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Ruling

Subject: Public trading trust

Question

Will the receipt of a grant by entities of which the trust is a shareholder result in the trust being considered to be a public trading trust?

Answer

No.

This ruling applies for the following periods:

1 July 2010 to 30 June 2011.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

The trust is considered to be a public unit trust. The trust receives rental income. The trust owns shares in a number of entities.

The entities have applied to receive a grant. The grant will not be assessable income to the entities.

Relevant legislative provisions

Income Tax Assessment Act 1936, Section 102M

Income Tax Assessment Act 1936, Subsection 102N(1)

Income Tax Assessment Act 1936, Subsection 102P(1)

Income Tax Assessment Act 1936, Section 102R

Income Tax Assessment Act 1997, Section 6-5

Income Tax Assessment Act 1997, Section 6-10

Income Tax Assessment Act 1997, Section 10-5

Income Tax Assessment Act 1997, Section 15-10

Income Tax Assessment Act 1997, Section 240-25

Reasons for decision

Public trading trust

Section 102R of the Income Tax Assessment Act 1936 (ITAA 1936) provides that a unit trust is a public trading trust in a financial year if the following conditions are satisfied:

1. the unit trust is a public unit trust in relation to the relevant year of income

2. the unit trust is a trading trust in relation to the relevant year of income

3. either of the following conditions are satisfied -

(a) the unit trust is a resident unit trust in relation to the relevant year of income, or

(b) the unit trust was a public trading trust in relation to a year of income preceding the relevant year of income; and

4. the unit trust is not a corporate unit trust within the meaning of Division 6B in relation to the relevant year of income.

Public unit trust

Subsection 102P(1) of the ITAA 1936 sets out 3 primary tests for determining whether a unit trust is a public unit trust in relation to a financial year:

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

2. any of the units in the unit trust were offered to the public; or

3. the units in the unit trust were held by not fewer than 50 persons.

Trading trust

A unit trust is a trading trust in a financial year, as per subsection 102N(1) of the ITAA 1936, if, at any time during that year, the trustee:

1. carried on a trading business, or

2. 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.

Control of an entity

The terms controlled or able to control are not specifically defined, and therefore, taken on their ordinary meaning.

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.

In Mendes v Commissioner of Probate Duties (Vict) (1967) 122 CLR 152, the Court concluded that a company was not controlled by a person if that individual did not control a majority of the voting rights at general meetings of the company, as to all matters able to be dealt with at such meetings, with the exception perhaps of matters that were incidental or minor.

A member of a company who holds enough hares to give a majority of votes generally has control of the company.

The trust is the majority shareholder in the entities, and subsequently, is considered to have control of the entities.

Trading business

Section 102M of the ITAA 1936 defines a trading business as a business that does not consist wholly of an eligible investment business.

Eligible investment business

An eligible investment business is defined in section 102M of the ITAA 1936 as a business conducting activities that fall in one or more of three categories.

Category One: investment in land for rental income
The first category is investing in land for the purpose, or primarily for the purpose of deriving rent.

Rent is not specifically defined. It was stated in Booker Industries Pty Ltd v Wilson Parking (Qld) Pty Ltd 149 CLR 600 rent is generally:

a sum of money which the tenant has contracted to pay to the landlords for the use of the premise let

Category Two: investing or trading in financial instruments

An eligible investment business includes investing or trading in any of the following (section 102M of the ITAA 1936):

(i) secured or unsecured loans (including deposits with a bank or other financial institution);

(ii) bonds, debentures, stock or other securities;

(iii) shares in a company, including shares in a foreign hybrid company (as defined in the Income Tax Assessment Act 1997);

(iv) units in a unit trust;

(v) futures contracts;

(vi) forward contracts;

(vii) interest rate swap contracts;

(viii) currency swap contracts;

(ix) forward exchange rate contracts;

(x) forward interest rate contracts;

(xi) life assurance policies;

(xii) a right or option in respect of such a loan, security, share, unit, contract or policy;

(xiii) any similar financial instruments

Investing requires more than just mere holding, there must be an expectation of financial return from the holding.

The act or action of trading should generally exhibit the characteristic of the buying and selling or exchanging of a commodity, service, good or security.

Category Three: investing or trading in financial instruments that arise under financial arrangements

Section 240-25 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that financial arrangements are, fundamentally, arrangements that are made up of legal or equitable rights to receive and/or obligations to provide financial benefits that are monetary in nature.

An entity will be deemed to have a financial arrangement where it has an equity interest or rights and obligations in relation to an equity interest.

Receipt of the grant

You contend that the entities which the trust controls currently consists wholly of eligible investment business.

A payment or other benefit received by a taxpayer is included in assessable income if:

§ It is income according to ordinary concepts in terms of section 6-5 of the ITAA 1997, or

§ If not ordinary income it may be included in your assessable income because it is caught under the general 'statutory income' provisions in section 6-10 of the ITAA 1997, as listed in section 10-5 of the ITAA 1997. Included in the list in section 10-5 of the ITAA 1997 are bounties and subsidies (section 15-10 of the ITAA 1997).

Ordinary Income

Section 6-5 of the ITAA 1997 states, in part, the following:

6-5(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

6-5(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The intent of section 6-5 of the ITAA 1997 is to include in assessable income those receipts which can be categorised as income according to ordinary concepts.

A characteristic of income receipts is an element of periodicity, recurrence or regularity, even if the receipts are not directly attributable to services rendered. This view is supported by ATO ID 2003/902 which states that a government grant paid in two instalments to a medical practitioner was not assessable under section 6-5 of the ITAA 1997.

Taxation Ruling TR 2006/3 discusses government payments to industry. Paragraph 84 provides that ordinary income generally falls within three categories:

§ Income from providing personal services,

§ Income from property, or

§ Income from carrying on a business.

The grant does not constitute ordinary income. It does not constitute income from the provision of personal services, it is not sourced from property, and it has not been derived directly from the trust's usual activities.

Some amounts that are not 'ordinary income' are included in your assessable income due to another provision of the tax law (section 6-10 of the ITAA 1997). These amounts are 'statutory income'. Subsection 6-10(1) of the ITAA 1997 refers to provisions about assessable income - a summary list of these provisions is contained within section 10-5 of the ITAA 1997.

One of the statutory income provisions listed in section 10-5 of the ITAA 1997 is section 15-10 of the ITAA 1997, which deals with the treatment of bounties and subsidies.

Section 15-10 of the ITAA 1997 provides that 'assessable income includes a bounty or subsidy that:

(a) is received in relation to carrying on a business; and

(b) is not assessable as ordinary income under section 6-5.

In determining the correct treatment of the payment it needs to be considered whether the bounty or subsidy has been received 'in relation to carrying on a business.'

The entities are not carrying on a business, and therefore, the grant does not constitute an assessable bounty or subsidy.

Conclusion

The entities are not currently carrying on a trading business. As the grant received by entities which the trust controls is not assessable income, it does not change the trading business status of these entities.

As the trust is not carrying on a trading business, and it does not control, or is not able to control, the affairs or operations of another person in respect of the carrying on by that other person of a trading business, the Trust does not meet the definition of a trading trust per subsection 102N(1) of the ITAA 1936.

Subsequently, the Trust fails the second condition of an entity being a trading trust (section 102R of the ITAA 1936).

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