including carrying out other functions compatible with those objects (including generating income to promote those objects) and the Company shall be organized and operated exclusively for the attainment of, and will hold its assets and any income derived from those assets to be used for the furtherance of, these objects.

The current and proposed activities of the Entity are also listed in the relevant facts.

Direct

Of the above activities, providing land for use by a club may be seen to fall under direct encouragement though 'providing purchased facilities for the activities of the game or sport for the use of club members and visitors'. However, as the club is a water activity and it is the shed on the land that is used by the club, the shed itself is not used for the activity of the water sport but for storage of equipment and the like. This is not a strong indication of the encouragement of sport.

However, the Entity will also acquire new grounds to provide facilities for sporting activities which would be in line with direct encouragement in the form of the provision of purchased or leased facilities for the activities of the game or sport for the use of clubs.

Indirect

The second activity is the leasing out of the Hotel. TR 97/22 does state that encouragement can occur indirectly however it does not specify as example such as distributions to sporting clubs from passive investments. Taxation Ruling TR 2005/22 Income tax: companies controlled by exempt entities, however, provides examples of circumstances in which the Tax Office would accept a 'financial support' entity as falling in a Div 50 category:

91. The holding of passive investments to generate returns is unlikely to amount to a purpose in its own right. Where this is the major activity of a non-profit company, its objects and distributions are likely to be the main indicators of its purpose. In such situations (in contrast to the examples in paragraphs 87-90) there are unlikely to be any facts which would point to a different purpose.

Example 7

92. A non-profit company is set up and controlled by a community service organisation that is exempt from income tax in terms of item 2.1 in section 50-10 of the ITAA 1997. The company has the same objects as the exempt entity. Its sole function is to hold passive investments to generate a return, and to make distributions from the surplus for community service purposes.

93. The company's main purposes are community service purposes, as required by item 2.1. Its holding of passive investments to generate a return does not indicate any different purpose. It falls within the description of community service organisations set out in TD 93/190.

In looking at the purpose of the Entity, its passive income does not indicate any different purpose other than the object stated in its amended constitution which is "to encourage and promote sporting activities" through its objectives listed above.

The Entity has within the scope of its objectives, providing financial support from 'passive income' to entities that directly encourage sport and therefore could similarly be considered to be an association established for the encouragement of a game or sport.

Conclusion

Based on the above direct and indirect activities, the Entity is considered to be for the encouragement of a game or sport and it appears to be the main purpose of the Entity as it does not undertake any other activities or have any other purpose other than to provide financial support and sporting grounds/facilities for the encouragement of a game or sport.

Impact of Word

The Entity has put forward Commissioner of Taxation v. Word investments Ltd [2008] HCA as relevant (considered in relevant facts and circumstances). That case considered whether a company limited by guarantee that carried on commercial activities was an income tax exempt charity.

Given that one of the Entity's activities is to lease out the parcel of land it owns containing the Hotel , it doesn't actually undertake commercial activities itself as was the case in Word. The Entity deals with its passive investment income which it applies to its purpose of the encouragement of a game or sport.

In this respect the Word case in terms of the application of funds from commercial activities is not as relevant as the reference to passive investment in TR 97/22 as discussed above.

3. it must meet the special conditions of s50-70.

3.1 The entity must be a society, association or club;

The Entity does not meet this requirement (as discussed at 1 above).

3.2 Not carried on for the purpose of profit or gain of its individual members;

Page 6 of the Income tax guide for non-profit organisations NAT 7967-03.2007 provides the following in relation to non-profit requirements:

The basic premise of a non-profit organisation is that it is not operating for the profit or gain of its individual members, whether these gains would have been direct or indirect. This applies both while the organisation is operating and when it winds up.

The Tax Office accepts an organisation as non-profit where its constituent or governing documents prevent it from distributing profits or assets for the benefit of particular people - both while it is operating and when it winds up. These documents should contain acceptable clauses showing the organisation's non-profit character. The organisation's actions must be consistent with this requirement.

A non-profit organisation can still make a profit, but this profit must be used to carry out its purposes. The profits must not be distributed to owners, members or other private people.

The Entity has the following proposed non-profit clauses for its operation and on winding up as stated in relevant facts and circumstances. While the proposed clauses are appropriate non-profit and winding up clauses, the organisation's actions must be consistent with this requirement and as explained earlier, the profits must not be distributed to owners, members or other private people. In the Entity's circumstances, the Entity currently makes distributions to its member, the Sports Club, however this will cease in accordance with the proposed amendments above which prohibit distributions directly or indirectly, to members, either by dividend, bonus or otherwise (it is assumed this would also include any capital returns over and above original paid up capital).

There are other clauses still included in the Constitution which the Entity has not proposed to remove and these may pose a problem or be contradictory to the non-profit clause and removal of other clauses. These Clauses are:

· Definitions of 'dividend' and 'share'.

· Clauses on Shares (4-15) which do not restrict dividends or return of capital.

Member benefits

Despite an adequate non-profit clause, it is necessary to consider the relationship between the affiliated clubs, the Sports Club and the Entity, to examine who the ultimate owner, and hence, beneficial owner, of the Entity is.

In relation to Directors, Clause 73 of the Entity's constitution states: The Directors of the company in General Meeting by resolution or any member or members holding a majority of the issued shares of the company by writing delivered to the company at any time and from time to time, may appoint any person to be a Director of the company either to fill a casual vacancy or as an addition to the Board but so that the total number of Directors shall not at any time exceed the maximum number for the time being fixed.

The Sports Club is the sole shareholder/member of the Entity. The Entity has advised that, under the terms of the Entity's Constitution, the Sports Club has the sole right to appoint directors of the Entity and the Sports Club exercises that right. The above clause seems to indicate that the directors of the Entity can also themselves appoint additional directors.

The directors of the Entity are normally the same persons who comprise the executive committee of the Sports Club. The executive committee of the Sports Club are appointed by the board of the Sports Club.

The Entity has stated that the Directors of the Sports Club represent a mix of these affiliated clubs. From information provided, of the directors of Sports Club, two directors are on the committees of affiliated clubs.

The Entity has advised that the members of the Sports Club do not have any direct power to appoint directors of the Entity or to interfere in the management and control of the Entity. The members of the Sports Club only have indirect power to control and manage the Entity through their capacity to elect the Board of the Sports Club.

The connection between the affiliated clubs and the Sports Club is not clearly stated in any of the governing documents or the 5 clubs or the Sports Club, apart from what Entity has advised, that "each of the five clubs is recognised by the Directors of the Sports Club as the principal affiliated bodies".

Distributions of profit

The Entity intends to apply its income directly in furtherance of the amended objects - that is, solely for the promotion of games or sports. Generally this will be achieved by the Entity paying amounts directly to sporting clubs and organisations. These clubs will include the sporting clubs associated with the Sports. Payments will be made directly to those clubs rather than to the Sports Club.

Decisions regarding distributions will depend on requirements at the date of distribution. The Entity will distribute amounts solely for the benefit and encouragement of sport in the district and not necessarily to the affiliated clubs. For example, it may be appropriate for Entity to apply its assets towards new grounds and facilities to be used for general sporting activities.

The Entity may elect to not pay out all amounts of income in a particular year, but may choose to retain some profits for re-investment.

The directors of the Entity will consider and make recommendations regarding how the profits generated by the Entity will be distributed. These recommendations will be considered by its member, the Sports Club, through the full committee of the Sports Club.

The Entity does not have any proposed rules regarding the distribution of its profits beyond the general limitations contained in its constitution - namely, that the income and property of the Entity must be applied solely towards the promotion of the object of encouraging and promoting sporting activities.

The Entity will only distribute funds to the affiliated clubs if the clubs are able to demonstrate the need for funds related to the promotion of that club (in particular the promotion of junior sport) and the provision of facilities, and in respect of the general running costs of the sporting facility or club. The Entity will provide funds to assist with these financial requirements on the club demonstrating a need.

Therefore, this would be in favour of meeting the non-profit requirement.

Conclusion

It does not appear that the affiliated clubs could be the ultimate owner of the Entity. The members of Sports Club are only indirectly linked to the Entity via their right to vote for the board of the Sports Club. Distributions are based on a needs basis in line with the Entity's objects and will not only be given to the affiliated clubs but may be distributed to other sporting clubs or organisations in the area or used towards new grounds and facilities to be used for general sporting activities in the area.

Therefore, there does not appear to be member benefits and non-profit requirements appear to be met (subject to removal/alterations of the remaining contradictory clauses (definitions of 'dividend' and 'share' and Clauses 4-15) as specified above).

3.4 Meet one of the three tests described under section 50-70.

In this case the relevant test is that the entity must have a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia.

The Entity is incorporated in Australia, and incurs its expenditure and pursues its objectives principally in Australia. Therefore this requirement is met.

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