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Ruling

Subject: Income Tax: Commissioner's discretion - 102P(5)

Question 1

(a) Will the Commissioner exercise his discretion under subsection 102P(5) of the Income Tax Assessment Act 1936 (ITAA 1936) to allow the taxpayer to be treated as a public unit trust for the 2008-09 income year?

(b) Will the Commissioner exercise his discretion under subsection 102P(5) of the ITAA 1936 to allow the taxpayer to be treated as a public unit trust for the 2009-10 income year?

Answer

(a) Yes

(b) No

This ruling applies for the following periods:

1 July 2008 to 30 June 2009

1 July 2009 to 30 June 2010

The scheme commences on:

The scheme has already commenced.

Relevant facts and circumstances

Company A is the responsible entity ("Responsible Entity") for several investment funds including the taxpayer and Fund B.

The taxpayer is a unit trust established to provide investors with an exposure to a diversified portfolio of assets.

The taxpayer does not undertake any trading activities. It maintains investments in other managed funds which included ownership of Fund B units on issue.

Fund B is a unit trust.

Company B (the parent entity) is the parent entity of a group and its subsidiaries.

The parent entity acquired the taxpayer making it a 100% owned subsidiary.

After acquisition, the parent entity held approximately half of the units on issue in the taxpayer.

A Convertible Note Deed (Note Deed) agreement was entered into between the taxpayer and the parent entity. The parties agreed to offset the at-call loan of and replace the loan by the taxpayer by issuing convertible notes to the parent entity. At the same time an additional amount of funding was raised.

The Note Deed specified that the notes will convert to equity in the event the parent entity becomes insolvent.

Convertible Note Deed

There was a trigger event inserted in the Note Deed to the effect that should the parent entity suffer an insolvency event, the notes would automatically convert to units in the taxpayer.

A conversion notice was issued by the Responsible Entity to the parent entity.

The notes held by the parent entity were converted into units in the taxpayer. The notice was issued prior to the actual triggering of an "insolvency event" as the director's of the Responsible Entity were concerned that the parent entity was close to triggering such an event.

The combined ownership of the top 20 investors in the taxpayer exceeded 75% of the units on issue.

Capital Raising and the Buy-back of Units

Upon the conversion of the notes, the taxpayer had the intention to buy back the units that were issued to the parent entity.

Funding the buy back of the units required public offerings to be undertaken and both the taxpayer and Fund B to offer additional units.

Once these units were bought back, less than 75% of the units on issue in the taxpayer were held by the top 20 persons'.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 102P.

Income Tax Assessment Act 1936 section 102R.

Reasons for decision

To be classified as a public trading trust, the taxpayer needs to satisfy all of the requirements of paragraph 102R(1)(b) of the ITAA 1936.

Subparagraph 102R(1)(b)(i), requires that for the relevant income year, a unit trust must be classed as a public unit trust. A public unit trust is defined in subsection 102P(1) and it states:

102P(1) [Qualifying unit trusts] For the purposes of this Division, but subject to the succeeding provisions of this section, a unit trust is a public unit trust in relation to a year of income if, at any time during the year of income:

(a) any of the units in the unit trust were listed for quotation in the official list of a stock exchange in Australia or elsewhere;

(b) any of the units in the unit trust were offered to the public; or

(c) the units in the unit trust were held by not fewer than 50 persons.

Some guidance on the policy intent of section 102P is stated in the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 4) 1985 (EM), where it is stated:

Section 102P: Public unit trusts

Section 102P sets down a number of tests to be considered in determining whether a unit trust will be a "public unit trust" for the purposes of Division 6C. It also contains safeguards against arrangements that might otherwise defeat the purpose of the amendments. These will ensure that a unit trust which may otherwise come within the scope of Division 6C does not escape its operation by arranging specially to be put beyond the tests for determining whether a unit trust is a public unit trust. Other safeguards will ensure that public unit trust status does not apply in relation to unit trusts that are not public in nature.

Subsection 102P(1) sets out the requirements for determining whether a unit trust is to be regarded as a public unit trust for a year of income. However, in order to satisfy any of the requirements in subsection 102P(1), a unit trust may also satisfy the requirements of subsections 102P(2), if this has no application, then subparagraph 102P(4) must be satisfied.

Subsection 102P(2) states that:

102P(2)  [Alternative tests of qualifying unit trust]  

For the purposes of this Division, but subject to the succeeding provisions of this section, a unit trust is also a public unit trust in relation to a year of income if:

(a) at any time during the year of income, an exempt entity or exempt entities held, or had the right to acquire or become the holder or holders of, a unit or units in the unit trust that entitled the holder or holders to not less than 20% of:

(i) the beneficial interests in the income of the unit trust; or

(ii) the beneficial interests in the property of the unit trust;

(b) not less than 20% of the total of money paid or credited by the trustee of the unit trust during the year of income to unitholders as unitholders was paid or credited to an exempt entity or exempt entities; or

(c) by reason of:

(i) any provision in the instrument by which the trust was created, or any contract, agreement or instrument authorising the variation or abrogation of the rights attaching to any of the units in the unit trust or relating to the conversion, cancellation, extinguishment or redemption of any such units;

(ii) any contract, agreement, option or instrument under which a person has power to acquire a unit or units in the unit trust; or

(iii) any power, authority or discretion in a person in relation to the rights attaching to any of the units in the unit trust,

the rights attaching to any of the units in the unit trust were, at any time during the year of income, capable of being varied or abrogated in such a manner (notwithstanding that they were not in fact varied or abrogated in that manner) that:

(iv) units in the unit trust that entitled the holder or holders to not less than 20% of:

(A) the beneficial interests in the income of the unit trust; or

(B) the beneficial interests in the property of the unit trust,

would have been held by an exempt entity or exempt entities;

(v) not less than 20% of the total of money paid or credited by the trustee of the unit trust during the year of income to unitholders as unitholders would have been paid or credited to an exempt entity or exempt entities; or

(vi) in the case where no money was paid or credited by the trustee of the unit trust during the year of income to unitholders as unitholders - if money had been so paid or credited by the trustee of the unit trust during the year of income, not less than 20% of the amount of that money would have been paid or credited to an exempt entity or exempt entities.

The EM says of subsection 102P(2):

Sub-section 102P(2) sets out an alternative test to those in sub-section (1) for determining whether a unit trust is to be regarded as a public unit trust. The basic purpose of this test is to ensure that the intended operation of the new provisions cannot be by-passed, e.g., by limiting the number of unitholders to less than 50. To that end, sub-section (2) will treat a trading trust as a public unit trust if, although its units are held by fewer than 50 persons, units carrying entitlement to 20% of the income or property of the trust are beneficially owned, directly or indirectly, by persons or bodies (including governments), that are exempt from income tax.

In specific terms the sub-section will operate to treat a unit trust as a public unit trust in relation to a year of income if, at any time during the year -

· an exempt entity (as defined in section 102M) or exempt entities had the right to acquire units in the trust entitling them to 20% or more of the beneficial interests in the income or property of the trust (paragraph (a));

· 20% or more of the total of moneys paid or credited by the trustee to unitholders was paid or credited to an exempt entity or exempt entities (paragraph (b)); or

· an exempt entity or exempt entities were in a position to require the rights attaching to any units to be varied to achieve the position in paragraphs (a) or (b) (paragraph (c)).

The above subsection 102P(2) does not have an application in this case as an alternative means of qualifying a public unit trust within the meaning of Division 6C. Hence, the unit trust must then satisfy the requirements of subsection 102P(4) to be regarded as a public unit trust for a year of income.

Subsection 102P(4) states that:

102P(4) [Unit trusts deemed not public unit trusts] Subject to subsection (5), a unit trust that, but for this subsection and subsection (7), would be a public unit trust in relation to a year of income by virtue only of subsection (1) shall be deemed not to be a public unit trust in relation to the year of income if, at any time during the year of income, one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, a unit or units in the unit trust that entitled the holder or holder thereof to not less than 75% of:

(a) the beneficial interests in the income of the unit trust; or

(b) the beneficial interests in the property of the unit trust.

The EM says of this subsection:

Sub-section 102P(4) sets out circumstances in which a unit trust that would otherwise be a public unit trust in relation to a year of income, because of the operation of sub-section (1) (but not sub-section 2) of this section, is not to be treated as a public unit trust for the purposes of Division 6C. Subject to the operation of sub-section (5), such a unit trust will not be a public unit trust if at any time during the year of income 20 or fewer persons held or had the right to acquire units in the trust entitling them to 75% or more of the beneficial interests in the income or property of the trust.

Accordingly, subsection 102P(4) provides that a unit trust will not be a public unit trust in an income year pursuant to the operation of subsection 102P(1) if, at any time during that year 20 or less persons held, or had the right to acquire, units in the unit trust carrying 75% or more of the beneficial interests in the income or property of the unit trust.

The facts provide that notes held by the parent entity were converted to units in the taxpayer. As a result, as of 30 June 2009, the top 20 investors of the taxpayer held more than 75% of the units on issue. Until the parent entity units were redeemed in 2010, the top 20 investors of the taxpayer continued to hold more than 75% of the beneficial interest in the income and property of the trust estate.

Therefore, the taxpayer satisfies the prohibition within subsection 102P(4) and the threshold limits therein and will not be a public unit trust for 2009 and 2010 financial years unless the Commissioner exercises the discretion pursuant to subsection 102P(5) to allow the taxpayer to continue to be treated as a public unit trust.

The Commissioner's discretion under subsection 102P(5) provides that:

102P(5) [Unit trust deemed public unit trust] Subject to subsection (7), where by virtue of subsection (4), a unit trust would, but for this subsection, be deemed not to be a public unit trust in relation to a year of income by reason that, at any time during the year of income, one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, the unit or units referred to in subsection (4) and the Commissioner is of the opinion that, having regard to:

(a) the length of the period or the aggregate of the lengths of the periods in the year of income during which one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, the unit or units referred to in subsection (4); and

(b) any other matter that the Commissioner considers relevant,

it is reasonable that the unit trust should be treated as a public unit trust in relation to the year of income, the unit trust shall be deemed to be a public unit trust in relation to the year of income.

The EM says of subsection 102P(5):

Sub-section 102P(5) bears on the operation of sub-section (4). It will over-ride the operation of that sub-section by allowing the Commissioner to treat a unit trust as a public unit trust in relation to a year of income if, for only a short time during the year of income, the unit trust is closely held in terms of sub-section (4). This will safeguard against any attempt to cloak a unit trust that has the real character of a public unit trust as other than public by fulfilling the test in sub-section (4) for a minimal period.

Subsection 102P(5) therefore allows the Commissioner to treat a unit trust that has failed the test contained in subsection 102P(4) to be deemed a public unit trust.

However, the operation of subsection 102P(5) is further subject to conditions outlined in subsection 102P(7) which states that:

102P(7) [Unit trust deemed not public unit trust] Subject to subsection (8), a unit trust that, but for this subsection, would be a public unit trust in relation to a year of income by virtue only of subsection (1), shall be deemed not to be a public unit trust in relation to that year of income if:

(a) not less than 75% of the total of money paid or credited by the trustee of the unit trust during the year of income to unitholders as unitholders was paid or credited to one person or persons not more than 20 in number; or

(b) by reason of:

(i) any provision in the instrument by which the trust was created, or any contract, agreement or instrument authorising the variation or abrogation of the rights attaching to any of the units in the unit trust or relating to the conversion, cancellation, extinguishment or redemption of any such units;

(ii) any contract, agreement, option or instrument under which a person has power to acquire a unit or units in the unit trust; or

(iii) any power, authority or discretion in a person in relation to the rights attaching to any of the units in the unit trust,

the rights attaching to any of the units in the unit trust were, at any time during the year of income, capable of being varied or abrogated in such a manner (notwithstanding that they were not in fact varied or abrogated in that manner) that:

(iv) units in the unit trust that entitled the holder or holders thereof to not less than 75% of

(A) the beneficial interests in the income of the unit trust; or

(B) the beneficial interests in the property of the unit trust

would have been held by one person or persons not more than 20 in number;

(v) not less that 75% of the total of money paid or credited by the trustee of the unit trust during the year of income to unitholders as unitholders would have been paid or credited to one person or persons not more than 20 in number; or

(vi) in the case where no money was paid or credited by the trustee of the unit trust during the year of income to unitholders as unitholders - if money had been so paid or credited by the trustee of the unit trust during the year of income, not less than75% of the amount of that money would have been paid or credited to one person or persons not more than 20 in number.

The EM says of subsection 102P(7):

Sub-section 102P(7) is complementary to sub-section (3) and will apply to deem a unit trust not to be a public unit trust where 75% or more of the income or property of the trust is paid to, or is capable of being required to be paid to, 20 or fewer persons, not withstanding that those persons might not hold 75% or more of the units in the trust.

To paraphrase, under subsection 102P(7), if either of the following two conditions are satisfied, the unit trust is deemed not to be a public unit trust.

· The first condition is if 75% of the total money paid or credited by the trustee was paid or credited to 20 or fewer people.

· The second condition is if the trust deed is capable of being amended so that 20 or fewer unit holders could hold 75% of either the trust property or the net income of the trust.

As the Trustee of the taxpayer did not make any income or capital distributions to its unit holders for a period, paragraph 102P(7)(a) has no application.

The taxpayer issued notes under the Note Deed with a clause inserted to the effect that should the parent entity suffer any insolvency event, the notes would automatically convert to units in the taxpayer. A further clause gave the Responsible Entity the right to convert the notes into units in the taxpayer upon issuance of a conversion notice to the parent entity during the conversion period. In such circumstances subparagraph 102P(7)(b)(ii) is satisfied as the rights attaching to units in the trust were capable of being varied or abrogated by reason of entering into the Note Deed.

Subsequently, subparagraph 102P(7)(b)(iv) is satisfied as the top 20 unit holders of the taxpayer would have been entitled to 75% of the beneficial interest in the income or the property of the trust estate. Hence, as the overall conditions of subsection 102P(7) are satisfied, the taxpayer will be deemed not to be a public unit trust for 2009 and 2010 income years.

However, subsection 102P(7) is further subject to the exception in subsection 102P(8) which states that:

"102P(8) [Variation of rights] A unit trust shall not be deemed by subsection (7) not to be a public unit trust in relation to a year of income by reason that rights attaching to any of the units in the unit trust were, at any time during the year of income, capable of being varied in the manner mentioned in paragraph 7(b) if the Commissioner is of the opinion that the person or persons who were able to vary the rights in that manner intended not to vary the rights in that manner during the year of income.

The EM says of subsection 102P(8):

By sub-section 102P(8), which has a similar operation to sub-section (6), it is proposed that a public unit trust not be able to acquire non-public status by entering into arrangements to invoke the operation of sub-section (7).

Where the Commissioner is satisfied that the trustee intended not to vary the rights in that manner during the year of income, subsection 102P(8) provides that a unit trust shall not be prevented from being a public unit trust by virtue of subsection 102P(7).

The circumstances which would provide for the Commissioner to exercise his discretion under subsection 102P(8) do not exist in this case.

Section 102P has a statutory ordering mechanism as the several subsections within are subject to the operation of preceding subsections. In light of the facts and circumstances of this ruling, the discretion contained in subsection 102P(8) is not attracted and the Commissioner must reconsider the previous discretion contained within subsection 102P(5).

As explained previously, the discretion in subsection 102P(5) requires the Commissioner to review the length of the period during the year of income when the unit trust is closely held in terms of subsection 102P(4).

In determining whether it is reasonable to treat the taxpayer as a public unit trust in relation to a year of income despite the concentration of ownership, the Commissioner is required to consider the length of the period in which the ownership was concentrated and any other factors he considers relevant.

2008-09 income year

The following events took place in the 2008-09 income year:

· the Responsible Entity of the taxpayer entered into a Note Deed with the parent entity for the purpose of attaining short-term funding. The terms of the Note Deed specified that the notes issued to the parent entity would convert to units in the taxpayer in the event the parent entity experienced an insolvency event.

· the Responsible Entity provided a conversion notice in accordance with the Note Deed evidencing the conversion of the notes held by the parent entity into units.

· the conversion of the notes into units took place and subsequently combined ownership of the top 20 person in the taxpayer exceeded 75% of the units on issue.

· The parent entity suffered an insolvency event and was placed into Voluntary Administration.

· As of 30 June 2009, the combined ownership of the top 20 investors in the taxpayer equated to more than 75% of the units on issue.

The Commissioner is of the opinion that given the length of time in the year of income and the other relevant matters, it is reasonable that the taxpayer be treated as a public unit trust in relation to the 2008-09 year of income. Therefore, the Commissioner will exercise the discretion under subsection 102P(5) to treat the taxpayer as a public unit trust for the year ended 30 June 2009.

2009-10 income year

The following events occurred in the 2009-10 income year:

· PDSs were issued to existing unit holders.

· The main purpose of the offers was to raise proceeds in order to fund the redemption of parent entity units held in the taxpayer.

· Subsequent to the buy back, the top 20 persons holding units in the taxpayer was reduced to less than 75% of the units on issue.

· The parent entity disposed of its interest in the Responsible Entity.

· The top 20 investors owned less than 75% of the units in the taxpayer.

The Commissioner concludes that it is not reasonable to treat the taxpayer as a public unit trust in relation to the 2009-10 income year. The Commissioner will not exercise the discretion under subsection 102P(5) to treat the taxpayer as a public unit trust for the year ended 30 June 2010.

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