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Ruling

Subject: Assessable income of superannuation fund

Question

Whether the gross taxable amount stated in a property trust's tax statement to a superannuation fund, which is a unit holder in the property trust, is the assessable income of the superannuation fund?

Advice/Answers

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commenced on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

A property syndicate (the Syndicate), managed by a management company (the Manager), owns a specified number of retail properties in Australia. A related property trust (the Trust), also managed by the Manager, owns part of the Syndicate.

Investors who hold a direct interest in the Syndicate are known as Direct Investors. Investors who hold units in the Trust are Unit Holders. Collectively, 'Direct Investors' have borrowed to invest in the Syndicate and:

o pay for their financial costs annually in advance; and

o pay a specified fee (the Fee) to the Trust in consideration of the Trust providing its assets as security for the borrowing.

If the net income of the Syndicate attributable to Direct Investors for an income year is less than the aggregate of the financing costs and the Fee, Direct Investors will borrow from the Trust through the Manager an amount equal to the shortfall (Loan Amount). A Loan Amount is unsecured, will accrue interest at a fixed rate of interest and will be capitalised on Direct Investors' accounts.

At the end of each year (30 June) the Manager will apportion the Net Income of the Syndicate to the Trust and to Direct Investors according to their respective proportion of ownership of the Syndicate, including all non-cash deductions such as depreciation and allowances.

The Manager will then calculate the Fee and pay this amount to the Trust on behalf of Direct Investors.

Prior to making any cash distribution from the Net Income of the Syndicate, in any year and in priority to any other payment, the Manager may pay the cost of finance for the next 12 months.

This will be deducted from Direct Investors' accounts and to the extent that such account balance is insufficient, a Loan Amount will be provided by the Trust.

The Net Income of the Syndicate apportioned to the Trust will be distributed to Unit Holders all being presently entitled, calculated according to the number of Units held by them after first deducting cost of the Trust.

The Manager may direct payment of distributions to Direct Investors prior to reduction in the Loan Amount if taxes are payable by a Direct Investor or a capital call is made on all Direct Investors.

Documents in relation to the Trust further inform Unit Holders that:

(1) Unit Holder's interest in income derived by the Trust from rental of the Property would be derived by reason of the Unit Holder's ownership of units in the Trust.

(2) Unit holders (and not the trustee of the Trust) will be assessed on the net income of the Trust to which they are presently entitled as per section 97 of the Income Tax Assessment Act 1936 (the ITAA 1936). The constitution of the Trust has been drafted to ensure that as at each 30 June Unit Holders are presently entitled to all of the net income of the Trust derived for that year.

(3) The trustee of the Trust will only be assessed on net income of the Trust to which no Unit Holder is presently entitled, as per section 98 of the ITAA 1936. It is envisaged that there will be no such income.

(4) As per section 95 of the ITAA 1936, "net income" in relation to a trust estate means the total assessable income of the trust estate calculated "as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions…"

(5) Assessable income of the Trust will include its share of:

o lease income

o any income from the investment of surplus of not immediately distributed funds, and

o any capital gains.

(6) Allowable deduction will include losses and outgoings deductible to the Trust, such as operating loss.

Income is derived by the Trust as follows:

	Net Income of the Syndicate to the Trust
Add:	Fee from Direct Investors
Less:	Loan Amount to Direct Investors
Add:	Loan Amount (when re-paid by Direct Investors)
	Net Income paid to Unit Holders

(8) Generally the Trust distributes 100% of its taxable income to Unit Holders. However, often the Trust will reinvest part of this income in new and current Trust assets. Accrued distributions will be held in "trust" for each Unit Holder and paid when the Trusts assets have been sold and are in cash. A Unit Holder may, therefore, receive an amount each year which is less than that shown on the tax statement. This is an integral part of the Trust's investment structure. A Unit Holder is required to disclose the full amount shown in the tax statement in their taxation return, not the actual amount received in cash during the year.

A superannuation fund (the Fund) became a Unit Holder in the Trust. Each year the Trust distributed its income to the Fund and gave the Fund a tax statement.

According to the trustee of the Fund, for a number of years the Trust has, however, not distributed to Unit Holders any of the Fees which it received, or might have received, from Direct Investors of the Syndicate. Unit Holders have been told that the Trust would distribute to them the accumulated Fees once the Trust terminates and its assets are realised.

The trustee of the Fund has also advised that the 'gross taxable amount' on the Trust's tax statement to Unit Holders comprised a portion that represented the Fee. Consequently, what was stated in the tax statement given by the Trust to the Fund was greater than what was actually received by the Fund from the Trust. The trustee of the Fund has reported the gross taxable amount as the Fund's assessable income but wishes to know if the lesser amount actually received by the Fund could be reported instead.

It is anticipated that the Trust will be liquidated some time in the near future and that the realisation of its asset may result in a loss in Unit Holders' equity. It is also anticipated that the Trust will not be able to distribute to Unit Holders the accumulated Fees. Bound by the constitution of the Trust, the Manager can only issue revised tax statements once the Trust is liquidated.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 95(1)

Income Tax Assessment Act 1936 Section 96

Income Tax Assessment Act 1997 Section 97

Income Tax Assessment Act 1997 Subsection 97(1)

Income Tax Assessment Act 1997 Section 98

Income Tax Assessment Act 1997 Section 99

Income Tax Assessment Act 1997 Section 99A

Reasons for decision

Question

Whether the gross taxable amount stated in a property trust's tax statement to a superannuation fund, which is a unit holder in the property trust, is the assessable income of the superannuation fund?

Advice/Answers

Yes.

Summary

As the Fund was presently entitled to the full gross taxable amount shown in the tax statement given by the Trust, it must report that amount as assessable income on its income tax return.

Detailed reasoning

The rules in Division 6 of the Income Tax Assessment Act 1936 (the ITAA 1936) set out the basic income tax treatment of income and gains generated from a trust estate. Generally Division 6:

o sets out the rules for determining the net (or taxable) income of the trust estate for a year of income;

o assesses beneficiaries for their share of such net income;

o as a collection mechanism, assesses the trustee for its liability to pay tax in respect of some beneficiaries' share of such net income, for example, beneficiaries who are non-residents or under a legal disability; and

o assesses the trustee directly for any residual net income.

Subsection 95(1) of the ITAA 1936 defines 'net income', in relation to a trust estate, as:

the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except deductions under Division 393 of the Income Tax Assessment Act 1997 (Farm management deposits) and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the Income Tax Assessment Act 1997 in respect of such of the losses of previous years as are required to be met out of corpus.

Sections 97, 98, 99 and 99A of the ITAA 1936 contain the rules to determine who, and how much, will be assessed on the net income of a trust estate. Broadly, these provisions operate as follows:

Section 97 assesses a beneficiary where the beneficiary:

(i) is presently entitled to a share of the income of the trust estate; and

(ii) is not under a legal disability.

Section 98 assesses the trustee of a trust estate in respect of a beneficiary's share of the trust estate's net income where the beneficiary:

(i) is presently entitled to a share of the income but is under a legal disability; or

(ii) is deemed to be presently entitled under subsection 95A(2) of the ITAA 1936, is a natural person and is not under a legal disability, or

(iii) is a non-resident at the end of the year of income.

Section 99 or 99A assesses the trustee of a trust estate for any amount of the trust estate's net income in respect of which either the trustee or a beneficiary has not been assessed.

In the High Court case of Tindal v. Federal Commissioner of Taxation (1946) 72 CLR 608; (1946) 20 ALJ 193; (1946) 8 ATD 152; [1946] ALR 369 (Tindal), the trustee of the estate of a deceased person was empowered by the will of the deceased person to pay debts and to stand possessed of the residue upon trust to pay the income thereof to the wife of the deceased person during her life. The deceased was a partner in a pastoral enterprise. The trustee obtained the leave of the Court to carry on this partnership business with the surviving partner.

For the income years 1936-1939 the trustee received Pd1,500, Pd500, Pd1,000 and Pd500 from the partnership. Each year the widow was entitled to receive Pd1,844 from the income of the estate or, if income was deficient, from the capital of the estate. However, for the same income years she actually received Pd6,606, Pd1,201, Pd1,200 and Pd1,425 from the trustee. In the 1940 income year, she received Pd2,858 from the trustee, which comprised an annual amount of Pd1,844 and a payment of Pd1,014 on account of arrears.

One of the questions to be resolved by the Court was whether Pd2,858 or Pd1,844 was to be included in the widow's assessable income for the 1940 income year. In the judgment delivered by Chief Justice Latham, it was stated that:

…

In order to answer the question submitted it is necessary to decide

(1) whether, upon the true construction of s. 97 of the Act, the assessable income of a beneficiary includes a share of the net income of a trust estate independently of actual receipt of that income by the beneficiary;

(2) if so, whether the facts stated in the case show that the sum of Pd1,014 actually received by on account of arrears by the beneficiary in 1940 was a share in the net income of the trust estate to which the beneficiary had become presently entitled in a year or years preceding the year 1940.

As to the first question I am of the opinion that, when s. 97 applies, the result is that the assessable income of a beneficiary does include his share of the net income of the trust estate, whether or not that income is paid to him. Otherwise the section would produce no effect in relation to assessment or payment of tax. Sections 95-99 are designed, in my opinion, to secure payment of tax upon the whole of the net income of a trust estate, either from a beneficiary or the trustee, whether or not that income is paid over to or on account of the beneficiary. (italics and emphasis added)

…

Thus, in my opinion, if the taxpayer in the present case was presently entitled to Pd1,844 as income of the trust estate in the years preceding 1940 (in which she was actually paid smaller sums by the trustee) the sum of Pd1,844 should have been included in her assessable income in each of those years, although that sum was not paid to her. The result of this view is that the excess of Pd2,858 over Pd1,844, namely Pd1,014, which she received in 1940, should (if it existed so that she could have a present right to it as income) have been returned by her as income in some one or more of the previous years, but not in 1940. (italics and emphasis added)

The judgement concluded that:

(a) Pd1,844 was to be included as the widow's assessable income for the 1940 income year; and

(b) due to the way facts in the case were stated, the High Court was unable to decide whether or not the sum of Pd1,014 should be included in the assessment of a year or years prior to 1940 and therefore not in the 1940 assessment.

For the purposes of this private ruling decision, it suffices to point out that based on Tindal a taxpayer has to include in their assessable income an amount to which they are presently entitled, even though the amount they were actually paid by the trust concerned is a smaller amount.

As to what 'presently entitled' is, it was stated in the High Court case of Harmer v Federal Commissioner of Taxation 173 CLR 264; (1991) 66 ALJR 89; (1991) 104 ALR 117; (1991) 22 ATR 726; (1991)  91  ATC  5000; [1991] HCA 51 at 91 ATC 5004 that:

The parties are agreed that the cases establish that a beneficiary is ``presently entitled'' to a share of the income of a trust estate if, but only if:

(a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and

(b) the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

For a beneficiary's interest in the income of a trust estate to be vested in interest, the interest must not be contingent. That is, the beneficiary does not have to fulfil a condition before they can have the legal right to the income and/ or corpus of the trust estate.

For a beneficiary's interest to be vested in possession:

(a) the beneficiary has the right to immediate possession or enjoyment of the income and/or corpus of a trust estate, which right may also be expressed as a present right to have a present enjoyment; and

(b) the interest must not be defeasible, that is, nothing can happen in the future (other than the termination of the trust estate) that will cause the beneficiary to lose their entitlement.

In Bamford & Ors v. Federal Commissioner of Taxation (2009) 2009 ATC 20-105; [2009] FCAFC 66; (2009) 1 ASTLR 627; (2009) 176 FCR 250; (2009) 73 ATR 49; [2010] ALMD 4702; [2010] ALMD 4706 at 2009 ATC 9656, paragraph 43, 'income of a trust estate' was discussed. Paragraph 43 states that:

The phrase 'income of the trust estate' in the beginning of s 97(1) refers to distributable income. Distributable income is income ascertained by the trustee according to appropriate accounting principles and the relevant trust instrument and in accordance with the ordinary concept of income, which the 1936 Act adopts when it refers to 'income'…

For practical purposes, this means that if a provision in a trust instrument directs the trustee to treat the whole or part of a receipt as income, it is classified as 'income of the trust estate'.

The trustee of the Fund subscribed to, and paid for, a fixed number of units in the Trust on behalf of the Fund. As a Unit Holder of such units on behalf of the Fund, the trustee of the Fund has a vested and indefeasible interest in income derived, and classified as such, by the Trust. As at the end of each year (30 June) the Manager will apportion the Net Income of the Syndicate to the Trust and to Direct Investors according to their respective proportion of ownership of the Syndicate, in our view there is no question of a Unit Holder being presently entitled to, and having a right to immediate possession and enjoyment of, the Net Income apportioned to the Trust by the Syndicate, which is essentially the Trust's share of the lease income derived by the Syndicate.

The next issue to be considered is the Fee. As noted in the 'Relevant facts and circumstances':

(a) the term 'Net Income of the Trust' follows the same meaning given to 'net income' in subsection 95(1) of the ITAA 1936, which is essentially the assessable income of the Trust less all allowable deductions;

(b) 'assessable income of the Trust' includes:

o its shares of lease income (from the Syndicate);

o income from investing any surplus of not immediately distributed funds; and

o any capital gains; and

(c) 'allowable deductions' refer to losses and outgoings deductible to the Trust.

The Trust is entitled to the Fee payable collectively by Direct Investors of the Syndicate. If the Fee is paid, it will of course form part of the assessable income of the Trust and, after applying all allowable deductions, the Net Income of the Trust.

If the Fee is not paid because the Net Income apportioned to Direct Investors is insufficient for payment to be made, it still has to be recognised as income of the Trust, to be covered by a Loan Amount provided by the Trust to Direct Investors as if the Fee were actually paid. If this is not so, then there is no need for a Loan Amount to be kept.

Alternatively, the unpaid Fee by way of a Loan Amount may be looked upon as an amount of income withheld, for the time being, in the Trust for the purpose of generating interest income for the Trust and, ultimately, for Unit Holders.

By investing in the Trust, Unit Holders are taken to have agreed to its investment structure and to also forgo, for the time being, the exercise of their right to immediate possession or enjoyment of the Trust's income that is derived from the Fee. It follows that Unit Holders are nevertheless presently entitled to that part of the Trust's income which represents the Fee.

As the Fee is part of the Net Income of the Trust, represented by the gross taxable amount shown in the tax statement, pursuant to subsection 97(1) of the ITAA 1936 the trustee of the Fund has to include the gross taxable amount in the Fund's income tax return.

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